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Why Crude Oil Will Present Investors with a Golden Opportunity in 2009

[Editor's Note: This is the ninth installment of our “Outlook 2009” series, which looks at the global investing outlook for the New Year.]

By Jason Simpkins
Associate Editor
Money Morning

Oil prices have fallen 70% since hitting Outlook 2009a record $147.27 a barrel in July, which means in just five months, crude has given up all the price gains it made in the past four years.

After such a wrenching plunge, many analysts believe the outlook for the “black gold” remains bleak – and in the short term it certainly is. In the long run, however, dwindling supplies, resurgent demand, and a lack of investment will cause crude oil to double, triple, or even quintuple in price over the next few years.

In fact, the Paris-based International Energy Agency (IEA) – energy advisor to 28 industrialized nations – says oil will rise to $100 a barrel by 2015, as a result of a major “supply crunch,” and will ultimately soar to $200 a barrel.

But before it does, prices are likely to sink even further, perhaps falling as low as $20 a barrel in the first quarter of the New Year.

Indeed, much of Wall Street expects oil prices to average about $50 a barrel in 2009. Some of the firms and their specific forecasts include:

  • Deutsche Bank AG (DB, which says oil prices will average $47.50 for all of next year.
  • Merrill Lynch & Co. Inc. (MER), which predicts that prices will average $50 even.
  • Moody's Investors Service (MCO) also says crude will average $50 a barrel in 2009, but says that average will increase to $55 a barrel for 2010.
  • Goldman Sachs Group Inc. (GS) is slightly more bearish, predicting that prices will average $45 for all of next year – after falling as low as $30 in the 2009 first quarter. (It’s worth noting that Goldman – just five months ago – predicted oil prices would hit $200 a barrel in 2009).

But analysts also agree on something else: When the recessionary tide finally recedes, all of the factors that drove oil to its record high last summer will once again be exposed, and crude again will again soar to record highs.

"We may see prices drop lower – into the twenties, even – but there’s a better-than-average chance that they’ll be back over $70 a barrel by the end of next year,” says Money Morning Investment Director Keith Fitz-Gerald. “That's where firms like Goldman and Merrill are getting all of these 'middle-of-the road,' $50-a-barrel estimates. And it’s why investors who buy in through the first quarter could enjoy compelling returns at the end of the year."

In the meantime, however, low oil prices are crimping investment in new capacity, a reality that will lead to much higher prices down the road.

Just ask the IEA.

IEA: Rising Demand + Lack of Investment = ‘Supply Crunch’

The IEA forecast 2008 global oil demand to slide 0.2%, or 200,000 barrels per day (bpd), to 85.8 million bpd on average. But the IEA also says that oil demand will rise 1.6% a year on average between 2006 and 2030.

The bottom line: Regardless of any short-term pullback, daily demand will rise from the current level of 86 million barrels to 106 million barrels in 2030. To meet that demand, the agency estimates that the world needs $26.3 trillion in supply-side investments over the next 21 years

China, India and other developing countries, alone, will need investments of $360 billion a year through 2030, the agency said.

About 7 million bpd of additional capacity needs to be added to the market by 2015. And right now – because of marketplace changes – the financial incentives to make that happen just don’t exist.

Exploration costs have more than quadrupled since 2000, as oil producers have been forced to take on more complex projects, and the costs of both labor and materials have skyrocketed. At the same time, the steep drop in oil prices has put even more pressure on energy companies to curtail their investments rather than increase them.

Earlier this year, for instance, ConocoPhillips (COP) and Saudi Arabia Investment Co. (ARAMCO) were forced to postpone bidding on the construction of a 400,000 bpd export refinery at the Yanbu Industrial City.

"We see and hear about energy investments being delayed … this is a major worry and could lead to a supply crunch and much higher oil prices than we've seen before," said Fatih Birol, the IEA's chief economist.

The IEA predicts that, by 2015, a lack of investment and rising demand will create a "supply crunch" – that will once again send oil prices up into the triple digits.

“There remains a real risk that under-investment will cause an oil supply crunch in that time frame,” the IEA said in an executive summary of its “2008 World Energy Outlook.” “The gap between what is currently being built and what will be needed to keep pace with demand is set to widen sharply after 2010.”

