From BigTrends.com ========
There's no doubt that oil prices have played a major role in recent market gyrations, in both good and bad ways. Throughout most of 2003, demand for oil was rising, but that demand was adequately met by a growing supply. That kept oil prices relatively low for most of the that period - well below $40 per barrel. Then when summer came the oil supply was threatened by an OPEC production cut. However, demand didn't ease, so we saw oil prices shoot past $40. Now it appears that the oil supply is stabilizing again as demand tapers, yet were still contending with record high prices at almost $50 per barrel! So what's next for oil? Here are a few ideas.
SUPPLY AND DEMAND
The bottom line is that oil prices - on a per barrel basis - are set by the degree of consumer demand and the level of oil supply. If the supply is limited (perceived or real), then a premium must be paid. Likewise, if there's weak consumer demand, the oil producers have to be willing to sell their oil for less. This model was painfully evident at the gas pumps this summer. Not only was the demand heightened by the ramped up auto travel frequently seen in the middle of the calendar year, but OPEC made good on their promise to cut their crude output. The result was gas prices in excess of $2 per gallon. If you recall (and we'll come back to this point in a minute), we were in a panic because oil had cracked the $40 price barrier as auto fuel prices went through the roof.
Did anybody notice how much gas prices increased when oil hit $50 a barrel? They didn't - they're actually about 10 cents lower than they were when oil was just over $40 per barrel. How is that? Although the supply and demand always comes back to an equilibrium, it's not perfect at all times. In this case, oil refiners may have been roped into paying higher crude prices based more on bark than bite. Granted, worldwide demand is still growing, but the pace of that growth is slowing down as well. Most likely, the momentum of the price trend at the time made it appear that oil was still going higher. Even though the supply had actually grown since then, and the intense demand was starting to taper off, the oil producers still had a little excess pricing power. The fact that the near-$50 prices the oil companies were paying was not reflected in gas prices at the pump illustrates the disparity between what the final consumer was willing to pay for auto fuel and what the oil companies were paying for crude. This is still the case as of today, but it's not an imbalance that's going to last forever.
THE SHORT TERM
Oil production had been adequate for a few weeks, but got even better this week when a handful of OPEC members bumped up their output by a combined total of 2.45 million barrels per day. Is that a lot? It's substantial. The average worldwide production per day is about 82 million barrels, so it's a 3 percent increase - enough to make a noticeable difference. Closer to home, the Energy Administration announced on Wednesday that the total supply of crude dropped by 1.7 million barrels last week. A problem? Not really. It was only a 0.6 percent dip in the total supply. Domestically, we still have 291.3 million barrels of oil on hand, which is 3.4 percent above where we were at this point last year. Auto fuel reserves didn't change at all last week. So generally speaking, the total supply isn't under any more pressure than it usually is, but the real test is in how the oil market reacts to the news. In this case, they didn't. The oil market was tame yesterday, before and after the announcements. That non-event is a likely sign that there were no surprises, and therefore, all the major players are thinking clearly and accurately. If that's the case, then we should start to see oil prices (not necessarily auto fuel prices) migrate back down to levels that better reflect the actual demand. What the "right" price is is subject to debate, but most models say that oil should be under $40.
But what about oil stocks? Interestingly, oil stock prices tend to move ahead of actual oil prices. As an example, take a look at the huge gains in the energy sector over the last few months, as these companies rallied as crude oil went from the mid-$30's to almost $50. So, don't be surprised to see crude oil prices dip shortly after any pullback from the energy stocks. As of right now the sector is at a pivot point, but it hasn't been all that impressive in the last few days. However, these stocks have led the market for months and deserve a break (and the profit-takers are likely to give it to them). That's possibly what we'll see shortly, as the summer gas demand weakens before we get into the winter heating fuel season.
THE LONG TERM
While oil prices may find their happy medium over the remainder of this year, in the bigger picture, there's still an energy crunch, and it's an issue that goes beyond the day-to-day price of oil. The global economy is still expanding, and that requires energy sources to fuel (no pun intended) that growth. But what happens when the supply shortage is not just perceived, but real? As of right now, China is the second biggest consumer of oil, using 6 million barrels per day. They import over two-thirds of that oil. With economic growth rates at better than 5 percent (estimates for Asia's GDP growth this year are coming in around 5.4 percent), the demand is not going to let up anytime soon. The United States is the biggest oil consumer, and although our growth isn't quite as strong, our GDP is still a positive one. Here's the thing....given the choice between paying higher oil prices or halting economic growth, is either country going to halt growth? Not likely. We're not going to enjoy it, but we're going to pay for it all the same. That's good news for the countries that are rich on oil, and good news for the companies that can process and sell it. In this sense, the bigger trend of heightened oil demand could last for years, provided that the global economy continues to grow.
BOTTOM LINE
The short-term oil volatility was largely rooted in geopolitical concern. Unrest in Venezuela, uncertainty about Russian oil giant Yukos, and the obvious threat to oil supply in parts of the Middle East all forced a premium on oil prices. As these short-term concerns dissipate, don't be surprised to see a similar trend on energy stocks. But once past that, we're still contending with global growth and record-breaking usage of oil. Forecasts for next year's global oil consumption are at 83.2 million barrels per day. That's slightly above the current rate of daily production, and some basic math will point out the problem. Obviously oil is a limited resource, and although we don't expect to 'run out' in the foreseeable future, the demand truly is on track to outpace the supply. Although that's a tough financial burden, it's great for the oil companies over the long haul. |
