Another View on Oil
Nigeria, Norway, Russia, Venezuela, Saudi Arabia, Iraq -- investors need an atlas and a shortwave radio to keep track of all the potential trouble spots for oil supplies right now.
On Tuesday, the president of OPEC said there was no more readily available supply to be put on the market, driving prices up, only to be contradicted by an unnamed Saudi official who told Dow Jones that the kingdom could add 1 million barrels a day. Prices fell, but then rose again on news that the Russian government was expanding its tax probe of OAS Yukos, the country's largest oil producer.
The risks and confusion have put unrelenting upward pressure on black gold. Futures prices closed above $44 a barrel on Tuesday for the first time in the 21-year history of the New York Mercantile Exchange's widely followed crude contract. It was the third record close in the past week and marked a 40% gain over the past year.
There was no relief Wednesday. Nymex crude rose 13 cents to $44.28, another record.
Crude's rise is killing stocks, especially those trading on the Nasdaq Composite, which has traded inversely to oil for much of 2004. On Tuesday, the Comp slumped 1.7% while the Dow Jones Industrial Average and S&P 500 each shed about 0.6%.
But I'll stake out the minority position and argue that oil is overbought. Once some of the noise settles down, expect prices to retreat (presumably to the benefit of equities). Futures due in the months beyond the current contract are already signaling that the market expects lower prices ahead. Yesterday October crude ended at $43.66 and November at $43.14. The six-year future -- Federal Reserve Chairman Alan Greenspan's favorite measure, according to a speech he gave in April -- closed at less than $35. And speculative players in oil futures and options have been increasing their net long positions over the past month after paring them in June -- a contrarian indicator supporting a pullback.
"If you look at the supply and demand fundamentals, oil prices are going to come back to more of a normalized level," said Brian Hicks, co-manager of U.S. Global Investors' Global Resources fund, the top performer in its class over the past three years.
The fund is looking at service and drilling companies, which should benefit as oil producers look for more supply. A handful of producers including Burlington Resources (BR:NYSE) and Pioneer Natural Resources (PXD:NYSE) have already said they'll be increasing spending on capital projects. (The fund was long both as of Dec. 31.)
"We're not looking for $20 a barrel again," Hicks added. "It's funny to talk about prices coming down to the mid- $30s. That would have seemed extremely high a year ago."
Oil in the Extreme
As discussed here last week, the Russian government has no interest in shutting down Yukos or curbing its oil flow. Russian President Vladimir Putin is using the situation to send a message to country's super-rich, like jailed Yukos founder Mikhail Khodorkovsky, not to meddle in politics.
Meanwhile, OPEC President Purnomo Yusgiantoro, also Indonesia's energy minister, might want to get a hotline to Saudi oil headquarters. "Saudi Arabia can immediately with no notice go all the way" to 10.5 million barrels a day, a 1 million barrel increase, the unnamed senior Saudi source told Dow Jones.
Just last week, Purnomo himself was reassuring reporters that OPEC could increase its production. On Tuesday he called current prices "crazy."
Once past the plethora of global hot spots, oil demand is expected to decline substantially next year, according to the International Energy Agency. This year, demand is forecast to increase by 2.5 million barrels a day, or more than 3%, vs. an expected increase of 1.8 million barrels a day in 2005, or closer to 2% annual growth.
Looking out even farther, the debate over crude supply and demand is seesawing between two extremes.
Cal Tech professor David Goodstein's slender book Out of Gas, published in February, argues that a disastrous spike in oil prices will come not when global supplies start to dwindle in 40 or 50 years, but much sooner -- in about 10 years. The disaster scenario will play out when production stops increasing and can't keep pace with the rate of demand increase, he says.
The turning point is known as "Hubbert's peak," named after the Shell Oil geophysicist King Hubbert who in 1956 forecast correctly that U.S. production excluding Alaska would peak around 1970. Goodstein says the worldwide peak for production could be reached in 10 years or less resulting in severe inflation and economic ruin. (My colleague Jon Markman recently penned a column on this issue, also known as "peak oil.")
At the opposite end of the spectrum are followers of Thomas Gold, the late Cornell astrophysicist. Gold maintained that oil is created under the earth's crust without need for dead plant and animal material. Under his "abiotic" theory, also embraced by some Russian scientists, oil supplies can never be exhausted.
The "peak vs. abiotic" debate ought to give investors plenty to mull over as they step back from this week's volatility, which crude itself is likely to do.
A reader comments:
Abiotic Oil Can't Save Us
Re: Another View on Oil
To the Editor:
Interesting that you bring up the theory of abiotic oil. It is a fringe theory to which I don't personally subscribe. However, I was forced to concede long ago that I will never know everything about oil, so I will concede it is possible. Unfortunately, the method of oil creation/generation is not particularly relevant to the issue of current supply. Regardless of how oil is generated in the earth, it must migrate into a suitable trap before we can find it and extract it.
As an industry, we are already drilling in 10,000 feet of water looking for geologic structures that we believe could be trapping hydrocarbons. Exploration success rates worldwide are falling off in spite of new seismic imaging technologies, and many of the targets are getting volumetrically smaller. There would be some new structures brought into play using an abiotic sourcing mechanism, but it would not add up to a huge opportunity of new structures we could bring into our plans. Even if abiotic oil is still migrating into the old-established fields, it isn't happening fast enough to offset the 12% -- 15% annual declines most mature fields exhibit.
Don't count the industry out yet; we tend to be a creative bunch. However, don't count on abiotic oil having any impact. If the theory holds, then a goodly portion of the worldwide reserves base is already abiotic, and deliverability still seems to be peaking.
Jim Zack, Operations and HSE Manager, ChevronTexaco, Rio de Janeiro, Brazil (Received Aug. 4, 2004)
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