Stephen Schork on the Recession, Oil and Market Rallies

 |  Includes: BTUUQ, DBO, OIL
by: Hard Assets Investor

Mike Norman, anchor, (Norman): Well, what is the outlook for oil prices? Here to talk with us is Stephen Schork, editor of The Schork Report. Hello everybody; I’m Mike Norman. Stephen, welcome back to the program. It’s good to have you here.

Let’s talk a little bit about what’s going on. I filled up my gas tank recently … almost $3, about $2.80 a gallon here in New York City. From what I read anyway, we are awash in gasoline. Something doesn’t make sense. Give us a little bit of an overview now of the market. Is the pricing for crude and products correct in your view, given the amount of the supply that’s out there?

Stephen Schork, editor of The Schork Report (Schork): Well, it’s almost a case of déjà vu all over again. If you recall this time last year, we were in the midst of a historic bubble which got oil on to the cusp of $150. At the end of June of this year, we went on another significant run, but we were in a mini-bubble, a bubble that took us to up to $75. We’re now in the process of correcting from that bubble, so therefore no, the price of oil, the price of gas is not reflective of the true underlying fundamentals. We’re still in the position of exercising this irrational exuberance, if you will, out of the market.

Norman: So a mini-bubble. It was mini, but no mini; I mean, was it a bubble in the same sense as the one last year, that it was driven by investors and speculators?

Schork: It was driven on a lot of hope, exactly; a situation where not underlying supply-demand cost jobbers. For instance, if you look at product today, gasoline in mid-July is at an eight-year high. Diesel supplies are at the highest levels since Reagan’s second inaugural address in 1985. Therefore it wasn’t the underlying supply situation … we have a lot of oil. It’s not the underlying demand situation … we don’t have a lot of demand.

Effectively what happened is that we manufactured a rally – the boys on the floor of the New York Stock Exchange and their brethren over on the New York Mercantile Exchange.

Norman: The stock exchange? You’re blaming stocks?

Schork: Well, I’m blaming stocks we went on. If you went and listened to the rhetoric back in February, the economic situation was dire. No one believed in it, but you know what? A couple guys just wanted to start buying, and because the economic situation was so dire, their buying was met with a little resistance, so they created a snowball, and the guys on the commodity markets jumped ahead of them.

And now we’ve got a situation where it wasn’t supply-demand driving up oil prices, it was the expectations of higher prices, because every time I bought, prices went higher, so therefore it was a bubble, because higher prices were becoming the justification for even higher prices.

Norman: Yet there are still those – if you listen to the debate going on, and it is still raging – who would say that speculation adds nothing to the price of oil. Yet we sit here, as you said, with almost decade-highs in terms of supply, in terms of inventory, gasoline and diesel fuel, and yet prices are really not down, in your view, as much as they should be.

How can people still say that speculation is not … or investment; I don’t care what you want to call it: investment, speculation. Look, demand has two elements to it, right? It has real physical demand – we need the gas to put in our car; and it has demand coming from investors or speculators.

Schork: To sit there and suggest that the speculators are not having an upward bias on this market is simply coo-coo-for-Cocoa-Puffs kind of talk. We are still in a very deep recession, but what’s happened is that we’ve seen a material rise in oil prices. The price of crude oil has more than doubled; the price of gasoline has jumped by about 50-60%.

That doesn’t happen in a recession. We have to appreciate that in a recession, when you come out of the recession and demand returns, that demand pushes prices up. What we’re doing right now is pulling prices up on the expectation that economic demand – once we come out of the recession – will catch up to those prices.

Click to enlarge

Norman: But if we don’t come out of the recession, these prices can’t be sustained; is that what you’re saying?

Schork: Absolutely. Not in this environment; these prices cannot be. We had a correction from the mid-70s; we are now flirting in an area between $62 and $58. For the technicians out there, this is a key area of support. Quite frankly, it’s do-or-die.

Being of the fundamental bent, I think we will see oil below $50. I think we can see $40, I think we can even see $30 oil before it’s all said and done, but it’s predicated on the technicals. If we don’t break support here, watch the speculators come in, watch them drive this back up ...

