On the demand side, world oil demand grew by 1.1% in 2006 and 0.8% in 2007, even though the average oil price (as measured by the OPEC basket) rose from $50.64 in 2005 to $61.08 in 2006 (a 20% gain), and then jumped to $69.08 last year (for a 13% increase).

In 2008, world oil demand is expected to grow another 1.2%, even though the price has so far averaged $94.50 – a full 36% higher than in 2007. This suggests that demand is very price-inelastic in the short term, so that even a price rise towards $200 might dent it only modestly.  

Since 2005, “easy-money” policies – global interest rates near zero, or even negative in real terms, after factoring inflation into the equation – has fueled a global growth boom that’s been unprecedented in its rapidity. Economic growth in China is still well above 10%, while that in India is running far above historical levels. Given those two countries’ huge populations, their tendency to control petrol prices and China’s massive switch from bicycles to automobiles, oil demand could well increase more rapidly than forecast. Since the Energy Information Administration predicts that demand will exceed supply again in 2008 – after doing so in 2007 – expect supplies to keep getting tighter.

This tightness is confirmed by the divergence in prices between West Texas and OPEC crudes. In a market where supplies were plentiful, any such difference would quickly disappear through arbitrage. In a tight market, supplies are constrained, so diverting cargoes to take advantage of arbitrage differentials may be impracticable. Currently, while OPEC crude sells for $109, West Texas crude is at $118, indicating an exceptionally tight supply situation.

Clearly, global oil prices are headed in only one direction – higher. And only a recession brought on by exorbitant energy prices or much higher interest rates is likely to cause a reversal.

Traditionally, if you wanted to invest in the world oil market, you bought shares in the world’s major oil companies, such as ExxonMobil (XOM), Chevron Corp. (CVX), Royal Dutch Shell or BP. That’s no longer a guarantee of success. The oil majors are the principal victims of the new trend of nationalism that’s sweeping the world oil market.

In country after country, their contracts are being renegotiated in a way that’s certain to crimp profits, or they are being pushed out altogether. Their oil reserves are declining; part of the return you get when you buy them is simply a return of capital as they slowly go out of business.

Crude Oil’s Three “Profit Pathways”

In today’s market, there are three possible approaches to buying oil stocks.

• First, you can buy a company with a politically secure – albeit high-cost – oil source, such as the tar sands or oil shale. Of the pure tar-sands plays, the most attractive – with operations focused primarily on Canada’s Athabasca deposit – is Suncor Energy Inc. (SU). On past earnings, the shares trade at a somewhat steep Price/Earnings ratio of 20, but that ratio drops to 11 when calculated on projected-future earnings since the higher oil prices for 2008 drop right through to Suncor’s bottom line.

• Second, you can buy an oil company from a politically stable country that allows foreign participation in its projects, meaning the company is able to explore successfully using the latest technology. The best example here is the afore-mentioned Petrobras, which has recently made an oil discovery reputed to contain 33 billion barrels, by itself sufficient to vault Brazil well up the leader board of global oil exporters. Petrobras even qualifies as environmentally sound, if you care about that sort of thing; it is a major producer of ethanol from sugar cane, Brazil’s successful alternative fuel technology that is eight times as energy efficient as the United States’ hopeless ethanol boondoggle. Petrobras has had a hell of a run – with its shares having run up 138% during the past year – but the stock may well have further to go: It is trading at 22 times trailing earnings but only 18 times forecast earnings, and a continued success with its exploration efforts could push the shares up even higher.

• Third, you can accept that many countries don’t like the United States – preferring, instead, to pursue inane socialist energy policies – and invest in a company that still offers them access to some modern technology when they do so. That company is Italy’s Eni SPA (E), which has operations in Venezuela, Libya and Kazakhstan. Unlike the other two companies here, Eni is a bargain, trading at only 9 times trailing earnings and 8.5 times forecast earnings, and with a 5% dividend yield as an additional enticement.

Although these are three different approaches, they all have one objective: Take advantage of the continuing increase in oil prices. As Venezuela’s Chavez cheerfully gloats, we may still be a long way from the end of that trend.

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