Not Calling Crude Oil Prices a Bubble For Now 17 comments
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Zacks senior oil & gas industry analyst Sheraz Mian is, understandably, a man in demand these days, what with near-record oil prices, more Middle East tensions brewing, and rampant discussions about a possible “oil bubble.” We were thankful he was on hand to give us his perspective.
Surely there are many reasons for higher oil prices – but $145? $150, possibly? Aren’t you seeing a short-term bubble here?
Given that we have to work with inadequate and at times contradictory data about global oil supply and demand, it is extremely difficult to get a good handle on the market in real time. As a result, the degree of elasticity of the supply and demand curves is not fully understood, which makes it difficult to conclusively evaluate short-term pricing moves.
Having said that, I wouldn’t call crude oil’s recent strength a bubble.
There are plenty of reasons, as you suggest in your question, to keep crude oil prices at elevated levels. In the context of supply and demand, the lack of a large excess production capacity is very significant. It is the absence of a comfortable cushion in the shape of a large enough excess production capacity that magnifies the impact of real or perceived threats to supplies, such as problems in Iraq, instability in Nigeria, or Venezuela, or fears about Iran’s nuclear ambitions.
There are a number of other variables as well that directly and indirectly impact crude oil prices, such as geopolitical instability, the foreign exchange value of the U.S. Dollar (crude oil is denominated in dollars), and the level of investment flows into the crude oil market.
I do, however, expect prices to pullback from current levels over the coming months.
What factors are you looking for that might end the trend of oil prices at these high levels?
The primary variable that should help bring oil prices down is demand. As would be expected, high prices have led to weak demand, particularly in the U.S. and other OECD markets. The current outlook for demand is much lower compared to what it was at the beginning of the year.
One key factor that is shielding demand from the full effects of high prices is persistent strong economic growth and fuel subsidies in emerging markets. While many countries have removed some of the subsidies in recent days, they remain unwilling to fully pass on oil’s recent rise to their citizens.
As a result, overall global demand is weaker than before. This should ease the tight balance between supply and demand in the coming days and weeks and help bring oil prices down. Oil prices should also benefit from a stable/strengthening dollar exchange rate given expectations of the Fed’s neutral/tightening bias in coming days.
Natural gas prices have been very strong lately as well. Is that related to the strength in oil?
The natural gas market is fairly distinct from the oil market and generally has its own supply-demand dynamics. In theory, there is a relationship between the two commodities based on unit energy equivalency (the BTU content of 6,000 cubic feet of natural gas is equivalent to one barrel of oil), but it typically doesn’t hold up in the market.
Natural gas trades in a local market (meaning North America) and local supply-demand forces determine its pricing direction. Natural gas demand has a very heavy seasonal component to it; the bulk of its usage is for heating purposes. It is also used for power generation, particularly in the summer peak usage months.
Typically, natural gas produced during the summer/fall months is stored and then taken out from the storage facilities during the winter months for consumption. The storage facilities get depleted during the winter heating months and re-filled during the summer months – that’s the commodity’s supply-demand cycle.
The most recent heating season was very favorable to the commodity; meaning that due to colder-than-normal temperatures, a lot of the gas in storage was consumed. This came after two back-to-back unfavorable winters when not much gas was used. As a result, the gas in storage at the end of the last heating season was lower than the year before.
This means that we will need to produce and store a lot of gas this summer to maintain normal supplies in the next winter. And this is the critical factor that is behind the current strength in natural gas prices irrespective of what happens in the crude oil market.
Which sub-sectors stand to benefit from the current environment, near term? In other words, how would you advise investors looking to play the oil & gas space over the next quarter or two?
On the whole, stock prices still reflect long-term oil prices that are significantly below current levels; so they have a lot of room to catch up. Many of the major oil stocks (for example the large-cap integrateds) haven’t moved up as much as crude oil has in the last 6 to 12 months.
So, for investors with a relatively low-risk threshold, the large-cap integrateds may be a relatively safe and stable group to be invested in. Remember, these companies both produce and consume crude oil. So, while their production units benefit from high oil prices, their refining and marketing units suffer.
My top picks have been Exxon (XOM), ConocoPhillips (COP) and Marathon (MRO) in this space. ConocoPhillips in particular is also a very North American natural gas producer, which gives you exposure to that commodity. Marathon has been an under-performer recently due to its large Midwestern refining/marketing presence, which has been battered by high oil prices. Marathon shares are very cheap at current levels.
Another major sub-sector is oilfield services and drilling. These companies do not need oil prices to be around $130-$140 to make a lot of money; they will be doing equally good in a $90-$100 oil environment. My top picks in this group include Halliburton (HAL), Baker Hughes (BHI), Diamond Offshore (DO), Transocean (RIG) and Pride (PDE), to name a few. While the first two are integrated service companies, the last three are offshore drillers, with rigs capable of operating in very deep waters.
Investors with relatively high risk appetites can look into companies more exposed to the domestic natural gas market. Here you would consider the exploration and production (E&P) and onshore drillers. We have long-standing favorites like Chesapeake (CHK), EOG (EOG), and Patterson-UTI (PTEN), to name a few. Many of these companies, however, have moved up strongly in the last few months. While we like them at current levels as well, investors may want to wait for pullbacks to make new positions. One could also play the domestic natural gas market through Halliburton, which provides a host of services to North American E&P players.
