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Money to be made from troubled waters

by Wayne Cheveldayoff, 2006-06-01

Is your investment portfolio ready for hurricane season?

Chances are very high that hurricanes will batter the U.S. Gulf oil and gas fields and refineries again this year and push crude oil prices up to record levels, says a special report by CIBC World Markets.

The specific prediction is for crude oil to average $78 U.S. per barrel in the fourth quarter of 2006 (versus $70 per barrel recently) and for the price for gasoline at the pump to hit $3.50 per gallon in the United States and $1.30 Canadian per litre here.

If this happens, investors owning oil and gas stocks will be making money this summer at a time when other investors probably won’t be. According to some market strategists, the U.S. markets (and non-commodity stocks in Canada) will likely be slumping in the June-October period as they usually do in the second year of a presidential term.

An investment strategy based on hurricane predictions would definitely be risky. Nobody can guarantee the hurricanes or that they will hit hard.

But the two economists who wrote the report, Jeff Rubin and Peter Buchanan, are not just guessing.

Their report, entitled Drilling in Troubled Waters, and available for viewing as Occasional Report #58 in the economics and strategy research section at www.cibcwm.com, is based on highly reliable weather forecasts, climatologists’ findings and the latest sea temperatures.

Their analysis cites the steady warming of sea surface temperatures in the Gulf of Mexico since the 1970s, which has been correlated with a sharp rise – more than double – in the storm intensity of hurricanes over that period.

Ahead of the June 1 start of hurricane season, temperatures in the Gulf of Mexico and tropical Atlantic are again well above normal, heightening the risk of severe hurricanes.

In addition, oceanic and atmospheric experts have recently projected a La Nina extending through the upcoming storm season. That phenomenon – a cold water current off the Pacific Coast – points to weaker-than-normal trade winds and wind shear, which are forces that limit hurricane formation. For this reason, a La Nina has historically been a harbinger of severe tropical weather in the Gulf of Mexico and the Caribbean.

This potential trouble is building at a time when 17 per cent of the region’s oil production remains off-line because of last year’s hurricanes, which damaged 167 offshore platforms and 183 pipelines. Some platforms were found as far as 60 miles from their original moorings.

The report points to a problematic longer-term picture. Prior to the 2005 damage, the U.S. Department of Interior had predicted U.S. Gulf production would almost double to 2.2 million barrels per day by 2010. But with hurricane activity and damage likely to persist, there is little chance of this.

“2005 not only set a record with the greatest number of Category 4 and 5 storms in a single season, but also posted the greatest tropical depression on record, which fortunately did not hit any oil and gas fields. The industry’s vulnerability to these storms has not changed and is not likely to change over the balance of the decade. There are few, if any, oil rigs or platforms in the Gulf that can withstand this level of storm severity,” the report states.

“The net impact is that oil production in 2006 from the Gulf of Mexico is unlikely to even match last year’s level, let alone provide the growth hoped for. In fact, our 2010 production estimate would still be below last year’s level and 20 per cent below the production peak for the region established in 2003.

“The result would have important implications for U.S. production, since the Gulf is the only area in the United States where production has actually grown. Total U.S. crude production would fall from 7.3 million barrels per day in 2005 to about 6.0 million barrels per day by 2010.”

With depletion working to reduce production at each well, oil and gas companies have to the difficult job of finding a substantial amount of new oil each year just to keep production steady. Hurricanes make it all the more difficult.

Watching this year’s storm activity should be more interesting that tuning into TV re-runs. If you can stomach the tension, take on some oil and gas exposure in your portfolio.

Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. His columns are archived at www.smartinvesting.ca and he can be contacted at wcheveldayoff@yahoo.ca.

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©2006 Wayne Cheveldayoff