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saunafool (98.77)

The Four Horsemen of the Oil Boom

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June 26, 2008 – Comments (10) | RELATED TICKERS: RIG , DO , OII

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. 

10 Comments – Post Your Own

#1) On June 26, 2008 at 10:38 AM, BlindSkuirrel (33.36) wrote:

Agreed - OIL BOOM it is!  Aside from RIG, DO and OII, which oil stocks are the hidden gems poised to make a run at 100 points?

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#2) On June 26, 2008 at 10:45 AM, XMFSinchiruna (27.51) wrote:

excellent post saunafool!!  You note the USD in passing, but be careful not to underestimate its importance in this issue.  Oil is traded worldwide in USD, with Venezuela and Iran so far the only countries willing to come out and start trading it in other countries.  Iraq switched out of the USD oil bourse before we went in.... coincidence?

The USD has lost about half its purchasing power over the last 5 1/2 years, and projections of where the dollar is headed going forward are a key driver of the long positions in oil that have held the $130 line for so long now. 

I love your post, but to extend the metaphor, I would just suggest that the USD may be the oft-overlooked fifth horseman of the apocolypse.

 

The U.S. Dollar Index

Wed, Mar 19 2008, 16:46 GMT
by Valerie Wood

Energy Solutions, Inc.


The U.S. Dollar Index (USDX®) is an index of the of the United States dollar relative to a basket of foreign currencies. The USDX® is a weighted geometric mean of the dollar’s compared to the Euro (EUR), Japenese yen (JPY), Pound sterling (GBP), Canadian dollar (CAD), Swedish krona (SEK) and Swiss franc (CHF) relative to March 1973. The USDX® measures the dollar’s general value relative to a base of 100.00. For example, a quote of 105.50 means that the dollar’s value has risen 5.5 percent since this base period.

March 1973 was chosen as a base period because it represents a significant milestone in foreign exchange history when the world’s major trading nations allowed their currencies to float freely against each other. This agreement was reached at the Smithsonian Institution in Washington, DC and was a victory for free market theorists. The Smithsonian agreement replaced the unsuccessful fixed rate regime established approximately 25 years earlier at Bretton Woods, New Hampshire.

The current level of the USDX® reflects the average value of the dollar relative to this 1973 base period. In March 1973, the value of the dollar index was 100.00. Since that time, the U.S. Dollar Index has traded as high as the mid-160’s and it recently set a new low of 71.99 on March 13, 2008. The index is updated 24 hours a day, 7 days a week.

Just as the Dow Jones Industrial Average provides a general indication of the value of the U.S. stock market, the U.S. Dollar Index (USDX®) provides a general indication of the international value of the U.S. Dollar. It is also important to note that the currencies and weights used in the calculation of the USDX® are the same as those used in the Federal Reserve Boards trade-weighted U. S. Dollar Index.

Similar to the stock market, investors can purchase the U.S. Dollar Index (USDX®\) through IntercontinentalExchange ® (ICE), which is considered a competing trading exchange to the New York Mercantile Exchange (NYMEX). ICE operates global commodity and financial products marketplaces and is probably considered the world’s leading electronic platform for energy markets and soft commodity exchange. USDX® futures contracts trade electronically on the ICE electronic trading platform as well as an open outcry platform on ICE’s Future U.S.’s New York and Dublin trading floors.

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#3) On June 26, 2008 at 10:46 AM, XMFSinchiruna (27.51) wrote:

Blindskuirrel,

I believe the best growth in energy in the near term will derive from natural gas and coal.

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#4) On June 26, 2008 at 10:58 AM, XMFSinchiruna (27.51) wrote:

Oil jumps on OPEC, Libya comments
Thursday June 26, 10:44 am ET
By John Wilen, AP Business Writer Oil prices rise sharply as OPEC president says prices could pass $150; Libya may cut output NEW YORK (AP) -- Oil futures shot up to nearly $139 a barrel Thursday after OPEC's president said oil prices could rise well above $150 a barrel this year and Libya said it may cut oil production.

