Why Oil is Cheap at $75 a Barrel (ETF: USO)

Oil? Cheap? at these prices? Here is why:

1) Demand from China and India does not seem to slow. Add demand from Indonesia, Australia and Eastern Europe, and and oil never seemed so scarce.

2) Supply is short. Resources are getting dried up with every barrel of oil thats pumped. Pair that with declining levels of reserve in the US, and an uncertainty over OPEC's reserves, and the outlook seems bleak. To give you an idea, OPEC's capacity has been reduced by over 15% in the last 25 years.

3) Governments of oil producing nations, specially in South America are increasingly weary of big oil companies drilling on their land, poulluting their environment and using their resources to fatten their own wallets. Bolivia, Peru, Venezuela and Ecuador are now looking to increase taxes on these companies, along with nationalizing the industry, which means that public oil companies like Chevron and ExxonMobil will be sharing their projects and profits with government owned oil companies. For instance, 85% of the worldwide known reserves were open to international oil companies back in the 1960's. Now, less than 20% is open to them.

4) Production and Refining is running at full capacity. Any breakdown in production would send prices soaring higher. Refining is currently running at an unsustainable 94% capacity.

5) Higher cost of drilling, producing and refining will keep putting a cap on the profits that oil companies make. Add the chance of facing wind-fall profit taxes at home and tax threats from other governments abroad and there is little incentive for companies not to hold on to their cash. Drilling oil wells now costs 5 times as much as it did just 10 years ago.

6) Global warming, which results in stronger hurricanes, higher tides and climatic changes, will eventually hinder off-shore and deep-sea drilling, raising costs and increasing operational risk.

While alternative forms of energy might keep oil prices in check, I believe they will only prolong the inevitable - even higher oil prices. My 2 year target for oil is $125 and $200 in 5 years.

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Comments

[advocatusdi...:]

While I don't like the conclusion personally, I cannot fault the logic and I draw the same conclusions. Mr. Laljee's timetable might be a bit aggressive though if China's bank succeed in cooling things of a bit. But prices will get there, perhaps more quickly than we'd like.

2006 Jul 11 12:07 PM

[Faisal Laljee:]

My price targets are a little aggressive, but thats partly due to the renewed focus on geo-political uncertainty, namely North Korea and Iran. And I don't blame you for not liking my conclusion. I don't like it either. :)

2006 Jul 11 01:34 PM

[Edgar C.:]

While I agree with your logic, I think alternative sources to energy will ramp up and dampen the cost of oil before it gets that high.

2006 Jul 13 01:32 PM

[CrossProfit_:]

Not a chance in the world.

See our comment on SA article
energy.seekingalpha.co...

Alternatives are salad dressing, not even the salad. Oil is still the main course. The world's unabated appetite is still growing.

Disclosure: This comment was written by a CrossProfit analyst. This is a personal opinion and may not reflect the opinion of CrossProfit.com.
www.crossprofit.com

2006 Jul 16 01:39 AM

[Ramrod:]

Your logic is fuzzy, and your arguments an attempt to buttress The Perception of Scarce Oil. The perception, not the reality, of scarce oil is, in my view, the real risk in the financial markets. The stated certainty of scarce oil is misinformation of the first order and eerily reminiscent of the Dotcom era's "This Time It's Different." Worse, it empowers every two-bit dictator with an oil field with the once in an epoch "knowledge" that he's got the world by the cojones.

#1 & #2 - "Seems scarce and bleak..." Seems? At $75 a barrel there is enough marginal crude to drown this market. Every hole that ever produced a drop of crude is profitable, even after overpaying a service company to come out and re-work it. On top of that you can afford to explore and drill on Saturn if the field potential is big enough.

#3 - Governments of so-called oil producing nations have zero credibility, in general, and are only interested in continuing the Perception of Scarce Oil that now propels prices to levels unsupported by actual of supply and demand. If they can wrap themselves in the Sincerely Green Flag of Environmentally Concerned Earthlings AND profit from the continued distortion of crude prices, well so much the easier to keep the market on its heels.

#4 - What does refinery utilization have to do with crude oil supply, in it's purest sense? If there is a refinery outage of large enough extent to actually matter, macro-economically speaking, then that has a POSITIVE impact on crude availability - not negative. All that crude has to go somewhere, and tanker owners are not generally happy to become floating storage tanks while some refiner fixes a busted cat cracker. And if you have to ask what that is, then we shouldn't be having this conversation.

#5 - One big reason drilling is expensive is due to an inherent shortage of rigs. We are short rigs because of the last couple of times crude spiked, crashed, and bankrupted the domestic industry. Another reason is the places they like to look are remote and often harsh. But make no mistake: at $55 oil is a profitable product to produce. At $75, well, soon enough you'll see it flowing in the gutters. I shudder to think of the vast pool of crude oil $100 a barrel will produce - and the accompanying crash.

#6 - Relying on "Global Warming" to create supply disruptions is, in fact, like relying on the Tooth Fairy to bring you a Krugerand. Neither Global Warming nor the Tooth Fairy have been conclusively proven to exist, and your bald-faced reliance on Global Warming's <i>certain</i... existence renders your entire argument suspect in the extreme.

Let me tell you: This time it is not different. The market will determine, through supply and demand, the reality or non-reality of scarcity for this commodity. Fuzzy logic that "seems" so real is no defense against the workings of this industry in the specific or the market.

2006 Jul 14 05:19 PM

[Faisal Laljee:]

As long as there are skeptics, the potential for this commodity to go higher remains a grave possibility. BTW - this is not just my opinion. I have stated facts justified with the numbers I provided (which are also facts).

So I am assuming you are short everything that is oil related??

-- Faisal Laljee

2006 Jul 14 11:58 PM

[Ramrod:]

When I decide buy into $200 oil, I'll let you know so you can go short with a clear contrarian conscience!

Honestly, I was long gold and energy at the start of the year. But as soon as I saw a seriously worded report that gold was heading to $3,000/oz I sold my position. Likewise, when the consensus view on oil got outrageous long I cut that position way back, as well.

Since then all I see is a lot of risk, and a lot of uncertainty, but not much opportunity. But the situation is now very fluid and I could be strong and long both by Tuesday.

But make no mistake: for everyone but Chicken Little, sustained prices at $100/bbl is outrageously long. Won't happen. If it does it's Katy-Bar-The-Door, and too many vested interests lie between here and there for it to ever happen.

2006 Jul 15 12:58 PM

[Faisal Laljee:]

People expressed the same skepticism last year when Goldman Sachs predicted oil to hit $100. I hope I am wrong, but seeing as how there is increasing tensions now between the US and Russia, North Korea and the US, and the Middle-East, I am dreading the price of gasoline.

2006 Jul 17 04:25 AM