The team at Casey’s Energy Opportunities believe that planned government buying or selling of crude oil for SPRs actually have very little impact in the overall market. However, an overall drawdown of worldwide inventory could put downward pressure on the price of oil. The various countries also have their particular reasons and influences in decisions to tap their reserves.

So which countries are executing preparedness plans to fill their strategic reserves with $70 oil now (as opposed to $140+)? Below are the 10 countries that consume the most oil in the world, as of 2008, the latest figures available from the BP Statistical Review of World Energy:

Russia, Canada, and Saudi Arabia can leave the list, as they are net exporters of oil and thus do not actually require a strategic reserve, at least in the short term. We’ll also bump Brazil, because its balance of imports is dwindling every year, and it should become a exporter before it requires a reserve. That leaves six countries to examine:

The United States

Not surprisingly, America has the largest strategic reserve in the world in an absolute sense. Its 727 million barrels are stored in four hollowed-out salt domes (and one pending) along the coastline of the Gulf of Mexico. These add up to some 62 days’ worth of imports, according to government sources. The United States government currently has plans to push this to 1 billion barrels, or about 85 days’ worth of imports, which would make the reserves equivalent to those of Japan and Korea.

The SPR build-up will be accomplished by expanding two of the current facilities, for an additional 113 million barrels, and (probably) building a new one in Richton, Missouri, for 160 million barrels. The Richton project has met local opposition, because it would require pumping 50 million gallons of freshwater per day from the Pascagoula River to dissolve enough salt to open up another subterranean cavern. The total cost of the program is estimated at US$3.7 billion, not including the cost to fill the reserves. Oil purchases are likely to be slow, at around 100,000 bpd (barrels per day) before 2014 and 150,000 bpd thereafter.

In a real emergency, the combined American strategic and commercial reserves (the latter held by private corporations, especially refiners) may seem unnervingly thin from the perspective of energy security. Add to that the fact that the government can release them at a rate of only 4.4 million barrels per day, or about half its imports.

Still, the 108 or so days’ reserve it has between government and commercial sources are considered adequate by international standards. The United States has used this reserve twice in the past 20 years (Desert Storm and Hurricane Katrina) to combat severe demand or supply disruptions. It also has the luxury of importing more oil from Canada in an emergency.

Scenarios that could force a sustained drawdown of reserves:

• Sustained hyperinflation in the United States due to actions by the Federal Reserve that causes oil-producing countries to look for better markets to sell oil.

• A prolonged general embargo by OPEC on the United States, forcing America to look to traditional partners such as Canada and Mexico, though they might not have sufficient oil.

• Another war, potentially in North Korea or Iran, requiring a large amount of oil input from America that it simply does not have.

• A particularly active hurricane season that knocks out a large amount of production capacity in the Gulf of Mexico, and the United States releases from the SPR to help.

China

China’s strategic reserves began being built in 2004, when leaders in China began to realize that the country had no adequate government-controlled reserves to combat any disruptions in the supply of oil. China is a large importer and is dependent on the same sources of foreign oil as the United States. China is even more anxious to build such a reserve, as two of its neighbors, Korea and Japan, both have large strategic reserves.

China currently has four government reserves with a total reserve potential of 272 million barrels, which translates to about 30 days’ consumption. Two of the four have been confirmed full, and there are rumors that all four are and that China has taken advantage of the recent precipitous drop in the price of oil to buy up. According to Chinese government sources, however, the reserves are likely not to be completely full until 2010, and 2009 buying of oil will be at around 42 million barrels.

The government has also announced plans to increase the country’s reserve from 30 to 100 days of consumption. The next stage of the development will call for an additional 170 million barrels in eight storage facilities. The locations of the facilities are as yet secret.

In an emergency, China would likely turn to Russia to buy oil, though only the naive would be surprised if Russia added a premium for the privilege.

Scenarios that could force a sustained drawdown of reserves in China:

• Worldwide embargo on China due to a Chinese invasion of Taiwan.

• High oil prices force Chinese industries out of business, pressuring the government to keep oil prices low domestically by selling some of the reserves to domestic companies.

• North Korea asks for oil from China to support military action on the Korean Peninsula, and China ships it to them on the black market.

