Oil's Gains Are Due to Fundamentals, Not Speculation

Wouldn't it be nice if those recent oil spikes were entirely due to speculators/investors, and these greedy hedge and pension funds are simply creating an "oil bubble" that will burst sooner or later?

According to Iraq's Oil Minister Hussain al-Shahristani:

There is more oil in the market than consumers want. What is driving up prices is an increase in speculative funds. An increase in production by OPEC countries would not really change the scenario – it would not affect the price. (source)

All bubbles ultimately end up the same way - They burst sooner or later.
If thats the case, oil prices would fall below $100 and we can all enjoy cheap oil, filling our cars for less than $4 per gallon.

Unfortunately, this scenario does not depict reality. In fact, it sounds more like a fairy tale ending. And of course, if speculators are indeed responsible for the spikes, those Arab nations would be freed from the burden of increasing oil production. In my opinion, oil prices are going to spike higher, at least in the long run. Heres why :

1) Stagnant Supply

There is a something called Hubbert's peak theory which predicts that oil production will increase, peak and stay stagnant for some time, and then decrease at almost the same rate it went up.

Dr. Hubbert predicted in 1956 that US oil production would peak around 1965-1970. Just like Arjun Murti (Goldman Sach's analyst who predicted oil will hit $100 a few years ago), he was snobbed by other "experts" who seemed to be extremely optimistic about oil supplies. Unfortunately, both Hubbert and Murti were proven correct.

Take a look at this graph :

The ASPO (Association for the Study of Peak Oil and Gas) has predicted that the peak in global oil production would occur in 2010. Some analysts even believe that the peak had occured in 2005.

The evidence proving that peak oil is coming soon is irrefutable.

Oil companies are finding it harder and harder to replace every barrel of oil consumed with another barrel from oil fields. Even Saudi Arabia's vast oil fields are drying up soon. The mighty Ghawar oil field probably peaked in 2005 , and other fields such as Shayba might soon follow Ghawar's footsteps. (Saudi Arabia still has LOTS of oil, but it is running out soon)

Its no surprise why oil companies are not investing money into oil exploration when theres not much oil left. As one analyst said, "Drilling more wells doesnt mean more oil. It simply means more holes."

Meanwhile, British Petroleum (BP) recently announced that global oil production fell for the first time, by 130 000 barrels/day. Supply was at 81.53 million, while demand climbed to 85.22 million/day, which leads me to my next point.

2) Rising Demand

As we all know, China and India are rapidly growing economies with a huge appetite for oil. Although China is still almost entirely dependent on coal for energy, this trend looks to change very soon as more and more affluent Chinese are snapping up cars. In 2002,General Motors (GM) enjoyed a 300% increase in Chinese sales.

Take a look at these two graphs:

(Doesnt the population graph resemble the graph of the prices of oil, food and metals?)

As you can see, it is fairly obvious that our world is experiencing an unprecedented population growth since the industrial revolution. Indeed, even Ken Lay and other Enron executives would probably be envious of such a high growth rate!

If you think oil is only needed for transportation, you are very wrong.

In agriculture, for example, most commercial fertilizers and pesticides come from oil. The tractor or combined harvester runs on oil. And of course oil is needed to transport food from the farm to the restaurants and supermarkets.

Petrochemicals (from which many plastics and gels are made), come from oil. A growth in population simply leads to a grow in the demand for oil, there is no doubt about this.

Currently, demand is growing at about 1-2% annually. This might not be a lot, but it does means that demand will double from about 85 million currently to 170 million in a few decades. (That is, assuming growth in demand remains constant, when it should in fact increase)

3) A Weaker US Dollar

The last, and perhaps weakest factor which leads to the oil spikes, is due to the weakening US dollar. Since oil traded on the NYMEX is bought in US currency, the price of oil must therefore increase, as simple as that.

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In my opinion, oil will go up even higher. In the short term, it might fluctuate, probably due for a correction some time next month.

Nevertheless, Im still extremely bullish about oil prices. Even Goldman Sachs' $200 prediction looks to cheap for me.

