We've been betting on lower oil prices for a while now, with neither gain nor loss to show for it. Our thesis was that the recession would last longer than consensus had it, therefore oil demand would remain low longer than most people thought. However, neither stocks nor oil have suffered much of a setback since the bounce began in March 2009.
Our long-term thesis on oil has always been that much higher prices are in store for one simple reason: more people are demanding more oil just as the world is running out of it. A report published last week by a task force of six companies in the United Kingdom, titled The Oil Crunch -- A Wake-Up Call for the UK Economy, lent its support to that thesis by warning that an oil shortage will destabilize economic, political, and social activity within five years. From the report:
There are now serious concerns that the free flow of relatively low cost oil, which has underpinned OECD countries economic growth since 1945, may not be sustainable for very much longer. Low-cost (under $25/b) oil supplies effectively ended in early 2005 and are unlikely to return. The actual global supply of oil is now expected to be limited to 91-92Mb/d (million barrels per day) of capacity that will be in place by end 2010/early 2011. Global capacity will then remain in the 91-92Mb/d range until 2015 from which time depletion will more than offset capacity growth from then onwards.
Between July 2008 and January 2009 virtually all the world's economies went from vigorous growth to economic recession. This has radically changed the short-term outlook for energy demand in general and oil demand in particular. The recession has changed the market dynamics and potentially moved the "oil crunch" point (when demand exceeds production capacity) out by around two years. This in turn provides one of the few positive aspects to the recession -- it gives companies and individuals more time to prepare and adapt to the coming oil supply crunch. The great risk is that as prices may remain fairly low for the next year or so, complacency may set, thereby making adaptive investments being postponed until oil prices start spiking again.
The next major supply constraint, along with spiking oil prices, will not occur until recession-hit demand grows to the point that it removes the current excess oil stocks and the large spare capacity held by OPEC. However, once these are removed, possibly as early as 2012/2013 and no later than 2014/2015, oil prices are likely to spike, imperiling economic growth and causing economic dislocation.
The complete report, a 60-page PDF, is here.
As we're still firmly in the recession's low-demand spell, and the dollar is in an uptrend, we'll keep our bet on lower prices in place for now. Toward the conclusion of this next leg down, however, we'll hunt for good oil-industry investments, such as Transocean, and look to go leverage long the commodity itself.