The Adventures of Tintin is a comic book series started back in 1929. My 9-year-old son loves it. I enjoy reading it along with him because the hero of the series, a young Belgian reporter named Tintin, often finds himself in interesting historical settings and exotic places. (My favorite story is “The Blue Lotus”, which takes place during Japan’s occupation of China in the 1930s.)
In one of these adventures, Tintin discovers oil on old American Indian lands. In a series of panels, a little construction boom transforms a wilderness into a busy city in a matter of hours. It’s funny, but it also makes a point: After you discover oil, there is a whole lot that comes after that. The infrastructure of the oil business, you might say. I was thinking of Tintin after reading more about Brazil’s big oil discoveries.
You’ve probably heard about Brazil’s Tupi and Carioca, which may be the two biggest oil fields discovered in the last 30 years.
The Tupi field may hold 8 billion barrels of oil. If true, only the 15 billion-barrel Kashagan field in Kazakhstan, discovered in 2000, is larger. Tupi, though, may be small potatoes next to Carioca. This latter field may hold 33 billion barrels of oil. Again, if true, Carioca would be the third biggest oil discovery in history, behind only the mammoth Ghawar in Saudi Arabia and the Burgan in Kuwait. Brazil has another field it is assessing now, called Jupiter, which could be of the same scale as Tupi
What makes these discoveries particularly remarkable, in addition to their size, is where they are. They lie underwater, hundreds of miles off the coast of Brazil. Call it “blue water energy.”
Tupi’s oil, for instance, is 7,000 feet underwater and beneath another 7,000 feet of rock, sand and salt. It costs about $240 million just to drill the well there, which is like paying a big cover charge to hear a band you may or may not be happy with. Who knows how many more hundreds of millions it could take to get the oil out and to market?
One thing is for sure. Petrobras, the Brazilian oil company that discovered the oil, will spend a lot of money trying. Already, Petrobras has plans to spend more than $20 billion for marine support vessels and offshore drilling equipment. Those are big numbers, especially when you consider how tight the market already is for these things – not to mention the shortage of men and material to make more.
For perspective, consider that Petrobras has already leased nearly 80% of the world’s deep-water drilling vessels. It will certainly try to lock up more rigs and vessels. But so is the whole industry, which is why offshore drilling companies are making money hand over fist like rose sellers on Valentine’s Day.
It’s not just in Brazilian waters that big prizes lurk. There are meaningful discoveries of oil and gas in the South China Sea, off the west coast of Africa and even in the waters off Trinidad and in many more wet places. Soon we could be poking around for oil beneath the Arctic seabed.
We’ll need lots of subsea wells and platforms and other goodies to put out there in those watery plains. Just consider the pipelines alone. We’ll need miles and miles of offshore pipelines to bring the oil to market. See the next chart, which shows the miles of pipeline needed by region.
According to Quest Offshore, between 2007-2011, the industry will have laid down 35,000 miles of pipeline. That’s a lot of steel. And a lot of pipelay barges to do the work. And crews. It’s a demand that should continue for years to come, even if the oil price comes down.
That’s only part of the story, though. Here’s the other: the existing miles of pipelines that are getting old. This is a familiar theme in our pages. We’ve often talked about the creaky infrastructure surrounding everything from roads and bridges to water and power supply. Matt Simmons, the oft-quoted energy analyst, likes to say, “Rust never sleeps.”
The problem is particularly acute in seawater. It’s more troublesome because you can’t see it. Such infrastructure requires a lot of maintenance, which is not cheap. On the heels of two decades of low oil prices, much of the industry deferred a lot of maintenance. This problem extends beyond just the offshore oil and gas business.
The whole oil and gas infrastructure is a “vast spider web of steel.” There are over 335,000 miles of pipelines in the U.S. alone.
There over hundreds of refineries in the world, as well as thousands of tank farms, gas stations and oil and gas wells. Simmons estimates that 90% of our offshore drilling rigs are too old, pushing the limits of what we know they can do. The average age of the world’s offshore jackup fleet – over 400 rigs – is over 24 years. Our experience running them past 25 years is limited. Plus, newer deepwater projects are pushing the limits of how deep we can go, putting bigger strains on everything.
As Simmons says: “The entire value chain is built of steel. Steel begins to corrode the day it is cast.”
The risk of failure – of leaks or breakages – is high. “If the world wants to continue using energy, its assets need to be rebuilt. Simple law of nature,” Simmons says. “The construction job will rival the combination of building the World War II war machine, the Marshall Plan rebuilding of Europe and the post-World War II Interstate Highway System.”
Simmons gives us one example, just a snippet of the infrastructure the industry is building. It is a $1.5 trillion energy project in the Middle East – Shell’s massive gas-to-liquids plant in Qatar. It is as large as 450 football fields. It will require 300,000 tons of steel and employ 35,000 workers. All the while, the prices of steel, cement, copper, etc., all continue to rise. People, too, are hard to find, like parking spaces in Manhattan. “We let Nintendo work stations replace skilled oil workers,” Simmons says.
