Oil stocks look too expensive in short term

Still plenty of extra supply to meet demand

Peak oil has arrived and prices are rising once again. The only problem with this story is that demand has peaked — not supplies. Normalization in oil prices is needed to encourage long-term production; however, the 47% rise in oil prices over the past five weeks is at odds with a well-supplied market for 2009.

The rise in oil prices in recent weeks is partly a U. S. dollar phenomenon and partly a result of less drilling, says Eric Sprott, president and CEO of Sprott Asset Management.

“We all have to get off the focus on U. S. dollar oil prices,” says James Cole, portfolio manager at AIC Funds, because Canadian producers have costs denominated in Canadian dollars. The rise in oil prices is still meaningful — 30% over the past five weeks when denominated in Canadian dollars — suggesting there is more to the rise than a fall in the dollar.

Investors are waking up to the reality of peak oil, says Sprott, who points to 8% decline rates for existing oil production. Peak oil is in fact a theory about falling oil supplies, and is based on the observation that oil production declines after half the oil is pumped from a field.

“For an industry that has generated massive amounts of cash flow and earnings, it has little to show over the last 10 years in terms of supply,” says Norm Lamarche, portfolio manager at Front Street Capital.

Financial Post