The Four Horsemen of the Oil Boom
Make no doubt about it, we are in the midst of an oil boom. This is not a bubble, prices are not going to crash, and the world is not going to be awash in excess petroleum suppy...at least not for many years. I've spent a lot of time trying to figure out what is going on in the oil market, and this is what I see--4 main factors driving prices.
1. Peak Oil: We can debate all day about whether or not global supplies have peaked and are in permanent decline (or whether that day is imminent), but we will only know once it has long passed and production levels have fallen significantly. However, we do know that the U.K., Norway, the U.S., Mexico, Indonesia, and a few other major oil producing countries are past peak. Other major fields around the world are straining to meet demand, Russia and Kuwait have both hinted they are near peak, and Twilight in the Desert has everyone wondering about whether Saudi Arabia is near peak. Peak Oil is a real phenomenon and it is has been impacting many non-Opec oil producers for the past several years.
2. Chaos: Iraq and Nigeria should both export a lot more oil than they do. Unfortunately, they are constantly subjected to exploding pipelines, refinery fires, and low-level guerilla warfare that targets the oil industry. Maybe Iraq will calm down and production will increase, but I expect a certain level of violence targeting the oil infrastructure to remain for a long time.
3. Incompetence: Iran, Venezuela, and many state-run oil companies have simply chased off all the people who know how to get the oil out of the ground. If drilling contractors know they won't get paid or will have their equipment confiscated by the government, they won't show up, no matter how much oil is in the ground. Add government policies which supply gasoline to the population at $0.25/gallon or less and you have rising consumption, stagnant supply, and falling exports.
4. Demand: The U.S. accounts for nearly 25% of global petroleum demand. This is where the average American can control oil prices--by using less oil. In the short run, this is nearly impossible as people have to go to work and it doesn't pay to sell a car, just to buy another one that gets better mileage. You have to save way too much gasoline (even at $4.00/gallon) to make the transaction pay out. Plus, cars with poor fuel economy get lousy prices on the used market these days. However, in the long run, more efficient cars, more public transport, and other energy-saving measures should be able to reduce our demand. It appears that U.S. demand is actually falling for the first time in 25 years. So, at least for now, we have finally stopped digging ourselves into the hole.
Yet, demand is a global phenomenon. Demand continues to grow at a rapid pace in China, India, and most of the oil exporting countries. Most of these places subsidize prices in some way to keep their economies growing (or in the case of the OPEC nations, to buy off the local populace--see Incompetence). As long as global demand keeps rising, oil prices are going to remain very strong.
Conclusion: While there are some bright spots (a bit more stability in Iraq, large oil finds in Brazil, China raising fuel prices, U.S. demand flat to falling), all four factors appear to remain solidly in place. Sure, there are other factors like the falling dollar which drive the price higher in the U.S., but I'm more interested in the real supply and demand factors. Note that I doubt speculators are responsible for much of the rise in prices. To my knowledge, speculators are not hoarding product anywhere. The extra trades probably drive up volatility, but not the absolute price at the end of the day--I think it's just politically expedient to blame shadowy "traders" because politicians and individuals are reluctant to face the facts about real supply and demand issues.
Where to invest: in the companies that help find oil in hard to reach places--RIG, DO, OII--three of my picks which are up over 100 points in CAPS and all of which I have owned for several years.