Disclosure : I own some DBO shares, which tracks the price of oil, and I'm very certain it will make even more profits in the future

 

 

Comments

[junkyarddog:]

>>Even Goldman Sachs' $200 prediction looks to cheap for me.<<
That's moronic, it can only come from people that look at charts and numbers every day without checking reality.

At $200 a barrel, gasoline would be around $9 dollars a gallon, diesel around $11, heating oil over $10. Simple question: who can afford that? Who do you think is going to pay for your $200 a barrel?

The author makes the classic mistake of thinking the price of oil is inelastic. His "facts" are questionable, for 10 authors you point out that support the peak oil theory, there are other 10 to question it. Besides the point, there are tar sands (reservers that are more than double the crude oil in Saudi Arabia), shale oil, coal, etc. So, in the long run prices will go DOWN, if anything, due to lower demand for sweet crude.

I just think it's ludricous to think the economy can support a $200 oil barrel. It sounds more and more like the house bubble as if people would never not stop buying 1/2 million dollar homes, the sky is the limit.

Ah, these stupid analysists... if they only would measure their "facts" against reality...

2008 Jun 16 02:06 PM

[BullishOnOil!:]

Why, of course oil will be cheap at 200$ a barrel! Heck, it will be cheap at 1000$ a barrel! But I'm holding out for when it's 3,281,192$ for a single tea-spoonful!!

Because NOTHING will EVER change, right? I mean, people will NEVER demand shale-oil excavation, nor will they EVER want to use natural gas. Electric cars will NEVER take off, and the fuel-cell car that is actually being delivered to certain test markets in California? Just a fad.

People will pay and pay and never even CONSIDER an alternative.

(LOL)

2008 Jun 16 02:38 PM

[einstein p ...:]

$200 a barrel is priced in dollars, not euros or pounds. Unless the dollar strengthens suddenly and we decide to change our environment policies, the alternatives such as tar sands, oil shale, natural gas, wind, solar, nuclear, and coal are not a viable. All of them are great long term solutions to the problem --- but in the short term there could and most likely will be a spike in the price. Those outside the USA are buying oil at a substantial discount thanks to our complete disregard to the value of the US peso.

The good news is that higher prices are finally starting to have an effect and we are addressing issues that we should have been addressing for the last thirty years. Maybe we'll learn our lesson and start dealing with problems before they become problems of this magnitude --- such as global shortages in energy, food, and water.

As far as housing goes, I sold my apartment 3 years ago and I'm renting ---- and I'm expecting to be renting for a long time. Another painful lesson that could have been prevented if Wall Street and the banks had a shred of common sense. The meltdown in commercial real estate and the credit card defaults, shouldn't be far behind. Let's face it, were in trouble.

As far as analysts go, I couldn't agree with you more.

2008 Jun 16 02:52 PM

[logicalthought:]

I recently did some back-of-the-envelope calculations, and all those new vehicles in China can’t be taking THAT much oil vs. the decreased demand we’re going to have. They’re selling around 7 million new cars and trucks a year there. If each vehicle drives 15,000 miles and averages 25 mpg, that’s 600 gallons per car per year x 7 million = 4.2 billion gallons of additional Chinese demand for gas/year. At 28 gallons of gasoline per barrel of oil, that 150 million barrels/year of increased consumption = 411,000 barrels/day. If you double that for the rest of the developing world's users, you get around 822,000 barrels/day of increased consumption in a world that consumes around 87 million barrels/day in total, which is an increase of just .95 percent, which is probably far less than the western world's consumption will decline in a recession (not to mention what happens as the increasingly unaffordable subsidies come off in the developing world). Thus, I think oil’s now ready to come in pretty substantially.

2008 Jun 16 02:52 PM

[AmericanAbroad:]

Hey, over here in Europe we're already paying the equivalent of about $9 per gallon (due to heavy taxation of gasoline), and I haven't seen much less traffic nor lower speeds on the Autobahns, here near Frankfurt. Fuel may be less demand-elastic than some think...

2008 Jun 16 02:57 PM

[junkyarddog:]

AmericanAbroad: in Europe you have the benefit of a large infrastructure for public transporation, so you may opt to drive your car to work or take the train. Here in the US, as you know, this is hardly an option. It is what it is and it's our fault.

