By William Patalon III
Money Morning/The Money Map Report
A plummeting greenback, inflationary fears fanned by the U.S. central bank and soaring global demand are combining to fuel a record advance in crude oil prices.
But the market madness of recent days is just the start. Crude oil prices will hit $187 a barrel within 36 months, translating into gasoline prices of more than $6 a gallon, and giving investors one of their biggest profit opportunities in decades, Money Morning Investment Director Keith Fitz-Gerald predicts.
That forecast runs counter to many analysts who are describing the current spike in energy prices as a speculative "bubble" fueled by fearful investors.
"Many people think high oil prices are a bubble. Maybe, but not for long and certainly not given the growth in global demand," Fitz-Gerald says. "Of course, prices will not stabilize anytime soon. Savvy investors [will realize that] we are still in the very early stages of a generational game with the potential to be played for great profits."
Skidding Greenback Behind Crude Price Spike
Investors have been pouring money into oil and other commodities amid spiraling worries about a U.S. recession, a spike in global inflation and a U.S. dollar that's in a freefall against such currencies as the euro.
The greenback hit a new record against the euro yesterday (Wednesday), falling to $1.5513 per euro, the lowest since the pan-European currency debuted in 1999. Oil prices have been in a scorching uptrend. Crude prices hit a record $110.20 a barrel on the New York Mercantile Exchange (NMX) yesterday, their 11th new high in the last 12 trading sessions.
Crude oil prices have jumped 8% so far this month, and are up 18% since the start of February and have surged 86% in the past 12 months. At this time a year ago, crude oil was trading at $58.92 a barrel.
Consumers are no doubt feeling the squeeze: Gasoline prices at the pump jumped to a new record of nearly $3.25 a gallon yesterday, as investors shrugged off positive news about inventories and demand. The U.S. Department of Energy said that stockpiles of oil and gasoline rose last week for the eighth time in nine weeks. And the Energy Department, the International Energy Agency and the Organization of the Petroleum Exporting Countries have repeatedly said that demand for oil and gas will advance at much lower rates than they'd previously projected.
Even so, gasoline is now expected to continue its march, and prices at the pump could reach $3.75 a gallon by spring.
Money Morning's Fitz-Gerald, a longtime energy bull, says that investors and consumers can expect more of the same. More than five years ago, when crude oil was trading at a price below $20 a barrel, the former longtime professional trader publicly predicted that crude prices would reach the century mark – $100 a barrel – within a decade.
Now that it's eclipsed that psychologically important price point, a number of experts have been predicting oil prices will move even higher.
In a March 6 report, Goldman Sachs Group Inc. (GS) boosted its oil-price target for 2009 to $105 a barrel, up 17% from its earlier target price of $90. According to Goldman, non-OPEC production is ready to plateau while growing consumption in China and other parts of emerging Asia is stoking global demand and constricting supplies.
Indeed, China – the world's second-biggest consumer of crude – increased its oil imports 18% in February, and simultaneously halted exports in order to meet rising demand for oil and gasoline.
Matthew R. Simmons, chairman of the Houston-based investment bank Simmons & Co. International, told Bloomberg News that oil is headed for $120 "in the short term. I'm one of the few people who's not surprised to see crude at $107. I still think it's a bargain" at current price levels.
If oil hits these lofty levels, gasoline prices will exceed $4 a gallon at the pump, though some experts say that gas prices also will drop back before they reach that level.
However, many analysts contend that the most recent run-up in oil prices is clearly a speculative bubble. The key reasons behind that assertion:
- Oil prices have risen 8% already this month – meaning that advance has come in only eight trading days. It's a pace that isn't likely to continue. Whenever asset prices rise that sharply in that short a time period, it's symptomatic of a speculative frenzy, meaning prices are likely to retrace some of their steps as investors take profits.