The agency predicts that crude will average more than $100 a barrel from 2008 to 2015 and rise above $200 a barrel by 2030, as demand far outpaces supply.

“While the situation facing the world is critical, it is vital we keep our eye on the medium to long-term target of a sustainable energy future," Nobuo Tanaka, the Paris-based agency's executive director, told reporters in London. "While market imbalances will feed instability, the era of cheap oil is over."

While it’s probably true that the “era of cheap oil” is in our rearview mirror, a new question has arisen: Just how high do oil prices go?

According to some analysts, the IEA’s target price of $200 a barrel is far too conservative.

$500 Oil?

 

The lack of exploration and development is certainly a problem. But a much bigger issue is the fact that output from the world’s existing oil fields has sharply declined.

“The future rate of decline in output from producing oilfields as they mature is the single most important determinant of the amount of new capacity that will need to be built globally to meet demand,” the IEA says.

And output from the world’s oilfields is declining faster than previously thought.

In its “2007 World Energy Outlook,” the IEA estimated that output from the world's existing oilfields was declining by 3.7% a year. But in its latest report, published in November, the IEA revised that estimate to an annual decline of 6.7%. (The November report was based on the first major study of the world's 800 largest oil fields.)

Unfortunately, the IEA is behind the curve.

For nearly a decade, Matthew R. Simmons has said that the world’s oil production was nearing – or already at – an “inflection point.” While his book "Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy," was scoffed at when it was originally published back in 2005, Simmons is now viewed as perhaps the preeminent expert on the so-called “peak oil” movement.

Like most people who ignore conventional wisdom, he was scoffed at, ridiculed, and denied," commodities guru Jim Rogers told Fortune magazine. "And now, of course, people are starting to say, ‘Oh, well, I thought of that.’"

Simmons, chairman of the Houston-based investment bank Simmons & Co. International, poured through hundreds of technical documents submitted by Saudi oil geologists to the Society of Petroleum Engineers over the past 50 years.

“I finished reading the last paper on a Sunday afternoon,” Simmons told Fortune, “and I sat back and thought, ‘Holy crap, this is unbelievable. I’ve just discovered the biggest energy illusion ever in the world. We’re in big trouble. I’m going to write a book.’ ”

Much of the alleged Saudi Arabia subterfuge has to do with a complete lack of transparency with respect to the Organization of Petroleum Exporting Countries. After OPEC decided to base its production quotas on reserve figures in the 1980s, several of the cartel's producers suddenly raised their levels of  "proven reserves" by 40% or more.

Back in 1988, for instance, Saudi Arabia raised its proven-reserve figure from 170 billion barrels to about 260 billion barrels. That figure has remained more or less constant since then, despite the fact that billions of barrels of oil have been pumped out of the ground.

"Saudi Arabia has announced for 20 years in a row that they have 260 billion barrels of oil in reserve," Rogers told Money Morning during an exclusive interview in Singapore recently.  "It’s astonishing.  The figure never goes up and it never goes down.  They have produced dozens of millions – billions – of dollars of oil in that period of time.

Every oil country in the world has declining reserves except Saudi Arabia,” Rogers said. “And I know that every oil company has declining reserves.  So unless somebody discovers a lot of oil very quickly in very accessible areas, the surprise is going to be how high the price stays, and how high it goes.”

Simmons thinks oil prices could hit $300 a barrel – and could possibly even surge as high as $500 a barrel – during the next several years.

“Black Gold” Profit Plays

When it comes to investing, the oil sector poses some very clear risks, especially given the murky near-term outlook. However, there are a number of large-cap integrated oil companies that may offer some truly compelling values at current prices.

Exxon Mobil Corp. (XOM) and Chevron Corp. (CVX) are currently trading at multi-year lows, making them exceptionally cheap in both relative and absolute terms. These companies also have strong balance sheets (Exxon is “AAA”- rated and has more cash on its balance sheet than debt), generate strong cash flows, and have traditionally increased their dividends on a regular basis.

Chevron was actually recommended as a “Buy” by Money Morning Contributing Editor Horacio Marquez in his “Buy, Sell or Hold” column earlier this year.

