Profit from the Strategic Reserve Fiasco

Addison Wiggin – July 14, 2011

  • What strategic reserves? The 5 digs into why oil has hit a one-month high, perhaps on the way to $150
  • Alaskan oil production in steep decline… but a few hardy souls soldier on. Chris Mayer uncovers the profit potential
  • Gold pushing $1,600 as Ron Paul presses Ben Bernanke on whether gold is money. (Think about it carefully, Ben…)
  • More weird tales from third-world America: Firefighters covering for cops in D.C. and the looming Minnesota beer shortage

   Oil is at $98.50 this morning — the highest in a month. That release of strategic reserves is working out like gangbusters, eh?

Heck, Barron’s had a cover story a few days ago about oil reaching $150 by next spring. It cited some of the same data we cited four months ago, about “spare capacity” — or lack thereof.

   “Spare capacity,” we pause to remind you, is the ability of oil producers to jump-start new oil production within 30 days and keep it up for at least 90 days.

According to Morgan Stanley, “spare capacity” will be tapped out in two years… and that’s based on figures before the war in Libya took that nation’s 1.5 million barrels per day offline.

The realities of shrinking spare capacity are becoming more evident by the day. To wit…

   The International Energy Agency warns that unless OPEC can raise production by 1.5 million barrels a day — about the same as that lost Libyan production — global demand oil demand will start to outrun available supply between now and year-end.

Thus, “If there is not enough supply to match the 89 million barrels of oil the global economy is expected to burn every day,” says former CIBC World Markets chief economist Jeff Rubin, “world oil prices have only one direction to go.”

   “With no obvious end in sight to the Libyan conflict,” Mr. Rubin continues, “and sectarian violence against oil fields and refineries suddenly on the rise in Iraq ahead of the scheduled U.S. troop withdrawal, the prospects are not promising for OPEC to increase supplies.

“This is even more evident given the region’s largest producer, Saudi Arabia, has little more to offer other than unwanted sour, heavy oil to add to the global supply mix.”

   It’s not that the Saudi sheiks aren’t trying. Production in the kingdom rose nearly 4% last month, to 9.7 million barrels per day.

Thing is, only half of that increase hit the international market. The rest went to Saudi Arabia’s own refineries for “power generation and water desalination plants during the peak summer season,” according to an IEA report out yesterday.

   Two more factors spurring oil demand: power shortages in China and Japan. Because of drought in China, hydropower plants can’t generate as much electricity. Diesel generators are making up the difference.

Diesel is also making up the difference in Japan after the Fukushima disaster. Two-thirds of the country’s nuclear capacity is offline… and won’t be coming back online anytime soon.

Thus, oil stands to be a profitable play for some time to come — even if what passes for a “recovery” in the United States ends up stalling out.

How to play it?

   “About one-fifth of the domestically produced oil in the U.S. comes from Alaska,” observes Chris Mayer, who’s been examining the investing possibilities. “But these assets have been in long decline. Production of crude oil is down more 70% from its high in the 1980s.”

With existing fields declining, and Washington keeping new fields off-limits, Big Oil is bailing on Alaska — or at least some of its historically prolific regions.

   Chevron, for instance, decided recently to dump its holdings in the Cook Inlet area. “The decision comes as production from Cook Inlet oil and gas fields is declining,” reports the Anchorage Daily News, “typically, a period when big energy companies lose interest in their investments and smaller operators jump in.”

For those smaller operators, there’s a surprising amount of oil yet to be tapped. “Nearly all of the operating oil and gas fields in Cook Inlet derive from exploration done in the 1950s and 1960s,” explains Petroleum News.

Then the giant Prudhoe Bay field was discovered and everyone ran off to work there instead. “As a consequence,” the trade publication goes on to say, “only limited exploration of Cook Inlet has taken place in more recent decades.”

   That’s not the only incentive for a small operator to work over a place like Cook Inlet.

“Some 80% of state revenues depend on oil and gas extraction,” says Chris. “It employs thousands of people. Those people in turn support shops, restaurants, and the whole wheel that is a community.