- The advance has been dollar-driven, and hasn't been based on such fundamental factors as reserves, stockpiles, refining capacity, or demand. Some analysts say that these factors warrant oil prices in the neighborhood of only $70 a barrel. If the dollar's plunge stops, or if the greenback reverses course and regains ground against other key currencies, traders won't continue to view oil as such a great hedge against the dollar. They'll dump oil, as will the speculators who are piggybacking their way to profits on this trend.
The Four Keys to Higher Prices
While it's true that oil prices are likely to drop back some in the near term, Money Morning's Fitz-Gerald doesn't agree that that this is just a bubble that will eventually burst, returning oil prices to much lower levels. Nor does he agree with analysts who think that crude oil will rise a bit more and then settle in at that new, slightly higher price point.
In the long run, at least, he believes oil and gasoline prices are headed higher – much higher.
Using the same predictive software that's allowed him to make other key market calls, Fitz-Gerald says that his analysis says crude oil will drop back from its record levels. Sometime in the next 36 months – sooner if a sudden event somewhere in the world either somehow crimps global oil supplies, sparks panic buying, or both – oil will advance from those lower levels until it hits the predicted price point of $187 a barrel.
But Money Morning's Fitz-Gerald sees oil-and-gasoline prices going higher – much higher. And he's very clear about just why that's going to happen:
- Obfuscation by OPEC: Members of the Organization of the Petroleum Exporting Countries have been misrepresenting their reserve capabilities for years. The key players have reported no new discoveries for decades.
- Terrorism Threats: The odds that a terrorist act will interrupt oil supplies – in the near term or the long term – are higher than most security experts would ever publicly confirm, Fitz-Gerald says. And this is especially problematic because of the double-whammy effect: Damage to a major pipeline or a strategic refinery could crimp supplies just as demand is continuing to escalate.
- The Dollar Doldrums: Oil is priced in dollars. And the dollar is in the dumper. Indeed, rising inflation and falling interest rates have put the greenback into a steep downward spiral. And if prices keep rising, and if Federal Reserve policymakers keep cutting short-term interest rates, the dollar will continue to lose altitude against other key global currencies. OPEC members will counter the greenback decline by marking up the price of crude, causing prices to increase still more in dollar-denominated terms.
- Cruising Goes Global: As an increasing number of households in China, India and other advancing overseas economies join the world's middle class, they'll start making such basic purchases as electronic goods, houses – and automobiles. The fact that China's oil imports jumped 18% in one month is evidence enough that this is happening. And the fact that leading India automaker Tata Motors Ltd (TTM) has unveiled a $2,500 car, the Nano, underscores that international carmakers are looking to recruit a whole new group of motorists. The fallout: For U.S. refiners, oil will first get lots more expensive, and then supplies will start to dry up as countries opt to halt exports and keep the precious black gold for themselves.
The Global Gusher Game
Oil prices have made a major move in the past five years – just as the emergence of China, Russia and several other key economies transformed crude-oil pricing into much more of a global game. High prices have sent cash pouring into the coffers of oil-producers in Asia and the Middle East. Many countries have used that capital to finance global investment initiatives, creating government-controlled "sovereign wealth funds" to do their bidding.
Little wonder crude oil has become a strategic asset – as well as an energy source.
"As oil and other fuels become a more and more precious resource, OPEC countries, China, Russia and others will begin holding back oil, instead of putting it into the market," Fitz-Gerald says. "That's going to be devastating in the short-run."
If it creates captive supplies of crude, China has demonstrated that it's more than willing to endure controversy and cut deals with countries U.S. refiners either can't or won't deal with. China Petroleum & Chemical Corp. (SNP), and PetroChina Company Ltd. (PTR) – two of China's biggest oil companies – have invested in such political hot spots as Africa and Iran.
The Chinese government, desperate to lock down supplies of such crucial natural resources as metal ores and crude oil, has sealed deals with Sudan, Chad and the Congo. African Business reports that trade between Africa and China has advanced at a rate of 40% a year since 2001. In 2006, bilateral trade between the two was $50 billion.
Already, 14% of China's oil imports come from Angola. About 60% of Sudan's oil goes to China.