• Russia slows or stops its exports as part of the Russian “dominance via energy” strategy, leaving Chinese pipelines trickling and Chinese industries disrupted.

Japan/South Korea

We have placed Japan and South Korea’s reserves together, as the two countries have a treaty that allows them to share their strategic reserves.

Resource-poor Japan has one of the world’s largest strategic oil reserves, enough for 82 days of imports. State-controlled reserves are run by the state-owned Japan Oil, Gas, and Metals National Corporation. The reserves consist of 320 million barrels in 10 different locations, which makes them second only to the United States in absolute volume. Japan’s island geography means that having an emergency supply of crude oil is crucial, and the Japanese government obviously has not ignored this aspect.

South Korea is in one of the global “hotspots” in the world, right beside North Korea. As the country is under an almost constant threat of war, the government has stocked up some 76 million barrels, with capacity for an additional 40 million barrels.

Scenarios that could force a drawdown of reserves:

• Just one at this time, from two possible sources: political instability in the region caused by either the Taiwan or the Korea conundrums disrupts tanker transport, perhaps even forces them to port.

India

India has a small reserve it began to build in 2004. This stockpile is sufficient for perhaps only two weeks of consumption. The country eventually wants to raise this level to 45 days, though the first phase has not even been completed yet. The projects are estimated to come online in 2012, which means it has taken eight years from planning to completion. These figures imply that India will not even have a somewhat sufficient strategic reserve until 2016, given that the expansion project was approved in 2008.

Germany

Germany has the largest reserve in Europe and is among the top in the world as well. Its government has satisfied a federal law that regulates storage be at least 90 days’ worth of net imports. More than half of the storage is in Southern Germany, where large salt caverns exist. Germany is well prepared in its strategic oil reserves, and there are no glaring factors that would force a drawdown of reserves, barring a global catastrophe. Furthermore, the reserves of Germany, France, and Italy are pooled and can be used by any of the three countries in an emergency.

So How Much Do the Reserves Matter?

According to the US Energy Information Administration (EIA) estimates, some 2 billion barrels are held in government-owned strategic reserves around the world. Though this seems like plenty of oil, does it really impact the spot price of oil? Collectively, the answer is yes, as this volume corresponds to 23 days’ worth of global consumption. If drawn down together over a short period of time, the effect on spot price could be substantial.

For illustration’s sake, suppose that countries collectively draw down their entire reserves over the period of a year. This rate would make up for 10% of the daily worldwide trade of crude oil, which could certainly impact price (imagine ConocoPhillips and ExxonMobil both going under at the same time).

Individually, however, even China and the United States have a limited impact on the spot price of oil over a single year. If the United States’ inventory were drawn over an entire year, it would only make for a 4% increase in supply. Under normal buying patterns of each country’s strategic reserves, the impact is even smaller. Since China’s 42-million-barrel purchase is over one year, their purchase would not even make a dent in the daily trade of oil.

Thus, a concerted effort by the worldwide reserves can definitely keep prices down in the short term (within a year, two at best), but cannot make for a paradigm shift in the supply/demand model of oil or the Peak Oil argument. And from the buying side, if governments plan the filling of their strategic reserves, the impact on the spot price of oil is likely to be minimal.

Perception is a tricky horse to ride, however, as we all know. Given a worldwide panic for oil à la the 1973 oil embargo, oil prices could spike in the short term, because government reserves would likely raise purchases 10% or so in a real emergency. This effect would be short lived for the foreseeable future, though, as worldwide reserves are already reaching their limits.

In short, if everything goes according to “plan” by the governments, even filling a large reserve such as the Chinese SPR would have little impact on the price of oil. For SPRs to truly impact the spot price of oil, it would have to be a global situation, with war and embargo the two most likely scenarios. Even then, the impact would be mellowed by limitations on how quickly governments can either release or purchase the oil.

Regards,

Marin Katusa

Source: Who’s Buying Oil?

• The Dow Jones Industrial Average remained steady above 12,000.

• The leading indicator of existing home sales was down over 21% from the previous year, and the official unemployment rate was just beginning its upward creep by crossing the 5% mark.

