How low can oil go?

How low can oil go? TheStar.com -

Business - MICHAEL STUPARYK/TORONTO STAR

The energy-focused hedge fund managed by Alex Ruus has lost 45 per cent of its value over the past six months — dreadful, but not so bad compared with the performance of many of its peers.
Fund manager makes case for rebound in price
November 15, 2008 Tyler Hamilton Energy Reporter

Toronto fund manager Alex Ruus was taken aback when a young broker in Calgary told him the price of oil was heading toward levels not seen in a decade.

It was late October, a month marked by a record 35 per cent plunge in the price of crude futures and Ruus was out meeting clients on a routine tour of Canada's oil capital.

"We were talking about what's happening in energy and this broker, a fairly young guy with no oil and gas experience, says oil is going to $10 (U.S.) a barrel," recalls Ruus, who manages the Northern Rivers Global Energy Fund.

He couldn't believe such an extreme view. "It just underlined to me the panic going on in this market. It's just totally unrealistic. Canada would shut down as an oil producer at those prices."

As the global economy sags, oil has staged a dramatic nosedive, falling from a record $147 a barrel in early July to its close in New York yesterday at $57.04. Ruus's fund has taken a beating – down about 45 per cent in the six-month period ending Oct. 31, compared with a loss of about 33 per cent on the S&P/TSX Composite Index.

Dreadful, sure, but not bad when measured against similar funds in the market that have been hit with the double punch of plunging crude prices and a credit crunch. DeltaOne Strategic Energy is down 60 per cent, Sprott Energy is down 58 per cent and Ark Aston Hill Energy Class is down 51 per cent during the same period.

"There's been nowhere to hide," said Ruus, 44, a mechanical engineer who in a previous life worked for Chevron Corp. supervising rig operations and construction projects in Canada's oil patch. "Everybody is handling it a different way. There are some firms shutting down because they can't deal with it and they're too stressed out.

"And it has been a stressful year. It's the worst market I've seen in my career, and you can't help but worry about stuff."

Calgary-born Ruus has boyish looks and no grey hairs – yet. A large map detailing Alberta's tar sands resources hangs on a wall in his office. Paper documents lay in neat piles on the floor and counter. On his desk sits a chrome-plated drill bit that was once used in a field he supervised. It now functions as a penholder.

Experience in the patch may explain Ruus's somewhat optimistic outlook and unruffled demeanour as he describes the stomach-churning volatility of the past few weeks. Ruus doesn't completely rule out oil falling to $40, even $30 a barrel as the global economy continues to slow.

Indeed, a rush of options trades on the New York Mercantile Exchange this week valued oil for February delivery at just $30 a barrel.

Ruus, however, predicts that over the next 18 months prices are destined to skyrocket again. Mergers and acquisitions are inevitable. Many oil and gas exploration and development companies, large and small, are being seriously undervalued and, if you can spot them, represent huge buying opportunities, he argues.

And the market, he adds, has already priced in a global recession for 2009.

"The stock market is down 40 per cent, but there are stocks that are down 75 and 90 per cent. The babies are getting thrown out with the bath water now," Ruus said. "Some of this stuff should go to zero, but there is also stuff getting thrown out today with fantastic management teams and decent balance sheets, and those stocks are going to come roaring back."

He's not alone in that optimism. Jeff Rubin, chief economist at CIBC World Markets, said last week that equities markets were "nearing a bottom." A week earlier he said the positive effect of $60 oil should start boosting the economy over the next six months, the same way $140 oil helped sparked the recession. That will cause crude prices to once again start climbing.

A hint of that thinking can be found in the price of oil futures contracts for delivery in three years. Those contracts have been holding firm above $80 a barrel. "Oil is still the best play on recovery, when temporary market fears of demand destruction should quickly morph into more lasting fears of supply destruction," Rubin said.

He pointed to the $90 a barrel marginal cost of new oil-sands projects and how the precipitous decline in oil prices has slashed more than $30 billion in investments from Canadian projects.

"Ditto for the investments in the Brazilian offshore, Gulf deepwater and many other sources of tomorrow's expected supply. Investors are likely to find that oil demand can be turned back on a lot easier than bringing back supply," Rubin argued.

Meanwhile, many of the world's conventional oil fields continue to struggle. For example, Mexico's state oil monopoly Pemex has failed over the past few years to replace the oil it extracts with new reserves even with annual production down considerably since 2004.

Output from Pemex's Cantarell Field, one of the largest oil fields in the world, is expected to fall to 700,000 barrels per day by the end of 2009 amid a loss of pressure – a decline of 25 per cent from today's daily output, the company's production chief said last week.

Earlier this month, the normally cautious International Energy Agency warned that triple-digit oil prices are poised to return as the economy starts to rebound and worsening production supply constraints, related to resources as well as investment, become more apparent. The agency went so far as to predict that the average price of oil will exceed $100 per barrel between now and 2015.

Ruus admits, like most analysts, economists and fund managers, that he was caught off guard by how low oil has fallen. "We didn't believe it was going to stay at $145, but I can't believe it's gone to under $65. That's the real shocker."

But his clients, who when joining agree to lock in their minimum $25,000 investment for at least two years, are looking long term. Ruus and Northern Rivers' principals are also heavily invested in the fund. "It makes clients feel a lot happier, because they know, in a bad year like this, that we're feeling the pain as much as they are."

With that long-term outlook, they're also taking advantage of a fearful market. "The average retail guy right now is looking at his portfolio down 40 per cent and saying, oh God, it's going to be down another 40 per cent so I better get out. Whereas the smart long-term investor is saying, wow, I can buy the same assets I could have bought a year ago for 40 per cent less."

It's the difference, explains Ruus, between a sophisticated investor and the average retail investors.