And while there remains a risk that prices will retreat further due to sluggish demand, there are also three very compelling reasons why oil is still a safe long-term bet:

• OPEC has made substantial progress in reducing the amount of oil on the market.
• The dollar has been made vulnerable by the U.S. Federal Reserve’s aggressive policy of quantitative easing.
• And low oil prices and tight credit have reduced global energy investment, putting future supply at risk.

There’s no question that downside risk remains. On April 13, the Paris-based International Energy Agency (IEA) lowered its demand forecast by 1 million barrels a day, and now expects the world will use about 83.4 million barrels per day in 2009. That would be 2.4 million barrels a day, or 2.8% less than last year.

But so far dwindling demand has failed to contain oil prices.

The futures contract for benchmark crude settled at $49.66 a barrel on March 31, up 11.3% from where it ended 2008. As Money Morning predicted in its annual outlook series, the first quarter was a volatile one, in which oil prices tested the low $30s before surging over $50 in recent market rally.

And analysts are almost completely united in the view that, despite its short-term volatility, declines in production, exploration and development, and the value of the dollar will drive oil prices substantially higher in the years ahead.

OPEC Keeps a Lid on Production

The members of OPEC generated tremendous revenue from oil prices that soared over $147 a barrel last year. However, just as the world’s top oil producers began looking for ways to spend their massive stockpiles of cash, prices began a plunge that would see crude lose more than three-quarters of its value.

In a desperate effort to put a floor under oil prices, OPEC – supplier of 40% of the world’s oil – has issued three production cuts totaling 4.2 million barrels per day (bpd), or nearly 12% of its capacity, since September.

While the cuts have not yet been able to return oil prices to the group’s desired price range of $60-$70 a barrel, the cartel abstained from making any further reductions at its latest meeting in March and even voiced optimism that crude would reach $60 a barrel by the end of the year.

“That suggests to us that not only does OPEC have the firepower to support this oil price but there’s enough internal agreement between OPEC members that they can actually achieve it,” Tom Nelson, an analyst for the Guinness Atkinson Global Energy Fund told BusinessWeek.

Many analysts had speculated that OPEC members would ignore the quotas and continue to produce oil to generate income, thereby rendering the cuts ineffective. But OPEC’s discipline has proven many critics wrong.

Despite foot-dragging from Iran and Venezuela – two countries that rely heavily on oil revenue to fund massive social programs – OPEC has gotten about 80% compliance on the 4.2 million bpd production cut. Historically, the cartel only gets about 60% compliance on such cuts.

As of February, Saudi Arabia accounted for about 46% of the 3.4 million bpd decline in production, according to PFC Energy. And the United Arab Emirates have fully complied with their share of the cuts. Iran’s compliance by that time was only 33% and Venezuela had only adhered to half of its commitments.

Still, Abdallah El Badri, OPEC’s Secretary General, estimates the production cuts will take about 800,000 bpd of supply off the market, significantly reducing the overhang in global markets, BusinessWeek reported.

OPEC officials from Libya, Algeria, and Iraq have all said that oil prices will reach $60 a barrel by the end of the year.

“One of the reasons why OPEC felt able to roll over quotas was that they do appear to have set a floor for prices,” Mike Wittner, an analyst at Societe Generale SA (ADR: SCGLY), told Reuters. “According to a lot of the balances, including ours, if you have OPEC holding steady or cutting a bit more, you get a big, counter-seasonal stock draw in the third quarter.”

Crude Thrives on the Diving Dollar

Crude futures doubled from July 2007 to July 2008, soaring from about $74 a barrel to a record-high $147 a barrel. Much of that rise can be attributed to supply and demand, but there was another catalyst for the soaring prices that few investors recognized: The rapid decline of the dollar.

From July 2007 to July 2008 the dollar plunged 16% against the euro. And as the dollar became less valuable the cost of commodities around the world skyrocketed.

At the time, inflation – not deflation – was the predominant concern among the world’s leading economists, as a decade of low interest rates and unconstrained lending in the United States sucked the life out of the dollar. And while inflation is nowhere near the levels it reached last year, it’s important to recognize that the policies of the U.S. Federal Reserve are no less inflationary.

