An Example Of Why You Have to be Careful With Commodities

With oil again nudging $100 a barrel, platinum above $2,000 an ounce, and even coffee, cocoa and tea at multi-year highs, the commodities market may appear overly exuberant. There are, however, still many opportunities in the sector if one is selective.

The main factors driving my conviction are the various balances of supply and demand.

Ok fair enough.

With oil bubbling around the $90-$100 dollar mark it makes sense to begin with this, perhaps the most emotive of all commodities. And it’s hardly veering outside the realms of popular conviction to suggest that the oil price is likely to remain elevated for the foreseeable future.

Much of the world’s easy-to-reach oil reserves have already been drawn out, and although there are great supplies lurking in locations like Canada, for example, it’s not so easy to process – and it’s expensive.

But you see this is wrong.

In mid-2006, the National Energy Board of Canada estimated the operating cost of a new mining operation in the Athabasca oil sands to be $9 to $12 per barrel, while the cost of an in-situ SAGD operation (using dual horizontal wells) would be $10 to $14 per barrel. This compares to operating costs for conventional oil wells which can range from less than $1 per barrel in Iraq and Saudi Arabia to $6 and up in the United States and Canada’s conventional oil reserves.

In addition, the capital cost of the equipment, such as the huge machines required to mine the sands and the dump trucks used to haul it to processing, is a major consideration in starting production. The NEB estimates that capital costs raise the total cost of production to $18 to $20 per barrel for a new mining operation and $18 to $22 per barrel for a SAGD operation. This does not include the cost of upgrading the crude bitumen to synthetic crude oil, which makes the final costs $36 to $40 per barrel for a new mining operation.

The article said it’s expensive, but the reality is that yes it’s expensive with respect to Saudi oil, but not to the current price. At 100 USD per barrel Canada is making over double the price per barrel. And places like Venezuela have huge reserves similar to Canada. In the FT article they talked about how India with its growing population is going to be sucking up all that oil. Actually somehow I don’t think it is going to happen. (Disclosure I am long Tata Motors)

“I want to stress that these are estimates, and that we’ll know soon more precisely from our engineers,” ZPM spokesman Kevin Haydon told PM, “but a vehicle with one tank of air and, say, 8 gal. of either conventional petrol, ethanol or biofuel could hit between 800 and 1000 miles.”

The Tata car is being touted as a real car at real conditions getting at least 100 miles to the gallon. Let’s imagine that every American decided to switch tomorrow to that car. It would mean America would need 30% of the oil that they need today, and India while needing oil will not need as much oil as the models have said. This is a game changer.

No, being long in Commodities is playing with fire…