With Oil Prices Poised To Jump As Much As 70%

[Guest Steve Cook]

http://www.moneymorning.com/2009/05/21/oil-prices-10/

With Oil Prices Poised to Jump as Much as 70%, Every Investor Needs an Energy Strategy

By Keith Fitz-Gerald

Investment Director

Money Morning

The U.S. news media has convinced many investors that oil consumption is falling because of the global recession. While that may be true, it's a disservice to millions of investors because production is declining at a pace that's actually three times faster.

And that suggests higher oil and gasoline prices in coming months - perhaps as much as 50% - 70% higher, or more - particularly if a U.S. economic recovery is truly in the offing.

To really see what I'm talking about, let's start with a close look at consumption. I'm asked about this frequently in my global wanderings, most recently at the Las Vegas Money Show last week.

For months we've been hearing about a drop in global demand. It's a popular story and one that sounds credible: After all, it seems logical to assume that during economic chaos, consumers and businesses alike will rethink their budgets and ratchet back their spending.

For consumers, the continued economic malaise will mean fewer trips to the store, less-ambitious vacations, and car-pooling to school or work . For businesses, the cutbacks by consumers will clearly translate into canceling trips where conference calls will suffice and using lower-cost shipping alternatives for the decreased sales volumes most U.S. companies will experience.

According to the U.S. Energy Information Administration, oil consumption fell by nearly 50,000 barrels a day throughout 2008. According to the latest figures, the EIA suggests that global oil demand may slump to 83.4 million barrels a day in 2009 - nearly 2.4 million barrels below 2008 consumption levels. On a percentage basis, that's almost a 3% drop. I have my doubts that we'll actually see a decline of this magnitude, but if it does occur, it will be the first time ever that consumption has declined for two straight years. That alone is pretty noteworthy in this era of cohesive and powerful global growth.

The reason I have my doubts about such a steep decline in demand is this: While overall consumption is dropping in such developed economies as the United States, Europe and Australia, it's being at least partially offset by continued growth in China, the Middle East and Latin America. Because the data produced there is less than transparent, I can't help but think that analysts are underestimating the growth we'll be seeing in those markets, where consumption is accelerating strongly. And it's entirely possible that growth in those markets will outstrip any fall here in the developed world.

Even if the growth in the emerging markets doesn't quite offset the decline in their developed brethren, analysts seem to be forgetting that oil prices are a function of two variables - consumption and production. And it's the change in production that's going to catch a lot of people by surprise.

After a run of record high oil prices punctuated by frantic resources development, we're now seeing the opposite scenario. The long period of lower than anticipated oil prices following oil's meteoric rise last year means that the entire industry is no longer making the investments needed to sustain production capacity or actual production.

And not many folks recognize this fact.

For instance, direct project investment in drilling may be down as much as 20%, while the number of drill rigs in operation in America alone has dropped by more than 40%. Various estimates from the EIA and private sources suggest that actual U.S. production may fall by as much as 320,000 barrels a day. While the amount is a matter of debate, the fact that production is declining is not.

More than 20% of total U.S. oil production comes from tiny wells located in remote areas that were marginally profitable producers when crude oil was trading at $100 a barrel. With oil currently at about $61 a barrel, those producers are practically worthless now. So the "mom-and-pop" shops that own them are actually abandoning entire fields and equipment without a moment's thought.

To be fair, at least part of the drop in demand can be attributed to increased reliance on methanol, ethanol and other types of biofuel, but that's hard to quantify at the moment because the long period of low oil prices has eroded the economic viability of alternative fuels - at least for now.

The story is much the same with new exploration projects being cancelled left, right and center. The trend is particularly apparent in the Canadian oil sands that were everybody's fancy only 24 months ago. Now we're seeing Royal Dutch Shell PLC (NYSE ADR: RDS.A, RDS.B), StatoilHydro ASA (NYSE ADR: STO) and Petro-Canada USA (NYSE: PCZ) each backing away from multi-million dollar investments that were to bring online an estimated 500,000 barrels a day.