“Chevron is the kind of company that is capable of continuing to post large profits – propelling its share higher from current levels – even if oil-and-gas prices were to drop from current levels over the next three years,” Marquez said. “That’s because Chevron’s business is well cushioned, since refining, marketing and chemicals margins would expand dramatically if market ‘spot’ prices were to decline. Also, the company’s production is poised to expand strongly and Chevron uses some selective hedging that works very well in downside oil markets.”

Offshore drillers, particularly those capable of drilling in the deepest waters, also offer value at current levels. Petroleo Brasileiro (PBR), also known as Petrobras, is particularly appealing, as it recently discovered one of the largest offshore oil fields on earth off the coast of Rio de Janeiro. Known as Carioca, the field could hold 33 billion barrels of oil and gas, making the world’s largest discovery in at least 32 years.

Fitz-Gerald, the Money Morning investment director, suggests investors look at China National Offshore Oil Corporation, or CNOOC Ltd. (ADR: CEO). The Hong Kong-based company recently got approval for a $29 billion exploration project in the South China Sea. The company expects to produce 50 million tons of oil equivalent per year from that region during the next 10-20 years. That would equal the production of China's biggest project, the Daqing Oil Field.

Petrobras and CNOOC are also attractive because, as foreign companies, they will also get a boost from any devaluation in the U.S. dollar.

All of these companies have been hit hard by the combination of commodity-price weakness and credit market turmoil. But these operators do not require peak-cycle commodity prices to generate stellar results and have little or no credit-market exposure.

For a more direct play on oil prices, you might also try an exchange-traded fund (ETF), such as the United States Oil Fund LP (USO), the iPath S&P GSCI Crude Oil Total Return Fund (OIL), or the United States Gasoline Fund LP  (UGA).

[Editor’s Note: As the whipsaw trading patterns energy investors have endured this year have shown, the ongoing financial crisis has changed the investment game forever. Uncertainty is now the norm and that new reality alone has created a whole set of new rules that will help determine who profits and who loses. Investors who ignore this “New Reality” will struggle, and will find their financial forays to be frustrating and unrewarding. But investors who embrace this change will not only survive – they will thrive.

Money Morning Investment Director Keith Fitz-Gerald has already isolated these new rules and has unlocked the key to what he refers to as “The Golden Age of Wealth Creation.” But Fitz-Gerald brings more than a realization – and an understanding – to the table, here. After a decade of work, he’s also developed a new computerized trading model based on a mathematical concept known as “fractals.” This system allows him to predict price movements of broad indexes, or individual stocks, with a high degree of certainty. And it’s particularly well suited to the kind of market we’re all facing right now. Check out our latest report on these new rules, and this new market environment.]

News and Related Story Links:

  • Saudi-U.S. Relations.org:
    Yanbu Industrial City
    .

Join the conversation. Click here to jump to comments…

  1. Michael R. Scott | December 29, 2008

    With Cheney/Bush leaving office it is no surprise that oil is falling through the floor. Once the investigative reporters get their teeth into this huge run up and uncover the conspiracy that has run Enron wild since the "Energy Summit" consumers will go crazy in rejecting oil as a fuel. If you really think oil is going to $200 I've got some swamp land you might be interested in. Natural Gas, plug-in's, and many other forms are going to replace oil. What Cheney/Bush and their minions didn't understand was that this short sided conspiracy would bury oil's future finally once and for all! Thing I'm wrong? I'm taking bets……..

  2. Craig Schaub | December 29, 2008

    i am surprised that in this article when you mentioned ETF's that you do not mentioned DXO which looks so cheap ($2.00) and has great upside potential.
    should oil return to it's last high it should return $14 dollars for every $1 investment!

  3. H. Craig Bradley | December 29, 2008

    The American economy is still very oil dependend, especially foreign oil. So, $300/barrel oil in "just a few years" would kill our economy and destroy our way of life. However, if oil prices increase gradually over a longer period, then we may have a chance to adapt to much higher prices and survive.

  4. Eswar | December 29, 2008

    yes , oil surely reach $100 a barrel in 2009 2nd half.according to transit of Saturn. from JANUARY 1st again saturn starts its retrogration course.and again he receives uranus aspects.this time oil again fell down upto $25-$20.but after retrogration over, again saturn will gets its original strength. and also coming year saturn enters in to his exaltation sign libra. the lord of oil saturn gains more strength. ultimately saturn main products like oil,iron,steel prices will be in high level. oil price will be gains 4times from its bottom level ie:if made low $20, then high will be $80, if low $25 then high will be $100 in 2009 in year.

