jrnyquist.com rss
Gordon Frisch |
The Perfect Oil Storm
“Economists, looking at a world economy
in which cracks are already starting to
appear, are getting distinctly fidgety
about the prospect that higher oil
prices may bring on inflation,
or recession, or both.”
—The Economist, Aug 12, 2005
U.S. light crude oil hit an all time high of
$67.10/barrel on August 12th. In the face of rising oil prices—up
51% since the start of the year—the world’s largest oil
consumer and its biggest economy, is whistling past the economic
graveyard. Although latest figures indicate the US economy is growing
at a brisk 3.6% GDP rate, the sheer weight of financial and economic
realities can no longer be ignored. The OPEC pipers must be paid.
Nonetheless,
hysteria over oil prices at current levels is unwarranted when
adjusting for inflation. For example, at the time of the 1979 Iranian
hostage crisis, the price of oil in today’s dollars was about $90
per barrel. And the average price per barrel for the entire year after
the 1979 Iranian revolution was $80 per barrel (in today’s
dollars), well above current levels. This is not meant to downplay the
significance of current (nominally high) record oil prices, as there
will be an enormous effect on not only the U.S., but also the global
economy. And since economic indicators always lag, we are likely
already suffering the substantial impact of higher oil prices, even
though we don’t yet clearly see it in the numbers.
Underlying the
inevitable speculative factors at work, there are fundamental dynamics
driving today’s high oil prices: worldwide, there is a very tight
gap between supply and demand, accentuated especially by China’s
rapidly growing oil demand; on August 11th, the IEA (International
Energy Agency) issued a report stating that non-OPEC supply growth was
below estimates; OECD countries (primary oil consumers) currently store
oil stocks amounting to only 54 days of forward demand, and they have
virtually no capacity to store more; recent U.S. refinery problems have
curtailed supply (14 U.S. refineries have been shut since July 20th);
ongoing war and tensions in the Middle East, not least Iran’s
intention to resume its nuclear program; OPEC is virtually at its
production limits, supply is barely meeting demand, and any major
crisis could throw markets into greater turmoil.
Near term, oil
prices look to remain firm to higher. Longer term, higher oil prices
have already triggered significant new exploration by oil companies,
which will result in greater supply and lower prices. Cambridge Energy
Research Associates, one of the premier oil consultants in the world,
predicts (The Economist, Aug 12) “that as much as 16m [16
million] new bpd [barrels per day] could come onstream by 2010, which
would probably mean a precipitous drop in prices.” But from what
level? From $100 down to $60?
The history of
oil has always been one of price cycles and supply-demand cycles that
inevitably self-correct over time. It will likely be no different this
time. Oil is a finite resource and in time, as scarcity and price
increase to make it more uneconomical, other energy sources will arise,
such as hydrogen power and bio-ethanol (renewable resources), which are
also environmentally cleaner.
Meanwhile,
underlying fundamental factors, together with political, have all
conjoined to create “the perfect oil storm” and drive up
prices. Oil should have a solid place in your portfolio, though if you
don’t already own some, it would be advisable to buy on
pullbacks. We recommend a mix of major, integrated international oil
companies, such as Exxon-Mobil (XOM), British Petroleum (BP),
Chevron-Texaco (CVX), or Conoco-Phillips (COP), and smaller independent
oil companies, such as Devon (DVN), and Apache (APA), which are more
pure oil plays. Also oil service companies are good investments, such
as Schlumberger (SLB) and Halliburton (HAL). The purest oil play, of
course, is oil futures. Futures are manageable and profitable only by
using charts and stop-loss orders.