Companies are getting much better at forecasting where to drill for oil, and maximizing their chances of striking energy significantly. By using sophisticated seismic data, energy companies can obtain general reserve estimates for oil and gas wells. In addition, with improvements in technology, companies can now recover much more oil and gas out of the ground, compared to before.
When the U.S. experienced its first oil boom in the early 1900s, the primitive technology made it possible to only skim a portion of the oil in oil wells. As pressure in the oil and gas wells decreased, production fell in those wells, and they were then closed out. With improvements in technology however, it is now possible to increase the life of wells significantly, as it is much easier to get more out of each well.
One thing I do avoid is purchasing U.S. oil and gas trusts. While they offer mouthwatering yields today, they are all destined to go to zero. This is because when these trusts were set up, their revenues were set to be generated from a fixed portfolio of assets. They cannot purchase new wells to earn revenue off of, and cannot drill for oil or gas. Even with improvements in technology, chances are that the wells you own will eventually dry up.
As a result, the reason why these trusts offer such high yields is because they are essentially returning a huge portion of investor’s capital back. If investors reinvest a portion of these distributions in other oil and gas producing wells, they can extend their income stream. If investors instead spent all of their distributions, then they will not do well in a typical 30 year retirement scenario. BP Prudhoe Bay (BPT) is an example of an oil trust that will go to zero by 2025- 2030. This is the time when the oil royalties will no longer result in distributions, due to costs, declines in production, even if oil went to $200 per barrel.
So what is the risk to my theory? If prices rise above a certain threshold, it might be economical for alternative energy sources such as solar and wind to be priced at par with oil and gas. However, oil would still be relevant 100 years from now even if it no longer were used for energy, because it is used in so many other aspects in everyday life such as chemicals, plastics etc.
Another risk is if the data I am using to base my assumptions is incorrect. The amount in proved reserves is simply an estimate. Actual reserves could turn out to be much different than estimates. In addition, just because there are proven oil reserves to last for 50 years, there is no guarantee that all the oil will be available to be pumped out within 50 years, even if estimates were correct.
On the positive side however, the reserves to production ratio does not account for undeveloped reserves. With the majority of the world’s surface being under water, chances are that high enough oil and gas prices will one day incentivize exploration in the deep sea areas of the globe.Those areas could potentially provide for an almost unlimited amount of energy.
Full Disclosure: Long CVX, COP, RDS.B, KO