Monday, July 25, 2011

Bern, Investing in Energy

I was looking forward to Gianna Bern’s Investing in Energy: A Primer on the Economics of the Energy Industry (Bloomberg/Wiley, 2011). My knowledge of the energy complex was haphazardly gleaned, so I thought a primer would be just the thing to pull all the fragmentary bits and pieces together. Ultimately, I was disappointed. Although the book is packed with information, the author’s disjointed, sometimes opaque, and often repetitive prose keeps getting in the way. I suspect that the author, who is the president of Brookshire Advisory and Research, simply knows too much and found it difficult to tell a simple, straightforward story.

The book covers crude oil and natural gas, the power sector (hydroelectric, nuclear, geothermal and wind, solar), and green energy (biofuels and ethanol, cleaner coal). Understandably, given its dominance in the energy markets, crude oil is the focal point of the book.

We read, for instance, about categorizing (not the highly technical task of measuring) reserves into the proven, the probable, and the possible. Proven reserves have a 90% certainty of being produced; probable reserves, a 50% certainty; and possible reserves, at least a 10% certainty. For some strange reason, the industry isn’t satisfied with this breakdown into P90, P50, and P10. Instead, it offers an aggregating typology: 1P reserves are proven, 2P reserves are the sum of proven and probable, and 3P reserves are the sum of proven, probable, and possible. “Why report 2P or 3P reserves if they are, by definition, unproven? Oil and gas producers report 2P and 3P reserves because they provide a picture as to future potential oil and gas reserve growth.” (p. 55)

Readers who thought they knew what the crack spread was will discover that, as is so often the case in the energy complex, nothing is definitive. The most familiar 3-2-1 crack spread “considers the theoretical profitability of refining three barrels of crude into one barrel of heating oil and two barrels of gasoline.” Since there are 42 gallons in a barrel, the formula is [(1 x HO price x 42) + (2 x RBOB price x 42) – (3 x crude price)]/3, where HO is the symbol for heating oil and RBOB for “Reformulated Blendstock for Oxygenate Blending base grade of gasoline.” (p. 91) (Sounds like a good Jeopardy question to me!) But since seasonal factors weigh on the relative demand for gasoline and heating oil, sometimes it makes sense to look at 1-1 spreads—the heat crack and the gas crack. And outside of the U.S., where diesel often takes the place of gasoline, other ratios—such as a 5-3-2 crack spread--are more commonly used.

The author covers a range of topics critical to understanding oil production, refining, and pricing. One of the more interesting chapters to me, since I’ve been following the ups and downs of the Hungarian oil company MOL, analyzes state-owned and mixed-capital oil companies. Successful examples of the latter are Statoil (Norway), Petrobras (Brazil), and Ecopetrol (Colombia).

Investing in Energy is a blend of information, analysis, and investing advice. It attempts too much and therefore fails as a primer. But for anyone who wants to know what he should know about the energy complex, it’s a good jumping-off point.

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