The Fed has cut its benchmark lending rate to a range of 0%-0.25%, and last month, Fed Chairman Ben S. Bernanke said the central bank would purchase up to $300 billion of longer-term Treasury securities and $750 billion of mortgage-backed securities as it pursues a policy of quantitative easing.

This announcement by the Fed, along with a corresponding rise in equities, has been the driving force behind oil’s recent rally.

“[Oil prices] are being possessed by the dollar and the stock market,” Phil Flynn, an analyst at Alaron Trading Corp. told The Associated Press. “It’s not an oil market anymore. It’s a stock-currency market because that’s what we’re reacting to right now.”

Ultimately, the same fear of inflation that typically drives investors into the gold market is similarly buoying oil prices. And even though the dollar has yet to be seriously affected, there’s no ignoring the fact that its value has been imperiled.

“The recent announcement by the U.S. Federal Reserve of its intention to purchase over $1 trillion worth of government bonds and mortgage-backed securities has served to put additional pressure on the value of the dollar as this is viewed by the market as creating a lower yield and fanning the flames of inflation,” Wall Street Strategies’ senior research analyst Conley Turner told Xinhua.

The Coming Oil Price Shock

Now that a weak dollar and reduced production have bolstered oil prices, there is a growing concern about how much higher crude will climb once demand returns. Tighter lending conditions and a trough in oil prices have badly crimped investment and jeopardized future supplies.

More expensive energy projects such as oil sands have been put on hold and the number of drilling rigs at marginal shallow-water fields around the world has been scaled back to a three-year low.

Oil drilling activity dropped 43% in the 12 months through March, with year-over-year oil exploration in the United States alone down 38%. High bids for offshore drilling rights in the central Gulf of Mexico fell by more than 80% compared with last year.

OPEC has said that with oil generating substantially less revenue as many as 35 new projects could be delayed past 2013.

“I have often described unsustainably low oil prices as carrying the seeds of future spikes and volatility. In a low-price environment, the trend is often to focus on survival instead of expansion,” said Ali al-Naimi, the Saudi oil minister. “If we place a low priority on preparing for the future, that lack of action can come back to haunt us through supply shortages and another round of high prices.”

The current economic crisis could reduce future oil supply growth by 8 million bpd, according to a recent study by the Cambridge Energy Research Associates (CERA).

CERA now says that production will grow by just 7.5 million bpd over the next five years, down from the 14.5 million bpd increase it predicted last summer. According to the research group, as demand recovers throughout that span, production will struggle to keep up and a new commodities bull market, similar to the one seen in 2008 will begin.

“Seven consecutive years of rising oil prices – unprecedented in the history of the oil industry – have come crashing down, thus burying the notion that the commodity price cycle was a historical relic,” said the report.

CERA isn’t the only organization worried about the lack of investment in new oil projects, either. The International Energy Agency (IEA) – energy advisor to 28 industrialized nations – has also issued warnings about a coming supply crunch.

The IEA estimates daily oil demand will rise from the current level of 86 million barrels to 106 million barrels by 2030. To meet that demand, the agency estimates that the world needs $26.3 trillion in supply-side investments over the next 21 years.

China, India and other developing countries, alone, will need investments of $360 billion a year through 2030, the agency said.

About 7 million bpd of additional capacity needs to be added to the market by 2015.

“Unless sufficient companies have the will and financial ability to invest through the downcycle, there is a real risk that supply growth may lag the eventual rebound of demand, leading to substantial price increases – possibly as early as this year,” Richard Jones, the IEA’s executive director said at a recent conference in London.

Jones estimates that as much as 2 million bpd of expected new oil production has already been deferred.

The IEA predicts that, by 2015, a lack of investment and rising demand will create a “supply crunch” – that will once again send oil prices up into the triple digits.

“There remains a real risk that under-investment will cause an oil supply crunch in that time frame,” the IEA said in an executive summary of its “2008 World Energy Outlook.” “The gap between what is currently being built and what will be needed to keep pace with demand is set to widen sharply after 2010.”

The agency predicts that crude will average more than $100 a barrel from 2008 to 2015 and rise above $200 a barrel by 2030, as demand far outpaces supply.