Light, sweet crude for August delivery rose as high as $138.95 a barrel shortly after the New York Mercantile Exchange opened before retreating some to trade up $4 at 138.55.

Chakib Khelil, president of the Organization of Petroleum Exporting Countries, said he believes oil prices could rise to between $150 and $170 a barrel this summer before declining later in the year. Khelil said he doesn't think prices will reach $200 a barrel.

The head of Libya's national oil company said the country may cut crude production because the oil market is well supplied, according to news reports.

"Shokri Ghanem, the nation's top oil official, declined to say when a decision would be made on whether to lower production, or give any indication of the size of the cut under consideration," said Addison Armstrong, director of market research at Tradition Energy in Stamford, Conn., in a research note.

Oil futures were also rising as investors reassessed comments the Federal Reserve made Wednesday when it held a key interest rate unchanged. Many investors who had expected the Fed to raise interest rates in August now think a rate hike is unlikely until after the November election or next year, said James Cordier, president of Tampa, Fla.-based trading firms Liberty Trading Group and OptionSellers.com.

Interest rates affect the dollar; many analysts believe the Fed's rate cutting campaign, which began last September, had much to do with weakening the dollar against the euro and sending oil prices skyrocketing. Investors buy commodities such as oil when the greenback is falling. Also, a weaker dollar makes oil less expensive to investors dealing in other currencies.

The dollar slid against the euro after the Fed's comments Wednesday, and was down again on Thursday.

"Breaking through $140 now ... seems hard to avoid," Cordier said.

Retail gas prices, meanwhile, were unchanged overnight at a national average of $4.067, according to a survey of stations by AAA, the Oil Price Information Service and Wright Express. Gas prices have retreated slightly from a record of $4.08 set June 16, but are likely to fall much more as long as crude oil remains in its recent range between roughly $131 and $140.

"If we go through $140, we're at $4.25 on gas within a week," Cordier said.

In other Nymex trading Thursday, July gasoline futures rose 10.69 cents to $3.501 a gallon and July heating oil futures rose 12.87 cents to $3.8779 a gallon. July natural gas futures fell 17 cents to $12.583 per 1,000 cubic feet.

In London, August Brent crude futures rose $3.68 to $137.96 on the ICE Futures Exchange.

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#5) On June 26, 2008 at 6:23 PM, dwot (64.71) wrote:

This will be interesting because I still expect a retraction in energy prices.

No question China is pushing demand, but they are also under enormous strain to stop/reduce their price controls.  As near as I can figure, the subsidy for energy is through the roof right now.  The rest of the world has seen 100% price increases in a period they've seen 20%.  That isn't sustainable.

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#6) On June 26, 2008 at 11:33 PM, jester112358 (28.78) wrote:

DWOT: 

 China can't afford to stop growing from a political standpoint.  With a savings rate of over 50% and high taxes on investment China has enormous reserves to continue subsidies and prevent riots and possible political change.  So, China demand for material and energy will continue unabated-there will be no price deflation.

 Agree with TMFSinchiura that a significant part of commodity inflation is deflation of the $.  In fact the Saudi oil minister suggested that deflation of the $ alone should bring crude futures prices to $150 by mid-to-late summer.  Also, agree that coal and natural gas have some catching up to do price wise and are still the best current buys in the market.   And the ability to expand coal production is very limited.

The next bull should be nuclear power and uranium-so people should monitor this sector closely.  As  as scientist I can tell you nuclear is the only viable "alternative energy" that can replace a substantial portion of fossil fuel demand in the next 10-20 years.  With enough black outs this summer even politicians will start to understand this reality.  Solar just isn't ready for prime time nor is wind.  A lot of research into better materials for both is required for massive scaleup of either technology.

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#7) On June 27, 2008 at 12:39 AM, camistocks (< 20) wrote:

saunafool, very informative post, as usual. But don't you think that oil is in a short term speculation bubble? It is easy to get carried away when everything works great (ie if you bet on the oil patch you may want to see higher and higher prices)

What if those second and third world countries who subsidy their oil products finally decide to raise prices as their state owned refineries are facing huge losses?

