Oil's Slippery Slope: Why Crude and Oil Stocks May Be Headed Down, Fast

After a weekend off, I am back to checking into this oil scam.

One key ingredient to unraveling a lie is to look back at the story as it unfolds. In the case of oil and oil projections we don't have to look very far back to see how the story changed.

The EIA released a study in June which gave us the worst case scenario for oil pricing. Here is the graph:

click to enlarge

There's $100 oil on the chart, but look at the date - 2030! We are already way over the red line on this chart, which predicted a 2006 high of around $60 based on production levels vs. demand. Everything above $50 is just a fear factor.

As we know, demand is dropping below expectations and production is back on track after Katrina. No matter what people say about supply, the fact is there are no shortages and no country has had to tap their reserves either.

Despite what you hear, during the entire 2005 hurricane season, with 25% of the nation's oil capacity off-line for weeks, we got by with a draw of less than 10M barrels (out of 82Mbd of Global production):

As you can see, these barrels have already been replaced and our nation's SPR sits at 687M barrels out of a capacity of 727M (94%). US consumption is, at the current pace, 20M barrels a day of which we import 14 and produce 6. Since half of that 14 comes from Canada and Mexico and another 4M barrels come from non-opec countries, that leaves just 3M barrels a day that we get from OPEC and, yes, Iran.

So IF Iran totally shut off oil AND stopped us from getting ANY OPEC oil for 6 months, we would still have half our reserves available. Iran, on the other hand (and the neighbors they cut off), would have effectively cut off 90% of their revenues for 6 months and likely plunged the world into a recession that would drastically cut oil demand.

This of course assumes that they actually cut the oil supply off, rather than sell it to someone else because if they sell their oil to someone else, then we just buy the oil the other person didn't buy and nothing changes for us at all.

The non-stop parade of oil "analysts" who debate whether oil will hit $80 or $100 at the end of the year assume that there is virtually no price elasticity in oil. They assume that, in defiance of all known economic principals, you will continue to consume more and more gas at $3 or $4 or even $5 per gallon than you did at $1. You are expected not to turn down the AC or turn down the thermostat in the winter no matter how shocking your bill is because, if you don't consume it, they are not going to be able to charge you $100 for it!

Here we have an article published by OPEC that says this is nonsense! Even though the US consumer has shown little penchant for saving so far, it seems very obvious to me that demand destruction is already on the march. 2/3 of US oil consumption goes to transportation and a 41% decline in truck and SUV sales last month shows you how quickly we will adapt.

Close to 10M barrels a day of US consumption goes into our passenger cars. All we have to do to shave 2M barrels a day off our imports is to increase our average vehicle mileage from 19 to 24mpg (Europe averages 34). I've read that if you keep your tires properly inflated you can add 10% to your mileage and I'm sure there's lots of other ways we can cut consumption if properly motivated.

The real problem is that we are so rich as a nation that we are just putting up with this price gouging which encourages them to just keep going!

What about China? China consumes less than 7M barrels of oil per day while we consume over 20 - a 5% reduction in US usage would offset a 15% increase in Chinese consumption. The fact is China is already taking steps to curb consumption on their end too.

Recent market action suggests that $75 is indeed a tipping point and you can see that the markets. After having accepted $50 and $60 fairly well, we have had a lot of trouble as oil breaks over $75. As pointed out, oil at $75 includes a 50% terror premium that adds nothing to the economy and I see nothing stopping oil from falling back to the $60-65 range in the near future if the Iranian "crisis" turns out to be a non-event.

A two-year chart of oil (OIH) and housing (HGX) gives you a good idea of where we could be headed if this bubble bursts:

Switch to the three or six month view and you will see something that should stop oil bulls from sleeping at night - the two indexes are getting back into sync! Now if you think housing is going up 50% in the near future, by all means keep buying oil stocks. If not, as any housing bug can tell you, it's a long way to the bottom.

As an extra, here's a good article on some overbought oil stocks.

Comments

[scott146:]

I agree 100% with this analysis. Thanks for pointing out a number of facts that are being largely ignored these days.

Scott

2006 Aug 23 05:14 PM

[Michael Rin...:]

Macroeconomic analysis is something I'm more comfortable with than trying to predict short-term swings, but you're painting a "best case" scenario in every possible way. China's attempts at 'curbing consumption' will only slow its growth in that consumption, not keep it from rising. SUV sales might be getting whacked, but the F150 still outsells any other vehicle, and Hybrid production numbers are too small to even count. I think you're also giving the consumer too much credit for self-sacrificing behavior like putting up with higher household temps in the summer and lower ones in the winter..

