Crude Prices: The Most Expensive Oil Ever?

By Adam Lass & Sara Nunnally

Plus... Oil Supply: What We Already Know

Blue-Chip Investing
Crude oil futures hit $73/barrel today. Not because of a storm in the Gulf of Mexico. Not because of a strike in Nigeria. Not because of Venezuelan saber rattling. Simply because Americans can’t back off.

Material Profits
If OPEC supply could be in trouble several years down the road, traditional buy-and-hold investors could find some great deals on companies developing other parts of the world.

Remember those prognosticators who were assuring you back in June that oil had peaked at some $69/barrel? You remember, they were the same guys who were touting $30 oil a year or so ago.

“Our reserves are replete, even overflowing… OPEC always over-pumps… Demand will naturally back off.” Wait, wait, here’s a golden oldie: “Once our troops take Baghdad, the Iraqis will flood the market with cheap oil!”

Crude oil futures hit $73/barrel today. Not because of a storm in the Gulf of Mexico. Not because of a strike in Nigeria. Not because of Venezuelan saber rattling.

Simply because Americans can’t back off. They live where they live (they certainly can’t move anytime soon, what with the current real estate market), and they must light, cool and commute to and from their once -- and future -- dream houses.

So is this “the high,” after which we can expect prices to settle back to a nice comfortable $60 or $65 a barrel? Heck, $73 may be the 2007 high, but we aren’t even back to the all-time high just yet. That honor is still held by last July’s $78.40.

But we are well on our way, folks. And just as it didn’t take a crisis to get here, it may not take one to get there either.

As per those optimistic types at the International Energy Agency, demand not just here in the fuel-thirsty U.S., but rather across the 26 industrialized countries the IEA advises, will rise by an average 2.2% a year between 2007 and 2012. This represents a 10% upgrade from its previous report issued last February.

Seems that in this global game of chicken, nobody is blinking or steering off. “Despite four years of high oil prices, this report sees increasing market tightness beyond 2010.” Let me help you out with the math: right now we can barely keep up with demand of 86.1 million barrels per day. By 2012 it will be up to 95.8 million barrels per day.

Think OPEC will bail us out? Combine “project slippage and geopolitical problems” and you can actually reduce OPEC’s spare capacity by 2 million bpd by 2009. How about Mexico, or the North Sea or Kazahkstan? Alaska? Surely at these prices, someone will gin up some additional supply? The IEA says that non-OPEC conventional crude production appears to have reached an effective plateau as falling output at ageing fields and setbacks such as 2005's hurricanes in the Gulf of Mexico have slowed growth.

And before you start coming back at me about ethanol, soy oil et al, the same bean counters are calling global production of biofuels to hit 1.75 million barrels per day by 2012. And while that does represent a doubling of 2006 levels, it is nowhere near enough to even bother adding to the calculation.

What does this mean in real life? Try this: $4 gasoline is no longer a sick fantasy. Rather, it is inevitability. May be even $5 gas. Beyond that, yeah we are still talking fantasies.

From an investing standpoint, overlapping oil company options remains the single most-successful strategy Bryan and I have cooked up this year.

The International Energy Agency (IEA) reported a rise in projected demand for the next five years that could tighten world oil supplies even further.

That’s not exactly news to us. I told you about a month ago that world demand was set to outpace world supply… That information was also based on data the IEA released.

Back in February, the IEA released its forecast for 2006-2011, calling an annual increase of 2% for global oil demand. From a global demand of 84.9 million barrels of oil a day last year, that’s an overall increase of about 10.4% by 2011.

In other words, by 2011, world demand will be 93.7 million barrels of oil a day.

The new demand forecasts, however, predict an average annual rise of 2.2% between 2007 and 2012.

So let’s redo the math, and keep the former 2% rise predicted for this year before we get into the higher growth range.

The new world demand by 2011 would be 94.5 million barrels a day, and 96.6 million by 2012… or 1% higher than previous forecasts. In total, that’s an additional 292–365 million barrels of oil a year.

That’s enough to supply the U.S. with oil (at current demand) for only 14.1–17.6 days, but enough to supply the U.K. for 5–6 months.

Okay, perhaps the U.K. is a bad comparison… It only uses one-eleventh the amount of oil we use.

At 6.5 million barrels a day, China’s oil consumption is still about 68% less than what the U.S. consumes. At that rate, the additional oil demand growth would supply China’s current oil demand for about 1½–2 months.

Despite the larger debate these comparisons may spark, one would assume this is very bullish for oil investors.

In addition to the increase in world demand, the IEA is now stating that OPEC’s spare capacity -- the amount of room OPEC production has to grow -- is most likely lower than what the oil cartel is predicting.

OPEC says it will have a 40 million barrel-a-day spare capacity in 2010. The IEA says OPEC is overshooting by about 1.6 million barrels a day.

Essentially, this means production growth may not have as much room to grow as OPEC thinks.

That could spell even tighter supplies down the road, particularly if there are any supply disruptions that need to be met by a sudden increase in OPEC production.

If OPEC supply could be in trouble several years down the road, traditional buy-and-hold investors could find some great deals on companies developing other parts of the world.

Russia’s a great place for companies to start looking for new opportunities -- if the politics don’t screw it up. Indonesia is another area that could see a boom in investment, particularly as it’s beginning to deregulate its power industry and attract foreign companies to its resources.

The rest of this week, I’ll be looking for a good candidate that just might be ahead of the game. If you have any other areas or companies that might benefit from non-OPEC oil investments, send me your ideas at e-news@taipanfinancialnews.com.