The big problem with the oil boom...

The big problem with the oil boom... A better way to buy real assets... Why ATP is only worth $200 million, instead of $17 billion... The real consequences of 'peak oil'...

In today's Digest... a genuine investment secret. This is something almost no one understands about investing in distressed assets. I'm going to give you a simple formula to use that will enable you to make a fortune over the next three or four years. In fact, I plan to use these same ideas to make $1 billion in oil and natural gas assets over the next five years.

I'm sure that sounds implausible... But the fact is, billions of dollars will be made in oil and gas in America over the next few years. Goldman Sachs predicts we'll see a new all-time high in daily oil production by 2017, more than 10 million barrels per day. This will make America – yes, America – the world's leading producer of crude oil. Huge fortunes will be made during the coming oil boom... But those fortunes almost certainly won't be made by investors who buy oil stocks. There's a huge irony behind this oil boom... And that's one of the most important lessons in today's Digest.

I hope you'll read today's message carefully... and think for a bit about the strategy I'm outlining below. I sincerely believe it could change your life forever... certainly, at least, the way you invest. But... please... if you're a brand-new subscriber, don't think that all of our messages will be this intense.

If you've never read the Digest before, you might think you've bought some Ph.D.-level online finance course. You haven't. But Fridays, when I write the Digest personally, I strive to actually teach our readers something useful that they probably wouldn't learn anywhere else. In short, I do my best to show you the things I'd want to know, if our roles were reversed. I believe today's message is particularly important... and worth exploring in some detail.

Oil production is soaring in the United States. Inventory data out this week confirm all of the anecdotal evidence I've been gathering over the past several months. The consensus forecast was for a stockpile drawdown of 1.3 million barrels, as the summer driving season is upon us. But instead, reserves grew by 2.8 million barrels. As a result, U.S. crude inventories have never been higher at this time of year than they are right now.

This trend toward massive new amounts of production is going to continue... for decades. Let me explain why…

At the end of 2010, the United States had about 15 billion barrels of proven, recoverable oil. Today, according to my sources in the industry, at least five new major shale plays have more than 20 billion barrels each of recoverable oil: the Bakken in Montana and North Dakota, the Eagle Ford in Texas, the Marcellus in Pennsylvania and New York, and the Monterey in California...

Plus, there's another shale formation in Texas that's still almost completely unknown. It is reported to be the largest in the country, with more than 35 billion barrels of recoverable oil.

Each of the major new shale plays will probably double the total reserves we have today. And one of them would triple our current reserves. It will take many years to drill enough wells to prove out these reserves. But as you can see from the chart below, that effort is now well underway. The number of drill rigs in operation has exploded. And that's why oil production is soaring.

Now... about that irony I mentioned... Over the past five years, we've seen what can happen to leading resource stocks when they're too successful at discovering new assets. Remember… the new drilling technologies allowing us to extract petroleum from vast shale formations have already created a glut of natural gas supplies.

So consider the fate of natural gas producer Chesapeake Energy... Nobody has drilled more wells or found more natural gas than Chesapeake over the past decade or so. Chesapeake basically came out of nowhere to become the No. 2 producer of natural gas in the United States. Sounds great, doesn't it? You'd think shareholders got rich, wouldn't you? Nope. Here's what happened instead...

As Chesapeake ramped up production, natural gas prices began to plummet. As a result, the company's margins disappeared. Because the company is so dependent on debt-financed capital, it's actually in jeopardy of going bankrupt. Now, let me be clear: I don't think that will happen. The company has plenty of assets it can sell... and natural gas prices are starting to rebound. The stock is actually likely to do much better going forward. But the point is... for resource production companies (like Chesapeake) that carry lots of debt, soaring production volumes can actually threaten shareholders. That's the exact opposite of what most investors expect to happen as oil production soars.

If you want to know what's likely to happen with most of the oil companies in America in the next five years, just look at what happened to natural gas stocks over the past five years. They give us a road map to see exactly what's going to occur.

And... I need to say a word about why almost all the onshore oil and gas exploration and production companies in America are so poorly capitalized. This is something that almost no one understands. As you'll see, it's critically important and plays a huge role in setting up our opportunity.

Beginning in about 2004, the idea of "peak oil" came into vogue. The theory was simple and compelling. In short, peak oil adherents claimed the world only has so much oil and we were starting to use it up. They argued production rates were sure to fall because we're running out of oil. In fact, the decline was supposed to be steepest in places like the U.S., where the oil fields were thought to have peaked in the early 1970s.