Norman: I want to talk about this pullback from $72, $73 back in June, because it seemed to coincide with a lot of talk about a new and very intense crackdown from regulatory agencies … the CFTC maybe putting on position limits, there’s always been position limits, but maybe applying now to some of these financial Wall Street firms.

It seemed like the timing was just too correct, and when that discussion came out in the media, oil started to tank. I know last year a couple of bills [came up] in Congress to curtail but nothing was passed. Are we closer to really seeing something happen here in terms of curtailing speculation?

Schork: There’s active talk now on the Hill with regard to position limits, margin requirements, forced clearing. There are a lot of issues out on the table and it’s more than a coincidence that when this talk really began to heat up back in June …

Norman: So you agree that the market or the participants are concerned about this, this time; that maybe something could really happen here now to damp down whatever you want to call it: speculation, investment?

Schork: Absolutely, because I think there is a general belief – with certainly this administration, and I know there was a belief in the prior administration – that speculation and undue speculation was really having an uplift.

Now we didn’t get anything done with the last administration and then prices crashed, so oil prices kind of fell off the radar. But now that we again got back into the mini-bubble, it’s a hot topic again, and I think the speculators – some of these big Wall Street guys – feel that they might be in the crosshairs of Washington right now.

Mike Norman, anchor, (Norman):

By the way, I just want to tell you, your publication is fantastic. I was in that business myself for awhile, and there are not too many newsletters or investment sorts of publications that I find to be very strong in their analysis; yours is excellent.

Stephen Schork, editor, The Schork Report (Schork): I appreciate that; thank you.

Norman: In the last interview, I said let’s take a look at the whole green movement and alternative energy. We have a president in place now who is really behind this trend. What sort of an impact, if any, do you think it’s going to have in the short term and in the long term?

Schork: Well, ultimately I think it has an upward skew on price, and my concern is that with this administration … unlike the prior administration – with the Bush administration, all things were on the table. Now this isn’t going to be a pro-Republican/Democrat argument, but what is clear with this administration is their outward hostility toward the oil and gas industry.

If we just take some of the quotes on Reuters and on Fox and so forth with regard to their stance, it is a nasty rhetoric. So I think this administration, unlike the other administration, has taken the approach that it’s all or nothing, that we’re putting everything behind the green agenda, which I fully support.

Norman: How does that translate into a higher … you’re saying the impact is going to be a bullish impact on petroleum prices.

Schork: A bullish impact on petroleum prices because ultimately it restricts supply of petroleum; because all the investment dollars … there were just so many dollars available to the marketplace. Now if I’m being told by government fiat that I have to allocate a certain amount of my production or my exploration toward green, well, those are dollars with which I can’t go after a proven, more efficient marketplace in the hydrocarbons.

So I am not going to be able to grow my hydrocarbon portion of the balance sheet like I did five years ago, and that’s a problem because we were in the situation 10 years ago with natural gas. There was a severe problem with the maturation of domestic sources of natural gas in this country. A tremendous amount of research, a tremendous amount of investment went into new extraction techniques.

We are now getting gas from sources – tight geological formations, coal bed methane, shale – which 10 years ago were not economically feasible. But it is now, so what happens is, we got that gas to the market. If you limit that investment – and this administration is signaling they are going to be absolutely unfriendly – then that next new technology to get the oil that is sitting in the Saskatchewan Plain right now is never going to make it to the market.

Norman: OK, but doesn’t the same thing happen … in other words, yes, in the short term, you limit the investment into the traditional sources of energy, petroleum, oil, natural gas. But in the longer term, because the investment is flowing into the alternates, the technology catches up and we start to produce more of that – just as we produced more of the natural gas, where in the beginning, as you said, there was difficulty in bringing it on domestically.

Schork: I certainly agree, and I’m certainly a big believer in technology catching up. If you make the price high enough, i.e., you put oil at $100 a barrel, all of sudden, you know what? Matt Simmons’ [author/analyst] argument about the world running out of oil kind of falls on deaf ears, because all of a sudden, we don’t find all that oil right off the coast of Brazil or under the Antarctic/Arctic polar caps.

