Oil: 'To the Moon'?

Oil, Still Oversold

Today we face many economic obstacles; the obvious ones are quite evident. From frozen credit markets and unemployment to the auto industry and housing, there is no shortage of problems. While the world grapples with these issues, we believe the market is underweighting a potential oil supply-crunch that could reignite higher prices. On the supply side, the current economic slowdown has eased significant exploration ventures.

This may cause a bottleneck, as future demand, spurred by emerging market growth, outpaces supply. Looking at the converging paths of new supply coming online and future oil field decline rates, we are led to believe that the world’s spare oil capacity will be gone by 2011.

Shrinking Giants

Giant oil fields account for the majority of the world’s oil production. Many have seen production rate declines and those that have not are shifting in that direction. Concurrently, the rate of decline for smaller fields could be greater if not equal to their giant brothers. Total decline rates will likely increase considerably from a current average of 6.7% to 8.6% in 2030 [source: IEA]. It is estimated that the world will need 45 mb/d of additional gross capacity to offset decline rates even if demand stays flat for the next twenty years. New production has only served to sustain recent global production levels, and the carrot of optimism being waved in the form of alternative energy will not alleviate the burden oil carries as the world’s main source of energy.

National vs. International

A shift is occurring between national and international oil companies. Oil production at nationals will account for the majority of the increases in future production. State run oil companies face many uncertainties in their ability to attract sufficient private capital or, for that matter, foot the bill themselves. As production becomes concentrated in a small number of countries and emerging markets begin to account for greater consumption of future production, inefficiencies and supply disruptions will likely lead to volatile spikes in pricing.

A Merging Market

We view the recent $16B acquisition of Petro-Canada by Suncor (SU) as a leading indicator of two oil industry themes. First, M&A activity will be driven by large cap energy names with massive war chests that are thirsty for additional reserves. Traditional growth will be spurred from historically non-traditional exploration sources.

Second, large firms will look to snap up smaller cash- and credit-strapped companies whose vulnerabilities have been exposed in this economic downturn. We view this as their ability and desire to double down at current prices, and an acknowledgment of dwindling supply prospects.

Consequently, we believe that investors will benefit from the industry’s rapid pace of M&A activity.

OPEC and Stimulus

The effects of massive stimulus packages by the US and industrialized nations will likely pressure oil prices higher on two fronts; a weakening US dollar and higher consumption. The U.S. and China (FXI-iShares FTSE/Xinhua China 25 Index Fund) alone have committed $1.3 trillion in an effort to reignite global growth. Evidence of the stimulus’ positive effect on oil can be seen by Japan’s recent signal to increase their economic spending, sending oil up 1.5% on the news. Given the accelerating economic decline of many OPEC countries, we believe they will be hard-pressed to increase capacity until oil reaches ~$70 per barrel. If OPEC does not reverse production cuts, growth in future supplies may fall behind a stimulus-driven recovery of demand, leading to higher oil prices. In addition, if OPEC were to delay infrastructure expansion due to inadequate funding and demand, the potential for higher prices increases dramatically with economic recovery.

Gimme Credit

Exploration and production companies (XOP) can no longer count on easy money to fund their operations. Projects that have been canceled or put on hold will be unable to ramp up quickly enough to take advantage of a quick recovery in demand. Those who would normally access credit markets to ramp up supply in anticipation of higher oil prices will be forced to operate within their current balance sheet constraints, further pressuring supply.

Furthermore, numerous international groups, both private and state-owned, have complained that cash-rich Chinese firms are overpaying for acquisitions in an effort to drive up prices. Unlike the rest of the world, the state-owned Chinese firms have access to their country’s massive reserves, giving them advantages over those who must operate in a tough credit market.

Rise Again

Energy problems have taken a back seat as the world searches for solutions to the current economic crisis. We believe that future supply concerns have the potential to be a Trojan horse, besieging the world again with higher oil prices. It is only a matter of when, not if, oil prices move higher. We prefer to invest in cash-flow generating investments (equity) as the potential M&A speculation will increase multiples while maintaining a relative high beta to the commodity.

At ETFDesk, we believe the best Ways-to-Play expectations of higher oil prices are the following ETFs:

• XOP: SPDR S&P Oil & Gas Exploration & Production ETF
• PXJ: PowerShares Dynamic Oil & Gas Services Portfolio
• USL: United States 12 Month Oil Fund LP

Disclosure: no positions

Comments

[pockyclips ...:]

I am afraid that we will be testing the highs (at least gasoline wise) as early as the mid term elections in 2010. So much future production has been cut and exploration curtailed that even if we returned to July 2008 levels of activity, a spike can not be avoided.