You need to realize how seriously people took these ideas. Consider, for example, what Fatih Birol, the chief economist of the International Energy Agency, said about the imminent arrival of serious oil shortages…

Yes... that's a real quote, from a March 2008 presentation he gave.

If these ideas were true... investors (and banks) could safely allocate almost unlimited amounts of capital to oil exploration and production projects. No matter how much capital you invested in it, oil production rates would never increase again. Oil prices, meanwhile, were sure to soar. Many large investors believed that oil represented a "one-way" bet. As a result, companies were able to borrow huge sums of money.

Well... what's happened since? I'm sure you know. As it always does, the free market worked its magic. High oil prices led to massive investments in new technologies that have unleashed huge new supplies. The simple fact is, the peak oil people might have known something about the geology of hydrocarbons, but they didn't know anything about how free markets work.

I don't want to waste too much time on this part of the discussion... But everyone who has ever predicted that we would run out of a major commodity – starting with 18th-century reverend and economic theorist Thomas Malthus – has been dead wrong. Scarcity is the central fact of economics... But the price system always leads to either more supply or a gradual decrease in demand. That's why it doesn't matter if the Earth holds a finite amount of oil. It's economically meaningless.

Believing in the wrong ideas comes with real consequences. And the real consequence of peak oil is that much of the oil and gas sector in the U.S. is weakly capitalized. Ten years ago, investors came to believe the price of oil would never decline. So they made decisions that now spell catastrophe if the average selling price of oil declines even moderately. Let me give you a real world example...

Imagine if you owned 40% of one of the largest natural gas discoveries in history... a find called Shimshon. It sits in shallow water off the shore of Israel, in a larger production area known as the Levant. Altogether, the Levant area is estimated to hold more than 35 trillion cubic feet of gas, making it the largest discovery of natural gas in decades – maybe ever. The Shimshon block alone is estimated to contain around 3 trillion cubic feet of natural gas, worth $19.5 billion at prevailing prices in Israel, $6.50 per thousand cubic feet (mcf). Based on the company's existing annual production of natural gas (17.4 billion cubic feet), this new find represents 170 years of additional production. That's a huge find.

If you owned that company, you'd be rich right? If you were a shareholder (a partial owner), you'd expect that your stock would have done great over the past few years as these huge discoveries were made and proven.

The company that owns Shimshon also produces oil and gas from big wells in the Gulf of Mexico. The company's revenues should come in this year at something around $600 million. Put this existing production together with a huge new find, and you would expect to see a company that's worth a lot of money – several billion dollars, at least. Right?

You'd be way off. The company is nearly bankrupt because it has $2 billion in bonds outstanding (at face value). It's even been borrowing from its contractors because it doesn't make enough cash selling natural gas to pay its operating bills. Its shareholders will likely walk away with nothing.

Don't worry... Those assets will be developed. Demand for energy in Israel and Turkey is tremendous. But the shareholders likely won't see any profits. Instead... another kind of investor is already preparing to make a move... to do a deal most investors have never considered... It's this investor who will end up owning billions of dollars of oil and gas assets.

The company I described above is real. It's called ATP Oil and Gas (Nasdaq: ATPG). Here's the shocker: Its shares are worth almost nothing – they're trading for less than $5, which values the whole company at only about $200 million. That's peanuts for a global oil company. And ATP stands a good chance of going bankrupt.

How much "should" ATP Oil and Gas be worth? For comparison, you might look at Noble Energy (NYSE: NBL). It also has operations in the deep water Gulf of Mexico and off Israel's coast. As little as four years ago, the two companies' shares traded for nearly identical prices. Today, Noble's market cap (its share price multiplied by its shares outstanding) totals about $14 billion, or roughly 70 times more than that of ATP Oil and Gas.

You can see for yourself what's happened by looking at the trading history of the two companies over the last five years. Even though they were both involved in the same huge, new field off Israel and even though they operate in nearly the same areas, one stock has done well and one has been destroyed.

That's why I always caution investors... owning an oil company isn't the same thing as owning oil assets. The assets are valuable, no doubt. But... if the company mismanages those assets or can't produce them profitably… the stock can still tank.

That's why I'm encouraging everyone who is interested in investing directly in oil and gas assets to focus only on buying the assets themselves, not the producing company's shares. I want you to invest like H.L. Hunt did. He bought the East Texas field in the midst of the Great Depression by buying out the bankrupt promoter of the field, Dad Joiner, for only $30,000 in upfront cash. The field went on to produce 4 billion barrels of oil, making H.L. Hunt the richest man in the world by the end of the 1940s.