“Every bull market in oil is really born in the zenith of a bear market,” said Alaron Trading Corp.’s Flynn. “The cutbacks we see today are going to lead to a spike somewhere in the future. The big question is when it’s going to happen.”

Source: Three Big Reasons Oil Prices Will Resume Their Rally

Here it is:

We need to pump 50,000 barrels more each day.

It’s a masterstroke. A policy that manages to be really bad in two different, fundamental ways.

Point one — we don’t have much oil left. This will deplete our reserves faster.

Point two — the world as a whole produces 85 million barrels a day. This extra production will have no impact on the oil price. It’s like throwing a dart at a tank.

Of course, there could be another motive for this. Brown famously sold a lot of our gold in 1999. Since then, the price of gold has soared. It was a really, really bad trade. If Brown was your fund manager, you’d sack him.

Maybe Gordon’s trying to make up for it now. Britain is a price taker in the global oil market. We have no influence on how much a barrel of crude costs. Now oil is hitting record highs. Some, like our own Bill Bonner and our Time Trader, Robin Tracey, suspect we could be in bubble territory.

Perhaps Brown is advocating increased production to capitalise on the high price (though even then, I don’t think it’s at all his call to make). I don’t really believe this… but I’m trying to think of a rationale for this mad policy.

If that is the case… OK. We’ll talk about it.

Just don’t dress it up as the energy solution it clearly, clearly isn’t.

Below, commodities hound Garry White proposes a far more workable solution. He also follows up on yesterday’s Blackout Britain story — why was it that the lights went out in Cleveland?

House prices lose their footing

Woops!

You remember my rock climbing analogy from two days ago? The one that likened the housing market to a climber on a rock face, trying to descend to a sustainable level and groping around for a foot hold?

Well, the climber’s slipped. He’s not at the bottom (at least, we don’t believe so). But he has slipped a bit, and grazed his face on the rock.

According to the latest Nationwide house price index, the average house price has fallen 4.4% since May last year. That’s the biggest fall since December 1992 (when prices fell by 6.3%).

But here’s a line from the FT that puzzles me:

“The price drop makes the position of the Bank of England’s monetary policy committee even more complex as it struggles to set an interest rate policy which is consistent both with surging inflation and a deep slowdown in economic activity”.

Why? Why should it make the Bank’s job more difficult?

I’m going to have to quote from the Bank of England Act again, aren’t I? Here we go…

In relation to monetary policy, the objectives of the Bank of England shall be — (a) to maintain price stability, and (b) subject to that, to support the economic policy of Her Majesty’s Government, including its objectives for growth and employment.

The key phrase is ‘subject to that’. If prices are stable, worry about growth and employment. If they’re not, don’t.

There isn’t an interest rate policy consistent with both surging inflation and a deep slowdown in economic activity. There’s no reason to think there would be. That’s why each policy tool should be used to achieve one, and only one, policy goal.

In the case of interest rates, the goal is price stability. Keeping inflation down.

Falling house prices may make ugly headlines, but that shouldn’t be the Bank’s concern. And besides, house prices got too high anyway.The housing market is trying to find an equilibrium. Let’s go back to my climber on the rock face. He knows there’s solid ground below. He’s making his way down… from time to time he slips, but then the safety rope kicks in.

This “Belay Effect” takes the form, for example, of people desperate to buy, but priced out of the market. As soon as prices slip a little, they’re in!

But our climber’s still searching for a surer footing. So he’ll keep edging downwards. And here’s where the Bank of England might make a nuisance of itself. The equilibrium is below the climber. Cutting rates has the effect of temporarily hoisting him higher up the wall.

But he still has to come down.

Solving Britain’s power crisis — the Garry White two-step

Step one — start building nuclear reactors. But remember — these take over a decade to build. You can’t just throw them up. Best get started, then, however unpopular it may be with environmentalists.

Step two — find a workable solution for the interim period. For Garry, the solution is a four-letter word. Coal!

“Coal’s making a comeback,” says Garry. And that, dear reader, leads me onto step three:

Invest in coal. This is exactly what Garry told his Smart Commodities readers to do last October. But Garry was too far ahead of the curve — his coal stock slumped straight after.

But Garry’s stuck with it. And he’s told his readers to stick with it, too. He sees the current energy crisis for what it is — a gap to be plugged… and a great investment opportunity.

