Money Morning Boosts Oil Target Price to $225 a Barrel, Thanks to Continued Scarcity, Burgeoning Demand in China

By William Patalon III
Executive Editor
Money Morning/The Money Map Report

Money Morning Investment Director Keith Fitz-Gerald - one of the first global financial gurus to predict triple-digit oil prices - has boosted his target price for crude oil from $187 to $225.

The case for the target-price increase of 20% was very clear.

"The math is really simple here," Fitz-Gerald said in an e-mail interview from China, where he was heading an investment-research tour. "We are burning through supplies at a rate that's four times to five times faster than we're discovering new reserves. Throw in a few [surprises] … perhaps a terrorist event …and add in the accelerating use of oil and gasoline in Third World countries, and we have the recipe for far higher prices. That's already in the oven."

Crude-oil futures jumped up over the $123 a barrel level yesterday (Wednesday) - closing at an all time record - as worries about worldwide oil supplies continued to sweep away any good news in the energy sector. In fact, prices have soared more than $11 a barrel - or 9.8 %  - over the past four days alone, reaching back to last Thursday, reported.

But it wasn't the price increases that prompted Fitz-Gerald to boost his oil-price target. In fact, he did that last week. In addition to the proprietary strategy he uses to project market prices, Fitz-Gerald said he relied on some of the observations he's been making as part of the investor trip he's leading through China.

In that country, all it takes is a stroll down the street to see that the demand for oil and gasoline is going to increase far faster than most analysts would ever believe.

"Nowhere is that more evident than China where I'm traveling now," Fitz-Gerald said last week in an e-mail from Mainland China's capital. "Beijing alone is adding 15,000 vehicles a day. Across China, the number is obviously higher. [The] same [is true] in India, but I don't have the figures at my fingertips. Then there's the other side … evidence suggests that OPEC reserve figures may be artificially high. Imagine what's going to happen when people figure out that there really isn't as much oil as everybody thinks. $225.21 is not out of the question ... after we get to $187."

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Alternative energy is the only answer, Fitz-Gerald says. But some of that is years from being commercially viable - cheap and reliable enough to be affordable to, and used by, mainstream consumers.

"Barring the introduction of a truly [alternative] and inexpensive technology, this is going to get ugly ... and very pricy before it gets better," Fitz-Gerald wrote. Investors need to be "long energy, long commodities" for right now, and for the foreseeable future.

China is doing all it can to overcome the massive energy deficits that it faces. One such project is the massive Three Gorges Dam, which Fitz-Gerald had visited the day of his interview with Money Morning.

"It's surreal how big this project really is," he noted.

Fitz-Gerald sees oil-and-gasoline prices going higher - much higher. And four factors will be the key catalysts. They are:

  • 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.

Oil Becomes a Strategic Asset

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."

Some big oil consumers such as the United States have lobbied OPEC to boost production in order to bring market prices down. But it's done no good: Members of OPEC have said over and over that market supplies are adequate and that the surging prices are not something that they can control.

China - a growing consumer of oil - has embraced a different strategy: To create 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.

To understand why you should heed Fitz-Gerald's observations, it's important to understand just how far ahead of the pack he's been - and how far ahead he remains - when it comes to predicting long-term energy trends and investment opportunities.

The Leader of the Pack

Back in early 2002, oil was trading at less than $20 a barrel. Before it began its northward march from that point, Fitz-Gerald - a longtime energy bull - conservatively predicted that oil prices would reach $100 a barrel within 10 years.

Ultimately, Fitz-Gerald's prediction came true - and then some, as crude prices smashed through the psychologically key "century mark," and kept going. But back in December, when oil prices were still trading about $90 a barrel, Fitz-Gerald reassessed the market and publicly boosted his target price to $187 a barrel, a level he said crude prices would hit within three years.
The prediction - and the timing - is important to note. The reason: The target price ran counter to the conventional wisdom of the time, since most analysts were describing the spike in energy prices as a speculative "bubble" fueled by fearful investors. At the time, most argued that prices had risen because of temporary imbalances that would work themselves out.