Currently pension funds and speculators now account for 70% of crude trading. Although 86m barrells are used for consumption apparently 15 times as much are being traded on the markets. What if those markets are going to be more regulated? Article from Marketwatch.com:


Gas could fall to $2 if Congress acts, analysts say
Limiting speculation would push prices to fundamental level, lawmakers told
By Rex Nutting & Michael Kitchen, MarketWatch
Last update: 4:24 p.m. EDT June 23, 2008
Comments: 1318
WASHINGTON (MarketWatch) -- The price of retail gasoline could fall by half, to around $2 a gallon, within 30 days of passage of a law to limit speculation in energy-futures markets, four energy analysts told Congress on Monday.
Testifying to the House Energy and Commerce Committee, Michael Masters of Masters Capital Management said that the price of oil would quickly drop closer to its marginal cost of around $65 to $75 a barrel, about half the current $135.
Fadel Gheit of Oppenheimer & Co., Edward Krapels of Energy Security Analysis and Roger Diwan of PFC Energy Consultants agreed with Masters' assessment at a hearing on proposed legislation to limit speculation in futures markets.
Krapels said that it wouldn't even take 30 days to drive prices lower, as fund managers quickly liquidated their positions in futures markets.
"Record oil prices are inflated by speculation and not justified by market fundamentals," according to Gheit. "Based on supply and demand fundamentals, crude-oil prices should not be above $60 per barrel."

Futures trading in London has not been a major factor in rising oil prices, testified Sir Bob Reid, chairman of the Chairman of London-based ICE Futures Europe. Rising prices are largely a function of fundamental supply and demand, not manipulation or speculation, he said.
"Energy speculation has become a growth industry and it is time for the government to intervene," said Rep. John Dingell, D-Mich., chairman of the full committee. "We need to consider a full range of options to counter this rapacious speculation." It was Dingell's strongest statement yet on the role of speculators.

entire article

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#8) On June 27, 2008 at 2:47 AM, saunafool (98.77) wrote:

Camistocks, 

Fundamentally, I don't think speculators are to blame because they don't hold inventories of the product. There is more trading, but I don't see how more transactions drive prices if the transactions don't take supply from the market. For example, USO holds no inventory, just futures contracts. GLD and IAU hold physical gold and so investing in those products takes actual supply from the market.

Here are some of Warren Buffett's recent comments:

Buffett also said...

Supply and demand, he argued, not market speculation, are what's driving oil prices to new heights. Oil futures fell sharply yesterday – light, sweet crude for August delivery fell $2.45 (U.S.) a barrel to settle at $134.55 on the New York Mercantile Exchange – but still aren't that far off record levels near $140.

At least nine bills proposing limits on oil speculation have been introduced in Congress in recent weeks.

"In my adult lifetime, up until the last year or two, there's been a huge amount of excess supply available," Buffett said.

"We don't have excess capacity in the world anymore, and that's why you're seeing these oil prices.''

I'll agree with Buffett long before I believe U.S. politicians.

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#9) On June 27, 2008 at 2:51 AM, saunafool (98.77) wrote:

Sinchiruna,

For Americans, the declining dollar is one of the factors. However, oil prices are rising in every currency. But, you are right, Americans cannot discount the impact of a devalued currency. 

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#10) On July 16, 2008 at 2:54 PM, Cuchulainn1 (< 20) wrote:

For offshore drilling I would recommend: NOV, OII, RIG, HERO, WTI, and FTI. 

 

Onshore: SII would be my number one followed by small and midcap E&Ps such as BEXP and BZP.  

 

Oil Sands: BUCY (also a fantastic coal play)

Nat Gas: SD and CHK are my favs.   

 

One area that I think is getting overlooked is Nuclear.  If you look across the world the number of new nuclear reactors being built is rapidly increasing.  I know Nuclear was a big fad a few years ago, but it quickly went out of style as people realized it will take longer to develop.  Most big Wall St. fund managers are analyzed by the quarter and don't have the ability to hold an investment that might not start making money for a few years.  

 

I think we are starting to see a new nuclear rush I like: SGR (for construction), FLR (for cleanup), DNN and  CCJ.

 

 

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