Garry’s been rewarded for his patience — his coal stock’s now showing a 19% profit since recommendation, despite the earlier dip. Now, past performance is not a reliable indicator of future results. Perhaps Garry was lucky?

“Not a bit of it!” says the man himself. “Investors are slowly waking up to coal’s profit potential. The world needs energy — and coal, however dirty it may be, is a proven source. This stock has a way to go yet. Get it in your portfolio!”

Find out today what Garry believes is the number one coal investment on the market right now!

Until tomorrow

Ben Traynor

Source: Gordon Brown’s Barmy Answer To The Oil Crisis

The Sunday Times’ advice appears to have fallen on deaf ears. The following day, Monday, oil hit $120. Another record. Rebel attacks in Nigeria disrupted production and renewed Turkish action against Kurdish insurgents in Northern Iraq were given as reasons why. They combined to push West Texas Intermediate sweet light crude to $120.36. Brent Crude hit a peak too – $118.58. Nigeria and Iraq combined accounted for 5.5% of global production in 2006 according to BP. Where would the price go we wonder if Saudi – accounting for 13% – announced peak oil?

As it is Goldman Sachs weigh in with another oil price forecast this morning. It suggests the Sunday Times is at best a little early on their call. We could see $150-200 oil in the next two years they calculate as supply plays tortoise to the hare that is demand. Shell CFO Peter Voser reiterated last week they see a market that is well supplied but still think prices will rise from here. Morgan Stanley analyst Hussein Allidina reminds us:

“The global oil market currently has very little margin for error with spare capacity constrained.”

Brazil may have found an offshore “elephant” or two but the stuff is six miles below ground and requires a pushing of the technology frontier to develop. Whether that proves economically viable remains to be seen.

Predicting the peak and the duration of the up cycle in oil prices this time around remains a tricky one admit Goldman Sachs. As we’ve noted before, Jim Rogers is less shy on the broad subject of commodities in general. Expect the commodity bull to run to 2014 or beyond he says (adding he’ll shout when it’s time to get out!). And the key driver is the industrialisation of the developing world: first and foremost, China. And there consumption continues to rise in spite of the relentless rise of crude – up 25% this year alone. In China’s case its thirst comes with the added kicker of inventory stockpiling ahead of the Olympics.

So it doesn’t look like the strengthening headwinds of oil prices (or commodity prices generally) are going away any time soon. And that hurts everyone – from the car driving commuter at the micro level all the way up to UK plc. Ernst & Young’s Item Club reckon a $150 oil price could cut growth to nearer 1% or less next year and push up inflation. At $200 we could see 6% inflation by 2010 they warn. Mervyn King will be an experienced letter writer (to the Chancellor) should that day come to pass.

So while the eye of the credit market storm looks to have passed, commodity prices continue to agitate and could yet sink even the modest economic growth projections of the industrialised world.

Warren Buffett told the 31,000 faithful at the Berkshire Hathaway annual shareholder jamboree that the worst has passed for Wall St but not the man in the street. Those with mortgages that is. There’s a lot more pain to come for US mortgage holders predicts capitalism’s nearest thing to a rock star.

Berkshire Hathaway actually took a 64% earnings hit in the first quarter from derivative losses but with a $40bn war chest it’s a good time to be a value investor with an eye for a bargain. He’s shopping in Europe too and is rumoured to be adding to his insurance empire by buying RBS’s insurance business. Elsewhere, US private equity firm Apollo wants a piece of battered UK house builder Barratt. And another private equity house, Blackrock, is buying $15bn worth of subprime mortgage debt from UBS.

Another home builder, Bovis might find interest from value investors too, following a profits warning today. Buyer reservations collapsed 70% since it released year end results on March 10. The shares at 457.75p are down 2.8% today as at 12.30pm. From a 52-week high of 1,160p and against a tangible book value of 562p/share according to the caveated calculations of ADVFN.

With European bourses showing up red today and the FTSE100 down 44, last week’s optimism is starting to wilt under the pressure.

Regards,

Rob Mackrill
The Daily Reckoning

Be the first to comment on this article! Now you can post your thoughts, reactions and views on the topics we talk about.
To comment, click here.