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Buffett and Munger on Future Oil Prices

October 30, 2010 | About:
CanadianValue

CanadianValue

212 followers


I’m long term bullish on oil. $80 oil is already a pretty heady price versus what we started the decade at (somewhere around $20). I think it is pretty hard not to be bullish on oil going forward once you do some reading and discover two things:

1) All of the super giant oil fields in the world were discovered in the 1960s or earlier. As the production from these fields which are so vital continues to decline we just can’t add enough new production every year to offset the declines AND grow production. The world isn’t running out of oil. It is just running out of the really easy to find, easy to extract kind that comes out at prodigious rates.

2) While we fight to stay on the treadmill by adding production to offset declines in the super giant fields we also have another problem. Global demand is increasing and will continue to do so as the developing countries move towards a more Western lifestyle. If you look at the number of cars per person in India and China you will see that both of these countries of a billion plus people have a miniscule fraction of the cars per person in the USA. That is changing and it doesn’t take much of change on a population base of over 2 billion people to make a big difference in global oil demand. The United States has 25% of the current daily oil demand in the world with 300 million or so people. Imagine if China and India had a per capita use of even 25% of what the United States does on their 2 billion.

But I’m no genius. So I try to confirm my beliefs by seeking out the opinion of those that I respect. And there are none that I respect more than Munger and Buffett.

Here is what they had to say on the subject at the 2008 Berkshire Annual meeting:

WB: Oil won’t run out - it doesn’t work this way. At some point the daily productive capacity will level off and then start declining gradually. There is the depletion aspect and the decline curves. We are producing 86m barrels per day or so, more than ever produced. We are closer, by my calculations, to almost our productive capacity, than we have ever been. I think our surplus capacity is less, and quite a bit less, than in past. Whatever that peak is, whether 5 or 10 yrs, the world will adjust, and we will think about it. Adjustments will cause demand to taper off. I don’t know how much oil is there, but there are lots of barrels of oil in place. We never recover total potential. We may have better engineering recovery in future. It is nothing like an on and off switch. You may still have enormous political considerations to get access to avail oil since it so important. There is nothing you can do over short period of time to wean world off oil.

CM: If we get another 200 yrs of growth dispersed over the world while population goes up, all oil coal and uranium will run out so you will have to use the sun. I think there will be some pain in this process. I think it is stupid to use up hydrocarbons of world so quickly. Stupid when there are few and limited alternatives. What should we have done? We should have brought all the oil over from Middle East and put it in our ground. Are we doing it now? No. Government policy is behind in rationality. If we have prosperous civilization, we must use the sun.

WB: Charlie, what is your over/under for oil production in 25 yrs?

CM: Oil in twenty five years, down.

WB: If this is true, that is big number. China is doing 10m cars this year, so down in 25ys is significant.



The financial crisis gave us a break from the $120 per barrel oil we had in 2008 as economies slowed and demand declined. There will be peaks and valleys in oil prices going forward but make no mistake the trend is going to be up.

About 40 people out of 1,000 in China have a car, fewer in India. In North America that number is more like 800 out of 1,000. Demand will rise, and the supply side is no brighter.

I’m trying to prepare my portfolio with undervalued oil reserves. I’m compiling my ideas here for anyone interested in discussing further.

http://valueinvestorcanada.blogspot.com/

About the author:

CanadianValue
http://valueinvestorcanada.blogspot.com/

Rating: 3.7/5 (16 votes)

Comments

AlbertaSunwapta
AlbertaSunwapta - 4 years ago
Surviving price volatility will be the key to maintaining a decent standard of living going forward.

I believe more large discoveries are inevitable, i.e. Saudi Arabia sized pools under the ocean floor could very well be discovered. I also believe that Saudi Arabia sized or North Sea sized discoveries will only provide temporary relief in today's high consumption world.

However since discoveries aren't evenly distributed over time and in fact are more likely only to occur as a result of more R&D expenditures - antecedent to high oil prices - I foresee a much higher level of price volatility ahead. (i.e. in the past 10 years oil have moved ten-fold as in $10/bbl to $100/bbl. We could expect much the same or worse in the next ten years.)

So, going forward, outside of war in the middle east, I figure it will play out two ways - two alternative orders of events (both trigger higher volatility):

One, no near-term large discoveries, no production gains and/or little slowing in demand and the numbers of the-peak-is-NOW adherents grow substantially as everyone thinks "the end is near" and drive oil prices sky high until oil prices kill economic growth or finance rapid production growth and new discoveries.

Two, a near-term large discovery(s), improvement in recovery rates or a slowing in demand and the numbers of the-peak-is-way-into-the-future adherents will grow and oil prices will see downward pressure and the rate of oil usage continues to accelerate delaying the next inevitable crisis.

It's all very similar to any bubble, say a continued and never ending debt buildup as has been happening in US finances. A liquidity crisis can hit early and help avoid an even bigger crisis further down the road, or it can be delayed by a number of factors until it really slams you.

Thus the people ignoring the whole peak oil theorizing game are THE VERY SAME SORT OF PEOPLE THAT ARE NOT WORRIED ABOUT THE BUILDUP OF US DEBT. This class of thinkers is counting on the system self-adjusting to skirt any kind of crisis. And there is some probability and historic precedence for this "don't worry be happy" approach. I'm sure a lot of doomsayers on a number of issues have been proven wrong - so far. Soviet expansion, computer systems collapse (i.e. Y2K), nuclear threat, etc.

softdude2000
Softdude2000 - 4 years ago
We dont see BRK buying oil companies like crazy. I dont know if BNI is oil bet but safe bet.

razorfangius
Razorfangius - 4 years ago
Price will be lower in 25 years, but higher in 5 years. 25 years from now all the cars will be fully electric or plugin hybrid that get 300 mpg, hence price of oil will drift lower. In the meantime buy low, sell high.
DocMoney
DocMoney - 4 years ago
I have some respect for WB and CM too. They have a good investment record so... Maybe I should ask them to reduce my dislocated shoulder? Or to install my shower door? Not!