Sheraz Mian is a senior analyst covering the oil & gas industry for Zacks Equity Research.
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This article has 17 comments:
> jack
Also, as we use more nat gas for transport, our electric bills will start to rise as it is a huge source of incremental power fuel. In fact, this winter the "big news flash" will be how "outrageous" our utility bills are. We are putting gas in storage this summer at $12-13/mmBTU. Last year we were putting it in at $7-8. Guess what's going to happen to home heating bills this winter???? When grandma's gas bill doubles, the Dem's will be screaming again!
Again, I love the idea of nat gas; I'm a big investor in many companies focusing on nat gas. But it will not be a single solution to our problem.
> jack
Per the model, which simulates a hypothetical land where about half of all produced oil is exported around the time of peak (roughly the global condition now), exported oil goes to zero in just 9 years after the global production peak. So we must destroy all demand for imported oil in 9 years to keep oil where it is! If we did a switch to electric cars so fast that half of all vehicles on the road in five years were electric, we could not match this demand destruction rate.
Destroying demand for imported oil is what needed to be done 30 years ago when Carter and Ford tried to get a build out of CTL (coal-to-liquids) plants going along with nuclear power plants, OCS drilling, solar and other things. But nobody believed or understood the math of Hubbert and others about the global production peak even though his modeling of the U.S. oil production peak in 1970 had just been proven stunningly accurate. In his 1956 work projecting the U.S. peak for early 70s, he predicted the global peak for shortly after 2000. So instead of listening to these people, we developed energy policy dictated by environmentalist airheads who reckoned that we needed to ban the needed changes to protect the natural habitat of the yellow speckled squirrel.
Well, here it is 30 years later, and America's natural habitat is about to be destroyed. But thank God, the yellow speckled squirrel is OK.
Take a look at some of the futures prices of a barrel of oil.
futures.tradingcharts....
Do you see a pattern there?
Look at the 2012 future prices for a barrel of oil...they are trading in the $70's
2012 will be "election season"....
Speculators don't want to touch buying it...if we were really living in a "tight" market....and $150/$200 a barrel is here to stay...That's the BEST deal OF THE CENTURY you could find, you could TRIPLE your investment in 4 short years...what other investment exists with that kind of "guarantee"...A 300% return in 4 years....?!
Why are people not buying up those futures contracts as fast as
they can?
You want further proof?!
How and why would a COMMODITY price...we're talking a COMMODITY, have $4-$5 swings in a matter of HOURS...that's a 3% price swing within HOURS of trading in a single DAY!!
Because the price is FALSELY inflated....and Oil Pricing is a SCAM manipulated on the ICE markets.
Has EVERYONE completely forgotten (or IGNORED) history? We've seen this EXACT SAME THING when Enron was around.
They were the Market makers and they manipulated the market to their whim......Anyone remember Dick Cheney saying "we can't pull anymore kilowatts", yet Enron was shutting down Power plants in California, to close grids and falsely increase demands on the rest of the grid...
it is the EXACT same thing ICE is doing.
Eliminate the Graham/Enron loophole, put more transparency on ICE Markets, and a price of a barrel falls in HALF, OVERNIGHT
I'll bet EVERYTHING I OWN on it.
About ICE,IntercontinentalEx... Inc.
Ice, Ice Baby Part 1
www.star-telegram.com/...
Ice, Ice Baby Part 2
www.star-telegram.com/...
Here are some teaser quotes:
When Enron failed and took its private, unregulated energy exchange to the grave, another rose to take its place. The Intercontinental Exchange (ICE) was the brainchild of
Morgan Stanley,
Goldman Sachs,
British Petroleum,
Deutsche Bank,
Dean Witter,
Royal Dutch Shell,
SG Investment Bank and
Totalfina.
In 2001 ICE purchased the International Petroleum Exchange in London; renamed ICE Futures, it now operates as an "exempt commercial market" under section 2(H)(3) of the Commodity Exchange Act. As the Senate hearings pointed out in the summer of 2006, "Both markets operate outside of any CFTC oversight."
www.star-telegram.com/...
We started as a society that worships hard labor and the basic business ethic of building value into the goods you create. How’d we get from there to worshiping Wall Street’s billion-dollar boys — who create nothing, build nothing, own nothing and deliver no goods, and yet can throw so much money into products made by others that they determine what we consumers will pay for those goods?
Oil Movements tracks every tanker at sea, from both OPEC and non-OPEC oil countries, along with their cargoes’ final destinations. Anne O’Shea responded immediately to my request with their report dated May 8, 2008. Just so you will know, oil shipments are up from a year ago in almost every class, including Middle East oil in transit and Non-OPEC in Transit. The only class of oil shipment that has declined is covered on page 3 of that report. That chart is labeled, "4-Week Changes in Westbound Oil at Sea."
That’s right, shipments of oil headed west have shown serious declines during the month of April, down 800,000 barrels per day in the week before the publication of the report
This is EXACTLY what Enron did when it's Electricity Manipulation, Turning off power grids to falsely inflate demand on other grids....