Apr 13 08:27 AM

[The Greates...:]

I just love the way oil and gas companies (5 major companies), along with OPEC (13 countries) have pushed how they are struggling today. After having ran the worlds economy into the ground, set new high bar numbers for the price of crude in 08, just can not seem to turn a dollar today. Really? They only reaped $476 billion in net profit over the last 6 years and are virtually debt free today.

Apr 13 09:26 AM

[The Greates...:]

Oil needs to go the way of the dinosaur, it is a relic fossil of the past. New alternative fuels and energy sources are becoming more readily and affordable everyday and will replace oil as our energy source if we are smart as a species.

Apr 13 09:28 AM

[Ferdinand E...:]

Thanks for saying a few things that I said in an oil book I wrote almost 30 years ago, but you are wrong on at least one point. Regardless of the price level or increase in price, a large increase in new capacity should not be expected. I won't efer to the logic which explains this, but merely to what e.g. the Saudi King said, which is that he is not going to allow future generations in his country to suffer in order to make things easy for motorists in the oil importing countries.

What I won't ask is WOULD YOU? Because there are clearly plenty of countries in this old world of ours where the movers and shakers would be only too glad to make things difficult for their own citizens in order to help some lost causes or no-hopers on the other side of the world.

Apr 13 09:32 AM

[The Greates...:]

With the development of unregulated international derivatives trading in oil futures over the past decade (the Phil Graham Enron Bill 2000-2001) or more, the way has opened for the presence’s of speculative bubble in oil prices. Artificially pushed through the buying and selling of futures commodities in oil futures. Key words here are unregulated, manipulation and speculation. but when the bubble burst, The US tax payer had to bail them out, even though the American public did not want too. (nor should they have)
Paper oil set physical oil prices. Like the big boys in NY, the same ones who needed the bail out.
It is one of the best articles on the subject of the oil scam that has wrecked our economy, as well as the worlds economy. It gives a very in-dept study naming all the known players in the rise to $147 a barrel and how when the bubble burst, who had the reasons for the bail outs.

Apr 13 09:36 AM

[The Greates...:]

I leave you now with this thought, all the big bail outs are going to the big name finical institutions on Wall Street, the working class (middle) got to keep a little more of their checks. But that working class is shrinking everyday due to job loss. Job loss floods the job market, lowing working wages because of the competition in the labor fields, benefiting the larger companies that do hire. (Lower wages means a bigger bottom line) So, if your big enough, it is a win, win situation all around. An also hard times squeezes out competition, creating more monopolies in big business.

Apr 13 09:45 AM

[baird2100:]

That would be nice wouldn't it? Next to instant teleportation I can't think of a better way to travel than filling up with good ole H2O.


On Apr 13 09:28 AM The Greatest Rip Off of our Time wrote:

> Oil needs to go the way of the dinosaur, it is a relic fossil of
> the past. New alternative fuels and energy sources are becoming more
> readily and affordable everyday and will replace oil as our energy
> source if we are smart as a species.

Apr 13 11:58 AM

[oscat:]

Since I earn money in the oil patch I really enjoy you people who continually knock the oil companies. You are the ones who will make me rich by refusing to face the fact that we DO NOT have alternative fuels in place in sufficient quantities to keep our economy going when the current congress induced recession ends. Demand will rise. We will need petroleum products for years to come. Refusing to allow drilling here will drive the price out of sight. Supply and Demand. Economics 101. The only logical case for the USA to pursue is to continue developing alternatives while we PRODUCE our own petroleum products.Incidentally, good grammar is indicative of intelligence. You use "your" when you mean "you are" or "you're". Look it up.


On Apr 13 09:45 AM The Greatest Rip Off of our Time wrote:

> I leave you now with this thought, all the big bail outs are going
> to the big name finical institutions on Wall Street, the working
> class (middle) got to keep a little more of their checks. But that
> working class is shrinking everyday due to job loss. Job loss floods
> the job market, lowing working wages because of the competition in
> the labor fields, benefiting the larger companies that do hire. (Lower
> wages means a bigger bottom line) So, if your big enough, it is a
> win, win situation all around. An also hard times squeezes out competition,
> creating more monopolies in big business. The consumer loses all
> the way around, write, call, email and fax your representative today,
> let them know your watching. Have a nice day.

Apr 13 12:09 PM

[a. palmer jr.:]

I think that our only hope is to develop electric cars and to start now. It's already been proven in the EV-1 that Chevrolet tried for awhile then destroyed. With today's batteries plus solar panels there's no doubt we can do it if we get off our collective rears and demand it be done. Our automakers seem to be dragging their feet about production startups but I think China will be shipping them over here pretty soon.

Apr 13 05:19 PM

[robtr31:]

gm's volt batties that would get 120-140 miles on when they first came out ? 5 year or more years ago ,gm sold that tech to chevern oil now there new one get half the distance .

