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The Commodity Investor Q&A

With Matt Badiali, editor, S&A Resource Report
Wednesday, May 7, 2008

Q: I've made a lot of money in Petrobras. Now it looks like it's expensive. What say you, Matt? – D.B.
 
A: By traditional measures like price to earnings, Petrobras is among the most expensive oil companies. That's due in part to its incredible run. S&A Oil Report subscribers bought in February 2007 and are now up more than 160%.
 
But oil investors have more useful tools than the P/E ratio to evaluate the likes of Petrobras: lifting costs, discovery costs, netback, and the recycle ratio. These figures tell me nearly everything I need to know about the health and prosperity of an oil company...
 
Lifting costs tell us how much the company must spend to get a barrel of oil out of the ground. We want to see low lifting costs, which mean higher profits.
 
Discovery costs tell us how much money the company spends to find a new barrel of oil reserves... It reveals the success of the company's exploration arm. The lower the number, the better.
 
Netback is the bottom line... the amount of money the company makes on each barrel it sells. In other words, the profit margin. I like this number because it tells us about both the quality of the oil and the efficiency of the company.
 
All these numbers are simplified in the recycle ratio...
 
The recycle ratio tells us how efficiently a company turns a barrel of reserves into a barrel of production. The higher the number, the better the company.
 
OK, now let's get back to the question... Is Petrobras cheap or expensive? Here's a quick comparison:
 
Company
Recycle Ratio
ExxonMobil
3.6
Royal Dutch Shell
2.8
Total
2.4
Statoil
2.2
Petrobras
2.0
Chevron
0.5
 
As you can see, according to the recycle ratio, Petrobras isn't the best company out there. That's because it's primarily an offshore oil company. Offshore exploration and development is incredibly expensive. That same problem is hitting Chevron and Statoil.
 
I still like Petrobras, but I think most of the easy money's been made.
 
Q: With the continued rise in the price of oil and gas, what form of alternative energy (biodiesel, ethanol, solar, wind, nuclear, hydrogen, etc.) do you think has the most potential to help meet future energy needs? – R.M.
 
A: First things first... we need to split these ideas into two parts – fuels for transport and fuels for electricity.
 
Oil is not electricity. Oil is transport – cars, boats, planes, trains. About 70% of all the oil we use in this country gets combusted to move us and our stuff from point A to point B.
 
Alternative transport fuels are tough. I'll save my thoughts on biofuels for another essay... but I will say, I think natural gas and hydrogen are the right way to go.
 
As for electricity fuels... right now we use coal and natural gas. Like oil, those prices are on the rise.
 
I don't believe nuclear energy is the solution to this problem, at least not in its current form. The dirty secret of the nuclear industry is that we still don't have an adequate waste disposal system. While carbon dioxide pollution may let New Yorkers grow palm trees, radioactive waste will kill you.
 
Technical advances in hydroelectric generation eliminated the need to dam rivers. Now, all you need is a steep section of river. That's great – right up until you have a drought.
 
Wind and solar face similar problems... You only get power when the wind happens to blow or the sun happens to shine. I think they're too inconsistent to be large-scale solutions.
 
On the other hand, geothermal energy – heat from the Earth – is plentiful and cheap. I wrote a report about it last year, and I am conducting research for a new one on the subject right now. Keep an eye on your inbox.
 
Good investing,
 
Matt




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