But they were wrong. The Datastream Internet Index reached its peak on January 3, 2000, and then collapsed, falling 93.8% over the next 34 months.

In 2005, investors thought the real estate market was “different.” Homeowners were buying houses more expensive than they could afford because they thought inflation would protect them. While home prices could stagnate, they wouldn’t go down.

But, as you know, they were wrong. Beginning July 2006, real estate has fallen 16.2%.

Investors will come up with any excuse to continue pumping money into a sector that’s produced amazing returns for them in the past. And when the money starts piling in, it’s time for you to get out.

Today, the sector is oil. In inflation-adjusted terms, the price of oil is up 140% in the last 18 months. At first glance, the logic seems plausible…

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Global demand for oil is surging. Most of this increase comes from emerging economies like China and India. And global oil supply is on the decline. A large cause is poor reserve management by nationalized oil companies.

Venezuela’s oil production, for example, decreased by at least 1 million barrels per day (bpd) since President Hugo Chavez nationalized the country’s oil fields between mid-2006 and 2007. And Iran’s leaders can’t attract private capital and technology, so production is down 3 million bpd to half of what it used to be under the Shah.

Russia and Nigeria are in the same boat… The problem is, high oil prices make governments greedy. They take over oil fields and mismanage them, decreasing supply growth… and leading to even higher oil prices.

This imbalance has catapulted the price of oil to stratospheric levels. Even when adjusted for inflation, the price of crude oil is now far above its 1980 peak.

In the long run, simple economics tells us the price of a barrel of oil should equal the cost of producing the most expensive barrel of oil needed to meet global demand.

According to the Energy Information Administration (EIA), the oil market has a small surplus of existing production. And according to a Dallas Federal Reserve economist, the most expensive barrel of oil needed to meet global demand is being produced at just $50. With oil currently priced at $137 a barrel, the incentive to find and produce more oil is enormous.

This process takes time… But there are already signs supply is climbing. Shale oil in the Dakotas and in the Canadian tar sands – which costs about $70 a barrel to produce in both places – is attracting enormous amounts of investment capital.

In addition, research into the process of converting coal to oil might yield a more environmentally friendly process sometime in the near future, which would overcome one of the major hurdles facing coal-to-oil production now. The supply of coal in the U.S., if you were wondering, is plentiful.

From the demand side, the EIA reports consumption in 30 developed countries has fallen 460,000 bpd since last year. Most of that decline comes from plummeting U.S. demand.

This commodity rally – and the oil boom in particular – is not any different than previous booms. The market will find a new equilibrium, and the price of oil will undergo a nasty correction.

Good investing,

Ian

P.S. As my colleague Matt Badiali explained in a recent DailyWealth essay, don’t confuse brains with a bull market. If you own oil and gas stocks, now’s the time to keep an eye on your stops. On the other hand, the market has mauled refiners. But I think right now, refining stocks are perfectly positioned for the coming oil rout.

Source:  Why Oil May Be Headed for $50

Indonesia no longer has the ”E” to stay in OPEC (Organization of Petroleum Exporting Countries). It had been a net importer of oil since 2004.

Casey Research’s Energy Division attended the recent oil and gas show in Jakarta, and it’s plain to see where the new oil demand is coming from. Greater Jakarta, Indonesia’s capital, hosts 23 million people, and while ten years ago the majority of them rode bicycles, now nearly everyone has a new 2-stroke Honda motorbike. Those who were riding motorbikes are now driving cars. (And those who were driving cars have moved to Australia to escape the smog.) In this light, it’s not surprising that Indonesia’s oil consumption has more than doubled since 1990.

As to their slumping oil production, it is no doubt partially due to a lack of reinvestment. Foreign oil companies are tired of paying 85% of their revenue into government coffers, and are looking to areas of the world where the fiscal regime is not as severe.

The main problem, however, is an extremely common one. Indonesia has exploited its fattest hydrocarbon targets, and the remaining exploration sites cannot make up for the decline from its existing oil fields. There’s certainly plenty of oil left to be found in Indonesia’s archipelago, but it’s equally certain that they’ll never regain their peak production rates of 1.6 million barrels per day.

Source: Indonesia Says ‘Goodbye OPEC, Hello Peak Oil’

Brazilian billionaire Eike Batista is planning a 5.59 billion real ($3.37 billion) initial public offering of OGX Petroleo e Gas Participacoes SA, betting the country’s recent oil finds will lure investors who snubbed 20 IPOs this year.

