Oil Prices Are Not Conflict Dependent

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Includes: APA, APC, CVX, XOM
by: Joseph E. Meyer

Ever since the political protests dethroned Hosni Mubarek in Egypt, we've all seen oil prices rising above $100 a barrel, then falling closer to the high $90s. Oil futures for WTI closed Tuesday at $98.25 for the April 2011 contract. My recommendation was to stay clear of buying into the crisis, because when the dust settled, prices would fall before they rise again. I'm a buyer of anything of quality related to oil. Be especially bullish when prices dip below $100. Now is the time to be vigilant.

In my view, oil is clearly ready to trade range-bound, with above $100.00 a barrel in the upper part of the range. When we start trading with $100 on the low end of the range, it will be paramount to what we witnessed when gold traded above the $1,000.00 per ounce level. We stayed up there, and never touched the floor again.

I'm going to stick my neck out here and say that we will never see pre-Egypt price levels in our lifetimes, barring the unforeseen circumstances of a major recession in the U.S., Europe, or China.

There are many products out there to play the oil market, but my favorite will always be the integrated oil companies like Exxon-Mobil (NYSE:XOM) and Chevron (NYSE:CVX) in the U.S., and the exploration companies like Apache (NYSE:APA) and Anadarko Petroleum (NYSE:APC) to name a few. You have to do some research or talk to a financial advisor about these, but those are some names that are worth a look if you want a portfolio that benefits from rising oil prices. Because your gas tank certainly will not be benefiting from it.

Taking oil into perspective

Back in 2008, oil prices were forecast to hit $200 within a year. By June, oil futures were trading around $140 a barrel. Then the banking crisis hit, and a recession in most markets around the world resulted. Oil prices collapsed. These are very volatile markets. But let's pretend you could have had that ubiquitous crystal ball back in October 2008 when the markets were crashing down all the way to the March 2009 low of 666 on the S&P 500. What would you have seen? You would have seen oil on the rise to $80 a barrel within two years. And that's without any crisis, anywhere, except the ongoing fallout from the U.S. housing and derivatives market collapse.

At the end of 2010, the market was pricing in oil prices of $90 for 2011. Egypt erupted. Then Libya. We're worried about Saudia Arabia now. So the market took oil prices over $100 because of that crisis. When those crises are no longer occupying the minds of traders, where is oil going to go without the support of these crises? Down. But it is not going to go very far down because the market already has around $90 as the floor.

We also have some new news to watch for. China is officially slowing down. The government said it will cut growth projections down to 7% for the next four years, according to Wen Jiabao, the country's premier. See the new Forbes.com page on the big emerging markets here. A Chinese slow down puts added pressure on oil. So, near term-- when things calm down in the Middle East, oil will pull back. This would be another good entry point into this market if you're afraid to buy into the bull rally.

I would add, though, that current fundamentals are very positive for the long-term. I've read a few comments to a post here on silver and gold that warned readers of that post about fears of buying into the trend. The letter writer said that if you don't buy into a trend, sometimes you get left behind. I believe we have reached the point where the fundamentals of long term appreciation of oil prices are fairly solid. We have lackluster discoveries and those discoveries that are being made are costly. We have increased demand, though that demand could stabilize in China in the next year or two. It will rise in the U.S. and Europe as its economies get back on track.

However, no one knows how long a rally will last. The rally in the Dow lasted two years. But there are entry points that make sense. We had pullbacks, even though they were not significant enough in my view, but we had them. If you bought the Dow into the rally when it was over 12,200 (I warned against it here, though admittedly Japan took the market by surprise), you'd be down. Now we are under 12,000 in just a few short months. If you prefer to buy oil outright in the futures, or in exchange traded funds linked to oil like the iPath S&P GSCI Crude Oil Return ETF (NYSEARCA:OIL), then I think it would be prudent to wait until prices reduce from their Middle East conflict gains. We could be trading between $90 and $110 for the rest of the year. Better to buy below $100 than at $105 if that is the case. I still recommend Exxon-Mobil, Chevron, Apache and Anadarko over the oil ETFs anyday; they have outperformed historically .

Four reasons to buy oil

1) In 2008 we witnessed gasoline selling for $4.00 a gallon in the United States for the first time in history. Hawaii became the first state to hit $4.00, doing so this week. This was without a doubt the catalyst that pushed our already very fragile economy into the worst and prolonged recession since the Great Depression. Yes, there is still a lot of oil in Saudi Arabia, but the Saudi oil fields cannot pump enough oil to keep a lid on prices. The conventional oilfields were discovered in the 1950s and 1960s, and are losing pumping capacity.

2) The global population will continue to increase, increasing the population of this planet competing for fewer available natural resources. The immediate question and concern is what happens when gasoline prices move to significantly higher prices, and wages once again fail to adjust accordingly? The current production levels of the Saudi oil fields are at the same levels as in the 1970s and 1980s. The last thing this fragile economy needs are rising energy prices and rising interest rates. The combination of those two things will cripple this so- called ongoing economic recovery.

3) If we witness escalating energy prices from these levels once again, the majority of the world’s population will be paying almost 50 percent of their wages for shelter and 40 percent of their income will be used to buy food. In other words, look for the same thing to happen here as what happened in Egypt. In the next 25 years, due to increased oil demand and falling supply, we will need to discover five more oil reserves equal to those in Saudi Arabia. It will take the production of 50 million more barrels of oil per day to meet the global energy demands of this planet. It is important to keep in perspective how the Chinese are now using three times the oil they were consuming in 2000, and this will triple again within the next 10 Years.

4) The super-giant oil fields are located in Burgan, Kuwait and Cantarell, Mexico. The large conventional fields are located in Alaska, the North Sea, and Western Siberia. All these fields are now well past peak production of oil. The world’s largest oil field, Ghawar, is finding it increasingly difficult to maintain production levels, and has been utilizing injections of sea water to boost oil production. These aging oil fields are losing between 4- 6 percent of production yearly. At the same time, the crude oil demands of China and India continue to grow.


Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.