4 Factors Fueling Oil Prices Higher

Just days after Money Morning Investment Director Keith Fitz-Gerald reiterated his prediction that oil prices would reach $187 a barrel within 36 months, Wall Street giant Goldman Sachs Group Inc. (GS) issued a report predicting crude oil prices would reach $175 in the next few years.

We first mentioned Fitz-Gerald’s belief that the $187 price target was a possibility in an article back in December when oil was trading at $90 a barrel. Fitz-Gerald then reiterated his prediction two weeks ago. When oil prices took off on their record run, we published the prediction as part of an in-depth analysis of the crude-oil market.

The article ran last Thursday, and the response has been stunning: It’s been picked up by other news services, and posted on Web sites all over the world.

Then, just last Friday, Goldman Sachs followed suit and said that crude oil prices could hit $175 a barrel in the next few years as the commodities sector experiences “explosive rallies” that are spurred by supply constraints. The prediction was contained in an investment research report that concluded that political decisions on money flows, labor and technology were “substantially constraining supply growth” of commodities, Bloomberg News reported.

A significant under-investment in refineries, mines and land was helping fuel the leap in commodity prices.

“This will likely support the ongoing structural bull market in commodities until these policy-driven investment constraints are removed and/or demand is adjusted,” Goldman Sachs said.

Pain and Profit

Although rising oil and gasoline prices are extremely painful for consumers to deal with, Fitz-Gerald contends that they also represent one of the greatest profit opportunities investors will see for a long time.

“Many people think high oil prices are a bubble. Maybe, but not for long and certainly not given the growth in global demand,” Fitz-Gerald says. “Of course, prices will not stabilize anytime soon. Savvy investors [will realize that] we are still in the very early stages of a generational game with the potential to be played for great profits.” [Editor’s Note: To read the full Money Morning research report – which includes Fitz-Gerald’s three profit plays – please click here.].

Oil prices spiked to a record level of $111 a barrel on Thursday as the U.S. greenback hit a 12-year low against the Japanese yen and an all-time record low against the euro. A key cause for the dollar’s weakness: Investors continue to question whether the U.S. Federal Reserve’s strategies for restoring order to the sputtering financial markets have any real long-term validity.

On Friday, gold spiked to a key historic high of more than $1,000 an ounce – eclipsing a psychologically significant barrier – as investors continued to turn to the yellow metal and other commodities as a way of hedging against the plunging greenback.

Goldman Sachs said $175 a barrel crude "represents the price level required to maintain trend economic growth against our anaemic supply growth forecasts, assuming growth in the U.S. [economy] re-accelerates early next year.”

Late last month, Matthew R. Simmons, chairman of the Houston-based investment bank Simmons & Co. International, actually predicted that oil prices could climb as high as $378 a barrel – characterizing current prices in the $100 range as “preposterously cheap.”

To underscore his point, Simmons told the Arabian Business news service that in the United Kingdom capital of London, gasoline can sell for as much as $9 a gallon. And even that doesn’t deter motorists from driving their cars.

Prices at that level don’t “seem to have slowed anyone down. It works out as much as $378 a barrel. Yes [I can see it reaching that high]," he told the news service.

Just last week, the International Energy Agency [IEA] warned last week the era of cheap oil had ended. In fact, only a sustained global recession could send oil back down below the $60 a barrel level for any length of time.

The Four Factors Fueling Higher Prices

Back in early 2002, oil was trading at less than $20 a barrel. Before it began its northward march from that point, Fitz-Gerald conservatively predicted that oil prices would reach $100 a barrel within 10 years. His price prediction was right on target.

Once crude prices hit that psychologically key “century mark,” Fitz-Gerald reassessed the market and ultimately boosted his target price to the $187 a barrel level. But Fitz-Gerald sees oil-and-gasoline prices going higher – much higher. And he’s very clear about just why that’s going to happen, listing four key catalysts:

• Obfuscation by OPEC: Members of the Organization of the Petroleum Exporting Countries have been misrepresenting their reserve capabilities for years. The key players have reported no new discoveries for decades.

• Terrorism Threats: The odds that a terrorist act will interrupt oil supplies – in the near term or the long term – are higher than most security experts would ever publicly confirm, Fitz-Gerald says. And this is especially problematic because of the double-whammy effect: Damage to a major pipeline or a strategic refinery could crimp supplies just as demand is continuing to escalate.

• The Dollar Doldrums: Oil is priced in dollars. And the dollar is in the dumper. Indeed, rising inflation and falling interest rates have put the greenback into a steep downward spiral. And if prices keep rising, and if Federal Reserve policymakers keep cutting short-term interest rates, the dollar will continue to lose altitude against other key global currencies. OPEC members will counter the greenback decline by marking up the price of crude, causing prices to increase still more in dollar-denominated terms.

