Now that oil is a long way from the $145 per barrel peak it hit in July 2008 and nobody on Wall Street is predicting, as Goldman Sachs did in 2008, that oil is headed to $250 a barrel, we’re not hearing much about peak oil anymore.

The peak oil model, initially developed by oil geologist King Hubbert and which accurately predicted a peak in U.S. oil production between 1965 and 1970, says that the production from an oil field grows exponentially over time, then peaks, and finally declines. The model has been applied to individual oil fields, national oil industries, and global oil production. Back in 2008, the fiercest proponents of peak oil as a global model were predicting that the world would start running out of oil sometime around 2020.

Now that the world is awash in oil, the only people talking about peak oil are its opponents, who are dancing on what they depict as the grave of what they call a “theory” that was never worth the graph paper it was plotted on.

Well, I still think that the peak oil model is the most useful description of what we see happening in the oil industry today—even if West Texas Intermediate, the U.S. benchmark, closed at a twitch under $100 a barrel on Friday, February 3. (Brent crude, the European benchmark closed at $114.58.)

And, I’d go on to say that the peak oil model is the best way to understand what’s happening to the prices of other commodities, especially copper.  (Full disclosure: I predicted that oil would go to $180 a barrel shortly before it began its collapse from the $145 a barrel high in 2008. And full, full disclosure: The only one predicting $250 a barrel oil right now is Iran, which is threatening that prices will reach that level if developed economies impose tougher sanctions on the Iranian economy in an attempt to slow or stop that country’s development of a nuclear bomb.)

And I think it’s even useful for thinking about how to invest in commodities such zs iron ore that, currently, don’t fit the peak oil model at all.

Let me explain why I still find so much value in this “discredited” theory. Read more

When will billions—okay tens of billions—in new investment put an end to the current boom in iron ore prices (and in the price of iron ore stocks)?

Brazil’s Vale (VALE) said, in announcing fourth quarter earnings Friday, February 25, that the market will experience supply constraints for three to four years. Vale will invest $24 billion in 2011 to expand its output to 522 million metric tons of iron ore by 2015. (522 metric tons is roughly equal to 10 months of China’s current iron ore demand.) That’s roughly the same 2015 time frame that BHP Billiton (BHP) talked about in its latest capital-spending plan. (For my latest update on BHP Billiton see my post http://jubakpicks.com/2011/02/18/update-bhp-billiton-bhp-2/

If you want to invest conservatively—and it’s not a bad idea with iron ore prices at their highest levels since the mining boom ended in 2008—I’d say it’s safe to let your iron ore stocks run for the next two years before looking for signs that supply might be catching up with demand. (Vale and BHP Billiton are both members of my Jubak Picks 50 Portfolio http://jubakpicks.com/jubak-picks-50/ )

Vale’s results certainly reflected the current good times. Revenue for the quarter more than doubled to $15.2 billion from $6.5 billion in the fourth quarter of 2009. Net income for the fourth quarter climbed to $5.92 billion or $1.12 a share from $1.52 billion or 28 cents a share in the fourth quarter of 2009. Wall Street analysts had expected $1.01 a share. Vale said iron ore prices in the quarter rose to $122 a metric ton from $56 in the fourth quarter of 2009. Production climbed to 308 million tons in 2010. That was 29% higher than in 2009. (The company’s goal to raise production to 522 million tons by 2015 represents a further 70% increase in capacity.)

Iron ore is no longer the only story at Vale, though. Vale produced 207,000 tons of copper in 2010, up 4.5% from 2009. The company’s goal is to produce 1 million tons by 2015.

Nickel production in the quarter doubled from the fourth quarter of 2009 to 65,000 metric tons. Nickel production will decline about 5% in 2011 as the company repairs a furnace at its Copper Cliff plant in Canada.

Vale’s stock didn’t exactly soar on the news, sinking 6 cents or 0.18% instead. But it’s been hard for any Brazilian stock to get traction this year in the face of rising interest rates, climbing inflation, and forecasts of slower domestic growth. The Bovespa Index was essentially flat today and is now down 3.4% in 2011. Vale’s stock is up a scant 1.6% in 2011.

I think Vale’s fortunes are tied more closely to the performance of overseas steel-making economies in China and the European Union (a more important market for Vale than for its Australian competitors due to transportation costs) than to the domestic Brazilian economy. Depressed share prices in Brazil, which could well last for another six months or more, give investors a very extended buying window on Vale. I’d put a 12-month price target of $44 on the stock.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did own shares of Vale as of the end of January. For a full list of the stocks in the fund as of the end of January see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/

Update BHP Billiton (BHP)

As tea leaves go, those presented to investors in BHP Billiton’s (BHP) February 16 post-earnings-report conference call could have been a bit clearer. I think the way to decide buy/sell/hold on BHP and on the mining sector as a whole is to look past the very confusing top down strategic message to the nitty gritty of the key commodities of iron ore and copper. (BHP Billiton is a member of my long-term Jubak Picks 50 portfolio http://jubakpicks.com/jubak-picks-50/ )

Let’s start with the murky top-down stuff first, okay?