Russian, Saudi and Mexican producers are reporting the biggest production drops seen in 50 years. Even Venezuelan leader President Hugo Chavez - the perennial motor mouth and longtime U.S. critic - is eating crow. He's begrudgingly invited (read that to mean "is begging") the oil companies whose assets he nationalized only a year ago to "come back" into the market.

He has no choice. Venezuela's oil production is already below its 1997 levels, and many analysts say that output could fall even more since Chavez has done such a thorough job of alienating the big foreign oil companies that actually possess the technology needed to extract crude oil from that country's hard-to-reach reserves.

Chavez's Chavez's government seized the assets of 60 foreign and domestic oil service companies after conflict erupted over nearly $14 billion in debt owed by the country's state-owned energy company, Petroleos de Venezuela (PDVSA). PDVSA accumulated the debt as oil prices took a dramatic slide from over $147 a barrel last July to less than $35 a barrel in February.

Then there's simple shrinkage. This is an oil industry term for declining output. The EIA recently released data suggesting that production at more than 800 oil fields around the world is going to decline by about 9.1%. It doesn't matter whether the decline is prompted by depletion, war, or simple neglect. The fact is that this shrinkage will take an estimated 7.6 million barrels per day out of the system.

I could go on but I think you get the picture.

Now imagine what could happen to oil-and-gasoline prices when normalized demand resumes. Not only will there be less oil in storage, but virtually the entire industry - exploration, production, refining and sales - is going to be caught sitting on its heels when the world needs it to be zooming along in high gear. And that means the companies that make up this industry will have to ramp up again to meet the newly increased consumption demands.

This whole process could take two years - or even longer - to play out.

As for prices, history is replete with examples of what happens when there are major shortages of key commodities.

In the Energy Crisis of 1973-74, for example, I can still remember the numbingly long gas lines and waiting in the car for hours to get a fill-up. My father and grandfather vividly remember that prices quadrupled in a matter of months. I'm sure you do, too.

Only a few years later, in 1979, we got another oil shock when prices quadrupled again. Because it was coupled with stagnant economic growth and virulent inflation (stagflation), this period was an economic disaster for the United States.

For those who had learned from the earlier crisis, however, it was a mondo- profit opportunity.

The same can be said for 2007-2008, when the huge spike in oil prices that I predicted contributed to the bear market in stocks, tight credit and recessionary conditions that led to the current malaise that continues to grip the U.S. economy. As much as anything else, high oil prices contributed to the carnage we've seen in the auto-making and airline industries, and to the financial crisis that started here before spanning the globe.

Which brings us full circle.

Many investors will refuse to believe we've arrived at this new energy nexus, especially given all the hype we've seen surrounding alternative fuels, hybrid vehicles and the new "green" mentality that's taken hold here in this country. If you listen to some of the real believers, they'll tell you that we could be living in a petroleum-free Nirvana - as early as tomorrow.

While I personally would like that, too, it's a misleading argument if for no other reason than there are millions of consumer items we use - from plastic bags to makeup - still created using petroleum. And there are still more than 60,000 manufacturing processes that depend on petroleum, and even the most aggressive estimates suggest that it will take the world decades to shift away from them.

We're in much the same situation when it comes to hybrid vehicles. There isn't a mass-produced electric vehicle available today that could offset the coming rise in recovery-driven demand for oil and gasoline. There's a strong effort underway, but I'm not aware of a single company ready to field the solution in cost-affordable quantities by 2010 - which is when most analysts say a recovering economy will stoke demand for oil.

Of course, U.S. President Barack Obama's much-lauded efficiency and greenhouse-gas-standards mandate will help significantly, but that's like bolting the barn door after the horses have run for the fields. The irony of watching auto executives "applaud" his press conference was almost too much to watch with a straight face. But that's a story for another time.

The bottom line is this: Our society will be highly dependent on oil for many years to come and investors should plan accordingly.

If governments around the world really want to get serious, they could collectively work to eliminate the fuel subsidies that are part of the price paid for gasoline in Asia or sugarcane ethanol in Brazil. We could also stop our own energy pork barreling. But given the complete lack of transparency that surrounds this issue - not to mention the influence wielded by vested industry interests, and the scores of well-paid lobbyists that patrol the halls of power in our nation's capital - I don't think we'll see any big changes anytime soon.