“The market is definitely not the best right now, but for the oil sector that doesn’t really matter,” said Daniel Gorayeb, chief investment analyst at Spinelli SA, a Sao Paulo- based brokerage. “Brazil is a very attractive investment from a macro point of view, and the outlook for oil exploration in particular makes this IPO even more interesting.”

“Brazil’s Carioca field is a reserve with tremendous potential,” says Jason Simpkins in Money Morning, “as it may hold 33 billion barrels of oil and natural gas. Unfortunately, the field is 170 miles offshore, more than 6,000 feet under the surface of the water, and trapped beneath a shelf of salt 500 miles long and 125 miles wide.

“Technologically challenging, physically intensive and costly projects like these are the future of the oil industry.”

Read on here to for a trio of petro-profit plays.

“Australia, Brazil, and Canada are the ultimate destinations for resource investors,” says Brian Hunt in Daily Wealth.

“Each is blessed with awesome energy, metals, and agricultural wealth… and each ABC currency is soaring right now.”

“We’re seeing the bout of profit-taking that everyone has been waiting on,” said Neal Ryan, manager at Ryan Oil & Gas Partners, after crude concluded a 4-day run that had taken it up by 7%.

“Just looking at the volatile price action today, it’s pretty evident that the market is being driven up and down by the traders waiting on some news to hit the tape,” Ryan added.

Meanwhile, the International Energy Agency is getting ready to issue a sharp downward revision of its oil-supply forecast, according to a Wall Street Journal report. The IEA is assessing the condition of the world’s top 400 oil fields, and will reportedly say in November that future crude supplies could be far tighter than previously thought.

And, in one of the more bonehead political moves of late, the House of Representatives approved legislation, by a veto-proof majority, allowing the Justice Department to sue OPEC members for limiting oil supplies and working together to set crude prices. The bill would attempt to subject OPEC oil producers, including Saudi Arabia, Iran and Venezuela, to the same antitrust laws that U.S. companies must follow.

Getting it right for once, the White House opposes the measure, saying that targeting OPEC investment in the United States as a source for damage awards “would likely spur retaliatory action against American interests in those countries and lead to a reduction in oil available to U.S. refiners.” $200 oil anyone?

Source: Crude Finally Pulls Back

The Bakken Shale is a rock formation in the Williston Basin, a 202,000-square-mile depression that stretches along the eastern edge of the Rocky Mountains from southern Canada through North Dakota and Montana. Oil-hunting geologists targeted the U.S. portion as far back as the 1950s.

By the 1960s, oil companies had discovered more than 375 million barrels of reserves in North Dakota and eastern Montana. In the early 1980s, Montana’s oil production peaked at 32 million barrels in 1982 and North Dakota at 50 million barrels in 1983.

Then oil plunged from $35 a barrel down to $10. It became too expensive to produce Bakken oil, and the companies shut down operations… until recently.

In 2004, Oil and Gas Investor ran a story called “The Bakken Is Back.” Rising oil prices and tremendous advances in drilling technology suddenly made the Williston Basin a great place to be again.

Wood Mackenzie, the oil and gas industry analysts, estimate Bakken holds 200 billion barrels of oil. That sounds like a lot of oil, doesn’t it? The problem is that it doesn’t tell you one vital piece of information: How much of that oil is recoverable?

In the best oil fields, recoveries are under 30%. However, Bakken isn’t an ideal field. According to a North Dakota Department of Mineral Resources study (which echoes federal findings), Bakken will probably see 1% recovery. So right now, with 200 billion barrels in the ground, we can expect to get 2 billion out.

That’s about six months worth of U.S. imports and not nearly enough to affect the price of oil.

Of course, with oil at $120 per barrel, somebody will figure out how to squeeze more oil out of Bakken. It may cost more, but as long as there is money to be made, somebody will work it out.

Q: I just read Russia is spending $45 billion on finding new oil and gas… How does this compare to other countries? – B.F.

A: Some of the biggest recent news in energy infrastructure has come from Russia’s state-run oil giant, Gazprom.

Gazprom plans to triple its annual exploration and production budget for natural gas to $45 billion by 2010. This is an enormous amount of spending… even more than Brazil’s Petrobras, which plans to spend $118 billion over the next five years (that works out to about $26 billion per year).

