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Where Does Oil Go from Here?

by: Chad Brand August 21, 2008 | about stocks: DBO / OIL / USO    
Chad Brand

Chad Brand

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After seeing the price of crude oil start the year around $100 per barrel, peak at nearly $150, and come nearly all of the way back, where does the oil market go from here? It is interesting to see how many people no longer think we see a range of $150 to $200 anymore. The Goldman Sachs year-end target of $149 is now considered overly bullish by most pundits. Is the bull market in oil over?

The sharpness of the recent decline lends some credence to the belief that much of the 2008 price spike was related to speculative trading activity. After all, the move from the 120's to the 140's came with nearly no new information that would lead one to think the supply/demand balance had changed materially. Daily price swings of $5+ became commonplace without significant events accompanying them. Now with oil down about 25% from its high, calls for $70 or $80 oil are easy to find.

Personally, I think it is important to note that the fundamentals of the oil bull market remain intact. Global demand is growing faster than global supply. It is true that we began to see demand destruction once crude passed $140 per barrel, but since that level was merely temporary, a price of $110 or $115 all of a sudden looks reasonable again. Should we expect gasoline demand to continue to drop at the same pace when gas drops from over $4.00 to under $3.50 per gallon? Probably not.

Even if demand growth drops in the United States, and China and India see lower GDP growth levels, oil demand should still rise in coming years. Consider 2008 worldwide demand. Despite the price spike we saw this year, daily global consumption is estimated to rise 1% to 86.3 million barrels per day. That comes on the heals of a 1% increase last year and another 1% increase forecast for 2009.

In any bull market there are periods of sharp spikes higher and even sharper declines. Looking at the global economy, it is hard to argue that oil demand will not continue to grow. Sure, alternative energy sources can cut that growth rate noticeably, but each and every price correction brings less pressure to really promote alternatives in a meaningful way.

A price correction moving toward $100 per barrel, without significant fundamental changes in the outlook for crude oil demand and supply and demand, makes me think triple digit oil prices are not going to become a thing of the past any time soon, for an extended period of time anyway.

From an investment perspective, leading oil producers have seen serious price per share declines, which now imply long term oil prices of far less than $100 per barrel (most are between $70 and $80 per barrel). If you think the next three to five years will see triple digit oil, as I do, then the stocks are going to prove to be excellent investments from here.

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This article has 16 comments:

  •  
    Aug 21 12:58 PM
    All the oil bulls love to mention how global demand will drive oil into higher and higher nosebleed territory.

    My question:

    If Americans can’t afford 140dollar oil- how can China and India afford it?
    Once gas hits well over 4 bucks a gallon Americans stop driving.

    If the average American can’t afford gas- how can the average Chinese driver afford it?
    Last I checked it they don’t make as much as Americans do- where do you expect China and India to find all that cash to purchase oil at 150 and above?

    Unless they wish to bankrupt their countries- I don’t see how they will continue to blindly and ravenously purchase oil at ever increasing prices.
    Reply
  •  
    Aug 21 01:19 PM
    Bob the Lover, a couple of comments for you.

    $10/ gallon gasoline has not stopped the British from driving. Americans love cars too much to stop driving, even if gasoline hits $15 / gallon. High gasoline prices have affected my driving, but not diminished it all. I stay within the speed limit, I coast to stop signs and plan my driving ahead of time so I can do all my errands in one trip.

    Gasoline in many nations like China, India, Venezuela, Iran, and Saudi Arabia is subsized by the government to buy peace and prevent revolts.

    I am very long on oil, because it is a no brainer. No serious effort is being made in either conservation, alternative energy or discovering new reserves. Oil is good investment for the 20 to 30 years. I see it slowly creeping up to $200 by 2010-12.
    Reply
  •  
    Aug 21 01:39 PM
    Once people see they can save big bucks by changing driving habits, they will make those changes permanent. Its always psychology, never fundamentals. Nothing has any intrinsic value other than what someone will pay IF they have the money to buy.
    Reply
  •  
    Aug 21 01:46 PM
    Longoil,

    I know that oil is subsidized in China- but my argument stands.

