Low Energy Costs Draw Investors Back to the Well
The smart money is investing once again in oil and gas. But don’t worry, that doesn’t mean your gasoline and heating bills are about to go up.
“Natural gas will go to $2 per thousand cubic feet and oil will go to $20 a barrel,” predicts Marvin Davis, the billionaire who made a fortune in oil and then became a legend of timing by selling most of his holdings in 1981, at the peak.
That’s not an inflationary outlook. Natural gas currently is selling at about $1.84 per thousand cubic feet and oil is near $18 a barrel. So Davis and other smart investors are not betting on a rerun of the 1970s, when energy inflation turned the world upside down, but of the decades before that when prices were stable, energy usage grew, costs came down and business was good.
Today’s outlook is for sustained prosperity because technology has lowered energy development costs, allowing oil and gas markets to grow worldwide. It’s a story with lessons for all from some very shrewd investors.
Davis, now 70 and worth $2 billion according to Forbes, started to get back into oil and gas about three years ago, buying land and leases and drilling platforms in the Gulf of Mexico for 3% of their original prices. Now he reports, without revealing details, that drillers for Davis Oil have hit two major gas fields, offshore Louisiana and in Oklahoma.
More important, as a signal that the business has turned, “I’ve got people lined up to buy my gas,” Davis says. “It’s a long time since people lined up for gas.”
A long time indeed. Natural gas went from scarcity in the 1970s to an oversupply in the 1980s and 1990s, as deregulation worked itself out. Prices fell to very low levels, discouraging drilling and development--but attracting money men such as Davis and Texas investor Richard Rainwater.
Now conditions are changing as computer technology reduces costs of development and gas finds growing markets in electricity generation here and abroad, says Gamble Baldwin, head of Natural Gas Partners, a company that invests pension and endowment funds.
In the United States, small production companies--which account for two-thirds of U.S. natural gas--are seeking an antitrust exemption from Congress in order to pool their gas output and sell more directly and competitively to utilities and residential consumers.
Overseas, natural gas usage is rising, even in places such as Asia where it has to be liquefied and transported in expensive tankers.
“A structural change is going on,” explains Joseph Tovey of Tovey & Co., an investment bank specializing in energy. “The business is getting better not because prices are going up but because costs are coming down.”
Challenge and response. The very low prices that hurt the business fostered the adoption of computer techniques that helped it.
Oil companies have always used sound waves to construct estimates of underground structures. But in the 1980s, computers made possible three-dimensional seismic pictures, allowing much greater knowledge of where to drill and what deposits looked like.
“Information technology is changing the cost structure of the industry,” says Robert Peebler, president of Landmark Graphics, a Houston software firm.
Peebler, an electrical engineer, explains that oil wells are not simply underground puddles but caves with pockets and crannies. With 3-D computer pictures, oil can be produced more completely and dry holes that once wasted hundreds of thousands of dollars each, can be avoided.
If such technology has changed business in the United States, it has caused a revolution overseas where costs of exploration and development can be prohibitive. The North Sea is seeing new development thanks to 3-D seismic.
And opportunities will be tremendous in Russia and the former Soviet states, where wells were damaged or left half completed by commissar-led oil ministries.
Also, global attitudes have changed. Because they have technology and expertise, U.S. oil companies are now being asked to develop deposits everywhere, from Argentina to China to West Africa.
A world moving to motor bikes and refrigerators is going to need energy. “Global usage is growing 1.5% this year and will grow 2% in 1996,” says Daniel Yergin, head of Cambridge Energy Associates, a consulting firm. “Asia’s use of energy will soon match that of North America.”
Yes but when will the world run out? Not soon: Global gas reserves allow for 68 years of production at today’s levels; oil reserves allow for 43 years. And the active exploration made possible by technology will lengthen those totals.
The outlook, barring war or revolution, is for stable prices. And while political disruptions in the Midde East are always a threat, smart companies plan to make a profit at relatively low prices--and smart investors don’t bet on windfalls either.
Really smart investors never did. After more than 30 years building up his oil company, Davis sold major holdings in 1981--when oil was selling at $37 a barrel and conventional thinking predicted the price would go to $80 and $100.
“I knew it wouldn’t,” says Davis today. “Two and two don’t make 22, they make four. The Arabs were going to produce more oil because they needed money, too.”
So why go back into oil and gas now? “Because they’re commodities everybody needs and the prices got too low,” says Davis, a civil engineer from New York University who learned a lot of business from his dress manufacturer father.
In his time, Davis has bought and sold the Pebble Beach Golf Course and Beverly Hills Hotel at a good profit, but he finds no attraction in prestige properties.
“My kids are driving me crazy, telling me to buy an NFL football team,” he says. “But what kind of business is that? A franchise costs $200 million and the best team only makes $12 million a year; reward for risk is lousy.”
“ ‘You’ll always get your money back,’ my kids say.
“But I say, I’ve already got my money, why should I try to get it back?”
Forget economic formulas. In those lines you’ve got investment wisdom and a hint of why it’s significant that the smart money is getting back into oil and gas.