And $9 is the "unit" price, which is one piece of the equation. The other piece is the volume of gallons. If I could get by with 1 gallon a gasoline per week and pay, say, $20 dollars for this single gallon, I'd jump for joy. So, it's not the $9 dollars alone, is the total cost of your energy bill.

Also, last I heard things weren't that rosy on your neck of the woods, with truck drivers striking in Portugal, Spain, and France to protest the current high prices of fuel. Imagine what they'll do if it goes even higher.

2008 Jun 16 04:03 PM

[Get real!:]

Junkyarddog thinks that $200/barrel oil means $10/gallon gas, and thinks "it's ludricous to think the economy can support a $200 oil barrel." Don't you remember that just a year ago, everyone thought it was ludicrous to think the economy could support $100 per barrel oil? And back in 2001, the first peak oil book I read predicted that oil at $40 per barrel would destroy the economy and lead to "demand destruction." Well, it turned out that $100/barrel oil barely caused a hiccup in demand, because in industrial (or industrializing) nations, oil is as much of a necessity as water. Here in NJ, the roads are just as clogged with SUVs as ever with gas at $4/gallon. Now there is even more traffic congestion with gas at $4 than there were when gas was $0.75 ! It turns out that gas demand is not elastic over the short term (meaning the 10 year lifetime of an SUV), and neither is heating oil demand.

As even Bush admitted, "We are addicted to oil," and when your pusher doubles the price of a fix, an addict sacrifices everything else to pay for that fix. If oil rose to $200, gasoline might hit $6 per barrel (not $10, see below), and Americans would cough up the $6, and sacrifice in other areas, because we're all addicts (except the Amish).

Your second mistake is assuming that if oil prices nearly doubled (from $135 to $200), then gasoline prices would actually double. FYI, even if it actually doubled (which would mean $270/barrel oil), gasoline prices would not double, because the price of oil is only one part of the cost of gasoline. Other parts include refining costs, pipeline costs, tanker costs, gas station overhead, federal taxes, and state taxes (which do not double when oil prices double, because voters would not allow it, so instead, taxes would actually fall by 50% as a percentage of the gasoline price).

2008 Jun 16 04:12 PM

[junkyarddog:]

Get real wrote: "oil is as much of a necessity as water". Although oil is critical, this assertive is ridiculous. If you think that way, oil is inelastic and thus people will pay, heck, $2,000 dollars for a gallon of gas. As such, what BullishOnOil! wrote above is true.

At $200 a barrel the world will go into a deeper recession, in which case I agree with George Soros, demand will decrease.

Keep looking out of your window at SUV traffic in New Jersey. Also check the sidewalks.

2008 Jun 16 05:06 PM

[logicalthought:]

It's not just "SUVs in New Jersey"... Take a look at all the docked power boats around the Long Island Sound these days... It's great if you're a sailor!

2008 Jun 16 05:25 PM

[Mmarrkk:]

For those who think we can just tap into that shale oil if prices get too high, do you know how much it will cost to produce one barrel of shale oil? It takes a lot of power to retort (heat) the shale oil and get it to flow. Then it has to go in an upgrader which also needs energy. Plus the cost for all drilling, development, etc. Last time I checked the numbers being published were in the $50 per barrel but that was before prices started going up for nat gas or other fuels to run these plants and other things. I'm guessing $70?? So shale oil won't save us from higher prices.

2008 Jun 16 05:25 PM

[gen:]

shale and tar sands production/extraction rate, assuming everything goes perfect, and the technology is perfected yesterday, will not make a dent in the problem

the truth is the technology is not there and the production rate needed will never be therem much less be there months ago

in a word, the economy cannot support $200 barrel an oil

hence the devastating tsunami of a hyperinflationary/depr... we are heading for in the coming months

got health?

2008 Jun 16 05:44 PM

[nycDem:]

I'm waiting for a real debate between the two U.S presidential nominees about energy.