• Cruising Goes Global: As an increasing number of households in China, India and other advancing overseas economies join the world’s middle class, they’ll start making such basic purchases as electronic goods, houses – and automobiles. The fact that China’s oil imports jumped 18% in one month is evidence enough that this is happening. And the fact that leading India automaker Tata Motors Ltd (TTM) has unveiled a $2,500 car, the Nano, underscores that international carmakers are looking to recruit a whole new group of motorists. The fallout: For U.S. refiners, oil will first get lots more expensive, and then supplies will start to dry up as countries opt to halt exports and keep the precious black gold for themselves.

Oil Becomes a Strategic Asset

Oil prices have made a major move in the past five years – just as the emergence of China, Russia and several other key economies transformed crude-oil pricing into much more of a global game. High prices have sent cash pouring into the coffers of oil-producers in Asia and the Middle East. Many countries have used that capital to finance global investment initiatives, creating government-controlled "sovereign wealth funds" to do their bidding.

Little wonder crude oil has become a strategic asset – as well as an energy source.

"As oil and other fuels become a more and more precious resource, OPEC countries, China, Russia and others will begin holding back oil, instead of putting it into the market," Fitz-Gerald says. "That’s going to be devastating in the short-run.”

Some big oil consumers such as the United States have lobbied OPEC to boost production in order to bring market prices down. But it’s done no good: Members of the OPEC have said over and over that market supplies are adequate and that the surging prices are not something that they can control.

China – a growing consumer of oil – has embraced a different strategy: To create captive supplies of crude, China has demonstrated that it’s more than willing to endure controversy and cut deals with countries U.S. refiners either can’t or won’t deal with. China Petroleum & Chemical Corp. (SNP), and PetroChina Company Ltd. (PTR) – two of China’s biggest oil companies – have invested in such political hot spots as Africa and Iran.

The Chinese government, desperate to lock down supplies of such crucial natural resources as metal ores and crude oil, has sealed deals with Sudan, Chad and the Congo. African Business reports that trade between Africa and China has advanced at a rate of 40% a year since 2001. In 2006, bilateral trade between the two was $50 billion.

Already, 14% of China’s oil imports come from Angola. About 60% of Sudan’s oil goes to China.

Comments

[maximax:]

I've just read somewhere that "pension funds are pumping their money into oil" - see www.upi.com/Internatio.../

This surprises me - anyone with info on this?

2008 Mar 19 06:31 AM

[kjapan:]

Well, Stephen Leeb, PhD has been calling this for qutie awhile.

2008 Mar 19 08:19 AM

[kjapan:]

Stephen Leeb PhD has been calling this for a couple of years.

2008 Mar 19 08:20 AM

[Serge:]

What a silly article! You cite the reasons why the price of oil HAS been increasing - these reasons are already well reflected in the price of oil. High oil prices are self-defeating. Oil prices are going to fall, folks. You read it here first.

2008 Mar 19 11:11 AM

[courther:]

Whatever! The article is saying that we Americans are screwed because of these four global factors and there is nothing we can do. You have forgotten one small component in your logical equation and that is Americans are not qoing to be squeezed by this government or anyone else. There will be a revolt or 21st century American revolution and the first victims will be the American politicians who will be voted out and replaced with individuals that will actively seek alternate energy solutions and look for better ways to support American people. Who knows in the future we may be able to find writers who will offer solutions rather than tell us to suck it up.

2008 Mar 19 11:49 AM

[briskforme:]

The same old adage ....Money Makes the World Go Round...The rich and the poor. The bottom line is there are too many greedy people in the world and we are at the point where we need a world wide catastrophe where money is worth nothing and bartering is the order of the day. What will the rich and powerful do then.......At least we will all be equals...We have moved way too fast in the past 58 years, at the speed of sound in fact, and the next 50 years will we move at the speed of light..... It's insane!!!! I for one was born too late, instead of 1946 I would have preferred 1846, at least there were no multi-billion dollar organizations and the majority of people worked harder to make a honest dollar. If you really think about it, it's sad really, that the world has come to this point.

2008 Mar 19 12:56 PM

[AMP:]

I think these financial giants are manipulatingthe market

2008 Mar 20 11:12 AM

[oilsands:]

Amazing. So many ignorant comments on top of an article which surveys but fails to mention important factors.