Clearly, supplies of crude oil are going to get tighter. Mix in a geopolitical surprise and crude prices could easily spike a price point up near the $200 level that has been predicted by Fitz-Gerald's proprietary analytics.
Three Petro-Profit Plays
Fitz-Gerald has developed a three-pronged energy investment strategy for investors who wish to capitalize on his forecast for crude oil prices:
Go Deep: As Fitz-Gerald noted, with oil prices soaring, oil companies have begun to exploit resources previously considered too expensive – or too dangerous – to tap into. When oil was trading in the range of $20 to $30 a barrel – creating meager profit opportunities for so-called "Big Oil" – companies refused to finance any project that couldn't generate crude for a cost of $10-$15 a barrel. Needless to say, rising oil prices have changed that corporate outlook. At $100 a barrel, companies are looking at an array of exploration opportunities.
In total, producers will spend a record $369 billion on energy projects this year, 11% more than in 2007, said a Dec. 7 report from Lehman Brothers Holdings Inc. (LEH).
Fitz-Gerald favors StatoilHydro ASA (STO). StatOil is an integrated oil and gas company that focuses on the exploration, development and production of oil and natural gas from the Norwegian Continental Shelf. It has business operations in 34 countries, proven reserves of 1.675 billion barrels and is expanding aggressively to diversify internationally.
Just last week, the company announced plans to spend as much as $2.1 billion on operations in Brazil and the Gulf of Mexico. It bought the 50% stake it didn't already own in Peregrino, a heavy oil field in Brazil, and 25% of the deep water Kaskida discovery in the Gulf of Mexico, from the Texas-based Anadarko Petroleum Corp. (APC).
Target China: According to Fitz-Gerald, every investor must have a China strategy. And that holds true for the energy sector, as well. CNOOC Ltd. (CEO) China's offshore oil and natural gas explorer, is a prime candidate to fill both those spots. At $169, the shares are closer to their 52-week high ($218.20) than they are to their 12-month trading low ($79.20), and are on the pricey side, Fitz-Gerald says. But as a long-term play on both China and on oil prices, investors with the patience to let such a strategy play out may find this a profitable pick, he said.
Goldman Sachs on Friday upgraded the shares from a "Neutral" to a "Buy," citing a profit forecast for this year and next that's much more aggressive than the consensus Wall Street estimate. Given the weak dollar, CNOOC could also be on the prowl for acquisitions, which would further boost its earnings potential.
Explore Your Alternatives: As Fitz-Gerald likes to say, "alternative energy is an alternative no longer." Just as the massive upward move in energy prices is jump-starting deepwater drilling, it is also supercharging innovation, starting with research into alternative fuels for automobiles and then moving into alternative sources of energy for the production of electricity for towns, cities and countries.
Investment opportunities abound. But this arena can be as tricky as investing in raw Internet startups – you never know which firms will thrive and which will founder. For that reason, it's sound strategy to turn to a fund manager with alternative-energy savvy. Indeed, there are a number of exchange-traded funds (ETFs) that focus on "clean" technology. Fitz-Gerald's choice: The PowerShares WilderHill Clean Energy fund (PBW).
News and Related Story Notes:
- The Associated Press:
Oil, Gas Prices Surging Amid Supply Concerns.
Oil Price Increases Since 2003.
- Bloomberg News:
Crude Oil Rises Above $108 to Record as Returns Outpace Stocks.
Learning From Tata's Nano.
- Bloomberg News:
Oil Rises to Record $109.85 as the Dollar Falls Against the Euro.
- Forbes.com: .
Oil prices close to record high 110 dollars.
Statoil in $2.1 billion Expansion.
- The Associated Press:
CNOOC shares rise after upgrade to "Buy."
About the Author
Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning. With his latest project, Private Briefing, Bill takes you "behind the scenes" of his established investment news website for a closer look at the action. Members get all the expert analysis and exclusive scoops he can't publish... and some of the most valuable picks that turn up in Bill's closed-door sessions with editors and experts.