Oil Will Continue to Trend Higher

Wowsers! What else can you say about this amazing past week?

I am sure you have all read about Freddie Mac (FRE), Fannie Mae (FNM), Lehman Brothers Inc. (LEH), Merrill Lynch & Co., Inc. (MER), American International Group, Inc. (AIG), wacko rules against short selling certain financial stocks, $700 billion bailout package, and probably several other newsworthy events that I have missed. I wish I had something meaningful or insightful to add to the recent developments.

If you want an excellent primer on the developments that led to the current crisis, I urge you to read Bill Fleckenstein's book: Greenspan's Bubbles: The Age of Ignorance at the Federal Reserve.

Like most people, I am overwhelmed by the severity of the financial crisis. For the most part, I have been sitting and observing. I did, however, get longer some oil related securities, which have enjoyed a nice rebound.

My decision to get longer on oil was based on recent low oil prices of less than $100 per barrel with a shallow drop in consumption in the United States. Oil consumption has only fallen by about three percent. Please see Energy Information Administration – Short-Term Energy Outlook quote below. While three percent at the margin is a large amount, a three percent reduction in consumption is not large for oil. Almost all oil fields have decline rates in excess of three percent. That means most oil wells will be producing at least three percent less oil next year.

Consumption. Total U.S. petroleum and other liquids consumption is projected to decline by 610,000 bbl/d, or about 3 percent, in 2008 based on prospects for a weaker economy and high crude oil and product prices continuing into 2009 (U.S. Petroleum Products Consumption Growth). Preliminary July and August 2008 weekly survey data indicate that year-over-year declines in total consumption, which began in August 2007, have narrowed since earlier this year. During the first 6 months of 2008, total petroleum consumption fell by an average of 930,000 bbl/d compared with consumption during the same period in 2007. During July and August, the year-over-year declines averaged 660,000 bbl/d. For the rest of the year (September through December), the year-to-year decline in consumption is projected to narrow to an average of about 130,000 bbl/d.

Many people believe that the commodity bull run, especially in oil, is over. I am not one of those. Most major oil fields are aging and will produce less oil next year. The world economy will continue to grow and demand more oil. Thus, I believe we are experiencing a lull in oil prices. Looking at the Bloomberg site, I see the latest WTI price was $104.55. While some might hope or believe that oil prices will be sustained at a much lower levels, I continue to believe that oil prices will continue to trend higher. That is not to say prices cannot or will not dip, even for months at a time. Rather, unless we suddenly find a new energy source or are able to change our habits in a dramatic fashion, the demand is likely to grow faster than the supply.

This coming week promises to be an exciting week as the markets digest and react to the government bailout. Will there be more surprises? Will volatility increase or subside? The answers to the last two questions are likely yes and yes.

Comments

[Steven Ward:]

We have had a S & L bubble, a High Tech/ Internet bubble, a Housing/ Sub prime bubble and now we will have a Carbon credits bubble.
No sense in fighting it makes some money on it. Just get out in time.
I wonder how Wall Street will collarterilize the carbon credits. Anybody for carbon credit swaps or bonds or side bets off the books?

2008 Sep 22 10:38 AM

[Ferdinand E...:]

Another interesting and useful article, although I wonder if a reference to Alan Greenspan belongs here. Personally I never cared for the man and his economics, but when it came to energy he usually knew what he was talking about.

2008 Sep 22 10:53 AM

[Stecyk:]

In response to Fred Banks above, first, thank you for the compliment on the useful article; and second, the reference to Greenspan is directed at the housing bubble. If you read the book and believe Fleckenstein's assertion that Greenspan was largely responsible for the housing bubble by taking rates so low for so long, then it is obvious why he is included. When I mention Greenspan in the article, you'll note that it comes after mentioning the debacle in financial stocks, which are all afflicted by the housing market.

2008 Sep 22 11:01 AM

[Gyoza Mimi:]

Oh, no.

We were just told last week that oil is 50% overvalued.

2008 Sep 22 12:14 PM

[Urbane Gori...:]

steve Ward:

Do you mean like the ETF 'GRN', which moves with the Carbon Credits? Here's the profile..... Damn! You're good! jegan ;-)

The investment seeks to replicate, net of expenses, the Barclays Capital Global Carbon Index Total Return. The index is designed to measure the performance of the most liquid carbon-related credit plans and is designed to be an industry benchmark for carbon investors. The index expects to incorporate new carbon-related credit plans as they develop around the world. The index currently includes two carbon-related credit plans: European Union Emission Trading Scheme or EU ETS Phase II and Kyoto Protocol's Clean Development Mechanism.

2008 Sep 22 01:34 PM

[mdmrjsds:]

Ha! While your article predicted higher prices, I don't think it was predicting what happened today.

Today's action in oil surely refutes any argument that speculators were not the cause of the runup in oil earlier this year.

2008 Sep 22 03:15 PM

[anarchist:]

dollar goes down, oil goes up thus OPEC does not lose purchasing power because the US can't get it's act together. That aint speculation just the facts of financial life as dictated by the Saudis

2008 Sep 22 10:49 PM

[Alex_G:]

Kevin,

I've gone through most of your other articles, and you appear to know very little about economics, price elasticity and the economic value of oil, which is stressed at over 100 a barrel.

There are actually novice investors on this site who take the advice of people like you. Think about that.

2008 Oct 09 10:43 PM