So I'm left with one inescapable conclusion, at least in the intermediate term. Every investor needs to have at least some sort of energy strategy - preferably one that includes a range of drillers, producers and suppliers to cover the spectrum from wellhead to consumer.

That way, we can profit from an increase in energy prices that we can only hope rise fast enough to jump-start the oil industry's production arm but not so fast that it snuffs out the badly needed economic recovery.

I am not in the general habit of cutting and pasting. However, this article more or less sums up my own position and I'm in a rush this morning.

As soon as we try to grow again, we hit the resource buffers in short order.

It really is different this time...

Edited May 22, 2009 by Steve Cook

[Tin Foil Hat]

Does that mean I shouldn't buy the 4 litre old Daimler or the 5.5 litre old BMW?

Bugger.

TFH

[loginandtonic]

what makes people think a recovery's around the corner ?

cheap money ?

i dont see it myself, i see a long depression after a euphoric false dawn, but i could be wrong of course & feel free to tell me so & why please

[Ruffneck]

how about he recognises this fact : DEMAND DESTRUCTION

[Johnny Storm]

I stopped reading at this point

And that suggests higher oil and gasoline prices in coming months - perhaps as much as 50% - 70% higher, or more - particularly if a U.S. economic recovery is truly in the offing.

There wont be any recovery for a long time yet. Unemployment will continue to grow, cutting demand for the foreseeable future.

It is correct that *when* or *if* a recovery happens the demand will increase and prices will go up.

[Guest Steve Cook]

what makes people think a recovery's around the corner ?

cheap money ?

i dont see it myself, i see a long depression after a euphoric false dawn, but i could be wrong of course & feel free to tell me so & why please

I am a bit schizophrenic about it myself to be honest. The way I see it, we get one of two scenarios:

Either we suffer a prolonged period of of economic stagnation at best and/or contraction at worst. In which case, we will still hit the resource buffers in the end some years down the line.

Or, our governments go all-in for inflating the recession/depression away. In which case we face those same resource constraints much sooner and much more violently. The problem of constraint of supply then conspires with a debased dollar to push the price to unimaginable highs.

Our governments seem to favour the second of the above scenarios. Presumably on the basis that either there is enough oil left in the ground to fund such growth despite nasty price hikes along the way as we hit supply bottlenecks, or on the basis that they are playing for time and hoping that an alternative to oil is found in the interim.

There is a third possibility of course and that is that our illustrious leaders simply don't have any solutions and are just playing the game out to its inevitable end. Sure, it doesn't make any sense in the long-run. But, given that there may not be a long-run in any ordinary economic sense of the term, it makes sense for our politicians in the here and now to avoid contraction, however short-term such a strategy might be.

Edited May 22, 2009 by Steve Cook

[Guest Steve Cook]

how about he recognises this fact : DEMAND DESTRUCTION

In the case of oil, I take if you mean starvation for large swathes of the human population. Not for us in the developed West, of course (at least not for a few decades). But, certainly for the developing countries as we progressively price them out of the energy and other resource markets

[loginandtonic]

the natural human condition is to be optimistic - to encourage breeding and paying council tax,

so i guess its no surprise people who have never known a depression think a short interval between 2 debt-driven 'booms' is likely,

perhaps they are more tuned in to todays spend today never pay back society, but all things being equal as in the old days of paying back what you owe...well in that case theres a serious slump likely to go on for years

[OnlyMe]

what makes people think a recovery's around the corner ?

cheap money ?

i dont see it myself, i see a long depression after a euphoric false dawn, but i could be wrong of course & feel free to tell me so & why please

Agree, if they carry on printing and QE - we get default, currency crises, possibly hyperinflation, hyperinflation is not recovery.

They have already created to much false growth out of debt, the tank is empty.

However, there is still a baseline level of demand for basics which must (under most circumstances) be met and with reference to oil in particular if there is a disconnect between this level of demand and the ability of the oil sector to produce it at an economic price then prices will have to rise.