    Eswar

    see my previous articles about crude.in my blog
    http://astroakella.blogspot.com/

  5. Matt Garrett (soon to be hedge fund manager) | December 30, 2008

    The opportunity in oil has passed. It will likely be range bound with no major trend for the foreseeable future. The one of the best trades came is related to this topic. It was a short the oil/gold spread ( short oil:long gold). I made this call in early july. The two assets have a 5+ year track record of a .84 correlation coefficient. at a constant 1:1 ratio from the beginning point of the trade(using futures) it would have yielded an ROI in access of 1,367% to date. The fact that the two assets are heavily correlated really reduced risk. The trade was really perfect global growth expectations were way too optimistic and the market wasn't recognizing a global recession/depression deflationary environment. So the rational for shorting oil @140 is obvious, the long gold goes beyond a hedge, Gold would benefit from CB's easing and direct market interventions while the economic situation and the CB's addressing the economy both feeds the theme of gold being the currency of last resort.

  6. Matt Garrett (soon to be hedge fund manager) | December 30, 2008

    one of the best trades of the year. made the call mid july short oil/long gold. ROI in access of 1,367%. the correlation coefficient of the two is above .84 for the trailing 5years ( low risk trade).

  7. J B Patel | December 30, 2008

    As overall worldwide living standard of life is at high and all activities of every human are connected directly or indirectly with oil/oil product it can not sustain at lower lever for more then 3/4 months. It it is likely to move upward by mid Feb 2009 and I believe it will touch to 70US$ around March/April 2009 and I believe it can touch even 100 US$ durig these days.

    Indian farmers are running tractors instea of bullock in farming think about other activities. everybody either poor or rich moving here and there by usig Oil/Oil products world wide.
    It is very Short term Lower prices for OIL.

  8. Carl Kirsch | December 30, 2008

    I think that if you print that Goldman Sachs had predicted $200 a barrel previously that you should be honest about your own Keith Fitz-Gerald. He predicted not to long ago that by Dec. 2008 oil would be $170 a barrel. Now he predicts $70 a barrel for 2009. This has been an unusual time but this is the kind of market and situations on would hope the "real experts" could predict before it happened.
    It would really be useful if the errors were admitted in all prediction areas with a discussion of why that happened. Experts who predict but do not show their track record and what went into arriving at it really are no better than fortune tellers.
    I have tracked some of these experts-yours and others-most have a record that is less than 50%. The transparency that you all ask of the banks and others in your articles should also apply to you all and your newsletter. In the well know saying you all should eat your own cooking.

  9. Giulio Negrini | December 31, 2008

    We are buying and developing crude oil producing companies in U.S.A. Economic development projects need fuel for infrastructure
    project development, overseas sources of crude oil are less available for many reasons. Gold is not the currency of last resort,
    but crude oil is the real base currency.

  10. PMac09 | January 2, 2009

    As an investor viewpoint, I'm optimistic about 2009. If you noticed how just a little good news skyrocketed oil on the 31st of 2008. If the market is reacting that way over something so small about the inventory amounts, once the supply/demand issue resolves itself, oil will skyrocket again. And I'm thinking it will be in 2009 because demand will rise eventually as the winter season ends and the summer driving season begins. I'm not sure we'll see $150 again, maybe not until 2010, but it's possible it will work it's way up once good news on supply/demand feeds into the market. Plus after crude's history of rising so high, I think more people will jump into oil funds, futures, or whatever type of energy-based investment they can get their hands on. As for me being optimistic, I will be investing in oil this year but for the long term, I'm not an active trader.