That wasn't the case then, and it's certainly not now.

"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 said at the time. "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."

Observations like that seemed to embolden a small group of analysts to re-assess the market. And most of them were longtime energy bulls, just like Fitz-Gerald.

For instance, in late February, Matthew R. Simmons, chairman of the Houston-based investment bank Simmons & Co. International, and another longtime oil bull, actually predicted that oil prices could climb as high as $378 a barrel - characterizing current prices in the $100 range as "preposterously cheap."

To underscore his point, Simmons told the Arabian Business news service that in the United Kingdom capital of London, gasoline can sell for as much as $9 a gallon. And even that doesn't deter motorists from driving their cars.

Prices at that level don't "seem to have slowed anyone down. It works out as much as $378 a barrel. Yes [I can see it reaching that high]," he told the Middle East news service.
Money Morning's global research team continued to track both oil prices, and the key catalysts that helped set them.

In mid-March, global supply concerns, a falling dollar and geopolitical uncertainty combined to help oil and gasoline prices to hasten their advance - and that prompted Fitz-Gerald to reiterate his $187 price-target prediction; the response was stunning: Not only was that mid-March Money Morning report picked up by other news services and reposted on Web sites all over the world, our report once again seemed to induce other analysts to finally turn bullish.

Just days after that Money Morning report appeared, there was a surprising development: Wall Street heavyweight Goldman Sachs Group Inc. (GS) followed suit and said that crude oil prices could hit $175 a barrel in the next few years as supply constraints touched off "explosive rallies" in the commodities sector.

Goldman Sachs said $175 a barrel crude "represents the price level required to maintain trend economic growth against our anemic supply growth forecasts, assuming growth in the U.S. [economy] re-accelerates early next year."

Because it was released overseas, the Goldman report seemed to lack the impact of a later version. Even so, it wasn't the last oil bull to embrace a viewpoint close to Money Morning's.
In late April, noted MSNMoneycentral columnist James Jubak predicted that crude prices would soar to $180 a barrel in the next few years, a prediction that was again well-covered by Money Morning.

Just days later, Standard & Poor's Inc. analysts took a Contrarian viewpoint - or, sort of. S&P analysts said that the price of crude oil would stabilize, or even drop, by the end of the year, thanks to an expected U.S. recession - even if that contraction was "mild and short."

However, S&P analysts gave themselves a pretty wide margin of error: Although their year-end target was set at $91 a barrel for crude oil, the S&P analysts cautioned that their estimates could range as much as $50 a barrel on either side of that mark.

In other words, S&P's estimate for year-end oil prices range from $41 t o $141 a barrel.

On April 24 - that same week - CIBC World Markets Inc. analysts released a report predicting that U.S. gasoline prices would hit $7 a gallon within four years as oil prices jumped to $200 a barrel.
Articulating a point that Fitz-Gerald has been making for years, CIBC analysts said that crude supplies are actually lower than some official estimates indicate, while demand is unlikely to fall anytime soon. The result: These tighter supplies and continued strong demand will drive oil and gasoline prices to roughly double their current levels by 2012.
"It is increasingly clear that the outlook for oil supply signals a period of unprecedented scarcity," CIBC analyst Jeff Rubin told "Despite the recent record jump in oil prices, oil prices will continue to rise steadily over the next five years."

None of that sounds good. Ironically, however, it was a Goldman Sachs prediction issued - or should we say, reissued - Tuesday, which seemed to re-ignite the oil rally. The investment bank handed out a May 5 research report that projected crude oil prices hitting $150 to $200 a barrel in the next six to 24 months. Except for a bit more urgency in the timing, this prediction differed little from the forecast released back in March - although the afore-mentioned earlier forecast was distributed overseas and possibly only trickled back into some U.S. financial publications (we should note, however, that Money Morning carried that earlier report).

Whatever the reason, this time around the prediction (which described as "dire") sent crude oil prices up over $122 a barrel almost instantly.

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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 at Money Map Press.

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