Why make all these elaborate points that all have such simple counterpoints when a much more traditional concept would do just as well? Something like this: Consumers fail to reduce energy consumption, and instead must make cuts elsewhere. Those other cuts slow the economy, slowing compensation growth, boost unemployment, etc. Those that aren't making as much or are out of work won't be consuming nearly as much energy, thereby moderating energy prices a little.

As in many things in life, the truth if often somewhere in the middle. It won't be doomsday, and I'm pretty sure it won't be as peachy-keen as you're thinking it will be either.... in the long run.

In the short run, you might be right, for a few months. Given that it's debated outside the investing world whether supply can expand much beyond its current level even if it wanted to though, I personally find the "reference" projection, or something slightly more cynical but not "worst case" much more believable than a long-term return oil below $40. If this were a normal business that could expand supply to meet demand, sure, but when 'god', or Earth, doesn't allow supply to expand, well then...

2006 Aug 24 12:54 AM

[Rob Sanheim:]

First - the small steps that some people are taking to cut their use of oil is really a tiny drop in the bucket compared to what is needed. Maybe if gas were $10/gal we'd see car and van pooling, mass transit, and thermostats at 60 in winter. As it is, I see most people buying a few compact flourescant lights and _maybe_ buying a mid size sedan instead of an Escalade.

Second - even if Americans were ready to make drastic changes to their lifestyle, what would it matter if Iran really did cut its oil supply? The price of just about every necessity would explode, and it wouldn't matter much how little John Doe drives if his grocery bill and heating bill is 3x as much.

Third - we know that there doesn't need to be an actual cut in supply to see it shock the world economy. All it takes is threat of a cut in supply or maybe a terrorist attack on Ghawar to send the price to new heights. If the US was actually burning through its reserves, can you imagine the resulting panic? No drilling in ANWR or Alberta oil shale would be able to take up the our slack and that of India, China, Japan, etc...

2006 Aug 24 01:37 AM

[Philip Davis:]

I'm amused at how this is being called a "rosy picture" when we are using the IEA and OPECs own statistics.

As to cuts in usage: Current US fuel consumption = 10Bpd @ 19mpg, a move over time to 30mgg would knock out 3M barrels a day of usage, instant glut on anyone's projections. Europeans did it because they have been taxed at $4 per gallon for years - perhaps that's the magic number for the US as well.

Al Gore proposed a .50/gal gas tax back in 1993 which was quickly shot down by the Republican Congress. He had this radical left-wing idea that we could put the $150Bn a year into exploring alternate energy to avoid the "hopeless" situation we are now in. At the time the Republicans said that allowing gas to go to $1.50 a gallon would destroy the US economy...

Perhaps, in hindsight, spending $2T over the past 13 years to develop fuel cells and solar energy etc. may not have been such a bad idea. He also wanted to do insane things like double the SPR so we could use it to hedge price spikes, rather than be at the mercy of an obviously manipulated market.

We are not even discussing the very real possibility of increased usage of alternate energy in this country including renewed interest in nuclear power (think GE) and the obvious popularity of solar companies who are having trouble keeping up with product demand.

Since 180M of us work in the daytime (and another 60M are in school), a lot more energy than you may think can be saved by corporations turning down the AC or lowering the wattage of light bulbs than by worrying about whether or not you personally can suffer in a 76 degree room.

A 1 degree adjustment room temperature equals a 4% reduction in fuel consumption:
www.eia.doe.gov/emeu/c...

Perhaps you are not willing to make this sacrifice in your own home but bottom-line sensitive companies will make this adjustment much quicker than you think.

It is interesting to note that, last March, OPEC considered $50 oil as unsustainable and felt that oil prices at that level would trigger global recession and force production cutbacks. At the time global productionw was at 83.6M barrels per day yet we are now being told that only 82M barrels a day are being produced (followed by the IEA adjusting 79M barrels into inventory in a single quarter).

If you doubt US sources to that effect, here is the original article from Al Jazeera:
english.aljazeera.net/...

We don't need an actual drop in demand to drive oil prices back below $60. All it takes is a pullback by speculators to dump a portion of the 3Bn barrels that they have tied up and the only "crisis" we will have will be the one faced by oil bulls as they stare at losses that make today look very mild indeed.

2006 Aug 24 03:43 AM