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How High Will The Price of Oil Go?

|Includes: BP, PowerShares DB Oil ETF (DBO), E, OIL, RDS.A, TOT, USO, XOM

Higher Oil Prices Are Caused By:

  1. A Weaker U.S. Dollar.
  2. Competition From Alternative Transportation Fuels
  3. Supply: Opec's Production Quotas And The Inventory Of Crude Oil
  4. Demand: The Pace Of The Global Recovery.
  5. Speculation And Hoarding 

What Is A Realistic Price Of A Barrel Of Oil?
A barrel of oil is mainly valued for it's conversion to gasoline and diesel. A refinery cracks a barrel of oil and it yields so many gallons of gasoline and so many gallons of diesel (depending on your cracking ratio). So the price of a barrel of oil is really the sum of the prices of its two main products.

Weaker US Dollar.

Weak U.S. Dollar is a big driver in the price of Oil. Oil is a global commodity that is priced in a local currency. Naturally, if the dollar crashes and loses 90% of its value, then oil prices would rise by a factor of 10. Therefore, The prices quoted in this article are using 2009 constant dollars.

Competition From Alternative Transportation Fuels

At the right price, oil has competition from synthetic equivalents. Coal is nearly unlimited and is a superb feedstock to create oil equivalents. A barrel of synthetic oil (Syn Diesel) is made using Coal-to-Gas then GTL (Gas-To-Liquids) conversion. The same process can be done using natural gas as a feedstock and using Gas-To-Liquids conversion. If oil prices stayed high long enough, then a whole crop of Syn Diesel plants would spring up.

Supply: OPEC's Production Quotas And The Inventory Of Crude Oil

Could oil (or oil equivalent) go to $200/bbl and stay there? Doubtful, as so many marginal producers would come on line (shale oil, tar sands) and demand would drop. Synthetic diesel (made from coal) would be very profitable with oil prices at a sustained $100 to $200/bbl. Even the Saudis wouldn't want $200/bbl because it would encourage other sources to permanently come on line.

The oil will run out, yes. Sure, in the distant future, the price for natural oil could go to $1000/bbl. That's when oil will be useful only for it's rare complex hydrocarbons. The markets for natural, crude oil would be meaningless. They would have been supplanted by barrels of synthetic oil equivalents.

Demand: The Pace Of The Global Recovery.

Could oil be $30/bbl (in 2009 dollars)? Not likely, as that exceeds most of the worlds cost of production. This could happen only if a) there were a global collapse in demand, brought on by a much more severe global depression, and b) Saudi Arabia ran into serious cash flow problems and ran their spigots full blast.

The Saudi's made it through the recent tough spell. They have a fat bankroll to last them thru lean times so they can reduce production when the price is low. The Saudis have built up there bankroll over the years by saving the money they made by exporting oil to us.

Therefore oil has many natural (market forces) and man-made forces keeping it within a range.

Speculation and Hoarding

Even though oil has a natural price range, speculators can drive the price of oil. The proof of this is that the price of oil reached $147/bbl not too long ago. A year later, folks were worried that oil would drop below $45/bbl and stay there. Why were they worried? They should have been praying for such a miracle.

Getting Into Oil Futures

Consider the U.S. Oil Fund ETF (NYSEARCA:USO) and PowerShares DB Oil Fund (NYSEARCA:DBO) or their ilk. These funds hold only oil futures contracts. You can successfully win in oil speculation if you can predict 1.) The future level of the U.S. Dollar & 2.) The pace of the global recovery (demand) and 3.) The actions of Speculators and Hoarders. Not an easy task.   Oil Futures are highly speculative. For the prudent, risk-adverse investor looking to steadily grow his or her portfolio, there are far better ways to get oil exposure.

Buying Oil Producing Companies

Question: Should you buy oil?

Answer: Yes. Oil is a key sector of the global economy. Oil has far more upside potential than downside potential. After all, there is only so much oil left in the ground.

If you want to buy some oil, the best way is to own an Oil Major: Consider Exxon Mobil (NYSE:XOM), British Petroleum (NYSE:BP), Total (NYSE:TOT), ENI Spa (NYSE:E) and Royal Dutch Shell (NYSE:RDS.A). This list of dividend-paying oil majors is by no means exclusive, there are many more. All of these stocks pay a sizeable dividend, so you get paid to wait for the price of oil to recover. These large caps occupy significant places in the worlds leading stock indexes. If you own an SP500 index fund, you already own some XOM.  If you want to overweight oil, adding some of the Oil Majors would be the way to go.

DISCLOSURE: Author is long BP and E. You should perform your own due diligence and consult with an investment advisor before investing.