CEO Marius Kloppers said the company would increase its dividend for the first half of 2011 to 46 cents (U.S.) from 42 cents. I’m not clear what that is a sign of since the increase barely keeps pace with appreciation in the Australian dollar—for Australian shareholders, in other words, the increase is no increase at all.

Kloppers also announced an expansion of the company’s current $4.2 billion share buy-back to $10 billion. That amounts to about 4% of the company’s outstanding shares.

And he said that the company wasn’t actively looking at any acquisitions right now although the company has plenty of cash and cash flow: BHP Billiton reported six month profits of $10.7 billion on February 16.

So was BHP Billiton saying that it thinks mining stocks are expensive now, so no acquisitions? Hard to tell because Kloppers may be feeling a bit burned on the acquisition front after a failed bid for Potash of Saskatchewan (POT) in 2010.

And are the increases in the dividend and in the share buy-back plan a signal that the company thinks the commodities boom is getting near an end and it’s time to pull back on investments in its business? Read more

The sky’s the limit. The sky is falling. In the short term pretty that much describes the behavior of commodity stocks.

And it’s all too easy to get caught up on the drama of those short-term moves because the possible profits if you can outguess the market are all too tempting. (I know because I get caught up in it myself.)

But for most of us who aren’t blessed with market-beating 20/20 foresight, playing the short-term volatility of commodity stocks isn’t the best way to make money in this sector.

For most of us most of the time, it’s the long-term swings between scarce supply (which sends prices up and up) and scarce demand (which sends prices down and down) that can last for years and years and years that are the best source of profits.

And right now the long-term pattern says we’re an upswing that has at least two more years to run before it sees a significant downside challenge.

Why do I think that? Supply and demand tell me so. I’m going to end this post with my take on the supply/demand picture as I see it for several important industrial commodities. But first, let me try to put the current short-term volatility in some context.

It’s the potential rewards that get our attention in the short term. Iron miner Vale (VALE) was up 42% from the August 2010 low to the January high. One-stock commodities portfolio BHP Billiton (BHP) was up 44% from the August low to the February high. Molybdenum and copper miner Thompson Creek Metals (TC) was up 88% from the August low to its January high.

But the volatility? Who can stand the drops? Look at just one stock, Freeport McMoRan Copper & Gold (FCX).

On January 11, 2011 shares had rallied to $60.90. Two weeks, January 25, later the stock had dropped 12.6% to $53.22.

On November 11, 2010  it traded at $54.01. Six days later, on November 17, at $48.42. That’s a 10.3% drop, a correction, in just six days.

But by November 11 the stock had soared 62% from its August 25, 2010 low at $33.33. That’s 62% in two and a half months.

And just in case this volatility wasn’t enough by itself to make you insane, hovering over all of these moves is the memory of great commodity rally of 2007 when Freeport McMoRan climbed 86% and the great commodity collapse of 2008 when the stock dropped 74% for the year. The volatility in 2008 was even worse than that if you looked at just the last six months of the year. Freeport McMoRan fell from $61.65 on June 13, 208 to $9.03 on December 3 of that year.

But if this kind of short-term volatility is what you’re focused on, you’re paying attention to the wrong time frame. Read more

Update Vale(VALE)

And the biggest winner from Argentina’s huge natural gas from shale discovery in Patagonia?

YPF Sociedad Anonima (YPF) is certainly a winner. The find of 4.5 trillion cubic feet of gas is roughly double the Argentine company’s previous proved natural gas reserves of 2.7 trillion cubic feet. YPF already produces some natural gas from four wells at the Loma La Lata field with a daily output of 100,000 cubic meters.

Repsol YPF (REP), the Spanish oil and gas company that controls YPF, is certainly a winner. Media reports, unconfirmed by either company say the find could hold as much as 250 trillion cubic feet of gas. By contrast Argentina’s proved natural gas reserves before the find totaled 12 to 13 trillion cubic feet. (“Proved” is a much more meaningful measure than “reported in the newspaper,” I’d note.) Repsol is planning to sell 15% of YPF in a public offering.

But the biggest winner might actually be Vale (VALE). The Brazilian iron ore giant is moving to become the biggest fertilizer producer in Brazil and it’s new $4.3 billion Rio Colorado project sits in the neighboring Argentine province of Mendoza. To mine potash there Vale needs natural gas, lots of it, and until this find it looked like it was going to have to battle a tight Argentine natural gas market to get the supplies it needed or import it from somewhere. The alternative sources were all either politically iffy or likely to be very expensive. The Rio Colorado project is scheduled to begin production in the second half of 2013 with initial production capacity of 2.4 million tons and the potential for 4.4 million tons.

And now?

It’s clear now how Vale will find the gas it needs. (And in retrospect I doubt this find comes as a surprise to Vale. We are talking about a mining company that’s pretty good at assessing future resource potential.) Vale will invest $150 million along with YPF to begin developing the find with half of natural gas production going to Vale.

This is the second big deal that Vale has signed to secure infrastructure for the Rio Colorado mine. Read more