Investors face a turbulent new era in which oil prices will soar and the economy will face a severe energy crisis according to Stephen Leeb, investment advisor and author of a new book entitled “The Oil Factor: How Oil Controls the Economy and Your Financial Future.”

Oil is key to every facet of the economy and has been overlooked in importance over the last several decades. While oil prices fluctuated around the $20 a barrel level in the 1990’s the energy markets are about to get much more exciting according to Leeb – and volatile.

In his book Leeb claims it is essential that investors grasp the following realities:

* For the last thirty years the price of crude oil is the single most important determinant of the market and the economy. Sharp rises in oil prices have been deadly for the stock market and for the economy. Level or declining oil prices have correlated with an expanding economy and rising stock market.
* The U.S. has more or less ceded control over oil prices to third parties over the last thirty years – mainly OPEC countries – that act as swing producers and influence global energy prices.
* Crude oil production in the U.S. began to decline in the early 1970’s, and many of the larger fields worldwide are mature and peaking or themselves in decline. Because of the importance of energy to the economy, we now exercise little control over our economic fate – and by extension the stock market.
* This situation is about to shift from bad to worse as for all practical purposes crude oil supplies are peaking. Demand for crude oil continues to expand in both the U.S. and in developing countries such as China.
* The fate of the U.S. economy hangs in the balance – at the mercy of a few nations with excess crude oil productive capacity – countries that may not share the same interests or goals as the U.S.

Leeb points out that oil supplies around 40% of U.S. energy demand. While the economy uses energy much more efficiently than it did several decades ago, the bottom line is that economic growth requires the use of more energy to produce that growth.

With additional demands on the crude oil markets from strongly growing economies (like China’s) demand for oil continues to increase year after year. A growing world economy will demand that more energy be consumed.

Coupled with the fact that many oil fields are mature and are nearing their peak production rates – worldwide crude oil supply is expected to plateau then begin to decline. Plenty of oil is left in the ground, but extracting it will prove to be more difficult as reserves are depleted and the easy, most accessible oil, has been produced.

* Crude Oil Allocated by Price

As supply is constrained and demand continues to grow the resource will be allocated by price – or by force – according to Leeb. Whether we experience inflation or deflation will depend on how fast oil prices rise.

A quick rise in oil prices will cause deflation – it will stall the economy and the massive debt levels will create a deflationary environment. If oil prices rise steadily, Leeb sees inflation as the main issue investors must face.

Looking at historical data Leeb claims that when oil prices increase greater than 80% in the previous 12 months investors would do best by selling their equities and shifting their assets to deflation hedges such as bonds, or into cash.

When oil prices increase less than 20% he advises to invest in the equity markets in inflationary plays such as gold, defense or real estate stocks, and in energy firms.

Natural gas will be “among the best investments you can make in energy patch” – while coal, nuclear, solar, wind, and conservation will have relatively limited impact as a solution to the energy problems.

And in an inflationary environment small cap stocks will outperform the larger companies such as those in the S&P 500 index, Leeb claims, as they have historically

* Good Analysis of the Impact of Oil Prices

Leeb does an excellent job of focusing on how higher energy prices could impact the economy and on the investment implications. In previous books he has been very astute at identifying long term trends that could impact the investor, and it appears to have repeated that theme in his latest book.

If he his correct, higher energy prices will have a significant impact on our lifestyle, our economy, and our investments. The book is well worth the price.

Joseph Dancy, President, LSGI Advisors, Inc.