Who cares what these two have to say about oil. They are not true oil experts. I'd much rather listen to someone like Rex Tillerson, who has actual experience in the business.

WB: "We are closer, by my calculations, to almost our productive capacity, than we have ever been." Congratulations, sir, your statement will hold true at most times with most finite resources (given a smoothed trendline). And oil won't run out? I know many oil fields that have run dry. If oil is finite, and we keep extracting it, it WILL run out. Of course, at some point, if and when extracting oil becomes uneconomical, it may be left in the ground but I don't need WB to enlighten me about that.

CM appears to start off a bit more realistically, admitting that finite resources are, well, finite. Finite means that run out if they continue to be used. But then he blurts out the following: "We should have brought all the oil over from Middle East and put it in our ground." Seriously, Mr. Munger? How would we have done that? By building another 1000 supertankers and driving up the price of oil substantially as we were stressing production capacity to buy up this oil? By building a transoceanic pipeline for a few trillion bucks and driving up the price of oil substantially as we were stressing production capacity to buy up this oil? Also, something tells me the folks in the Middle East may have had something to say about that.

Also, there are other alternatives to the sun. Hydro, wind, geothermal and tidal... Biofuels, I suppose, it solar energy stored in a plant so I will not mention that as a sun alternative.

paulwitt
Paulwitt - 4 years ago
In 2003 BRK starting buying PetroChina and in 2007, when BRK started selling PetroChina, they were estimated to have a 600% profit. Not bad for 4 years...

I think they always have their eye on oil - for example COP

As a interesting side note, PetroChina became the first stock to hit $1 TRILLION market cap....,and if I recall correctly BRK sold because of overvaluation.

batbeer2
Batbeer2 premium member - 4 years ago
Also, there are other alternatives to the sun. Hydro, wind, geothermal and tidal...

You realise of course that these are all derivatives of solar energy; with the possible exception of tidal which is more lunar than solar. And yes.... without the sun, the core of the earth would not have been hot to start with.

WB: "We are closer, by my calculations, to almost our productive capacity, than we have ever been." Congratulations, sir, your statement will hold true at most times with most finite resources (given a smoothed trendline).

I read this to mean we are closer to the absolute maximum productive capacity..... say peak. This is probably not true for most other finite resources. In fact, many "resources" like iron, Zinc and platinum are not really consumed. The oil we pump out of the ground is.

DocMoney
DocMoney - 4 years ago
Batbeer, are you serious?

To say that hydro, wind and geothermal are derivatives of solar energy is stretching it, a lot. Hydro is more a derivative of gravity than solar, even though solar energy melts the snow/ice that gives rise to rivers. The sun does not cause water to flow, however. Gravity does.

Geothermal from sun? Nope! Radiogenic heat (90% or so of total), gravitational heat etc. all play a role... check this out: http://www.rps.psu.edu/probing/earth.html.

Wind I will give you. Wind energy is derived from the sun. Still, harnessing wind is not quite the same as harnessing solar rays directly. By that rationale, you can say oil and coal are derivatives of sunlight and yet we have a different name for them, fossil fuels.

As for metals not being really consumed and oil being consumed, we may differ on definition of consumed. By consumed, I mean used in a way that will not make them easily recoverable. Much iron is lost irretrievably to corrosion. Much silver has been used for photography and discarted in soluble form, to never be recovered again... perhaps most gold and platinum ever mined are still above ground. But no matter. The fact that extracted resources can be well preserved above ground does not change the fact that their extraction (production) will one day hit the peak and then will slow perpetually.

batbeer2
Batbeer2 premium member - 4 years ago
Yes I'm serious and yes I'm stretching it a little.

1) Gravity causes water to flow downward..... but how did it get up there in the first place ?

2) Gravity caused the pre-earth space to condensate and AFAIK the friction involved is what caused the earth to heat up. Now what is the source of that gravitational force that caused that pre-earth space to condensate ? In fact, a better term for pre-earth space would be extra-solar space no ?

As for oil and coal.... indeed, nothing but pent-up solar energy. Bio energy is the same thing, just with higher turnover. Come to think of it, the only major source of energy we have that is not in some way derived from the sun is nuclear energy; we synthesise our own sun.

Much iron is lost irretrievably to corrosion.

Ever wonder why the ore is red ? Most of the stuff they mine now is an oxide of iron.

Silver.... good point ! much of it is washed away and diluted into oblivion.

Just some thoughts.....

It makes no difference..... oil and coal were formed over many many thousands of years and we will have burnt most of it in 2 centuries. That is not sustainable. But I'm optimistic; there will be solutions. Europe ran on whale oil for a century or so till we started running out of whales.

- EDIT -

I just learnt most of the heat beneath our feet is from ongoing nuclear fission. So.... OK I concede that's not solar.

DocMoney
DocMoney - 4 years ago
Corroded iron does not neatly pile itself up into deposits that could be mined:)

Also the reason I did not mention nukes is that CM said radioisotopes (Uranium) will run out... Which, as a finite resource, it will eventually.

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