I want our subscribers to look for those same kinds of deals. You want to buy the oil assets, not the troubled, highly indebted companies. During the coming oil boom, dozens of companies will suffer the same fate as ATP Oil and Gas. They are overleveraged. As production rises and prices fall, the shareholders will get wiped out. I plan to be there... waiting... And I want you to be there too... sitting at the table... when they come begging for a deal. We're going to wait and buy these assets for pennies on the dollar.

How can you do deals like this? Let's look again at ATP Oil and Gas. Right now, most unsophisticated investors would simply buy the stock. "Why not?" they figure. "It's trading at around $4 a share, how much could I lose?" Well, you can lose 100% if it goes bankrupt.

Meanwhile, its bonds – securities that represent loans made to the company – are currently trading for less than 50 cents on the dollar. And they're yielding 50% annually. If you buy these bonds... and if ATP doesn't go bankrupt… you'll make a 100% capital gain and earn 50% annually until they reach maturity in 2015. That's a total return of around 250%. That's far more than you're likely to make in any stock in just three and half years.

But that's not the best part. The best part is, if anything goes wrong and the company can't pay back the bonds in full... you end up having a legal claim to the assets. In other words, either you're going to be paid 50% annually and end up collecting $1 for every $0.50 you lent the company... or you'll end up being one of the owners of that huge new find in Israel.

This kind of investing, known as distressed debt investing, is almost completely unknown to most people, but it is the most powerful secret of real asset investors – folks who finance things like oil wells and gold mines. I've worked with some of the world's best real asset investors for more than a decade. I know most of them by their first names. I know the deals they're looking at. I know the assets they like. And most important, I know what price to pay for the bonds.

Investing in bonds is actually much safer than buying stocks. In the worst-case scenario (bankruptcy), the average recovery for the average corporate bond is 45 cents on the dollar. So if you're buying bonds for 50 cents on the dollar or less, you practically don't have any downside. And remember, those are average figures. Firms backed by real assets frequently have larger recoveries because their collateral is worth so much.

Again... just look at ATPG. If you assume its assets are worth half as much as its competitor (Noble), you'd expect these assets to be worth $7 billion today. That's a conservative estimate. It represents only half the market value of ATP's competitor, a company that's active in the exact same natural gas field off the coast of Israel.

But you can buy all of ATP's bonds today for only $1 billion. The ultimate potential upside... assuming the worst does occur and the bondholders end up owning the assets… is as much as seven times your investment. Yes, I realize you're probably not going to buy all of the bonds. But these numbers are the same for any fractional owner. There's a huge upside to investing this way… and little possible downside.

This is the kind of investing we do in True Income. You won't find anything like this analysis anywhere else. Right now, we're building a huge database of every single oil and gas company in the world. We will track these companies' bond prices every day. We're waiting to see when the value of their capital structure – their stocks and bonds – offer us what amounts to a can't-lose bet.

Our formula is simple. We evaluate the quality of the assets based on the company's production cost, which is a function of the amount of natural gas in its reserves. A simple calculation based on this information shows us how much of a discount we need to buy safely.

I hope you won't think I'm bragging... But I doubt another newsletter editor in America has done even half as much work on the sector as I have or has applied this level of sophistication to his analysis. You can buy other letters, of course... buy and hope. Or you can watch my weekly updates and know with extreme precision exactly what you're getting when you invest in these companies… exactly the risk you're taking... and exactly what the upside is most likely to be.

Imagine... Some buddy of yours says, "I'm taking a flyer on a little oil and gas stock. It's just $4, but it owns a huge field off Israel." Six months later, the company is bankrupt, and your friend has lost his entire $10,000 investment. Meanwhile, using our advice, you've been quietly buying up $10,000 worth of the same company's bonds – but paying less than $5,000 for the entire bunch. Within about 18 months, the company exits bankruptcy... and you've doubled your money. Plus, you own a stake in a reorganized, highly profitable oil and gas firm.

Deals like this will happen over the next 12-24 months. And unless you're going to invest in a hedge fund or start your own distressed-debt investment company, there's really only one way to participate: Start reading True Income. We'll do all the heavy lifting for you. We'll find all the best deals... and tell you exactly what price to pay. All you'll have to do is call your broker and tell him what bond to buy and how much to pay. There's only one thing we can't do. We can't make you subscribe. That's up to you.

So do you want to make a killing on the oil boom? If so, now you know exactly what to do. To sign up for True Income (without watching a long video), click here…

New 52-week high (as of 6/21/2012): Alico Inc (ALCO).

Are you already set up to profit big from the coming oil boom? Which of our energy picks have you invested in? Tell us your stories at feedback@stansberryresearch.com.

Regards,

Porter Stansberry

Baltimore, Maryland

June 22, 2012