• The first official admissions of the “R” word. In early April 2008, the International Monetary Fund (IMF) declared a 25% chance of a global recession, and Federal Reserve Chairman Ben Bernanke told Congress that gross domestic product “could even contract slightly.”

• The novelty of bailouts began. Bernanke also assured Congress that the Fed’s emergency authorization of a loan against $29 billion of Bear Stearns assets wasn’t putting taxpayer money at risk: “I feel reasonably confident that we’ll be able to recover all the principal and indeed some interest, and there is some chance of even upside beyond that.”

• The dollar’s six-year slide against the euro, hitting its lowest ever at $1.60 in late April. It also fell below the 7-yuan mark in China for the first time.

• And oil, comfortably above $100/barrel, was heading for its summer crest of $147.

A scant 12 months later, the Dow is trying to stagger back from a plunge to 6,500. Home sales are hinting a possible turnaround, unemployment (even the official, conservative figures) is expected to reach double digits before long, “recession” and “bailout” are household words (often accompanied by four-letter ones), the dollar is recovering… and a barrel of oil is worth half that hundred dollars. Hardly worth pulling out of the ground.

What happened? And even more important for us as investors, what’s going to happen?

The Casey Energy Opportunities team pulled together the pieces of the oil sector picture that other sources tend to scatter or ignore. We’ll give you a broader understanding of the drivers within the oil industry, the markets in which they operate, and how you can use that knowledge to push your profits upward.

The Oil Industry Now: A Rock, a Hard Place, and a Supply Glut That Isn’t

Everyone who drives a car or heats a home with petroleum has welcomed the fall in oil prices from their high in the summer of 2008.

While it’s hard to argue that filling your tank at $2 per gallon is a lot easier on the wallet than $4 or $5 per gallon, the broader economic effects of such low oil prices are troubling.

Leading the concerns is the drop in oil exploration and drilling that accompany a drop in price. Below the $50/barrel mark – and for many companies the bar is closer to $65 even for conventional fields – oil producers typically spend more money getting oil out of the ground than they can recoup by selling it. At the same time, turbulent financial markets have tightened credit. These two factors have pressured producers to allocate exploration budgets away from drilling projects and toward meeting debt obligations and day-to-day operating costs instead.

The plunge in prices has consumed the cash buffers of even the major oil companies. ConocoPhillips, for example, announced in January that along with eliminating 1,300 jobs and writing down $34 billion in assets, it was also planning to cut its 2009 investment budget by 18%. Exploration projects are part of both writedowns and spending cuts. The results of curtailed exploration are two-fold. First, some oil companies will be simply unable to survive the economic crisis. Second, supply in the longer term is being sacrificed to stay afloat now.

Storage facilities are bulging. The chart below shows the contents of the Cushing, OK, storage facility — where NYMEX deliveries take place — have recently doubled from their average 2008 volume. Along with a host of other facilities around the world, it got this way because of an unusually dramatic contango at the beginning of 2009. (A contango is a kind of market inversion, when the current [spot] price dips lower than the future price.)

In January, the spot price of oil plummeted as low as $37/barrel, while futures for July delivery were trading for $52. That meant if an oil company could buy and store product for seven months, it could lay out $37/barrel and be guaranteed a profit of $15 – or 40%, minus costs – in July. And indeed the buying frenzy took off, reinforcing the decision to turn off the drills.

So for the moment, we are artificially flush with oil, and demand has dropped as the global economy will likely shrink for the first time since World War II. It’s no surprise that oil prices have been staying down.

Many analysts say we won’t feel the effects of declining exploration for a few years. But the numbers are emerging already. According to the U.S. Energy Information Administration (EIA), non-OPEC countries demonstrated an average annual growth in supply of 570,000 barrels/day from 2000 through 2007. In contrast, they recorded a drop last year of some 300,000 barrels/day.

At the same time, OPEC appears to be conforming to its production cuts of 4.2 million barrels/day, begun in September 2008. The oil cartel is known to announce cuts that its members don’t actually follow; it’s in their economic best interest, if only in the short term, to sell all they can. But this time, oil has plunged far below levels to sustain their economies. Even Saudi Arabia expects to run a budget deficit this year.

