By Jason Simpkins
As Money Morning predicted in its 2011 Outlook for oil prices, crude is poised to surge over $100 a barrel this year. And gas prices are likely to follow suit - perhaps even testing their record high above $4 a gallon.
And gas prices are going along for the ride.
The national average for gasoline hit $3.08 a gallon on Friday, according to the AAA Daily Fuel Gauge report. That's up from $2.96 a gallon a month ago and $2.70 a gallon a year ago.
"There is a confluence of factors developing that will guarantee further increases in gas prices," Money Morning contributor and Editor of the Oil & Gas Trader Dr. Kent Moors said in an interview. "I am not prepared to say $5 within the next year, but $4 by high summer seems safe."
Moors predicts oil will top $100 a barrel by the end of March, if not sooner. He says the main factors driving oil and gas prices are:
- The return of demand, especially in non-U.S. and non-Western European markets.
- The weakness of the U.S. dollar.
- Inventory concerns.
- Supply constrictions.
- And mergers and acquisitions further limiting competition - energy industry consolidation.
Of those factors, rising energy demand in non-OECD (Organization for Economic Cooperation and Development) economies will be the biggest catalyst for higher oil and gas prices.
Global oil consumption has rebounded from the lows in early 2009 and now exceeds pre-crisis levels. However, consumption in developed economies remains 8% below 2007 levels, which means emerging markets have picked up the slack.
Indeed, the usage gap between developed markets and their "emerging" counterparts has shrunk from 12 million bpd three years ago to just 4 million bpd today.
"It comes as no surprise that the geographic distribution of oil demand growth follows that of economic growth: Emerging markets, rather than the OECD, drive the increase in global oil demand in 2010 and 2011," BNP Paribas SA (OTCQX:BNPQY) said in its 2011 forecast.
The International Energy Agency (IEA) forecasts global energy demand will rise to 88.2 million barrels per day (bpd) in 2011, up from 86.9 million bpd this year.
The most dynamic emerging market growth has come from China, whose economy is expected to have grown by 9.1% in 2010. Oil demand in China is expected to grow 10.4% this year - the fastest rate of any country in the world.
"It is hard to overstate the growing importance of China in global energy markets," Fatih Birol, chief economist for the IEA, said in that organization's annual report. "The country's growing need to import fossil fuels to meet its rising domestic demand will have an increasingly large impact on international markets."
Birol says that 700 out of every 1,000 people in the United States and 500 out of every 1,000 people in Europe own cars today. But in China, only 30 out of every 1,000 people own cars. That figure could jump to 240 out of every 1,000 by 2035, he says.
Furthermore, when Japan hit $5,000 of gross domestic product (GDP) per capita, oil demand grew at a 15% annual rate for the next 10 years, according to oil-industry consultant firm PIRA. The same is true of South Korea. However, China reached the $5,000 GDP per capita mark in 2007, and oil demand has only grown at a 7% compounded annual growth rate.
As the world's largest and fastest-growing auto market, demand for gas and oil is poised to accelerate very quickly in China over the next several years.
Oil demand is also growing briskly in other economic hot spots around the globe.
India consumed nearly 3 million bpd in 2009, making it the fourth-largest consumer of oil in the world. The Energy Information Administration (EIA) expects approximately 100,000 bpd of annual consumption growth through 2011.
India has the second-largest proven oil reserve in Asia - behind China - but the EIA expects that subcontinent to become the world's fourth-largest net importer of oil by 2025, behind the United States, China, and Japan.
India will become the world's fourth largest passenger vehicle (PV) market in the next three years, reaching 3.5 million units, according to global consultant Booz & Co.
"By the next three years, India will be the fourth largest PV market in the world. Only the U.S., China and Japan will be ahead of India," Booz & Co. Partner Vikas Sehgal told the Press Trust of India. "India will even cross Japan by selling about 5 million PVs by 2017-18."
India's domestic passenger car sales rose 21% in November from a year earlier, according to the Society of Indian Automobile Manufacturers. And the China Association of Automobile Manufacturers reported that sales of passenger cars to dealers in that country increased 29.3% in November from a year earlier to a monthly record of 1.34 million units.
Demand isn't the only thing pushing prices up, either. Serious concerns about a supply squeeze are mounting as the Organization of Petroleum Exporting Countries (OPEC) - which controls 40% of the world's oil supply - hesitates to boost production.
Not wanting to hurt fragile demand in the depths of the financial crisis, OPEC was comfortable with crude prices of $70-$80 a barrel. But as demand rebounds, the cartel is showing an interest in making $100 a barrel the new standard.
