Now is the Time to Buy Oil Stocks
By Jeff Opdyke, Editor of The Sovereign Individual


Dear Georges Aslanian,
Every investor has that trade he wishes he could replicate – the one trade he’d like to go back in time and do over and over again because it was so profitable. For me, that trade is oil stocks in the late 1990s.

Oil prices had raced past $40 a barrel in 1990 in the wake of the War in Iraq, Part 1… and then spent the remainder of the decade racing toward $15. By the late 90s, many high-paid Wall Street types were yapping about permanently low oil prices.

At the time, I was a reporter in The Wall Street Journal’s Dallas bureau, and spent many a day talking with the great oil investors in Texas. And they all had a very different take on the market: The low prices were a rube’s view of reality.

The underlying fundamentals of the supply/demand curve told of a coming price rise. The pros spent dozens of hours with me, explaining why in intricate detail. They taught me how to value exploration and production companies and the oil-service providers. As I wrapped up an interview with one in particular, he counseled, “Buy oil now. The idiots know not what they’re talking about.”

And so I did, grabbing exploration and production firm Apache Corp. in the $14 range and an offshore driller then known as Global Marine in the mid-teens… and then I watched as the world disproved the notion that oil prices were permanently low. I ultimately sold out of Apache above $70, while Global Marine, through two mergers, was ultimately subsumed into Transocean Offshore and led to a huge profit for me.

The message here is that, once again, the rubes know not what they’re talking about today, and I’m once again buying oil. I’m doing so because, just as it was in the late 90s, only the rubes today believe oil prices are headed lower long-term.



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The Supersized Clue Indicating Oil Must Head Higher


Oil is certainly not as cheap as it was when it closed near $15.50 a barrel in early 1999. But relative to global socioeconomic history of the past decade, oil is absolutely a bargain now.

Today, daily demand for oil in the U.S. is about 18.8 million barrels. Because of our economic malaise, that demand is down from the more than 20 million barrels we consistently consumed every day between 2003 and 2007. In fact, today we’re actually consuming less oil than we did in 1998 and 1999, when oil prices were sagging.

An identical trend has played out across Europe, thanks to its own debt-fueled economic funk.

Yet, look at what has happened since the late 1990s in the rest of the world.

Demand across all of Asia in 1998 was essentially equal to America’s demand. Today, Asian demand for crude oil is 50% larger than America’s and growing by 2.5% a year – a torrid pace in the energy market. African demand is up nearly 40% since 1997. The Middle East is sucking up 66% more oil than it did in the late 90s. Latin America’s daily demand is up by nearly a quarter.

No doubt that demand in many of the countries I’m talking about is so small that it’s almost irrelevant when compared to the huge consumption that defines the U.S. and Europe. But, on a cumulative basis, all the world’s non-Western economies are now burning essentially the same number of barrels every day that the West does. And back in the late 90s they burned only about half as much.

Western demand has gone backwards, largely because of current economic woes. Emerging demand has surged.

Consider that in the late 90s, the West accounted for 64% of the world’s daily oil demand. The non-West, just 36%.

Now it’s an almost even split.

That’s a supersized clue that the world we know has changed dramatically beneath the surface when it comes to oil-price expectations.

The Riches Hidden in Turkmenistan


The risk in the oil market isn’t $50 oil.

The risk is oil at $150 and above.

The reason is hidden in plain sight in those daily-demand statistics. Remember, Western consumption is down because of the weak-kneed economies in the U.S. and Europe. But both of those are temporary. At some point – likely in the next year to 18 months – America and Europe will begin moving in the right direction again.

When that happens, rising demand in the West slams headlong into rising demand in the developing world… and that will push oil prices higher. (Go back and re-read my recent piece on the marginal cost of producing oil to understand why higher prices are inevitable.)

The way to profit from this is to buy oil stocks now… and then to sit patiently and allow the obvious fundamentals time to play out.

One oil stock in particular that I’d be buying now is the Dubai-based and London-listed Dragon Oil (London: DGO), an exploration and production company with its key production coming out of energy-rich Turkmenistan.

Everything You Could Want in an Oil Stock


Investors have put Dragon Oil in the penalty box temporarily because of worries about production-rate decline tied to technical reasons and because of expectations for higher transportation costs across 2012. Those are minor concerns.

Dragon Oil aims to drill 16 new wells in Turkmenistan (about a 20% increase in its producing wells), and will soon begin drilling in Tunisia and Iraq. Its goal is to increase daily production to 100,000 barrels by 2015 from roughly 72,000 now – and it clearly has the skill set, assets, experience and balance sheet to make that happen.

Dragon is loaded with cash and has no debt. At the end of June, the company held more than $2 billion in cash and securities, or about $3.93 per share. Those shares trade at just $9.60 as I write this – meaning the cash on Dragon’s balance sheet represents 40% of the company’s share price. (The shares trade in British pounds, so I’ve converted the current quote of £6.11 to dollars.)

Strip out the cash and we’re effectively buying Dragon’s business for less than $6 a share, or a miniscule 4.5 times earnings.

And it’s a very profitable business. Dragon has been running net profit margins well above 50%. Its cash-flow margins are close to 90%.

On top of that, Dragon is paying us a respectable dividend yield of 2.3% to hold the shares. And the company is buying back up to 5% of the stock in the open market.

This is exactly the kind of oil company I want to own – increasing production, promising new projects, a cash-heavy balance sheet, fat profit margins… and I get some annual income, too?

Dragon Oil is a buy up to £6.50 (US$10.20).

Until next time, stay Sovereign…

Jeff D. Opdyke

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