OPEC, which produces about 40% of the world’s oil, would like to see prices around $75/barrel, at least. But the fragile global economy would have a difficult time absorbing such a price at the moment, and the cartel decided against further production cuts when it met in March. In fact, some three weeks later, Saudi Arabia actually announced a price cut on all its grades of crude to European, North American, and Mediterranean markets – a dramatic attempt to spur demand amidst high inventories.

So, entwined as it is with the economy, the oil industry is currently in a conundrum. The fix it requires – higher prices for its product – will choke the framework in which it operates.

At the same time, we’ve got supply problems ahead.

How Did We Get Here Anyway?

Like many aspects of the markets, movements in price are driven partly by real factors and partly by perception. Rags-to-riches-to-rags-to-riches Texas oilwoman Sue Sanders summed it up when she noted wryly in her 1940 autobiography that “nothing succeeds like reports of success.”

Last year’s run-up of oil was no exception: part real, part report. Some of the real factors:

• The weak U.S. dollar. The United States is not the only country that buys oil in U.S. dollars. The price per barrel is pegged to it, in fact. When the dollar is weak, the cost of U.S. exports drops; and indeed by December 2008, the U.S. trade deficit had fallen to its lowest in nearly six years ($39.9 billion, according to U.S. Commerce Department data). However, a weak dollar means it takes more dollars to buy a barrel of oil. Global concerns over the strength of the U.S. economy, including America’s ever-rising level of debt, had undermined the dollar to the point that OPEC members began to murmur about dumping it for the euro or a basket of currencies.

• Geopolitical turbulence in oil-producing countries. The Iraq war, oil-related militancy in Nigeria, and Iran-Israel-U.S. posturing over nuclear issues were hotspots in the first half of 2008. The average nightly news covered casualties in Iraq, but industry watchers tracked attacks on pipelines and oil facilities. Likewise, in Nigeria, sabotage and oil worker kidnappings by militant groups such as the Movement for the Emancipation of the Niger Delta (MEND) regularly shut down facilities to repair, negotiate, or improve security. And as spring warmed up, so did the war of words between Iran and Israel. By early July, Iran had gone so far to indicate it would move against shipping in the Persian Gulf if attacked. The United States would have moved next, of course… thus driving up the price of oil in the jittery oil markets, which depend on Persian Gulf shipping lanes.

• Unusually low crude and gasoline supplies entering the 2008 summer driving season. In early April, the EIA reported significant drops in supply – gasoline declined by 4.53 million barrels and crude oil by 3.2 million barrels, a one-two blow that surprised and worried industry watchers. Behind the gasoline slump were lower refinery margins, called crack spreads. In mid-March, when refineries would normally be coming off their maintenance schedules to churn out gasoline for summer driving, the margin for turning a barrel of crude into gasoline was negative for the first time in three years. Refineries sought profits in other oil products, and the markets responded to the expected imbalance in supply and demand.

• High demand. China is a stand-out here, and for more than its usual energy appetite. China has a penchant for aiming to break records – from its goals in five-year plans and building projects to its haul of Olympic medals – and in the first half of 2008, it was visited by some dramatic examples: a great earthquake and major snowstorms, events that disrupted the country’s energy industry. Combine that with the fact that China was also preparing for the Beijing Olympics in August, and it’s easy to understand why it was buying oil very heavily until mid-summer.

On the perception side of price drivers, it’s hard to overlook the fact that the market push stayed strong in the face of increasingly gloomy economic data. Casey Research was earlier than most in predicting the economic crash (we published reports such as “The Coming Currency Crisis” in June 2006), but by spring 2008, even officialdom was dancing around the word recession.

Normally, news of burgeoning foreclosures, plummeting home sales, spiking personal and business bankruptcies, rising unemployment, and other economic indicators would tend to exert a bearish influence. After all, consumers generate 70% of U.S. economic activity, and if they stop or cut back on driving to work or the shopping mall, telephone relatives or business partners instead of flying out to see them, reduce purchases of items containing plastics, turn down the thermostat, and other weather-the-storm measures, oil consumption should decline.

It took months for all these drivers to realign – but as we all know, they did, and then some. The chicken-and-egg debate, whether oil’s sky shot triggered or portended the economic debacle in the closing months of 2008, will require more distance and data to resolve. But it’s true that the dollar had started its comeback by mid-summer, supply had caught up, geopolitics had settled a bit, China backed off on its buying, no major hurricanes hit – but economic realities did.

