The headlines seem to be rolling in nonstop for Big Oil: “Chevron Posts Record $17 Billion Profit. BP Profit Up 52%, Record $4.4 Billion Quarter.” And the giant among giants, “Exxon Mobil Reported All-Time Record $39.5 Billion Profit.”

We’ve all seen these headlines before and, sad to say, many investors bought into the hype. Both Chevron and Exxon Mobil shares have climbed more than 150% in the past five years. BP, despite constant problems with its pipelines and international operations, has scored a 50% gain in the past five years.

On the surface, it seems like a pretty safe bet, right? Big equals safe. With Big Oil sporting a total market value of more than $2 trillion, how could you go wrong? A barrel of oil is trading around $90 and not showing any signs of falling back to $50 or $60 anytime soon. Profits are up. And all should be well and good in oil country.

That rationale couldn’t be more wrong.

Since the start of 2008, Big Oil stocks have led the market down falling about 15% across the board. And this fall is just the start.

Profits are high right now, but that’s all about to change. Big oil is actually impoverished. Simply put, the cost of finding and producing each additional barrel of oil is soaring, and Big Oil can’t handle the expense. (You’ll see in a second who can.)

The cost of finding each new barrel of oil in the ground has surged from $2 in 2000 to more than $9 in 2007. That’s a 350% increase… and it’s only getting bigger.

To offset this increased cost, oil companies are spending more and more in capital expenditures, or capex. Capex is the amount of cash a company reinvests in itself to keep the business growing. As a result, capex is the lifeblood of any industrial company.

In the oil industry, capex includes the cost of buying new rigs, tracts of land or offshore areas for development, and developing new oil-finding technologies (once they are proved economically viable).

Last year, Exxon’s capex surpassed $15 billion, Chevron invested $4 billion in new projects, and BP unloaded $15 billion into finding more oil. They were all trounced by Shell when it spent more than $24 billion in capex, more than double what it had reinvested in 2003. These were all record amounts for capex in the oil industry.

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However, each dollar invested back into the company is producing a smaller and smaller return. Take a look at the chart below.

Big Oil’s reserve replacement rate is in sharp decline while they’re spending record levels of cash to find more oil. Big Oil is running out of oil. (Hold on for a second! It’s not because of the reasons those “peak oil theory” nutjobs always point to.)

Clearly, there’s a problem here. Is the world running out of oil? Not a chance. According to the most recent report from the end-all, be-all energy industry consultant, Cambridge Energy Research Associates (CERA), the world has only consumed one-quarter of the total oil reserves in the world. So, there’s plenty of oil left out there.

The real problem is actually twofold.

First, Big Oil is not spending enough to find and develop new oil fields. Granted, they’re spending more, but not enough — not by a long shot. That’s why they’re replacement rates are falling; because they’re currently producing more oil than they’re finding each year.

The second (and most profitable, for that matter) is they’re getting beaten to the punch. State-owned oil companies are the ones developing the new sources of oil. Take a look at the chart below and you’ll see what I mean.

In the last few years, Petronas, Malaysia’s national oil company, has uncovered more than 4 billion new barrels of oil. ONGC, India’s national oil company, has located about 1.5 billion new barrels of oil. Petrobras has uncovered a little less than 1 billion barrels. CNOOC of China and Statoil of Norway are right there, too.

These oil companies are breaking the mold of state-influenced bureaucracies (think Social Security Administration) and not just beating Big Oil at their own game, but destroying them.

The world has changed. Big Oil is losing out and will be paying the price down the road. And shareholders of Big Oil titans are going to be feeling the pinch as well. However, that doesn’t mean there aren’t gains to be had in the oil sector.

Andrew Mickey
TFN