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When oil was at $65 a barrel, almost no one believed it would double. There were a few nuts making the case, but they were ignored like Galileo was when he said the Earth moved around the sun.
Now, it is hard to find analysts who do not believe oil is going to move over $140 a barrel, and, perhaps above $200. Their reasoning is sound enough. Demand in emerging nations like China and India is still increasing. While crude use in the U.S. may be off slightly, it's not off enough to matter. Supplies may be drying up as fields in the Middle East, Mexico, and Russia age. A political catastrophe in Nigeria or Venezuela could cut production.
Against all that, a case for a sharp drop in oil prices is quietly forming and its logic is powerful but poorly understood.
The first argument that oil is too high is that it has been pushed up in part by speculators rushing to cover bets that crude will fall. It is a bit like a "short squeeze" in stocks. Once the "covering" is done, oil prices will face less pressure on the upside.
Perhaps the strongest rationale for a drop in crude is that supply is more abundant than it seems. Petróleo Brasileiro has found what is probably the largest deposit of crude uncovered in the past 40 years. According to The Wall Street Journal (subscription requited), the field could "contain about 33 billion barrels of oil." In the U.S. there are debates about letting oil companies drill on previously protected land and offshore locations. In addition, technology advances are helping get more oil out of aged deposits.
In Asia, particularly China, the governments are not willing to subsidize gas and diesel prices, at least to the extent they have in years past. State-owned companies would buy crude at high prices and then sell the by-products dirt cheap to keep cars and trucks on the road. It was a way to fuel economic expansion, but the practice is becoming too expensive as crude sits above $130. If fuel prices in China and India move up as the central governments back off, demand will drop, perhaps by a lot.
The reasoning about tapping biofuels and solar energy, and increased use of nuclear and coal, to cut oil demand has been around for nearly a decade. When oil was at $50, no one thought that these businesses could do well. Either the technology was too new or citizens would not accept reactors filled with uranium sitting just a few miles away. But, the sight of the gallows focuses the mind. Paying $100 to fill-up a car with gas has started to become a real hardship.
The sun moved around the Earth until it didn't. Oil will go up until it doesn't.
Douglas A. McIntyre is an editor at 247wallst.com.
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Reader Comments (Page 2 of 2)
6-02-2008 @ 1:26AM
Ronsonit said...
Doe reports Domestic oil production steadily decreasing 9m barrels a day in 1985 (US Oil went bust) to 5m today. Refined Product has been flatline since 1991 and is still running @ 80% capacity. How can my business continue to output the same amount of product despite my closing many of the processing facilities too? I've heard that we haven't built any refineries in 30 years and a couple blew up and another big one recently closed. Yet, our refineries are still only running @ 80% capacity yet processing the same total volume as though they were all operating. That's really cool how they can accomplish this without building a tanker or buying the fuel to run a super tanker half way across the planet to bring us "World Market" fuel. How much is the delivery fee to bring a barrel of crude from Saudi or Russia compared to pumping it out of the ground here? Oh, Lastly... How many BTUH in 1 Barrel of "Light Crude" vs 1 Barrel of that nasty, hard to process imported "Heavy" Crude?
6-02-2008 @ 2:23PM
John said...
They've closed a large number of refineries in the last 30 years. They were inefficient.
The medias tired refrain that no new refinery has been built is really incorrect. What they have been consistently doing is rebuilding inside of existing refineries. It was a very smart play. A new refinery gets all sorts of opposition. An existing refinery that is modernized to double its production, gets none.