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Refining the Oil Picture



April 16, 2013 – Comments (1)

Board: Value Hounds

Author: jackcrow

The short answer is that I do still believe in $75 oil is closer to the current natural price then either the $85 is NYSMerc or Brent Sea $100.

If we dial back to pre-crisis the USD has strengthened against the EUR by about 10%. Not much of a currency trade to make but it does show a shift in direction that effects how oil is priced internationally. Merc prices have remained flat while Brent is up about 15% over the same period.

World wide demand has not risen by 10%-15% over the last 5.5 years, it is pretty close to flat due to the recovery of finance stupidity. There is always some sort of international crisis premium tucked into the price. N. Korea is the biggest worry on the radar, they neither produce nor can afford consume significant amounts of oil and they are not geographically in a position to disrupt delivery. Iran has hated us since the '70's, Venezuela will continue to saber rattle at us even as new management takes over, African oil is no more or less politically secure then it has been for decades, OPEC sees no reason to change production. So, really nothing has changed for 6 years.

Assuming the worry premium is within the same band it has been for the last 6ish years and that the USD and US Treasuries remain the least of current evils oil price should tick down about 10% to meet the change in currency and that equals $72 for Merc and $90 for Brent.

Other factors, much has been yacked about since the discovery of shale oil and gas and finally the infrastructure for that gas is starting to move gas further and wider. This makes the NG a more viable fuel for more applications leading to downward pressure on national price of oil. For the longest time the price per BTU in most fuels was regionally equal across most sources.

Said another way if years ago you lived in town where the options were heating oil, LPG or NG odds are there was little long term benefit to switching and it would be a pure loser to chase prices because eventually the price/BTU levels out and you would be swapping out expensive equipment. Recently, if the NG supply comes to you the obvious choice for a new heating (stove, water, furnace). The same is true for much larger BTU users.

On the macro scale NG is being drawn out at a rate way beyond its usage driving the price down creating a price opportunity for anyone building new anywhere that has the infrastructure to deliver it. The obvious price/btu choice is NG. There will be a long lag as infrastructure chases profits that will slowly drive up the usage of NG which will place downward pressure on oil.

World supply looks much larger as shale and sands oil become more viable.

On the local level the argument will continue to rage over NIMBY and refineries that will have greater need to effectively distill the crude being drawn up nationally. Refining capacity may be the biggest hurdle to usable oil supply and have the greatest impact on national oil pricing.

What does all this mean? Oil's extended trend will, for the most part, chase GDP, actually its likely to lead GDP but there will be to much noise in the number to be a useful predictor.

The one great mystery is that we know current monetary policy has had an impact across most if not all commodities but we have no idea how this going to unwind across those same commodities. Is it fair to assume that if current policy has driven prices up then the unwinding should drive prices down? Uncle Ben (not the rice guy) seems to think that the unwinding will naturally be consumed by the growing economy its being unwound into. Many others worry that the fat money supply of both the Fed and that currently being sat on by dragons to avoid punishment of regulators and that cannot find enough ROI will poor into the market creating unnatural, relative to the rest of the economy, inflation.

All of the above is but one rational argument for one potential price band. A) it could be wrong, many inputs all of which effect the out put; B) the market can remain irrational much longer than I can remain liquid.

Best investing thesis out of this mess. Who makes money retro fitting or building out new refineries within Canada, US and Mexico? Who makes money piping NG extended distances? Biggest burdens to overcome - NIMBY and unfriendly regulators(we do want common sense safety and environmental protection).

And as always if one of the big oil companies goes on sale because of short term easily survivable news its a buying opportunity.


1 Comments – Post Your Own

#1) On April 17, 2013 at 2:07 AM, Melaschasm (71.37) wrote:

Good post.  I mostly agree.

According to generally accepted economic theories, the Fed's money printing should have an upwards push on comodity prices.  However, this shift in prices may be partially or fully offset by reductions in demand resulting from an event such as a recession.  Thus the money printing by the Fed may not have increased gas prices by as much as would be expected.

On the flip side, were the Fed to shrink the money supply in the future, that should have a downward effect on prices.  However an increase in demand could partially or fully offset the actions of the Fed.

Because the Fed has historically favored inflation over deflation, and has not been extremely aggressive in fighting inflation since the early 1980s, I predict that we will not see major tightening by the Fed until after we experience high inflation.  I think the Fed will slow the printing of money, and even take some slight actions to reduce the money supply in the coming years, but such changes will only occur after economic growth has pushed up commodity prices more than enough to offset the Feds deflationary policies.

I personally think oil should be trading in the $80 to $120 range for a few years, and maybe longer depending upon technology. 

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