“So the state government created some sweetheart deals for oil and gas companies to spend money here. Among these goodies is a 40% state refund on money spent for drilling and exploration costs — paid in cash to the operator. There are other laws in place that could refund as much as 20% of other costs and 25% of net losses incurred.

“For a small operator looking to get a sweet return on a moderate-sized pot of money, Alaska is like the El Dorado of oil and gas.”

   The story gets even better for a small operator that sits on not only oil, but also natural gas. Unlike in the lower 48, there’s a natural gas shortage in Alaska. “Current proved reserves may well fall behind demand by 2012,” Chris notes.

Gas, after all, is mostly a local market: You can’t ship it on a tanker across an ocean unless you liquefy it — an expensive process, seldom performed. So if you want gas, it has to come through a pipeline.

“While gas wallows around $4 per million cubic feet in the continental U.S.,” Chris says, “Alaskan natural gas goes for $6.50 and as much as $10 per mcf in the winter.” That’s a nice boost to the bottom line of a company that can prove up Alaskan gas.

   “I could see a kind of echo boom to Alaska’s oil and gas,” says Chris, “where it becomes a very profitable region for smaller companies. Cook Inlet may well enjoy a revival.

“In fact, the seeds are already starting to germinate. One group is bringing the first new drilling jack-up rig to come to Alaska in 16 years. Another group is bringing back shut-in wells. There is actually a fairly long list of companies squeezing life from old assets and/or exploring new prospects, spurred on by generous state incentives.”

Chris has devoted considerable time and energy this year to uncovering who is best positioned to profit from this new Alaskan “oil gush.” He’s identified one that’s acquired some prime acreage for an unbelievable bargain.

The historical average a company pays for a barrel of U.S. proven reserves is $19 per BOE, or “barrel of oil equivalent” — a figure that includes both oil and gas. Owing to a confluence of happy circumstances, this company bought some substantial territory for the princely sum of… 40 cents per BOE.

“This tiny U.S. exploration company,” Chris sums up, “has made one of the greatest market buys in the history of the oil industry… getting the oil rights to over 13 million barrels of Alaskan oil at a 99.6% discount.

“And it stands to reason… that anytime a company can acquire such a valuable resource as oil at less than 1% of cost — they’re going to make a sizable profit.” Chris sees early gains of up to 376%… and that’s before the company ramps up to full production. Wait till you see the full potential — which Chris outlines in this brand-new presentation.

   Gold is reaching higher into record territory today — the spot price now $1,590. Silver has powered up $4 in three days, to $39.26.

“The base is now technically strong to support a rise in gold to $1,760,” says the dean of newsletter men Richard Russell, consulting his charts. “Gold is in a most bullish position — out in the clear at a new high — with no overhead resistance above it.”

As we’ve said before, it’s not too late to get rich with gold. Examine nine ways to get started — here.

   Gold’s $40 move over the last three days coincided with the release of minutes from the last Federal Reserve meeting and Ben Bernanke’s semiannual visit to Capitol Hill — both of which fed expectations for QE3 in one form or another.

But the seminal moment in Bernanke’s testimony came yesterday in a discussion about gold itself.

Rep. Ron Paul, with an air of relaxation befitting a man who’s decided to run only for president and not for Congress as well, peppers Bernanke with a series of questions — the main one being, “Is gold money?”

The deer-in-the-headlights look on Bernanke’s face would be worth the price of admission, if such a price existed:

It’s a safe bet Bernanke has never read The Case for Gold — Dr. Paul’s “minority report” from his time on President Reagan’s Gold Commission 30 years ago. Too bad — it reads like a layman’s history of U.S. monetary policy. You can get your own copy here for a steal.

   Stocks are adding onto yesterday’s gains. Both the Dow and the S&P are up about 0.6%. For the life of us, we can’t figure out what traders are celebrating:

  • Weekly first-time unemployment claims clocked in above 400,000 for the 14th straight week
  • Producer prices fell 0.4% in June, a phenomenon owing almost exclusively to a 2.8% decrease in energy costs. That’s your release from the Strategic Petroleum Reserve. Enjoy it while it lasts — oh, that’s right, it didn’t.
  • Retail sales grew a meager 0.1% in June. Take away auto sales and the number was ruler-flat — the worst performance in 11 months.