Mohammad Ali Khatibi, Iran's representative at OPEC, in November said that the current price range of $70 to $90 was a "suitable" range, but noted that the global economy was capable of absorbing higher prices.
"Oil prices increasing to $100 (per barrel) would not hurt the global economy," Khatibi told the oil ministry news agency SHANA. "Not only producers, but consumers have reached this agreement that $70 to $90 is a suitable price for oil because it encourages investment and does not hurt the global economy."
Saudi Arabia's oil minister, Ali Al-Naimi, also has mentioned a range of $70 to $90 a barrel, which is a deviation from his previous target of $75 a barrel.
"We think OPEC is unlikely to raise output ahead of its June 2011 meeting unless oil prices push above $100 (per barrel), leaving inventories to draw over the first quarter, pushing Brent crude oil into backwardation, a structure that is likely to remain in place for much of 2011 and 2012," analysts at JPMorgan Chase & Co. said last month.
Oil will breach the $100-a-barrel level in the first half of 2011 and $120 before the end of 2012, JPMorgan said.
Finally, the key oil-price catalysts transcend the simple arithmetic relating to supply and demand. Other factors are at play, including investor sentiment and the value of the U.S. dollar.
Because oil is priced in dollars, it is vulnerable to changes in the greenback's value relative to other currencies. A stronger dollar makes oil more expensive for foreign countries that have to convert their domestic currencies into greenbacks to buy crude.
Conversely, a weaker dollar makes it cheaper for countries that import oil.
Currently, the U.S. Federal Reserve's commitment to a loose monetary policy has undermined the value of the dollar. Furthermore, the Fed has effectively flooded the system with cheap money, meaning there are more investment dollars available for commodities such as oil.
The price of oil has surged some 16% since mid-August, when the U.S. Federal Reserve first indicated it would consider a second round of quantitative easing.
"The additional liquidity pumped into the markets by the Fed's Treasury purchases should also reach commodity markets and is thus leading to increasing oil prices," said analysts at the Frankfurt-based Commerzbank AG. "What is more, the higher price level reflects the weaker U.S. dollar which is a direct consequence of the ultra-expansive U.S. monetary policy."
When oil reached its record high in 2008, it was largely because speculators had piled into crude - and a host of other commodities - to hedge against the beleaguered greenback. Similar behavior could exacerbate oil's 2011 ascent.
"As for speculation, it is the nature of the beast," says Money Morning's Dr. Moors. "Oil is both a commodity and a financial asset in its own right. That means its trading impact is much broader than the oil for delivery alone."
How to Profit from Higher Prices at the Pump
One of the simplest ways to profit from surging oil prices - outside of investing in futures on the NYMEX exchange - would be to invest in an exchange-traded fund (ETF) that tracks the commodity's movement.
The iPath S&P GSCI Crude Oil Total Return ETF (NYSEARCA:OIL) and the PowerShares DB Oil Fund (NYSEARCA:DBO) are two options. There's also a gasoline ETF: The United States Gasoline Fund L.P. (NYSEARCA:UGA).
If you're looking for specific companies, ConocoPhillips (NYSE:COP) would be a good place to start your search. It's the third-largest integrated energy company in the United States and the fifth-largest refiner in the world.
Chutinush Taksinapinunt of Heffernan Capital Management recently issued a "Strong Buy" on ConocoPhillips with a 2011 target of $90. The stock closed Friday at $66.11 and a price/earnings ratio (P/E) of 9.49. What's more, the stock has a 3.3% dividend yield.
You might also look at China National Offshore Oil Corp. (CNOOC) (NYSE:CEO). CNOOC is often referred to as the most "Western" of China's oil majors because it was founded with a mandate to form joint ventures with foreign companies. CNOOC is the vessel through which China is acquiring foreign expertise in the energy sector.
CNOOC in October announced it would pay $1.08 billion for a 33% stake in Chesapeake Energy Corp.'s (NYSE:CHK) Eagle Ford shale acreage in Southern Texas, a deal that highlighted China's desire to develop its shale-gas extraction techniques.
China has 26 trillion cubic meters of shale-gas reserves that are largely unexplored due to a lack of drilling ability. Chesapeake is a pioneer in the shale gas industry.
It's far pricier than ConocoPhillips, however. CNOOC closed Friday at $235.39 a share, with a P/E ratio of 16.22 and a dividend yield of 2.25%.