GDP On Debt Steroids

http://suddendebt.blogspot.com/

[interestrateripoff]

Good job Gordon's got a plan.

The world can't afford oil 70% higher, the global economy can't take it. Looks like we are in for a hell of a ride over next couple of decades. I just hope it doesn't end in global war.

We have idiots for leaders.

[Confounded]

what makes people think a recovery's around the corner ?

cheap money ?

i dont see it myself, i see a long depression after a euphoric false dawn, but i could be wrong of course & feel free to tell me so & why please

I am with you on this one. I have been in and out of Oil and commodities but feel this recent rise is going to be a disappointing false dawn for investors. I think Oil could even halve from this point. What we have seen is an orchestrated greenshootaphon around the world. Commodities have been stockpiled with reports oil is running out of hiding places, this is a high risk gamble, we may ignite a crack up boom but when I look at the effects of a crack up boom and the hyperinflation argument I see more problems than the managed decline that I think they are aiming for.

I am poised to go into commodities and if they start getting close to their old highs I think I would have to concede that we are entering into a crack up boom/hyperinflationary phase, however if you go in at that point you will protect you money fairly well as the rises will be massive from that point, however if you go in at this point you could IMHO loose half your money in the next 6 months.

I am a big subscriber to managed markets and I feel the big one they fear most is the bond market, they put it back in its box with a managed decline in the stock markets, they have rallied the stock markets to allowed banks to sell their shares and recapitalise at a far better point than just 2 months ago. Now the bond market is starting to twitch I think we could be in for another manged decline in the stock market causing another flight to quality.

So I guess in summary all I am saying be careful, I think we are at a very dangerous juncture.

[dr ray]

The other consideration is that developing alternative energy sources is expensive and while governments are choosing to rescue the banks rather than spend on infrastructure we wont benefit from constructions like the Hoover Dam from the last Great Depression

[Guest Steve Cook]

I am with you on this one. I have been in and out of Oil and commodities but feel this recent rise is going to be a disappointing false dawn for investors. I think Oil could even halve from this point. What we have seen is an orchestrated greenshootaphon around the world. Commodities have been stockpiled with reports oil is running out of hiding places, this is a high risk gamble, we may ignite a crack up boom but when I look at the effects of a crack up boom and the hyperinflation argument I see more problems than the managed decline that I think they are aiming for.

I am poised to go into commodities and if they start getting close to their old highs I think I would have to concede that we are entering into a crack up boom/hyperinflationary phase, however if you go in at that point you will protect you money fairly well as the rises will be massive from that point, however if you go in at this point you could IMHO loose half your money in the next 6 months.

I am a big subscriber to managed markets and I feel the big one they fear most is the bond market, they put it back in its box with a managed decline in the stock markets, they have rallied the stock markets to allowed banks to sell their shares and recapitalise at a far better point than just 2 months ago. Now the bond market is starting to twitch I think we could be in for another manged decline in the stock market causing another flight to quality.

So I guess in summary all I am saying be careful, I think we are at a very dangerous juncture.

Actually, I would more or less agree with this analysis.

In terms of where the price of oil will be in five years, my view is that it will either be at historical highs or be well on the way to them. In other words, there is only one way for the price of oil to go over the coming decade.

However, right-here-and-now, the economic environment is so volatile that the short-term price could swing wildly in either direction.

Anyone investing in oil will need to have a strong stomach and nerves of steel, have as little leverage as possible (unless they have a bottomless pit of capital and can set their stops low enough), and be prepared to play the long-game.

If they can play the long game, then this will be the biggest one-way bet in history.

Unless we get a global conflict along the way, in which case all bets are off.....

Edited May 22, 2009 by Steve Cook

[OnlyMe]

So I guess in summary all I am saying be careful, I think we are at a very dangerous juncture.

I agree, your analysis makes sense - especially spiking up the stock market to allow companies to recapitalise.

But, if they try to manage a decline and force the money back into the "safety" of treasuries whilst whilst trying to continue with QE then the risk is the market doesn't, it did it before but it may not now. Safety may be commodities because rather than outright loss of capital the market has switched into the threat of loss via inflation, which was one of the reasons participants were so easily drawn into the stock market again despite the obvious risks.

