Oil Shortages Within 5 Years

The Financial Times wrote: “Fears of a shortage within five years propelled long-term oil futures prices well above $130 yesterday, further stoking inflationary pressures in the global economy. Investors rushed to buy oil futures contracts as far forward as December 2016, pushing prices as high as $139.50 per barrel, up $9 on the day.”

Wow. The price rises $9 in just one day? People are rushing to trade out eight years. I had to e-mail Kevin Kerr to find out if that really happens in trader land (yes). Oil traders are saying that they have never seen such a jump.

Apparently, investors are betting that oil production will soon peak due to geopolitical and geological constraints. According to Robert Hirsch, who wrote a major energy study for the U.S. Department of Energy in 2005, we are more likely to see a several-year-long plateau than an actual “peak.” Still, the Peak Oil viewpoint is establishing a beachhead in the futures markets and supporting high prices. Greed and fear are just plain hitting the fan on this one.

Veteran oilman T. Boone Pickens has been beating the drum on this topic for quite a while. In Houston last October, Mr. Pickens told me, “All the world can produce is 85 million barrels of oil per day. But the world demand is nearer 87 million. Something has to give. It’s the price.” And Mr. Pickens has repeated that comment many times since then.

Apparently, the markets are listening to Mr. Pickens. On a large scale, investors are shifting their energy focus from the short to the medium term. Beyond the medium term, fears for future oil supply dominate the thinking. Since January 2008, long-term futures oil contracts, such as those for delivery in 2016, have jumped almost 60%. Near-term prices have gone up 35%.

I just hope that you have been following the Outstanding Investments energy recommendations over the past year or so. My goal has always been to align the portfolio with the energy-scarce future. I want you to benefit from these macro trends.

The View From Chevron

I had the recent opportunity to interview Peter Robertson, vice chairman of the giant oil company Chevron Corp. The American Petroleum Institute arranged the call. Mr. Robertson was in Washington, D.C., to testify before the U.S. Congress on — you guessed it — energy issues. Mr. Robertson made some time available to talk about the oil business with your humble editor.

Mr. Robertson focused on the oil markets from the perspective of what he knows best. That is, what does he see every day as he runs Chevron? “The U.S. market is well supplied” with oil and refined products, he said. In fact, “gasoline demand is down” in the U.S. That is, Chevron has seen a 1.5% decrease in gasoline demand. (Exxon has reported as much as 4% demand drop in some parts of the country.)

“What is causing angst is crude prices,” Mr. Robertson added. But Chevron has no control over the world price of oil. Chevron just accepts whatever price the world marketplace sets. With 9,800 gas stations nestled among the 160,000 total in the U.S., Chevron is hardly in a position to move the U.S. market for motor fuel one way or the other. Chevron just reacts to demand trends. Chevron does not cause them.

Chevron buys and sells about 2 million barrels of oil per day, according to Mr. Robertson. But these are “real” barrels, as opposed to trading futures. That is, Chevron either takes delivery or releases crude from inventory. So the company gets its hands dirty in the old-fashioned oil business. It does not speculate in the futures markets.

According to Mr. Robertson, in the first quarter of 2008, Chevron “made no money in the downstream business,” referring to the refining and marketing of refined products. He characterized it this way: “Downstream operations are not taking money out of the market. It’s all the cost of crude oil and taxes.”

This made me wonder how much higher fuel prices would be if refining DID take money out of the market. From what I know, gasoline at $3.75 per gallon reflects oil at $110-115 per barrel. At $140? The price of gasoline has more to go on the upside. Time to stop driving that SUV down to the strip mall to buy a box of Kleenex, right?

As an aside to Mr. Robertson’s comment on taxes, let me note that one recent study reviewed the total taxes paid by the top 27 energy-producing companies in the U.S. In 2006, the 27 largest energy companies paid more than $81 billion in income taxes, resulting in a 37% overall effective tax rate. That figure is higher than the top U.S. corporate tax rate of 35%.

Mr. Robertson notes that over the past six years, Chevron has earned about $72 billion total in after-tax profits. And it has invested over $73 billion in new energy and energy-related projects. So Chevron is investing more into its future asset base than it earns.

Interestingly, Chevron is the largest private producer of geothermal power in the world. Chevron sees a solid investment climate and return for geothermal in the U.S. This is of interest to me because I have five much smaller geothermal companies listed in my Energy & Scarcity Investor publication. All five aspire to be the Chevrons of the geothermal future. I won’t list the five names here, but I have recommended geothermal player Ormat (ORA: NYSE) for Outstanding Investments.

Mr. Robertson discussed Chevron’s efforts to assure future supplies of oil and natural gas. In the Gulf of Mexico alone, Chevron is the lead player or interest-holding partner to 40 different projects. Each project represents a commitment in excess of $1 billion by Chevron. The major constraint for Chevron to invest more hinges on its ability to obtain skilled personnel and to find vendors that can supply equipment and services.

According to Mr. Robertson, “Our personnel constraints are not just within Chevron, but with our contractors. The contracting community shrank in the days of cheap oil. Now the contractor community needs to grow.”

Of interest, about two-thirds of the total Chevron investment of $73 billion over the past six years has been outside the U.S. This is because of the level of restrictions on investing in energy projects domestically. Chevron would like to invest more in the U.S., but the national (and some state) investment policies discourage it.

For example, Chevron has struggled for several years just to obtain permits to upgrade its refinery at Richmond, Calif. Chevron is still waiting for approvals, but meanwhile, it’s operating one of the oldest refineries on the West Coast.

During this same time, India’s Reliance Industries Ltd. has constructed a new, state-of-the-art 600,000 barrel per day refinery in India. That refinery exports product to the U.S. West Coast market. So instead of having a more efficient Chevron refinery near San Francisco, drivers in California are buying fuel imported from India.

Goldman Sachs raised its forecast yesterday for the average price of West Texas Intermediate crude in the second half of 2008 to $141 a barrel from $107 a barrel. Long-term oil prices will need to continue to rise to bring trend oil demand growth in line with trend supply growth, which stands at around 1% a year, Goldman said.

“We believe that the market is not defying fundamentals but rather experiencing a structural repricing much like it did in 2004, searching for a new equilibrium against an uncertain long-term supply environment,” Goldman wrote.

Source: Oil Blasts to Nearly $128 Before Easing

But from a technical analysis point of view, there is no longer any overhead resistance – nothing to stand in the way – and the price can go anywhere. But where?

We saw exactly the same thing with uranium last year, we saw it with wheat, corn and soybeans this year; we saw it with copper, lead, zinc and nickel, we’ve just seen it with rice; we saw it with UK housing; we saw it to an extent with gold, though that one didn’t run wild; we’re seeing it with coal and iron ore; and we’re starting to see it with food.

In these inflationary times, it’s going to be a recurring vision, so better get used to it. But just how far is the oil price going to go?

Why this won’t be the highest point for oil in the long term

Oil is now well and truly at unheard-of levels, even adjusting for inflation. However, to those bears who are calling the top, I’m not saying that looking for a short-term shorting opportunity is unwise. But you shouldn’t expect this to be the highest point that oil hits in the longer term.

The price may decrease, but Peak Oil is yet to strike

As soon as people say, ‘it’s different this time’, you can be sure the top will be in within a few weeks. But, when Peak Oil – the point at which we are getting as much oil out of the ground as we ever will – strikes, it really will be different this time. Is Peak Oil kicking in now? I would say fears of Peak Oil have certainly been pushing the price up for some five years or more.