    As a consumer viewpoint, the falling price of oil is definitely aiding many in the U.S. throughout the recession. It is much needed I think, seeing as the economy worsens and jobless claims continue to rise. I think the whole reason we are seeing this steep drop in demand is because when gas was hitting $4 thanks to oil, people couldn't afford it and drove less and less, and less. I knew plenty of people who would started barely driving at all because of it. It was an illogical price, and I still think $4 gas is ridiculous. I could understand maybe a few years from now, but that steep increase so quickly was abnormal and not the way it should have happened. But, for every extreme high, an extreme low waits around the corner. Oil prices can't rise to $200–500 anytime soon, otherwise what we are seeing now will repeat itself again and even worse than before. Demand will be impacted if the price of crude rises to an unreasonable level and oil will collapse maybe even moreso than it is now.

    What is irritating too is that OPEC made no supply increases whatsoever when crude was on the rise, and they had room to do so. But as soon as it starts falling, they panic and want it high again. They were profitable before oil hit that high a few years ago, so I don't see how a price of that magnitude is necessary for them to be profitable. It's always a scam to rip off the consumer in one way or another.

  11. Alex Daoulas | January 4, 2009

    I see a lot of predictions for oil to be rised from $200 to $500 per barrel. My question is simple: 'Who is going to buy it in such prices?' But even if the sale will take place – the demand eventualy will be dropped – consummers will be looking for other surces of energy – the inflation will be rised world wide and at the end of the day 'what would be the worth of your investment?'

  12. shulamit lazarus | January 7, 2009

    Hi Jason,
    You say that oil will probably come down the first quarter of 2009. Don't you think that the events in Isreal now throw a wrench into that? Or, do you think that oil will pullback no matter what to potentially $30?

    I'd love your thoughts.

    :-)

    Shulamit
    http://www.limitfreeself.com
    Getting you "unstuck in Health, Self and Success

  13. Jason Simpkins | January 7, 2009

    I'd say it already has thrown a wrench into oil's decline, because crude was briefly over $50 a barrel yesterday (Jan. 6). But the thing to remember is that this conflict, like others before it, is only temporary. It’s already gone on for more than a week and diplomatic efforts (while ineffective so far) are underway.

    The problem right now is that it’s hard to tell how much of oil’s recent rally is driven by this event and how much of it has been driven by a shift in market sentiment. (Stocks have been rising recently as well.)

    I can’t say whether crude is finding a floor or will sink back into the 30s. But I can say that for anyone investing long-term there’s not much of a difference between buying at $45 a barrel and buying at $39 a barrel.

    It’s probably just best to wait for conflict in the region to subside before trying to guess which way crude’s going next.

    Thanks for reading!

    Jason S.
    Associate Editor
    Money Morning

  14. KENT LINNET, Esq. | January 27, 2009

    I QUITE BELIEVE THAT THIS MAY VERY WELL BE THE WAY THINGS WILL BE GOING BUT NOT SO VERY FAST. SURELY IT WILL NOT BE IN 2009 NOR 2010. TRUE POSITIVE FUNDAMEN-TALS WILL CANNOT POSSIBLY STARTING TO SHOW UP UNTIL END OF 2010 OR EVEN A LITTLE LATER.

    NATURALLY THE "MARKETS" MAY GO UP AS WELL AS DOWN FROM TIME TO TIME, BUT THAT MAY NOT MEAN THAT THE GLOBAL SITUATION IS IMPROVING. DO NOT FORGET THE AMOUNT OF WORKERS, WHICH HAS BEEN LET GO, AND ABOVE ALL THE EVEN BIGGER AMOUNT, THAT WILL BE RECEIVING THE RED SLIP OVER THE NEXT FEW MONTHS.

    INDEED, AT THE PRESENT MOMENT IT IS FAIRLY EASY TO FORECAST IMPROVEMENTS AFTER SUCH A DRASTIC FALL, WHICH HAS NOT ENDED YET, BY FAR, BUT THE TIMING SHOULD BE RIGHT AND CORRECT. THE TIME IS TO BE CAUTIOUS FOR THE FEW, WHO STILL MAY HAVE A LITTLE MONEY LEFT, ALTHOUGH I DO REALISE THAT WHEN SOME PEOPLE LOSE THEIR MONEY OTHERS GAIN MONEY.