[InternationalRockSuperstar]

With [nominal] Oil Prices Poised To Jump As Much As 70% Every Investor Needs an Energy Strategy

don't hold dollars or other fiat.

that was easy.

[Guest Steve Cook]

don't hold dollars or other fiat.

that was easy.

It's not just the debased nominal value of an inflated dollar supply that will push the price up, though I agree that this will play a significant part.

You are ignoring the deflation of supply of the thing those dollars are being exchanged for. This will, in the end, be the biggest factor in the price.

Put both variables together and we get a price for oil that, even when compared to the the price hikes of last year, will be unimaginable

Edited May 22, 2009 by Steve Cook

[nickd]

I stopped reading at this point

There wont be any recovery for a long time yet. Unemployment will continue to grow, cutting demand for the foreseeable future.

It is correct that *when* or *if* a recovery happens the demand will increase and prices will go up.

And meanwhile, that gives plenty of time for car manufacturers to shift to 70+-mpg-VW-Golf-Blue-motion-type engines to be standard, and increasing number of inefficient 30yr-old "back boilers" to be replaced with combis, and more loft insulation installed, double glazing added to the remaining houses without it.

To me, the future looks like, people have to drive fuel efficient cars, share lifts, use bus/train/cycle more, have a less thirsty heating boiler, stop shipping stuff like apples and lamb from New Zealand, not go by plane for stag parties but instead have 1 or 2 holidays a year and maybe not by plane.

Sounds OK to me. Not economic armageddon or all-out war. Humankind did exist for many centuries with a fraction of the oil consumption, in case anyone forgot.

Hey, maybe sailing ships will make a comeback, with modern materials more effective at catching the wind. I'm not even joking, it could be done if speed of goods delivery wasn't critical

[The McGlashan]

Here is a more balanced outlook for oil prices.

http://321energy.com/editorials/bibbings/bibbings052109.html

Slightly bullish immediate term - next few weeks (US summer driving season) Upper $60's.

Bearish short term - autumn (Economic realities) $40 - $55

Bearish medium term - 1 year (Demand destruction) $25

Bullish long term 2-3 years (economic recovery, resource depletion and capacity constraint) $100

[DrGUID]

Oil company shares are heading for huge falls IMHO.

We've seen the biggest fiscal stimulus in history, but my income is tanking. I think people are going to be shocked at the Q2 GDP figures.

[Namaste]

On a side note, I notice my local BP is now at 99.9p/litre. Everytime I drive by it appears another penny has been added, especially over the last couple of weeks. How many months ago in terms of crude price is today's pump prices suppose to relate to? Cause with both crude and the pound on the up recently, I wouldn't have thought we should be seeing price rises, so surely today's stock comes from sometime in the past when sterling was weakening and crude had a bounce? Or are we just being ripped off by the oil giants?

[dr ray]

Oil company shares are heading for huge falls IMHO.

We've seen the biggest fiscal stimulus in history, but my income is tanking. I think people are going to be shocked at the Q2 GDP figures.

Oil company profits are heading for huge falls but the survivors will corner the market if and when recovery ever comes. There will be a dramatic fall in production and barriers to entry are very high.

Personally I am buying oil majors, knowing I might have to bear a dividend cut, as my response to rising oil prices in future.

My income is tanking too- partially self inflicted because I don't intend to pay 65% tax - are you a medical Dr?

[youthoftoday]

And meanwhile, that gives plenty of time for car manufacturers to shift to 70+-mpg-VW-Golf-Blue-motion-type engines to be standard, and increasing number of inefficient 30yr-old "back boilers" to be replaced with combis, and more loft insulation installed, double glazing added to the remaining houses without it.

To me, the future looks like, people have to drive fuel efficient cars, share lifts, use bus/train/cycle more, have a less thirsty heating boiler, stop shipping stuff like apples and lamb from New Zealand, not go by plane for stag parties but instead have 1 or 2 holidays a year and maybe not by plane.