1. Canada is our number one source of petroleum. The crash of the dollar is strictly a result of turning Uncle Sam into a beggar; George Bush and cronies think the solution to every problem is to print more money and talk big. When Bush took offic the Canadian dollar was at 65 cents, US; now it is over a dollar US. You do the math.

2. We have unlimited free energy if we choose to tap it. Geothermal, wind, tidal, hydro, solar are all around us. The gulfstream has mind boggling amounts of dependable energy.
An article in Scientific American stated that a mere 1 % of the Nevada desert could provide all of the electric needs of the entire USA.

3. Unfortunately our energy policy is dictated by the foreign oil companies who make lavish campaign contributions to both parties.

4. Contrary to the propaganda we are fed, we can harness this free energy NOW; it does not require decades of research. Sure, there are advances that can be made in utilizing coal, but that is not necessary for our energy independence.

5. Canada's oil sands have more petroleum reserves than all of Saudia Arabia. Yet our government was apparently asleep while China arranged to build a pipeline from the oil sands refinery to Vancouver where it can load it aboard tankers for delivery to the PRC. How's that for protecting our interests?

6. Congressional subsidies to oil companies amount to 81 billion per year. Factor that into the price per gallon and we are really paying $7.00 plus per gallon. That isn't coounting the amount we have spent year after year deploying troops strategically to watch over our interests.

Our family has been making money on oil for generations. But we don't need or want to see our country go belly up from sheer stupidity.

Wake up people. Start by not accepting the propaganda from Washington and through the lavish ads of major oil companies. Demand a policy which benefits American citizens for a change.

2008 Mar 20 01:37 PM

[thinking ahead:]

You are right about China, in particular, wanting to lock up supply at any cost. No US Multinational oil company can compete with the Chinese government. I have no solution for the US. I do have an obvious recommendation for profiting from this reality: RIG, NOV, DO and any other world-class deepwater oil service participant. The NOC's don't care who drills for the oil, they just want to own the result. Deepwater drillers are the investment of a lifetime. And DO even pays a dividend > 5%.

2008 Mar 20 04:40 PM

[BrucePile:]

One reason for climbing oil prices that doen't get talked about is EROEI. That's Energy Returned On Energy Invested and it's one of the least understood and most important issues with oil. We tend to look at the massive reserve numbers and the massive flow rates of total liquids production and think we have more energy supply than what we actually have. A sharply increasing amount of our high EROEI conventional crude is being used to manufacture the unconventional oils that go into the total liquids number (tar sands, shale oil, deepwater, ethanol, and biofuels). But these oils are very low EROEI taking about as much "real" oil to make as they supposedly add to our supply.

When oil was extracted decades ago, it took about 1 barrel of oil energy to hand us each 80 barrels of net energy from shallow, naturally pressurized reservoirs. Now it's about 10 to 20, depending on location. This figure is dropping faster and faster as the "hanging fruit" has already been exploited. There is a simple math fact about EROEI that dictates a rapidly collapsing net energy supply to the economy as you go below an EROEI of around 3 to 4. If you go from an energy source with an EROEI of 20 to a source with an EROEI of 1.3 (the most agreed upon figure for corn ethanol), YOU MUST MAKE 60 TIMES THE AMOUNT OF THE LOWER EROEI SOURCE TO GAIN THE SAME NET ENERGY AS GIVEN BY THE HIGH EROEI SOURCE. That means to displace one barrel of oil, you must make 60 barrels of ethanol. Most all of the manufactured fuels have EROEI of less than 3 making them nearly useless in displacing foreign oil, but very usefull in causing catastrophic food inflation.

EROEI makes our true energy supply not the total liquids curve commonly accepted but something much closer to conventional crude plus condensate, which is falling behind the total liquids curve at a quickening pace (it peaked in 2005 and hasn't made a new high since, although it nearly did this past month).

What's left of the big reserve amounts of oil has big EROEI issues and a large amount of it is going to take more energy to extract than the oil will supply. The rapidly declining EROEI curve is going to make the energy world going forward much different than what we've been spoiled by in the past. For some charts on this and a good overview, see the current EROEI story by Robert Rapier at theoildrum.com

2008 Mar 20 07:20 PM

[Pax Americana:]

Oilsands....Canada oil -sands have more stategic reserves than
Saudi Arabia, yet we allowed the Chinese to negociate with Canada,
for a oil-pipeline from the oil-sands refineries to the west of Canada
at Vancouver for shipment to the PRC, hows that for an Intelligent
"National Energy Policy" . China has deep pockets and a long term
consistent "National energy Procurement Aim" that is making decisions ,based on 20 year horizons.

Jun 22 06:08 PM