    At some point the Chinese government will stop the subsidies. Oil at what cost- if it continues at a torrid pace past 150dollar per barrel- what chance does the Yuan have?

    Inflation will decimate emerging markets if oil does not subside.
    Americans have stopped driving SUV’s mass transit usage is up- Neither the Chinese government nor its citizens will continue to purchase oil at obscene prices.

    Have you seen how small the cars are in Great Britain - mass transit in Europe is first rate. 10 dollar oil has made the Europeans extremely Spartan in their driving habits.

    Demand destruction is real- and if oil continues upwards demand will drop from the emerging markets- because they won’t be able to afford it.

    I ask- if the United States cannot afford 150dollar oil- how can the Chinese Yuan afford it?
    Reply
  •  
    Aug 21 01:51 PM
    bob-
    many nations like china subsidies oil in some countries gas is under a us buck/gal. I hate 2 say we need 4 gal gas so that we will move closer to energy independence. opec likes to tighten the screws on us as prices fall. drill! drill! drill!, get rid of corn ethonal (food cost goes up), bio, nuke, wind, solar or crazy idea nat gas.


    On Aug 21 12:58 PM bob the lover wrote:

    > All the oil bulls love to mention how global demand will drive oil
    > into higher and higher nosebleed territory.
    >
    > My question:
    >
    > If Americans can’t afford 140dollar oil- how can China and India
    > afford it?
    > Once gas hits well over 4 bucks a gallon Americans stop driving.
    >
    >
    > If the average American can’t afford gas- how can the average Chinese
    > driver afford it?
    > Last I checked it they don’t make as much as Americans do- where
    > do you expect China and India to find all that cash to purchase oil
    > at 150 and above?
    >
    > Unless they wish to bankrupt their countries- I don’t see how they
    > will continue to blindly and ravenously purchase oil at ever increasing
    > prices.
    Reply
  •  
    Aug 21 03:43 PM
    I gotta say that this statement:

    "If Americans can’t afford 140dollar oil- how can China and India afford it?"

    Gave me the best laugh I've had in some time. It posits America as wealthy and China as poor - now *that* is rich! Thanks for the laugh.

    Seriously, just how many US Treasuries is China sitting on? $2T worth? More? And just how far in debt is America, and are Americans?

    Puh-lease...that hoary old myth of the affluent American and the poor rest-of-the-world is not exactly 'congruent with reality', as they say. I think someone needs to get out more and stop reading fairy tales. We're flat broke, and so are our kids, their kids, and their kids after them, compliments of those thrifty guys and gals in DC. And with Helicopter Ben spinning up the printing presses for a full court press to save America's banks and brokerage houses from the folly of their idiocy at our expense, that's only going to get worse.

    The question you should be asking is *not* how can China afford $10 gas (hint: bilateral agreements will be the new oil pricing regime - and it probably won't be priced in USD anymore anyway), it's how will I be able to afford bread when it's USD1000 per loaf?
    Reply
  •  
    Aug 21 04:51 PM
    ozzy43, damn near every government on Earth is in debt. The notion that the U.S. is screwed because the debt has reached 60% US GDP is laughable, especially when you compare that level of debt to the rest of the world.

    Also, if you ask the people of the Austrian persuasion what's going to happen to the United States, who would care if China hd 2 QUADRILLION in US Treasuries? Worthless paper. So's the yuan. So's the euro. So's many other forms of currency.

    We're all screwed, unless we stop listening to those who want to destroy the world economy for some strange reason.
    Reply
  •  
    Aug 21 07:27 PM
    The only countries subsidising oil are those that produce it. China has stopped. China has just placed huge taxes on large cars. Demand is dropping big time. Can the producers eat all the oil. Of course not --oil has only started to go down. I closed my DUG (short oil stocks) for nice profits but will rebuy as you drive up the price again.
    Reply
  •  
    Aug 21 08:01 PM
    I agree with Bob. Everybody and I mean everybody is looking to conserve.
    Reply
  •  
    Aug 21 10:37 PM
    Anybody heard of a bell curve? Whatever the average income is there are a certain proportion well above the average. If the average rises then the number that can afford luxuries rises as well. Has nobody seen the pictures of packed roadways in China? Well the oil bears can hold their hopes. I made good money off them today.
    Reply
  •  
    Aug 22 12:50 AM
    Ozzy, that was a clever one and so right on!

