Question: Where is the price of petroleum going?
Eric Sprott: Long term, up… I can see it hitting $200 or $300 or $400 a barrel.
— Barron’s, Aug. 18, 2008

Eric Sprott runs the Sprott Offshore Fund, a fund that’s delivered sizzling returns of 32% per year since 2002. Certainly, timing is important, as 2002 was the last great bottom. Even so, it’s not so easy. Lots of people have done a lot worse than average 32% since 2002. Sprott, a 63-year-old billionaire, has been on the money when it comes to calling the resource markets. That’s his meal ticket, and his fund is loaded with resource names.

Of course, with oil down more than 40% off its July high and the whole resource market in the tank, it seems outrageous to think that oil could hit $400 per barrel, as Sprott says in his Barron’s interview. I choked on my bagel as I was reading it one Saturday morning.

The point, though, is not really what anyone thinks the price of oil may or may not hit. The point is that the fundamentals of the resource markets still look good on a long-term basis. Sprott points to the continuing depletion of big oil fields and the difficulty of increasing production. “We spend more and more every year and get no more net production,” he says. He continues:

“And the list of countries whose oil production has peaked keeps growing, including Russia, which for eight consecutive months has had year-over-year declines. Companies have the same problem. The latest results from Exxon showed that its production was down about 3%.”

Oil is still immensely profitable to produce. If producers could economically up production, they would. In fact, many resource companies are making good money. They’ve got good balance sheets. They own things that are hard to find and reproduce. I think we’ve got to stick with the names even though the price action in the last few months has been horrible.

It’s a tough market right now. There is no way around that. Even those of us who stayed away from the imploding financial firms and avoided housing bubble stocks still got hurt. Even as we stuck with companies loaded with tangible assets at cheap prices, we’ve watched many of them just get even cheaper.

But we can’t give up the quest. Mostly, because getting through the valley will mean making a lot of money on the next ascent. I keep thinking how we’ll look back on this time one day and marvel at the prices some stocks traded at. We’ll wonder why we didn’t pick up some of Stock X when it was trading for one-fifth of the price.

That’s the sheer greed part of it all. But the quest is built on firmer ground. We hold to the theory that value wins out. Wide gaps between stock market prices and business values eventually close. We take it as a given that we won’t be able to time the tops and bottoms. So we play a probability game. We bet on probable winners in the full knowledge that some won’t work out. But we choose to stick with them as long as our essential theses remain intact…

Until next time,
Chris Mayer
November 13, 2008

This Small Cap Oil Company Will be Catapulted by the Coming Resource Rally was originally featured in the Penny Sleuth.