Depressed Oil Prices Approaching Good Point for Speculation

By Eric Roseman

From its high of $147 a barrel last July, West Texas Intermediate Crude oil prices have crashed a cumulative 74%. That ranks as one of the worst absolute declines for any asset since the onset of deflation last July as investors dump most commodities, except gold, silver and several other soft commodities.

Oil prices now trade at a five-year low.

If oil prices overshot on the way up to US$147, then the opposite is certainly true today with prices at US$36 a barrel. At some point, crude oil will bottom; the odds of a spectacular bounce occurring is highly likely as global governments spend trillions of dollars at the same time to desperately boost economic growth in 2009-2010.

China, which is the world’s second-largest consumer of oil after the United States at 9.4 million barrels per day, is now importing the lowest amount of crude oil this decade amid a softening economy. U.S. demand has also declined sharply to less than 19 million barrels per day.

Did Crude overshoot on the way down to US$36?

According to the International Energy Agency (IEA), oil consumption in 2009 will decline to its lowest levels since 1982.

The IEA cut its demand outlook last week as the global economy continues to deflate since the fourth quarter. The Paris-based agency now projects oil consumption will decline by 570,000 barrels per day to 84.7 million barrels. Just 12 months ago, the world sat on a net supply deficit of about one million barrels.

More than any other nation, China has seen the largest spike in net oil consumption this decade. Chinese oil consumption has increased by 3.2 million barrels per day since 2000, accounting for a third of the total increase in global demand.

The Chinese are also in the midst of their biggest expansion of credit in history following the passage late last year of a US$541 billion dollar stimulus package. That spending should at least boost short-term demand for oil assuming consumption in the United States is also supported by the government’s recent passage of the $878 billion fiscal spending package.

Even the biggest bears will concede that concerted global government spending will buy at least a few quarters of economic growth later this year or in 2010 – and that should boost oil prices. Combined with additional supply cuts by OPEC and a host of cancelled exploration and development projects over the last few months, oil prices are bound to bottom shortly.

The above chart shows oil prices dating back to 1997. In 1998, amid the tail end of the Asian economic crisis and the Russian debt default, oil prices bottomed at an incredible $10.50 a barrel. Ten years later, at its peak, oil climbed a cumulative 1,300%.

I think it’s highly unlikely we’ll see 1998 prices again, unless another major bank fails or worse, a major sovereign borrower defaults in this cycle. This remains a possibility in a brutal deflationary environment.

Yet, if the time to buy an asset is when prices are low and in near disrepute, then crude oil fits that bill right now. When the time comes to buy oil, look to the oil futures or oil futures related ETFs. They’ll give you much more bang for your buck than most oil stocks.

Stock position: None.

Comments

[ROLEXDAYTONA:]

on the graph oil looks good, pity only that deleveraging wiped out all dollars to buy it, investors who were screaming oil/gas last year to me look funny, this is what happens when you are part of the bubble, it pops you drop.

Feb 18 04:44 PM

[blu:]

The decreases in demand are not as great as the decreases in supply.
It just takes longer for the lower supply to work its way through the market.
I agree with the author's basic premises, too.
The lower oil goes now, the higher it will go later. Volatility is to be extreme with this commodity. We have reached peak oil.

Feb 18 05:06 PM

[NutritionFacts:]

"When the time comes to buy oil, look to the oil futures or oil futures related ETFs. They’ll give you much more bang for your buck than most oil stocks."

Justification or rationale for that comment?

Feb 18 05:14 PM

[Hedged In:]

The chart suggests that oil could go to $20 per barrel. But the chart is misleading, because the price isn't adjusted for inflation. It would be interesting to see what $20 in 2002 looks like in 2009 money. And on that basis, oil might well be a buy, as the article suggests.

Feb 18 05:23 PM

[Ergo:]

Rolling forward ETFs can still get you in trouble, given the contango. The chart points out an interesting and well noted trend, but investing vehicles for individuals are not nearly as clear.

Feb 18 08:22 PM

[samerca:]

Any comments on DXO as a possible play? Also, what would a sudden collapsing of the dollar do to oil if such an event were to happen?

Feb 18 08:31 PM

[Audio Tactics:]

Not sure I agree with alot that is said in this article. For starters, don't expect growth this year. Secondly, there will be very little growth coming from the stimulus package anyways. Finally, why wouldn't oil go down to multi-year lows if we are in the biggest recession since 50 years ago? Also, the whole contago thing is definitely making this a difficult opportunity that will be difficult for the oil ETF's to capture. Given all the supply out there and the weakening demand picture, you're probably better off shorting the distant futures contracts. just my 2 cents...

Feb 19 04:07 AM

[Mad Hedge F...:]

The longer crude stays below $40, the more production is being taken off the market. At this stage all 35 million barrels of storage at the Cushing, Oklahoma delivery point for west Texas intermediate are brimming with crude. The 709 million barrel Strategic Petroleum Reserve (SPR) is nearly full. And there is another 50 million barrels stored in supertankers at sea which is building by the day. Demand has collapsed so fast, that oil companies can’t shut down production fast enough. The scary thing about this is that when the next crude spike upward in crude comes, it will be worse than the last one. Take advantage of the current distress prices to accumulate oil infrastructure stocks. Kinder Morgan Energy Partners (KMP) and has a PE multiple of 25 and a dividend yield of 8.3%. Enterprise Products Partners (EPD) has a $10 billion portfolio of fractionation facilities, storage, offshore drilling platforms, and 32,478 miles of product, natural gas, and crude pipelines, and carries a modest PE multiple of 12 X and a dividend yield of 9.2%. More expensive Kinder Morgan Energy Partners (KMP) with a PE multiple of 25 X and a dividend yield of 8.3% is also worth a look see.

Feb 19 09:14 AM

[Amvet:]

Current price swings in the oil price have nothing to do with supply and demand.

Oil prices are determined by futures contracts and the majority of futures contracts are bought and sold by people and funds who never take delivery of any oil. One US fund recently sold Feb futures for 80 million bbls. Such massive uses of futures jerks the price around. It is indeed a case of the tail wagging the dog.

This dumb system is destroying segments of the oil and gas industry. Small producers with debt are dieing.

Feb 19 10:08 AM

[not going t...:]

we cannot sustain a global economy on 4 dollar a gallon gas. yes the housing market melt down contributed to the finacial crises but $4.20 gas killed buisness and made it hard for people to keep up on price increases on everything that we buy. We will never rebound as a global economy when we spend most of our money to heat our homes and pay outrageous rates for electricity.....home insurance....car insurance...and especially food......People are becoming more strapped for cash and are changing their ways.....if gas ever spikes again it will only deteriate the economy at a fast pace. The good old days are over for the average worker. the world is going to hell in a hand basket and we better figure this mess out soon.....

Feb 19 04:06 PM

[El Jay:]

if $4.20 gas "killed" the economy, what would you suggest that we do to prevent $4.20 gas from happening again? If the vast majority of the growth in oil consumption is outside the USA, what options do we have as a country to protect ourselves from these kinds of rapid price fluctuations? I would contend that the issue is not necessarily the price itself, but the speed in which it can change. I'm pretty sure that if some all-knowing being told us "the price of gas will be $2 this year, and will go up 50 cents per year forever" -- we'd pretty quickly be able to come up with a way to manage that. But changes in price of 200-300% over just a few months are whip-sawing people and businesses into areas they can't manage.

Feb 20 12:00 AM