High Oil Prices: Are They Really All That Bad?

Todd Shriber
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Most of us are programmed to believe that high oil prices are a bad thing, particularly if we live in places without adequate public transportation systems. We feel the ''pain at the pump'' and have to deal with higher airline ticket prices and assorted other problems that arise on the back of soaring crude prices. So, at least in theory, it is reasonable to assume that most folks view high oil prices in a negative light. Fair enough, but that does not mean high oil prices are all they are cracked up to be.

The equation for explaining why high oil prices are not all that bad is like a high school algebra problem in that there are two variables. The first variable is that high oil prices send exploration firms scrambling to invest in new projects to exploit those lofty prices. Today, BP's Chief Executive Officer Tony Hayward, said the current floor for oil prices is $60 to $70 a barrel and that a drop below $60 would discourage fresh investments in projects in areas such as the Canadian oil sands and the Brazilian coast.

In the oil business, there is a cause and an effect. What that means is that when companies like BP (BP), the largest European oil company, and Exxon Mobil (XOM), the largest U.S. oil company, invest in new projects they create more jobs, many of which are well-paying. And when the integrated oil majors start new projects, they have to purchase equipment from the likes of Schlumberger, Halliburton (HAL) and National Oilwell Varco. This domino effect creates even more jobs, which can be a boon for important economic data points such as consumer sentiment and spending, home purchases and starts, not to mention how much money our friends at the Internal Revenue Service can collect.

The benefits of high oil prices reaped by oil explorers and service providers are a segue to next variable in the equation: The profit potential the so-called average investor can be exposed to when oil prices are high. Do not be fooled by the pain at the pump scenario. Assume that you have a car with 15-gallon tank that you fill up once a week every week of the year. If gas prices at local station are $2 a gallon, you'll spend $1,560 a year on gas. If gas jumps to $3 a gallon, you will spend $2,340, nearly $800 more.

That is not chump change and many consumers would argue that a price increase of that nature is a bitter pill to swallow. Most people could not absorb a shock to their wallets like that. Or can they? Readers of this newsletter can, and that objective is achieved through taking advantage of high oil prices by owning shares of the companies that are so frequently vilified for the tidy profits they accumulate when oil prices soar.

Not to be trite, but that $800 extra one would spend a year on gas could be paid for in the blink of an eye with the right oil-related stocks. If you had owned 100 shares of Smith International (SII) at $30 before it was taken over by Schlumberger (SLB), the largest provider of oil field services in the world, you would be sitting on $1,200 in profit. Take $800 of that to pay for your gas and you still come out ahead.

The point is a deal like that would not have taken place in December 2008 when oil was trading at $32 a barrel. Oil M&A thrives when companies want to take advantage of high oil prices but find doing so is more cost-efficient via an acquisition than through other methods of capital investment. Of course it is always great to be owning the shares of the acquired company before the acquisition, but the acquiring companies often end up rewarding their shareholders over the long-term.

National Oilwell Varco(NOV) is a prime example of this trend. The company has spent $12 billion on acquisitions over the past decade and without getting into specific stats, it is clear any of us would be quite pleased if we had owned NOV for the past 10 years. In other words, those higher gas prices would have easily been paid for.

This is a round about way of saying that there is in fact a benefit to higher oil prices and it is a benefit that readers of this newsletter can take part in. Higher oil prices may sting a bit at first, but they also represent opportunity so think twice before wishing for $32 oil.