Sounds OK to me. Not economic armageddon or all-out war. Humankind did exist for many centuries with a fraction of the oil consumption, in case anyone forgot.

Hey, maybe sailing ships will make a comeback, with modern materials more effective at catching the wind. I'm not even joking, it could be done if speed of goods delivery wasn't critical

All good points.

Except that 6 billion + humans have not been on the planet for many centuries with a fraction of the oil consumption. Yes humankind will survive without oil. Just not all 6 billion of us.

[cynic]

All good points.

Except that 6 billion + humans have not been on the planet for many centuries with a fraction of the oil consumption. Yes humankind will survive without oil. Just not all 6 billion of us.

I'd echo that. Googling for "more people alive than have ever died" shows it to be amusing and unresolved (unless some one has 'proved' it - I don't know).

But I'm all for the small-is-beautiful scenario that Nickd lays out. Whether or not this is even achievable or - if it were - capable of restoring some sort of equilibrium to resource supply/demand is another Q.

[carbonoid]

And meanwhile, that gives plenty of time for car manufacturers to shift to 70+-mpg-VW-Golf-Blue-motion-type engines to be standard, and increasing number of inefficient 30yr-old "back boilers" to be replaced with combis, and more loft insulation installed, double glazing added to the remaining houses without it.

To me, the future looks like, people have to drive fuel efficient cars, share lifts, use bus/train/cycle more, have a less thirsty heating boiler, stop shipping stuff like apples and lamb from New Zealand, not go by plane for stag parties but instead have 1 or 2 holidays a year and maybe not by plane.

Sounds OK to me. Not economic armageddon or all-out war. Humankind did exist for many centuries with a fraction of the oil consumption, in case anyone forgot.

Hey, maybe sailing ships will make a comeback, with modern materials more effective at catching the wind. I'm not even joking, it could be done if speed of goods delivery wasn't critical

Looks like our Teutonic friends are, once again, on the ball:

Telegraph, 19 Jan 2008

Ben Martin and Tony Paterson in Berlin.

A cargo ship pulled by a giant, parachute-shaped kite will leave Germany on Tuesday on a voyage that could herald a new "green" age of commercial sailing on the high seas.

The owners of the MS Beluga, a 462ft cargo vessel, will try to prove that modern steel ships can harness wind power and reduce their reliance on diesel engines.

During the journey from Bremen to Venezuela, the crew will deploy a SkySail, a 160 square metre kite which will fly more than 600ft above the vessel, where winds are stronger and more consistent than at sea level.

Its inventor, Stephan Wrage, a 34-year-old German engineer, claims the kite will significantly reduce carbon emissions, cutting diesel consumption by up to 20 per cent and saving £800 a day in fuel costs. He believes an even bigger kite, up to 5,000 square metres, could result in fuel savings of up to 35 per cent.

He got the idea while flying a kite as a child, and has now developed the concept into a hybrid of the sailing ships of old and motorised modern craft.

The MS Beluga's journey comes more than a century after the world's commercial sailing fleet was replaced by coal-burning steamships. Mr Wrage hopes for a similar revolution, and believes the kites could be suitable for up to 60 per cent of the world's 90,000 commercial ships: "Only the tough conditions imposed on a ship during a long voyage of this kind can show whether the SkySail is effective and whether the materials used in the kite can stand up to the stresses and strains," he said.

The kite works on a similar principle to rigs used by kite-surfers, who skim the water at up to 55mph, but bears little resemblance to canvas sails on conventional sailing ships.

Instead of support from a mast, boom and rope, the SkySail is tied to the bow by a single line that also contains a cable linking it to a computer, which controls it. It acts like a child's kite, carving figure-of-eight patterns in the air, reaching speeds four times higher than the prevailing wind, which dramatically increases its pulling power.

[Justice]

Yes oil will jump 70% or more but that assumes we come out the depresion which won't be easy with taxes going balistic and oil prices going up.

I don't pretend to have a crystal ball but the masses will not stand for the price of oil being fiddled by traders again and that in itself will keep a cap on things and if BP makes a massive profit then goverment will tax them more to help pay off the dedt we now owe due to the banksters.

Does anyone know the price of silver today !