Tuesday, July 10, 2007

Some Oil reminders

I would like to highlight the crude oil issue as reminded by FSO Market Commentator, Tony Allison, in his market wrap, The Fundamental Things Apply...as time goes by

  • An Insatiable Thirst

    On any day of the week, those of us in Southern California can drive to the Port of Long Beach and see oil tankers lined up to the horizon and beyond, bringing in oil and refined products from all over the world. We as a nation will not and cannot stop using oil, and $70 per barrel is not slowing down demand. The US used to export oil to the rest of the world, but now we must import over 60% of our energy needs. That number will go higher with increasing energy demand, and with domestic supply steadily decreasing since the peak in 1970.

    Even if Wall Street insists on stripping out energy and food costs from the “core” CPI data, higher energy costs are seeping into every aspect of the economy. Our insatiable thirst for oil and our increasing energy dependence will add to our inflationary burdens. Inflation takes a long time to become embedded into the system. Once inflation awareness and expectations set in among the public, it will take a long time to get rid of it.

    In the years and decades to come, oil will be in ever-greater demand around the world. Supply will continue to be found, but the cost of getting the oil to market will get higher as companies and countries look to deep sea drilling, tar sands and oil shale production. All these methods are extremely expensive in terms of labor, materials and energy expended. Oil will always be available, but the cost of producing a barrel of oil, transporting it, and refining it will likely continue to rise. In addition, the supply of light, sweet crude is declining rapidly. Heavy sour crude will be the substitute, but it’s harder to extract and more expensive to refine. Many refineries are not equipped to refine heavy crude at any price. New technology will help, but labor and material costs are rising in the race to bring oil to market as quickly as possible. The demand for oil will continue unabated, given rapid Chinese and Indian industrialization, but future supply will likely arrive with a higher price tag. From an investment perspective, capital will continue to flow to this critical sector. The best companies, with good reserves in stable locations, will be enormously profitable in the years ahead.

    In 2002 oil was $20 per barrel. In 2004, $50 per barrel. Now it is $72+ per barrel and demand is still increasing at 2% per year (which exceeds growth in supply). The world is adjusting to a higher cost of energy, but it is functioning like a global tax, which is beginning to bite into US consumers.

    In the future, oil will be even more critical to global prosperity, as it will be more and more coveted by every nation on earth, both sellers and buyers. The arrival of Peak Oil will likely be the most critical and defining event of the 21st century. Energy and other tangible assets will form the mirror opposite of the global currency glut, as the particularly debased currencies become less and less coveted, as time goes by.

And in yesterday markets, Mr. Allison notes:

  • Crude-oil futures fell Monday, but closed above $72 a barrel, as traders locked in profit from recent gains and shrugged off a bullish report from the International Energy Agency. Crude for August delivery closed down 62 cents at $72.19 a barrel on the New York Mercantile Exchange.

    "No less than the International Energy Agency has given market bulls its endorsement with its latest report, which states that world oil demand will rise faster than expected to 2012 with expected production lags, leading to a supply crunch," said Michael Fitzpatrick, analyst at Man Financial, in a research report. (emphasis added)

    There are those fundamentals again. Keep them in mind.