Apr 14 03:00 AM

[dbaldwin:]

Not a bad article Tom, and believable, but I feel you threw out some facts on meteorology and then tried to predict the weather on Wednesday four weeks from now. Very wishy-washy. With a title like "Oil: 'To the Moon'?" and your first para "Oil, still oversold", the article was filled with 50% this and 50% that. I'm not even sure you've convinced yourself. You need to be more opinionated. The article sounds like it was written by a politician. Sorry, but true.

"we believe the market is underweighting a (potential) oil supply-crunch that (could) reignite higher prices." "This (may) cause a bottleneck," "(could be) greater (if not equal to)" "will (likely) pressure oil prices higher on two fronts" "(the potential for) higher prices increases dramatically with economic recovery." "future supply concerns (have the potential to be a) Trojan horse,"

Apr 14 09:13 AM

[dbaldwin:]

Not a bad article Tom, and believable, but I feel you threw out some facts on meteorology and then tried to predict the weather on Wednesday four weeks from now. Very wishy-washy. With a title like "Oil: 'To the Moon'?" and your first para "Oil, still oversold", the article was filled with 50% this and 50% that. I'm not even sure you've convinced yourself. You need to be more opinionated. The article sounds like it was written by a politician. Sorry, but true.

"we believe the market is underweighting a (potential) oil supply-crunch that (could) reignite higher prices." "This (may) cause a bottleneck," "(could be) greater (if not equal to)" "will (likely) pressure oil prices higher on two fronts" "(the potential for) higher prices increases dramatically with economic recovery." "future supply concerns (have the potential to be a) Trojan horse,"

Apr 14 09:18 AM

[Auto Knowledge:]

[snark on]And car prices are sure to shoot up any day when demand comes back... now that the plants are all being shut down! [snark off]

Apr 14 01:45 PM

[stockstalker32:]

I still think we have some serious deflation to endure before we can count on big numbers from oil and gold, but yes, I believe it will end up soaring.

Apr 14 02:26 PM

[Jake Blues:]

"Disclosure: no positions"

Yeah...sure...

Apr 14 07:48 PM

[Duderonomy:]

Oil could shoot up, if you believe in a V shaped recovery. Course, Bear Sterns predicted oil was going to go to $200/barrel by the end of 2008. Now where are they?

Apr 15 12:31 AM

[Duude:]

Oil needs the world economy hitting on all 12 cylinders. Anything less leaves too much available supply for demand. As the world economy recovers, oil suppliers won't be hesitant about adding supply back into the market. Many of these nations are desperate for revenue after this draw down on prices. Eventually, oil will see $150 a barrel and more. Obama's energy plan will make absolutely no difference. Competitive and viable alternative fuels for the masses are more than 20 years away. Electric cars sound great but technological advances in battery technology is glacial. Not enough range, fast enough recharge, cheap enough to produce, durable enough to last and cool enough not to create a fire hazard.
I wish we weren't so dependent on oil but the fact is oil will be king for decades to come.

Apr 16 11:44 AM

[User 353732:]

When the price of oil(or iron ore or copper or natural gas or. bauxite or.........) is low, the safest prediction one can make is that it will shoot up. Yes, it will. When the price is high, the safest prediction is that it will plummet. Yes, it will. That is what cyclicality in a globally traded, capital intensive, risk sensitive and liquid market means.
In my view the more compelling predictions concern
1. When high, how long will the price stay elevated( or when low etc...)
2. If this time it is different and cyclicality has been repealed, then what are the key second and third order consequences for the global economy , for capital flows and for investment strategies
( in support, describe any important commodity in history that reached an all time in price and simply stayed there for an extended period)
3.If , according to some ( and I do NOT imply in the least that the author of the thoughtful article above is, in any way, included in this group of pamphleteers and commentators) a powerful conspiracy and rapid depletion ( i.e crooks and constraints) explain a high price then what explains a low price? why do the crooks and constraints become so impotent when faced by a pretty small decrease in consumption?

Apr 16 05:45 PM

[Maxe Paul:]

Yet more oil pumping garbage with no real facts and a load of pump and dump, quote "we believe the market is underweighting a potential oil supply-crunch that could reignite higher prices."

Yes, this is why again we see a MASSIVE supply overhang, increasing exponentialy every month, which will see prices ultimately go back and test the lows.

Non OPEC countries increasing output and Opec countries not following the cuts. Seriously, WAKE UP!

Apr 17 01:48 PM

[Freya:]

I think its more about profits in the refining sector than the price of crude itself.

Considering how many have shut up shop, I wouldn't be surprised with $2.50-$3.00 by july.

They were really reamed last year.

Apr 13 09:22 AM