I don't see McCain bringing anything new to the table (he's a Bush clone so vote for him if you like where the U.S. is heading), but I'm unhappy with the lack of discussion on this issue by Obama.

But we shall see.

Personally, I hope oil goes to $200/barrel. Maybe the U.S. will wake up and start funding much needed public transportation initiatives and curtail destructive suburban sprawl. In the meantime, I'm just going to continue to profit on my energy stocks (oil, gas and solar) as I watch the price of oil spiral upwards and upwards.

I got rid of my car years ago. I live in the city and walk or take public transportation. Whenever I leave NYC, I find that the rest of America has been transformed into a hideous strip-mall of tacky chain stores, fast-food outlets, parking-lots and freeways. We can thank the automobile industry, the oil industry, the housing industry, and the U.S. Congress with it's highway subsidies for the devastation wreaked upon the American landscape.

Personally, I'm hoping for an ending out of the Talking Heads song (Nothing But) Flowers: "This was a Pizza Hut, now it's all covered with Daisies..."

If the apocalypse is coming, might as well profit from it. In the meantime, write your congressman and tell them to support renewable energy...

2008 Jun 16 08:22 PM

[mrexcessive:]

Dollars are just pieces of paper, Oil is actually useful. If the dollar declines then people will cease accepting dollars for oil and ask for something else instead, gold ?


Re. Shale Oil/Tar Sands etc. Watch the energy, not the dollars. The EROEI (Energy Returned On Energy Invested - ie. how many Barrels of Oil you get for each Barrel of Oil used during production) with these is certainly below 5:1 and quite probably below 2:1 for the foreseeable future. Whereas light sweet crude, even now, has an EROEI more like 20:1 (and was close to 100:1 in the early decades of oil).

Dollars don't matter, if some country has all the oil and another country has all the dollars why would the owner of the oil want to swap these days - the dollar is in decline. You can't power your car with dollars, you can with oil products.


I think that Either
a) Oil will hit $1000/barrel by end of 2010 due to Peak Oil and very high dollar inflation
OR
b) There will be such a severe worldwide recession - including the BRIC countries (Brazil, Russia, India, China) - that worldwide consumption of Oil will actually fall for 5 years or so.

I think that either way, once we get to 2012, the dollar will no longer be the World's reserve currency - something gold based probably (or oil based!)

2008 Jun 17 04:48 AM

[pockyclips ...:]

Mrexcessive:
Oil already is the backing of the US dollar and has been since the early 70's. The problem is it's like getting an equity loan by using someone else's house, and that house is in better condition than yours!

Atlantic Ave:
Since our economy is highly dependent on being mobile, any major change to the mix will be very disruptive. We probably should get back to rail over air transportation, and move toward electric/natural gas over gasoline for personal transportation, but will we?

In any event, we won't see $1000/barrel oil (for long). The Western powers won't tolerate it, and it'll be WWIII. Anything over $200 and the middle class will disappear.

2008 Jun 17 08:40 AM

[Wallace Werner:]

POPPY COCK! I think all these people who say oil prices should be high because of consumption are liars. What's odd is when the Arabs want to they can up production to where there is an over supply or they can reduce production any time to create a shortage and make the option traders and speculators increase the price. This poves it's not actually supply and demand. After all it still cost the Arabs $10 a barrel to get it out of the ground where mother nature has it stored. It's a big scam for the rich as usual, ruining the world economy for greed. Just look at all the golden building s being built in Dubai. That's where all our money is going. It's time for us to let our people start drilling for oil in our territory.

2008 Jun 17 08:44 AM

[Mmarrkk:]

wallace: I agree with your ultimate point: we need to drill and start finding ways to be less dependent. I also think we need to start finding other alternatives for the future. BUTTTTTT, you comments really do prove its a supply and demand issue. When the Arabs squeeze down on supply, prices go up. Just as you say. When they open up the taps, prices go down. All at a constant or rising demand. That, my good fellow, is supply and demand. Now, your real point is that the supply is being "managed" by a foreign government. That, too, is correct, but doesn't disprove supply/demand theory. But you know, its their oil; they can do with it what they please. However, its our military and we can provide protection or we can be less protective!! Of course, the Chinese would also love to provide the Saudi's with protection so we have to be careful what we threaten them with.