And both companies have giant projects to finance. Gazprom needs about $75 billion to develop two giant Arctic fields, including one that holds enough gas to supply the entire world for a year. And Petrobras will spend an estimated $50 billion to $100 billion to develop Tupi – the second-largest discovery in 20 years.

These mind-boggling spending plans are further evidence that the costs of finding and exploiting giant oil and gas fields are soaring. Most of the large fields being discovered are in technically challenging places. It’s not anything like Saudi Arabia’s legacy fields, where you can stick a straw in the ground and up comes crude oil. This spending is incredibly bullish for oil services… and it’s another reason I’m buying Canada.

Gazprom has to drill in the unforgiving Arctic, and Petrobras is trying to tap oil under miles of water. Canada’s oil sands, on the other hand, are right there on the plains of Alberta and Saskatchewan. We already know where it is, how to drill it, and how much it’s going to cost – comparatively little when you look at Tupi and other difficult fields.

And while oil prices are high, oil-sand drillers are making a fortune. Most of Alberta’s main players already have this priced into their stocks. But I’ve found a few fantastic companies next door – in Saskatchewan – that have so far gone undiscovered. Click here to read more details. Good investing,

Matt

Editor’s note: Each Wednesday, Matt Badiali, our frequent contributor and natural resource expert, will answer your most pressing questions regarding commodity investing.

Source: The Commodity Investor Q&A

According to Bloomberg:

Saudi Arabia’s influence as the biggest oil exporter would wane if the fields are as big as advertised, and China and India would become dominant buyers of Persian Gulf oil, said Peter Zeihan, vice president of analysis at Strategic Forecasting in Austin, Texas.

“The only certainty that comes with the discovery is that the oil, no matter how much there is, will be very hard to reach,” says Jason Simpkins in Money Morning. The field is 170 miles offshore, more than 6,000 feet under the surface of the water trapped beneath a shelf of salt 500 miles long and 125 miles wide.

“A decade ago, gaining access to such a field would have been a pipe dream (no pun intended). Just like Khurais, extraction will be a very costly process, even with today’s technology.

“Petrobas will have to ante up quite a bit of cash to expand its use of drilling rigs, which are in short supply. Right now, there are only 40 rigs on the planet capable of drilling into massive deep-sea salt deposits.”

According to the most recent figures from the U.S. DOE, in January 2008, U.S. crude oil output was just over 5 million barrels per day, plus additional natural gas liquids. The balance of oil consumption comes from imports. (Also, the U.S. supply of transportation fuel is supplemented about 3-4% with ethanol that comes from distilling about half the U.S. corn crop. That is why your grocery bill is skyrocketing.)

But domestic volumes of oil output are depleting and declining inexorably. From the North Slope of Alaska to the deep water of the Gulf of Mexico, U.S. output is just plain falling. There is very little good news, and even the good news is oft-times not so good.

New discoveries and new wells just cannot keep up with depletion of older oil fields. By 2025, U.S. daily oil output will be a fraction of its current level (probably down to about 2-3 million barrels per day), even with an aggressive program of drilling offshore and in Alaska — which is not happening, in any case.

Also by 2025, U.S. imports will almost certainly decline. The oil will not be available to buy and import from world markets. Not everyone agrees with this. In one fanciful projection from 2005, the U.S. DOE forecast that “Total U.S. gross petroleum imports are projected to increase in the reference case from 12.3 million barrels per day in 2003 to 20.2 million in 2025.” Maybe in somebody’s dreams, but my view is that this is one projection that will never come true.

Really, by 2025, the rest of the oil-producing world will simply lack the product to export. This will be due to reasons of depletion on a global scale, and fast-growing internal demand in oil-producing nations. Gasoline consumption in places as diverse as Russia, Iran, Venezuela and Saudi Arabia is just soaring, so there is less net oil available for export.

And oil output everywhere is flat or declining. (Just last month, Russia announced a plateau in oil output.) And closer to home, Mexico’s Cantarell field is simply crashing at an annual depletion rate of 8% or more.

So what will happen in 2025? Will the U.S. pump its own oil? No, it’s not there. Will the U.S. continue to import large volumes? No, it won’t be available. The bottom line is that conventional oil sources for the U.S. — domestic output and imports — are simply drying up.

Until next time,

Byron King

Note: Byron King is a frequent contributor to the free e-letter Whiskey & Gunpowder. To receive daily insights into energy, oil, commodities and other natural resources sign up here!