    China and India, as well as most o fthe world have begun driving less...China will adding more new car/truck units so their demand for oil will stay in an upward trend, just not as robust...and thier growth estimares by our energy agnecies is based on more vehicles like we drive as opposed to the more energy efficient that they are purchasing.

    The oil bulls are stilling lurking, having come back out from hidding, since the CFTC is in thier pocket and the Rep. Congress thinks that Com. Spec. is a myth. - See David Cho's article in Aug. 21 Wash. Post. - Specs control 70% of the market - mostly in the hands of 4 to 5 big groups...Only when Congress gets back and the heat is turned back up on them will we see the retreat to where Oil should slip jsut below $100 - this against an actual production cost of $75/barrel and against the fact that we still pull, or can pull, 1 million more barrels per day out of the ground than we are using - this is good for two more years....but, alas, the analysts and specs tell us that there is a potential for Atlantic based hurricanes to corss Fla. 3 times on its way to LA/TX gulf waters...give me a break, please. Thus, acording to Trader Ric Carbone and Sharon Apperson of CNBC we should talk each other into believing this is a good "possibiltiy' and we should raise oil some more. When will the insanity end and the spotlight move on so that real energy traders can once again trade and jump when Putin or Goldman Sachs tells them to...
    Y
    Reply
  •  
    Aug 22 08:56 AM
    Has anyone remembered that both China and India have more than 1 billion people each? They also have rising middle classes that are gaining greater wealth thanks to their economic successes over the past decade. I have been to both countries several times and I am astonished by the substantial affluence that exists alongside great poverty.

    Tim

    Reply
  •  
    Aug 22 09:23 AM
    YogiZ,
    Where did you get you information that speculators control 70% of the market ? If they did, oil prices would $1000/barrel.

    If you look at all open futures contract for the next 10 years, you will see only 1 billion open contracts. The world uses 30 billion barrels a year and 300 billion barrels (assuming no demand growth) for next 10 yrs.

    How does open contracts on 1 billion barrels have an effect on a consumption of 300 billion barrels ? It does not ! With supply stuck 85 million barrels/day and demand increasing steadily since 2002, we have a simple explanation for the 6 fold increase in oil prices. Same thing happened in 1973 and 1979 with only a small portion of supply taken off the market.
    Reply
  •  
    Aug 22 11:14 AM
    I believe that world demand for oil will continue to increase as India and China continue to grow. However, I wonder to what degree demand for oil in America will decrease as Americans transition from SUVs to more fuel-efficient vehicles. If I sell my SUV and by a fuel-efficient car, my fuel consumption should drop by about 20%. If everyone in America did the same wouldn't that substantially decrease American consumption?
    Reply
  •  
    Aug 22 02:02 PM
    Sanibel, I like your reasoning to a point - fuel efficent cars will help drive the conservation of GAS. However the underlying inflation factor is Diesel, which given the refinery mix in the US is underproduced. A serious drive to replace oil heat with electric would help offset this shortage as Home Heating Oil and Diesel are both #2 fuel oil and pull on the same stocks. BTW - not everyone can drive a prius, My cattle trailer and hay trailer need a full size diesel pickup to pull them, which there aren't seriously fuel efficent alternatives out there yet. The good news is there are more fuel efficent diesels being designed than ever, but fleet turnover on large trucks is a 7 year at best game, unless serious tax incentives are encouraged.

    Coolhand
    Reply
  •  
    Aug 22 08:11 PM
    $3.50 gas vs $4.00 don't mean crap to a guy with no job and upside down in his house.
    Reply
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