Can you say "rock and a hard place"??

Atlantic Ave: while McCain may not bring much "new" to the discussion, the crappola that Barack Hussein Obamma brings is downright frightening. He wants to slap a windfall profits tax on oil and place a confiscatory tax on 5 companies. All of this burden being placed on the only companies/people doing anything to help supply us with oil. Yeah, that's really going to help our supply problem!! Let's see, spin off Exxon into two companies, one US based and one international based. Huge percentage of profit and revenue would be in the international portion; small portion left in US. That way Bamma Mamma's greedy little marxist hands couldn't get to their earnings. Yeah, tax and tax, always works. Can we not get a "do over" on these two candidates?? I really think both are pretty crappy as it relates to oil and the economy.

2008 Jun 17 08:55 AM

[Paul Killinger:]

Hubbert was wrong, both about the amount of oil in the earth and its origins.

But the price of oil today is due to fundamentals alright. The fundamentally flawed thinking of the Greens and their minions in the U.S. Congress.

If and when we fix that, the price will come down. But, as posters point out, looking at our presidential candidates, don't look for that to happen anytime soon.

2008 Jun 17 11:14 AM

[jjason:]

Try this link:

www.commerce.senate.go...


and this one:

www.star-telegram.com/...

See what others are saying about speculation in commodity futures helping to drive up commodity prices.

Also check out Phil Davis and Anthony Schneider on SeekingAlpha regarding the fraud that is going on.

2008 Jun 17 11:27 AM

[Paul Killinger:]

You posters with your conspiracy theories about speculators driving up the price of oil never cease to fascinate me. So it follows, it MUST have been a conspiracy when oil traders drove DOWN the price of oil to $20 a barrel, wasn't it?

One more time, NO ONE testifies before Congress without being invited to by the respective Committee chairman. Now, let me ask you, since the Liberals run Congress, who do you think they're going to invite to testify?

Respected economists, who know something about supply and demand and oil prices, or Democrat flunkies they can trot out before their fellow travelers in the news media?

I'll let you anwer that for yourselves... I can't wait to hear your posts on this one.

2008 Jun 17 12:33 PM

[jjason:]

paulk#### CAN YOU READ? If you went to my links you would educate yourself.

Where were you when Enron was cheating everybody?

2008 Jun 17 02:52 PM

[baird:]

paulk,

Hubbert certainly wasn't wrong about US peak oil production, it's been declining since 1970

2008 Jun 17 07:08 PM

[Brian27:]

Hubbert has not been proven correct. In fact he will probably be proven to be a Malthusian. Oil reserves have been increasing every year. Check the BP statistical review. And this review has understated Canadian oil sands reserves by half.

Technolgy improvements are extending well life and making shale discoveries economic. Plus with the increase in oil prices deep water drilling becomes economic. That is two thirds of the globe that can be drilled. Brazil has found a huge reservoir and Canada has had productive wells drilled into the Atlantic Ocean for years. If America also drilled the Continental shelf major oil resevoirs would be discovered.

As Malthus population growth theory was proved incorrect due to technological advancements so shall Hubberts peak oil theory.

2008 Jun 17 10:42 PM

[Dorlan H. F...:]

Sir in all due respect please shut your damn mouth. What was the fundamentals that brought oil prices down to $30 per barrel after the financial crash? And with the global economy still in decline what fundamental propelled the price to $72? The fundamental is the FEAR and GREED of speculators. It was fear that pushed it down to $30 and it was unjustified and unsubstantiated cause for greed that pushed it up to $72.

I have never heard of ANY end user of oil needing oil and had to out bid other people for it thereby pushing up prices. I have never heard any oil supplier complaining about the weakness of the US $ and thereby demand more for their oil. All these technical measures are just convenient tools used by the speculator to justify their speculative activity. Speculators are parasites! They want to reap where they did NOT sow. And they want to make money doing nothing. There should be a law which would make the making of money without the adding of value a CRIME similar to counterfeiting!

Jul 10 07:11 PM