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Home > Business > Special

Why I am buying oil stocks

Mohit Satyanand, Outlook Money | October 04, 2006

About a month ago, I began buying into Bharat Petroleum. This, despite my resolution "thou shalt not buy PSU stocks". I put the rule in place because government-owned companies often violate business logic; being subject to political whims, their actions are unpredictable, and often destroy value rather than create it. So what made me break my own rule?

In the late 1960s economists and ecologists were predicting that the earth's growing population would lead to a new age of scarcity. For such doomsday 'scientists', it was obvious that countries like India would soon be starved out of existence.

In The Population Bomb (1968) Paul Ehrlich wrote, "The battle to feed all of humanity is over. In the 1970s and 1980s hundreds of millions of people will starve to death in spite of any crash programs embarked upon now."

In contrast, Julian Simon dedicated his book, The Ultimate Resource, to the triumph of man's mind. Using statistics that went back several decades, he asserted that human ingenuity had consistently driven down the price of energy and other natural resources.

He even made a public offer to bet hard cash "on my belief that the cost of non-government-controlled raw materials (including grain and oil) will not rise in the long run". For any date more than a year away, Simon was willing to bet that any such commodity's price would be lower than what it was at the time of the wager.

Ehrlich and his colleagues took up the bet, picking five metals: chromium, copper, nickel, tin, and tungsten. They built an index with $200 worth of each metal (for a total of $1,000), using the market prices on 29 September 1980.

The bet was to be settled exactly 10 years later, based on the inflation-adjusted prices of the metals. If prices rose, Simon would pay Ehrlich the total price increase; if prices fell, Ehrlich and co. would pay Simon.

To cut a long story short, in October 1990, Paul Ehrlich sent Julian Simon a cheque for $576.07.

Mind you, this was despite the fact that millions had not died due to starvation. In fact, in the 1980s, global population was up by some 800 million.

What happened? Julian Simon explains in his Cornucopian Thesis, which says more people, and increased income lead to resources becoming scarce, causing prices to rise. This prompts a search for solutions. In a free society, solutions are found, leaving us better off than before. That is, prices eventually become lower than before the scarcity occurred.

In the past year or so, doomsday predictions have been focussed on oil. Echoing the Ehrlich-Simon wager, New York Times columnist John Tierney has bet $5,000 against an oil analyst who predicts that, by 2010, oil prices will be at $200.

Though I would have gladly taken on the same bet, I waited till it seemed that the US would not confront Iran on the nuclear issue. Now, I believed that oil prices would no longer hold at $75 plus, and looked for companies that would be impacted by cheaper oil. For example, vehicle manufacturers will gain; Reliance, whose refining margins have risen with crude oil prices, will likely suffer.

The most direct beneficiaries, however, will be oil marketing companies - Bharat Petroleum Corp, Hindustan Petroleum Corp and Indian Oil Corp. Over the last 18 months, while the stock market has seen new highs, these companies have been squeezed between higher raw material prices and the government's refusal to let them increase product prices. Government bonds have helped them remain afloat, but as crude prices drop, these corporate giants should come back to profitability.

Over what time frame? I don't know, but I am prepared to wait 5 years, like Tierney, or even 10, like Julian Simon.

The author is an investment advisor to a select group of clients.

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