Saudi King halts oil exploration, a remarkable signal of change, and one that may indicate Peak Oil is here.

From Cabot Wealth Advisory 7/20/10 Sign up for free Cabot Wealth Advisory e-newsletter

On July 4, 2010, Saudi Arabia’s King Abdullah attended a cabinet meeting and then responded to a Zawya Dow Jones Newswires reporter’s question about what transpired:  “I told them that I have ordered a halt to all oil explorations so part of this wealth is left for our sons and successors, God willing.” 

The rest of the newswire item goes on to quote from unnamed Saudi oil sources that the king didn’t mean a halt to exploration, but that he simply wanted the country to be more judicious in its exploration. Other sources chimed in that Saudi Arabia is committed to its role of ensuring the world has enough oil to meet its needs. In other words, everyone was spinning the king’s statement.

The delicate dance of OPEC and Saudi Arabia regarding the image of oil availability is clear. 

The cartel wants strong oil prices, obviously, but not too strong lest high prices encourage consuming nations to pursue alternative energies, as they did during the oil shocks of the 1970s. It also wants to assure consuming nations that there is no need to worry about the supply of oil for the foreseeable future, since the fear of running out of cheap oil could force people to turn to alternatives before the cartel are able to sell all the oil they can at a good price.

Hinting at any other condition, as King Abdullah’s order does, strikes us as a significant departure from the narrative of reasonably priced, easily available, limitless oil the Saudis have used to make themselves very, very rich. The departure from the successful script OPEC has followed is a remarkable signal of change, one that indicates peak oil is here—there is only so much oil left, and the Saudis want to sell it when the oil crunch becomes apparent again.

Peak Oil is the theory that at some point, the world will have used more oil than there is recoverable in the ground, causing big problems for both the cost of oil and long-term energy stability. We didn’t put much credence in Peak Oil until we had a curious discussion at a conference in Thailand in 2006 with a high-level Brunei government official who expounded at length on the importance of getting the country’s economy diversified away from oil in the following years although, as he took pains to assure us, there was no problem with oil supplies at all. 

Why pursue the more labor intensive and weaker return-on-investment of eco-tourism, for instance, when oil has made your country the wealthiest on the planet? Unless, of course, the oil is running out.

We're not the only ones who thinks Peak Oil is here, or at least just around the corner. Just last Sunday, Lloyd’s Insurance and the Royal Institute of International Affairs warned the British government the world is headed straight into the peak oil crunch once the economy recovers and with it, demand. By 2013, oil could easily be over $200 a barrel, they warn. 

The International Energy Agency, noting that the world needs to find the equivalent of four Saudi Arabias in the next 20 years to even hope to sustain current oil demand, has all but said Peak Oil is upon us (and, anonymously to the press, some individual analysts at the IEA have said so). Discoveries of vast new oil deposits are unlikely: Since 1968, the world has been using more oil annually than it has been discovering.

Even setting aside Peak Oil—and we could be wrong, we admit—there is enough upward pressure on prices to indicate that right now is probably the lowest priced gasoline we’ll see from now on. Why? 

Consider this: About 10 years ago, OPEC sources indicated Saudi Arabia needed to sell a barrel of oil at $18 to break even. Two years ago, data from ratings agency Fitch (which cares because it evaluates sovereign debt) estimated Saudi Arabia’s breakeven had risen to $26. In January, Fitch pegged breakeven for the country at $68 a barrel. If it costs more to produce oil, it clearly is harder to get. And Saudi Arabia is the primary low-cost oil producer on the planet. 

OPEC members like Venezuela and Iran are estimated to need oil over $95 to break even on their costs. Other OPEC members are even dropping out: Indonesia abandoned the organization in 2008 because it can no longer export oil—it needs to import it to meet its own growing domestic demand. Our only respite from skyrocketing oil prices right now appears to be the slumping global economy, which has eased demand downward so we (and most of the government and most business leaders) don’t see the problem at the gas pump or in utility bills. But we will, soon.

So how does an investor act on the belief that Peak Oil is imminent? The temptation could be to buy oil stocks, but that overlooks one crucial characteristic of the stock market: It is forward looking and puts a premium on the price of stocks in expectation of future growth. And if the market believes there isn’t much of a future for oil companies in the business they are best at—even if prices are currently high—then why should their shares enjoy large price to earnings multiples? They won’t.

The way to play the coming energy crunch is to invest in the companies that have the products that will replace oil in the energy network. We see dozens if not hundreds of promising technologies and advances that will not only alleviate the stresses of peak oil but also improve our environment and the quality of our air and seas. For more information, see Cabot Global Energy Investor.

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