    OIL AT US$ 500.00 A BARREL -SORRY I DO NOT BELIEVE. POLITICALLY SPEAKING THIS WOULD BE FANTASY, AS THE MANY NATIONS, WHO ARE DEPENDENT UPON IMPORTS OF OIL CANNOT POSSIBLY AFFORD THAT AND SURELY THE WORLD PRODUCERS WILL NOT ALLOW THAT TO HAPPEN, BUT WILL MUCH PREFER TO BRING BACK WORKERS AND HIGHER PRODUCTION OUTPUTS. – ONE CANNOT FORGET EITHER THAT BRAZIL WITHIN SOME YEARS MOST PROBABLY WILL BECOME A MAJOR PLAYER IN THAT MARKET AS WELL. PRESENT ESTIMATES OF COST OF PRODUCTION – PRE-SAL – ARE AROUND US$ 65/70.00 PER BARREL, ANYTHING ABOVE US$ 100,00 OR A LITTLE MORE WILL BE A GIFT FROM HEAVEN.

    MOST PROBABLY THE MARKET OF IRON ORE, WHICH HAS ALSO FALLEN IN RECORD TIME FROM US$ 165.00/MT/CIF TO PRESENT BIDS FROM OPERATORS OF US$ 75.00/80.00/MT/
    FOB. BUT WITH NO SELLERS WILL ALSO SHOW SOME IMPROVEMENTS, BUT MUCH DEPENDS ESPECIALLY ON CHINA, WHERE ALSO A LOT OF PEOPLE WILL BE DISMISSED. – O.K. THE FAMOUS INTERNATIONAL SHOPS MAY STILL BE BOOMING, BECAUSE O.5% OF THE PEOPLE IN CHINA STILL MAY HAVE MONEY, BUT WHAT ABOUT THE OTHER 99.5% ?
    LIKE HERE IN THE SO-CALLED FREE WORLD THINGS WILL GET WORSE BEFORE THEY GET BETTER, SO IT IS IN CHINA AS WELL. SORRY BUT I FIND THAT YOUR REPORTING THIS TIME IS SOMEWHAT MISLEADING.

    REGARDS,

    KENT LINNET.

  15. Giulio Negrini | March 10, 2009

    Exploration costs have more than quadrupled since 2000, as oil producers have been forced to take on more complex projects, and the costs of both labor and materials have skyrocketed. At the same time, the steep drop in oil prices has put even more pressure on energy companies to curtail their investments rather than increase them.
    At the today gas prices more people start using cars and in June 2009 perobably we will see crude oil at $70. bl.

  16. ESWAR | June 22, 2009

    In earlier comments on oil I said that crude will be drop up to $25/20 .But crude dropped up to $30 in retrograde Saturn time.in my earlier post i said that crude will gains 4 times from its low in 2009 2nd half after Saturn direct.May 17th Saturn came in to direct motion.and same time crude gain a lot and made high $73.32 in June. if it move upward then 4 times from lows ($100-$120) is quite possible before end of December 2009. July 22nd total Solar Eclipse.watch after this eclipse crude price moments.

  17. ilona@israel | December 27, 2009

    i care about oil prices just coz i belive that low prices will probably a problem for iran and the process of creating weapons will go slower. though i am not sure that even delay will help a lot.

Trackbacks

  1. […] Why Crude Oil Will Present Investors with a Golden Opportunity in 2009 Back in 1988, for instance, Saudi Arabia raised its proven-reserve figure from 170 billion barrels to about 260 billion barrels. That figure has remained more or less constant since then, despite the fact that billions of barrels of oil have been pumped out of the ground. "Saudi Arabia has announced for 20 years in a row that they have 260 billion barrels of oil in reserve," Rogers told Money Morning during an exclusive interview in Singapore recently. "It’s astonishing. The figure never goes up and it never goes down. They have produced dozens of millions – billions – of dollars of oil in that period of time. “Every oil country in the world has declining reserves except Saudi Arabia,” Rogers said. “And I know that every oil company has declining reserves. So unless somebody discovers a lot of oil very quickly in very accessible areas, the surprise is going to be how high the price stays, and how high it goes.” Simmons thinks oil prices could hit $300 a barrel – and could possibly even surge as high as $500 a barrel – during the next several years. […]

  2. […] the meantime, however, low oil prices are crimping investment in new capacity, a reality that will lead to much higher prices down the […]

  3. […] Money Morning predicted in its annual outlook series, the first quarter was a volatile one, in which oil prices tested the low $30s before surging over […]

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