True, J.P. Morgan Chase turned in nice earnings numbers… but shouldn’t that have been priced in weeks ago?

   Our ongoing survey of cash-strapped and crime-ridden streets and cities runs the gamut today from the sublime to the ridiculous.

We begin in Washington, D.C. — where firefighters are now under orders to park their trucks in the “rough” parts of town, to keep teenagers holding down summer jobs with the District government from getting robbed on payday.

“It’s to prevent things from bubbling up,” says Deputy Mayor Paul Quander. “The idea is that if you have a fire engine with adults there no one is going to commit a crime.”

The head of the police union speculates this is to make up for a shortage of cops on the beat. No doubt he’s talking his book, but news like this is enough to make you wonder: Could crime in the District end up spreading beyond the neighborhoods that federal bureaucrats never see on their daily commute to Montgomery or Fairfax counties?

   Meanwhile in Minnesota, the booze shortage is getting potentially serious as the partial shutdown of state government enters its third week.

Turns out that among the many institutions on the verge of having their state license expire, with no one on duty to renew it, is the beer giant MillerCoors.

“I would suspect within days to see that product leave the shelves,” says a spokesman for the Minnesota Department of Public Safety. (Guess the flacks are considered essential personnel if they’re still on duty.)

We suspect few will mourn the loss of Keystone Light or Milwaukee’s Best… but we understand some people do actually drink brands like Coors and Miller Lite. They might have to switch to Bud.

Heh… at least until Bud’s license expires in October.

   “It’s amazing what you find out when the government isn’t working,” writes a reader from Minnesota. “It also affects the day cares because of the money the state doles out to parents working in low-wage jobs.

“Local day cares are trying to get parents to totally foot the bill. Otherwise, they will just go out of business. But if the parents try to pay the whole bill, they just as soon as stay home with their children and stop working. It’s cheaper!”

   “I replaced my water heater a year ago,” a reader writes from the Las Vegas area, adding to our laundry list of weird fees that cities are using to generate revenue.

“The city has a 100 bucks permit to do the job, plus an ‘EARTHQUAKE STRAP’ that must be installed plus a DEEP WATER PAN, about 2" deep by 3' radius, to make it legal. Nevada has not had any major earthquakes since half a century ago.

“Now I did notice in my cell phone bill like $3.50, half for the state of Nevada and half for the county, some for the libraries, etc., etc.”

The 5: $100 for the privilege of continuing to take hot showers? Well, if San Diego’s thinking about licensing cats at $25 a pop, even if experts say the result will be more strays on the street, anything is possible.

Once again, we urge you to prepare for the onslaught by arming yourself with knowledge: How deep in the hole is your state? We spell it out using three metrics that no one has collected in one place — until now. It’s a real eye-opener. Here’s where you can get your copy.

   “Again with the ‘foreign aid is miniscule and therefore not a problem’ nonsense,” writes a reader, obviously peeved with yesterday’s issue. “I don’t care if it is $13.00 or $13 billion. I don’t want a dime of my money going to China, Venezuela, Cuba, et al. Got it?”

The 5: Loud and clear. We’re sure if it all went away tomorrow, the politicians could find some other means of pissing it away, if that would make you feel better.


Addison Wiggin
Agora Financial’s 5 Min. Forecast

P.S. We’ve just touched down in Las Vegas, where we’ll be attending Freedom Fest. Thanks to Dave Gonigam for contributing above and beyond the call of duty while we were enroute.

Tomorrow morning, we host a screening of our just-completed documentary Risk! — about the people who can create new jobs in the wake of the financial crisis, if only they are allowed to do so.

If you’re attending Freedom Fest, you’re cordially invited to join us at 9:30 a.m. tomorrow at Bally’s. Details here.


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