UV Market Blogs

Saturday, October 21, 2006

The oil situation

The oil situation

OPEC agreed on Friday to cut production of oil by 1.2M barrels per day.  That’s 200,000 or 20% more than expected in cuts.  The original cut was expected to be just 1M barrels.  Some OPEC leaders went as far to say that another 500,000 barrels of oil will be taken off the daily production when OPEC meets again in December.

Recently oil has taken a considerable tumble from the sky high $75 a barrel to just $57.  OPEC has decided to cut back on production in order to push oil back to the previous highs.

Oil is a tricky subject:

Everyday, 82M barrels of oil are produced and sold on the worlds exchanges.  Of the 82M barrels in production, 80M are used immediately to supply the world’s ever increasing thirst for oil.  The remaining 2-3M barrels are usually heavy Saudi crudes which cannot be easily converted into usable energy forms such as gasoline.  This crude usually comes from very sandy ground which is essentially tar.

In simple terms, all the oil that is produced is used up almost immediately.  There is really no room for comfort when it comes to oil.  OPECs 1.2M bpd cut could send oil prices up more than the oil actually represents of daily production.  Assuming that 82M barrels are produced daily, a 1.2M bpd cut would drop the production of oil 1.25%.  However prices would most likely rise 4-5% or even more.  Because oil demand is so tight, the gains and losses are heavily leveraged.

Even when oil is $75-80 a barrel the demand for crude stays the same.  Oil and energy are so much a part of our daily lives that we have come to the point of paying whatever we can in order to get it.  When gasoline was $3.50 in my town, I saw no more bikes on the road or less cars on the street, I did however, hear more complaining and threats of going on a “gas strike.” The fact is that oil is worth more than $75 a barrel.  It has been previously said that a barrel of oil is worth 10,000 man hours of labor, which in the US would cost $51500 even at minimum wage.

I can’t perceive a lesser demand until oil tops $100 maybe even $125 per barrel.  We are so energy dependant that money becomes no object when we talk about gasoline and our oversized cars.  The only solution to lessening prices is to lessen demand.

Google Vs Yahoo

This could be one of the biggest rivalries in the internet content arena.  Yahoo, which has existed years longer than Google and with its own portal filled with news, finance, and games, verses the newly founded Google with an array of disorganized subprojects varying from online video to satellite images of the Earth’s surface.

So who has the upper hand?  Google has a growth rate in the double digits but Yahoo is more like the blue chip stock with steady growth and consistent earnings.

My take on the two:

Google derives 99% of its income from its adwords infrastructure.  This system is basically an advertising agency which charges e-businesses to advertise on sites which display the adwords for a partial take of the revenue.  Without adwords, Google would not exist today.  It would be entirely broke.

Enter Yahoo.  Its a tech titan, its been through the ups and downs of the tech bubble and is trading at just 27 times earnings (Google trades at 67 times earnings).  Yahoo keeps revenue flowing through a variety of online services from news, email, games, groups and many more things including its pay per inclusion directory. 

Yahoo recently created an exact clone of Google’s adwords program, named Yahoo Publisher Network or YPN. This gives Yahoo a clear advantage over Google in the third party advertising arena for many reasons.

Yahoo has become a very profitable company WITHOUT their publisher network.  Only until recently was this program created so it hasn’t added anything to its bottom line.  Google makes 99% of their income from adwords, and Yahoo makes virtually nothing.

What does this mean?
Yahoo can essentially pass all of the money advertisers pay to the sites publishing the ads.  This does no harm to Yahoo’s bottom line because it’s survived without the program for years.  If Yahoo does this it will cause many webmasters from Google to Yahoo to serve ads.  Because Google is so dependant on their adwords program, Yahoo could put Google on its knees in a flash.

Google probably only serves about 15% of its daily ads from the search engine itself.  If YPN is able to offer higher rates to publishers, it could take away 85% of Google’s earnings overnight. 

Yahoo has the advertising networking done already.  Yahoo serves millions of ad impressions throughout its content pages in the portal.  These positive advertiser relations should only help YPN get off the ground and gain ad dollars.  When the advertisers start moving to YPN, so should the publishers.

I think Yahoo is the better long term play in this scenario.  In my opinion, Google is still a few years behind on Yahoo in building up a solid network in which they can display their ads.  Google has made several off the wall marketing decisions in the last year that have really sent investors for a spin.  It bought all rights to myspace ads for a year, they just bought YouTube for $1.65B, and now own a considerable percentage of the dieing AOL.

While I think both stocks are overpriced I think you should buy Yahoo shares if you want to have exposure to the internet.