Meanwhile, Congress jumped up and down and cried “Speculators!” “OPEC!” “Oil producers!” in tidy sound bites.

The Next Big Plays: Where You Need to Be

Oil companies are influenced by the range of market drivers and economic conditions according to size. The junior oil producers, those with market capitalizations of $250 million or less, have the small-business advantage of flexibility when times are good. These times aren’t good, of course, and even well-managed juniors with good projects are in trouble. Their vulnerability is in the credit market. You’ve likely heard of credit lines being revoked and refinancings denied to people with impeccable credit. Now imagine pitching a drill project without a wallet full of assets ready to lay on the table.

Mid-tier producers, with market caps between $250 million to $2 billion, will look to mergers and acquisitions to survive. The majors ($2-20 billion market cap) and Big Oil (over $20 billion) will also be shopping. With low oil prices shutting down exploration, development, and even production, these companies will be looking to replace their reserves instead by purchasing smaller, solid companies with proven production. It’s simply cheaper.

We see two ways to profit from this trend.

First, we buy shares in undervalued, producing companies that are profitable even below $40/barrel, are best of peer, and own large reserves. These are the companies that Big Oil will be looking to acquire. One such company, an oil sands producer, is currently a part of the Casey Energy Opportunities portfolio.

Second, we believe that owning a potential consolidator is the best position. As debt load and low commodity prices overtake them, junior producers will be forced to consolidate their projects. We currently own one such candidate, and are scouting for others with such muscle. Consolidators will be purchasing projects from the bank at 25 to 30 cents on the dollar.

Our tactics have already paid off handsomely in the last six months: all our recent recommendations have been on fire. A few tripled their value, and one generated a return of 540%.

As we’ve seen, supply problems are looming, no matter what timetable of Peak Oil you may believe in. With increased demand inevitably come higher prices. Our approach at Casey Energy Opportunities positions us to take advantage of the trend in both the short and longer term. And we guide our subscribers not only when to buy or sell, but also when to take profits and a “Casey Free Ride” to eliminate risk.

We’d like to offer you the opportunity to kick the tires of Casey Energy Opportunities RISK-FREE for 90 days, with 100% money-back guarantee. Click here to give it a try.

Source: The Price of Oil

Martin Katusa, writing for The Daily Reckoning, says what is less well-known is that almost half America’s energy needs is satisfied by countries hostile to, or with the potential to be hostile to, the US.

This means America’s quest for new oil will be vital in the years to come. And Martin says the smart money is not on the oil majors but on the small, more agile oil explorers targeting under-explored areas of the globe…

To better understand the reliability of America’s oil imports it’s helpful to see who America’s faithful oil-suppliers are – and who they aren’t. The chart shows that 54% of U.S. crude imports come from countries we consider Allies willing to work with the United States (shown in black and grey). Some 31% of imports come from Axis countries (shown in shades of red) that have demonstrated hostility to America. Another 15% are from Saudi Arabia, a Wildcard we believe could go either way. It’s unsettling to note that almost half of U.S. imports come from countries that are either unfriendly or have the potential to be.

The Allies

“A faithful friend is a strong defense; And he that hath found him hath found a treasure.” – Louisa May Alcott

First, let’s take a look at the good half. Although these oil exporters have been willing enough to work with America, they face their own internal challenges. For example, the U.S. has powerful competition for both Canadian and Mexican oil; and it’s from these countries’ inhabitants themselves. Canada already consumes 90% of the crude it produces, while Mexico consumes a growing 60% of its production. Further, both face challenges with their reserves. The only abundant reserves Canada has are the oil sands – expensive and difficult to extract. And Mexico, with its reserves dropping quickly, is likely to become a net importer of crude in about six years. Read that last sentence again, because right now Mexico is the third largest source of oil to the U.S…just after Saudi Arabia.

Shifting farther away from the continental U.S., the stability of exports from Nigeria and Iraq is challenged by internal unrest. Nigeria is destabilized by ethnic battles, ongoing supply scares, kidnappings, sabotage, clashes with militants and election unrest. In addition, resource competitors, including China and India, are both making inroads in that country. Meanwhile, Iraq’s reliability is largely dependent on a long-term U.S. presence in the area, a presence that is in doubt.