But again, with the technologies, it is this reasonable investment. We have to appreciate that what is so beautiful about hydrocarbons is the amount of energy that you can pack into a relatively small amount. This is why gasoline is such a beautiful source of energy.

Click to enlarge

Norman: Yeah, but they said that about whale oil in the 19th century.

Schork: OK, but look at where some of the investment is being forced on: wind technology, OK? Part of why there is a normal inclination, why there’s a convenience yield in commodity prices, a backwardation, prices going down in the future, is because energy has to be dispatchable: I turn my lights on, I want the lights to go on; I turn my thermostat up, I want my home to heat. I want that energy on demand.

You know what? When do I need electricity the most? I need it in July, in August. When it’s very hot, I want my AC on. Part of the reason why it’s hot, Mike, is the wind is not blowing; that’s why it’s hot. So I’m in a catch-22 here where I want that source, but the wind’s not blowing; so what’s going to happen? I’m going to need to keep a reserve BTU– probably natural gas, maybe even coal – in reserve. Now if I’m the company, if I’m one company, what do I do? I have to finance and maintain an inventory of dirty BTUs to compensate the marketplace when I don’t have the technology there.

So I’m never saying never; my problem is that if we are going to resolve this issue, why take a viable option off the table? It’s still leaning toward the hydrocarbon industry taking that option …the most viable economically in the near term; you’re taking it off the market. I don’t think we should not pursue green, I’m all for it; but it should not be at the exclusion of nuclear, of coal, of natural gas.

Norman: Right. Well, the problem is not so much electricity, is it? It’s more fuel to power our vehicle fleet, and what we use almost 100% is gasoline; that’s what the problem is. So there are other sources of electricity; we don’t use nuclear as much as they do in Europe, but we have nuclear-fired plants. But the problem is gasoline, isn’t it? We don’t really have an alternate for that.

Let’s talk a little bit about the cap-and-trade also being pushed by the president. Will this lead to any sort of a conservation? And if so, doesn’t that alleviate or reduce a little bit the demand side?

Schork: The current trading of the allocations – it’s a difficult question because right now we’re in the sausage-making process of the law and what we’re hearing from the industry with regard to being able to transfer this cost on to the consumer, it’s still a very murky area right now. Quite frankly, I don’t have a strong opinion on it, because I don’t think the cap-and-trade position, with the way they’re pursuing it in the Congress, is going to be … I think the law that ultimately comes out is going to be a much different animal than what we’re looking at right now.

Norman: All right, so quickly wrapping it up – just an outlook, let’s say, for the remainder of this year, really all depends I guess you would say on the economy. If the economy stays in the doldrums, and given the supply situation, prices are not going to stay where they are; they’ll go down.

Schork: Well, it depends on where, believe it or not, where the speculator wants to take the market. The economic doldrums are going to remain. We’re probably in a bottoming phase. We’re certainly not in a strong recovery phase, so the argument for $75, $85 – which some of the bigger Wall Street houses are making – I think is a little wishful thinking at this point. But prices right now are right around $60.

If we hold this support, that’s going to encourage speculators, investors into the market; we set the table for a run at $75. If we can break this support in the high $50s, we will see $45 oil. I believe you’ll sub-$50 oil, and I believe we’ll settle into a trading range, which all along is where I think we should be at this point in the economy: between $45-55.

Norman: So I guess the advice is, keep your eyes on the stock market.

Schork: Keep your powder dry.

Norman: If the stock market rallies, I guess the oil speculators …

Schork: Yeah, the oil will follow, if we have a good stock market. So it’s a catch-22: Do I want the stock market to rise? Of course I do, but be prepared, be prepared. If you see the stock market rise, oil will probably follow suit.

Norman: All right, there you have it. Thank you very much to my guest, Stephen Schork, editor of the Schork Report. I’m Mike Norman. That’s it for now, and as always, stay tuned right here at this site; we’ll have a lot more great interviews in the weeks ahead. Take care; bye bye.