Is oil entering a bubble? That was the question on everyone's mind at last week's "Inside Commodities" conference, where keynote speaker Nouriel Roubini argued in his speech that oil prices had risen too far, too fast, too soon.
But oil can still go much higher, says Stephen Schork, editor of The Schork Report, a daily briefing on the energy markets. With over 17 years' experience in commodities trading and risk systems modeling, Mr. Schork is a highly respected voice in the energy markets, and has offered his expert opinion to CNBC, the Wall Street Journal, Bloomberg and dozens of other media outlets.
While at the conference, HAI Associate Editor Lara Crigger chatted with Mr. Schork about his thoughts on the current energy picture, including whether oil prices have gotten out of whack with fundamentals, whether natural gas or oil has more upside potential, and why geological peak oil isn't as important as political peak oil.
Lara Crigger, associate editor, HardAssetsInvestor.com (Crigger): In 2009, oil went from $35/barrel back up to $70-$80 in relatively short order. Have oil prices gone higher than the fundamentals justify?
Stephen Schork, editor, The Schork Report (Schork): What is oil's value? It's what we derive from it, and what we're consuming. Certainly on the consumer level, I think we're seeing a rise in appetite, and a rise in the elasticity of demand.
So at this point, if we look at the cost of taking oil out of the ground, and what the Saudis (or any other government) are setting their budgets at, then I think fair market value is three times that. Petrobras (NYSEARCA:PBE) has said that at oil at $55-$65/barrel, they'd be tickled pink - so, really, anything above this, I think.
Crigger: Throughout 2009, we've seen the energy markets suffering from contango. Will this contango persist through 2010?
Schork: If we don't see a rise in demand, absolutely. That contango's been in place for awhile, and you will not see an increase from contango until you see actual demand for crude oil.
I would expect to see demand rise by the spring. If things tighten up in the spring with regard to product inventories, that would be the time that you'd want to look for. With rising demand and falling product, I'd expect that contango to invert toward backwardation.
Crigger: In your opinion, which has more upside potential for 2010: natural gas or crude oil?
Schork: At this point, I'd still have to say oil. With regard to natural gas, we're seeing the advent of nonconventional sources of gas: coal-bed methane, shale and so on. In the industrial complex, which is a major consumer (the steel industries mainly, and the metals producers, plus your fertilizer and chemical industries), I think production remains pretty weak through 2010. And given the amount of LNG already on the market, and that which is coming onto the market, I think that's going to help to continue to push natural gas prices down.
On the other hand, oil prices - especially in the U.S. - are less due to industrial consumers and more due to transportation. So I still think the upside's more toward the oil side at this point.
Crigger: There's a lot of discussion lately on this idea of peak oil, and how that affects supply and demand for oil. What are your thoughts?
Schork: I don't believe in it at all.
Crigger: Not at all?
Schork: Well, I believe there's political peak oil. I believe there may not be the will to extract. But as far as actually extracting the oil from the ground - look, if you incorporate the entire mass of the Earth, we've scratched 1/15 billionth of its surface.
So if you drive prices up to $100 oil, sure enough, you do find that oil in the Tupi field and so on. Surprise, surprise. All of a sudden, you start finding oil again.
And we haven't even touched the east coast of Africa. Forget the west coast, which still has a lot more to find. We haven't even gone near the east coast, and there's speculation that a lot more is there.
So putting the politics aside, I don't believe we have geological peak oil. But put the politics in, and you can get political peak oil.
Crigger: Speaking of Africa, does Angola have what it takes to become the next big producer?
Schork: Oh, Angola. You know, Nigeria - well, it is what it is. The amount of production that we lost from Nigeria when prices were going up, that was offset by Angola. So, yes, I think they're the next big producer to come out of that hemisphere.
Crigger: How will China continue to influence oil prices from here on out?
Schork: Well, I think the specter, or the thought, of China is what drives oil.
Crigger: The idea of what China could do, rather than the actual facts on the ground?
Schork: Right. The idea of a billion Chinese trading their Schwinns for Cadillac Escalades - I think that is driving the market. But we still don't have any reliable data coming out of China.
There's no denying that China and India are certainly a force in the market; that's 2 billion more consumers of oil and all things commodities. But as we saw in the aluminum market, in the distillates and diesel fuel, they were hoarding. They were building up their stocks. If they were buying it and then burning it, that would be one thing; but they're buying it and then sticking it in a tank. That's not demand. That's just building supply.
Certainly it's supportive of prices. But is it a driver of $150, $200/barrel? Will they go that high because China is hoarding? No, I don't think so, not unless we see that real demand in the market.
Crigger: How much control will OPEC have over pricing power in the future?
Schork: Well, they've got 40 percent of the market at this time, so how could they not be an influence? They'll absolutely be an impact, with regard to how much oil they put on the market.
But you have to keep in mind that OPEC prices in dollars. So if you want cheap oil prices, you want a strong dollar - but I don't know how the government can do this, given the deficits we're running. Still, if you get a strong dollar, you'll see oil at $50-60/barrel, and what's more, you'll see OPEC tickled pink. Because what does $80, $100, $120 oil do? It lowers the entry barrier of assault under the deals, and that's OPEC's worst nightmare. So they'll do their damnedest to get $50 oil, and make a very nice living.
Crigger: Lately, we've seen quite a bit of discussion about the how and why of increasing regulation of the energy markets. What are your thoughts?
Schork: I have no problem with regulation that brings greater transparency to the market. But from an economic and rational standpoint, my fear is that you'd drive business offshore.
But my real big concern is this notion of forcing clearing through a regulated exchange. I understand the rationale for it, but ... well, I'll give you an example. A lot of heating oil distributors in the Atlantic/New England area (the largest heating oil market in the U.S.) base their product off of regional racks that don't trade every single day. So how do you have a regulated futures contract when you can't have price discovery every single day?
The answer is: You can't. So are you going to force-feed a vanilla futures contract that doesn't necessarily pertain to the regional market dynamics in your particular area? The concern then, is: 1) you're going to raise the cost, and 2) you're going to prevent that heating oil distributor or natural gas LDC from hedging in the first place. When you have a physical entity that doesn't hedge in a market that goes haywire, that's when the real issues truly pick up.