It’s a massive opportunity. The offshore drilling boom, and Brazil’s offshore scores, only adds to the urgency of it all. I’m looking now at some of the companies that will participate in the big offshore infrastructure build-out. They also benefit from replacement work, too.
If Herge, the artist behind the Tintin series, were alive today, he wouldn’t be surprised to see the rush of infrastructure that follows big oil discoveries. Some things never change. He probably would be surprised, though, to hear about oil fields deep under the world’s big blue seas.
Sometimes you can buy assets in the stock market for cheaper than what it would cost you to get those same assets in the private market. Taking advantage of the gaps between the two is what investing like a dealmaker is all about. Such a gap, it seems, has opened up in the mining sector.
I think the gap exists because people in the mining business understand two things that stock market investors have yet to fully grasp. First, there is a growing scarcity of high-quality mining assets. Second, there is a shortage of skilled workers. Simmons calls it a “blue-collar boom in mining.” So stock prices don’t yet fully reflect these realities, and prices are cheaper than prices miners get when they buy assets from each other – or start them up from scratch.
First, let’s size up the scarcity of high-quality mining assets, which has led to something of a race to lock them down. For evidence of that, we need look no further than the merger-and-acquisition market. For the first five months of the year, the announced mining takeovers tripled compared with a year ago. The total, about $200 billion in deals, puts mining mergers at the top of the M&A list for the first time since Bloomberg began compiling the numbers, in 1998. Over the prior two years, financial services companies have led the pack.
This feat is even more impressive when you consider the storm in which this financial torch has passed – amid a U.S. recession, growing inflation and an unfolding credit crisis. Global M&A overall is down 37%. Yet there is the mining industry atop the dealmakers’ pile, grinning ear to ear and still flush with cash for even more and bigger deals. The world’s biggest mining transaction ever would be BHP Billiton’s $147 billion bid for Rio Tinto. Transactions this size would have been unimaginable even five years ago.
What this means, in my view, is that mining companies think it is cheaper to buy mining stocks than it is to open new mines. It’s pretty simple. If you can buy eggs for $1 or raise your own for $3, you buy eggs all day long. New mines are hard to bring online. And it takes a lot of time. As a Morgan Stanley adviser recently put it, “If companies want to grow, they can either find something that might take 10 years to develop or buy something,” he said. Even so, exploration is up, as well.
There is a lot of risk with new mines, too. Especially since many of the new sources of mines are in politically unstable parts of the world, like Africa, or are difficult and expensive to mine. What new deposits have been found also tend to have lower grades. That means the resource isn’t as concentrated and there is more filler to process to get to the good stuff, be it copper, zinc, iron ore or what-have-you. Repeatedly, too, I hear mining companies warn about rising costs – for labor, equipment, energy and transportation.
The newer twist to the metals story is the power supply problems of many countries – South Africa, Chile, China and others – all important producers. Years of underinvestment in power supply – an issue I’ve written to you about before – is a global problem. And you can’t fix it by flicking on a switch. It takes years to build power plants and add capacity.
South Africa is a particularly egregious case of power shortages. The effect on production is devastating. In the first quarter, mining output fell 22%, to its lowest level in 40 years. Mining companies in South Africa face the risk of repeated power outages and/or forced reductions.
Chile is suffering from severe power shortages, too. It depends on Argentina and Bolivia for natural gas. As the latter two countries consume more natural gas, they export less to Chile. Chile’s water levels are also 40% lower than a year ago. Since Chile depends on hydroelectric power, this is a big problem. Electricity costs are skyrocketing in Chile. As it makes about 35% of the world’s copper, its ability to expand or even maintain that production in the face of power shortages is in doubt.
These are just two examples, but there are certainly many more. Another factor holding back new supply and making existing mining operations so valuable is the lack of skilled people. Companies doing everything from mining coal to operating offshore drilling rigs all note the big challenge in finding enough qualified people.
The traditional skills are in short supply – people who can run a machine shop or a mining operation, for example. These skills are also not easily acquired. Yet a wide gulf exists between what these people make and what the guy running a mortgage trading desk on Wall Street makes.
As Michael Aronstein, a longtime money manager and strategist, recently put it:
“The relative compensation [difference] between somebody who is sitting on a derivatives desk and a guy who actually can diagnose and repair a locomotive has probably reached its millennial extreme… But that’s going to change. I think we’ll see the narrowing of all these spreads, a process that started at the lows in ’02.”
Add all this up – the hot M&A market, the power supply problems, worker shortages and more – and the bottom line is that supply is having a hard time meeting demand.
And demand is there, fueled by booming economies in China, India and Russia. In fact, much of the M&A business comes from these three countries. They need new supplies of metals to keep up with demand at home. For example, Aluminum Corp. of China and Sinosteel have spent more than $16 billion buying mining assets across the globe. These companies are looking to secure raw materials such as coal and iron ore.
Mining stocks, not surprisingly, have done well over the past couple of years, even as the broader market has gone nowhere.
For example, S&P’s Metals and Mining ETF, a decent proxy for mining stocks, has doubled over the past two years. The overall market has barely budged.
Yet the view from the ground, as the foregoing argues, seems to be that mining stocks may still be too cheap.
for Markets and Money