And these are the good guys!

The Axis

“Keep your friends close, and your enemies closer.” – Sun Tzu, 500 B.C, author of The Art of War

Now, let’s touch on the almost-50% of imports that come from considerably less reliable sources.

The stability of U.S. relationships with both Venezuela and Russia is questionable. Venezuela, under Hugo Chavez, has already reduced exports to the U.S. And Russia has shown dubious motives. Its recent tap- twisting with natural gas exports to the Europeans reinforces that it sees energy as a tool for gaining geopolitical power.

Angola, Algeria and Ecuador are very willing to sell oil to the US right now, because they need the money. But, they have also ramped up exports to other countries. Over time, they may pick and choose to whom they sell their increasingly precious commodity.

The Wild Card

Saudi Arabia – source of an impressive 15% of exports to the U.S. – is holding its dance card close to the chest. It either could supply the U.S. reliably over the next few decades, or, through its OPEC power, increase the price of crude even more. Despite the relatively stable relationship between the U.S. and the Saudi family, rising regional tensions, increased Islamic militarism and ongoing Israeli-Palestinian tensions could threaten exports. And, the U.S. presence in Iraq has implications for the stability of Saudi Arabia’s supplies, too.

Should the U.S. pull out of Iraq, any implied chance of U.S. troops supporting Saudi Arabia, should push come to shove, disappears. (How likely would the U.S. be to send troops back to Vietnam?) This could leave the Saudis looking elsewhere for security guarantees – guarantees that would invariably be purchased with a realignment of oil sales to suit the new benefactors.

“…We’re Advancing in a New Direction”

With such vulnerability in our supplies, America’s quest for new oil is vital. The single most important conflict of this war will be replacing declining reserves. But for war profiteers – or investors – profiting big starts with betting on the right army.

The unexpected victors of one early American military conflict come to mind as an example of the right type of regiment to back. Remember that famous 1775 battle of Lexington and Concord, the “shot heard round the world” that kicked off the Revolution and culminated in our freedom to pursue our way of life? It wasn’t the British Redcoats, trained to fight the old-fashioned way, lined up and advancing in unison, who won that one. They ended up scrambling for cover, tripping over their coattails as they hightailed it all the way back to Boston Harbor.

It was the Minutemen, the rebellious, nimble scrabblers, who knew the terrain, left business-as-usual behind and, sniper-like, came out on top. So it will be in the search for new oil today.

This time, the major oil companies are wearing the red furry helmets and buttoned up uniforms and are ending up the casualties of war. That’s because the old world army, including players like ExxonMobil, Royal Dutch Shell, BP, Chevron, ConocoPhillips, must cost effectively replace their flagging oil reserves and maintain production or face a quick retreat…in their share prices.

And these days, finding large new pools of oil that can be cost-effectively developed is no easy task. Plus, they’re facing stiff competition from China, Russia and others who are cashed up with plenty of fresh ammo – namely trillions of U.S. dollars thanks to the historic trade deficits of the last decade or so.

These new, nationally-sponsored competitors, who aren’t constrained by prohibitions against handing over suitcases of cash to win concessions, are quickly signing long-term off-take agreements where price is hardly discussed in the negotiations. In the war for new oil, the business-as-usual army has little chance of advancing in the right direction.

So, if not “big oil”, where should an energy investor look to deploy their capital? We’ll place our bets on the Minutemen, or the small, more agile oil explorers targeting under-explored areas in the U.S., Canada, and more remote areas of the globe. Rather than being caught up in layers of bureaucracy, and hindered by the negative associations of big oil, these smaller companies can act swiftly and have grass-roots connections with local politicians to help push their projects forward. Plus, they can operate in areas that are less populated by environmental protest groups that can challenge progress.

Most importantly, when a small company makes a large discovery it can have a huge impact on its share price…where even a large discovery, by today’s standards, will barely move the dial on a multinational giant.

Investing in one of these companies early is one of the best ways to not only insulate yourself against the personal inconvenience of steadily increasing energy prices, but also to make you one of the few real winners in the war now being waged.

Source: The War for Oil Reserves