After starting the year at slightly more than $80 a barrel, oil prices yesterday (Tuesday) rose to their highest level in two years, with West Texas Intermediate (WTI) crude surging as high as $90.76 a barrel on the New York Mercantile Exchange (NYMEX).
Crude oil prices are poised to again break the psychologically important $100 a barrel mark in a bid to move higher throughout 2011 and 2012, and some forecasters are calling for prices to zoom by as much as 65% from here.
If that happens, crude oil would approach – or possibly even eclipse – the all-time high of $147 a barrel, a price not seen since the summertime speculative frenzy of 2008.
"I believe we will reach triple digits early next year and could reach $150 by mid-summer," said Dr. Kent Moors, a frequent Money Morning contributor and editor of the Energy Inner Circle advisory service. "Dollar weakness is a factor, as is rising demand from non-OECD [Organization for Economic Cooperation and Development] countries. Other factors include supply concerns, quality of crude extracted, reserve replenishment, level of stockpiles and the occasional saber rattling."
But even if crude prices don't reach that admittedly lofty level, there is a strong consensus about the market for "black gold" in the New Year.
"In terms of oil markets, I believe the age of cheap oil is over," said Fatih Birol, chief economist for the International Energy Agency (IEA). "There may be zigzags in the future according to the economy, this and that, but the general trend is we will see higher oil prices."
The sluggish pace of economic growth has kept oil in check, even as other commodities have surged ahead. U.S. supplies have been ample and production from the Organization of Petroleum Exporting Countries (OPEC) has been strong. But going forward, the same factors that drove oil prices to a record high $147.48 a barrel in 2008 will again conspire to push oil prices higher in 2011.
Those factors include:
- A weak U.S. dollar.
- Greater global demand.
- Tighter supplies.
- And the potential for another speculative frenzy – like the one we saw in oil from 2007-2008, or the one we're currently seeing in gold.
JPMorgan Chase & Co. (NYSE: JPM) and Bank of America Merrill Lynch (NYSE: BAC) are among the major investment banks forecasting triple-digit oil prices for 2011. And Goldman Sachs Group Inc. (NYSE: GS) has said that it expects "substantially higher" oil prices by 2012.
No doubt, the rising demand for oil from emerging markets will be one of the main catalysts pushing oil prices higher.
Oil demand in the third quarter of 2010 was up 3.7%, marking the fourth straight quarter of growth – a trend that is likely to continue through 2011 and beyond.
"Global oil demand is set to hit a new record in 2011," Francisco Blanch, head of commodities at Bank of America Merrill Lynch, told Bloomberg News. "The underlying economic picture is still positive. We are still looking for economic growth because of quantitative easing and accelerating growth in emerging markets."
The IEA forecasts global energy demand will rise to 88.2 million barrels per day (bpd) in 2011, up from 86.9 million bpd this year. And most of that demand will come from emerging markets, which means oil prices will have the impetus to move higher, even if the U.S. recovery falters.
Global oil consumption has rebounded from the lows in early 2009 and now exceeds pre-crisis levels. However, consumption in developed economies remains 8% below 2007 levels, which means emerging markets have picked up the slack.
Indeed, the usage gap between developed markets and their "emerging" counterparts has shrunk from 12 million bpd three years ago to just 4 million bpd today.
"It comes as no surprise that the geographic distribution of oil demand growth follows that of economic growth: Emerging markets, rather than the OECD, drive the increase in global oil demand in 2010 and 2011," BNP Paribas SA (PINK: BNPQY) said in its 2011 forecast.
The most dynamic emerging market growth has come from China, whose economy is expected to expand by 9.1% in 2010. Oil demand in China is expected to grow 10.4% this year – the fastest rate of any country in the world.
"It is hard to overstate the growing importance of China in global energy markets," the IEA's Birol said in that organization's annual report. "The country's growing need to import fossil fuels to meet its rising domestic demand will have an increasingly large impact on international markets."
Birol says that 700 out of every 1,000 people in the United States and 500 out of every 1,000 in Europe own cars today. In China, only 30 out of 1,000 own cars. And Birol thinks that figure could jump to 240 out of every 1,000 by 2035.
Furthermore, when Japan hit $5,000 of gross domestic product (GDP) per capita, oil demand grew at a 15% annual rate for the next 10 years, according to oil-industry consultant firm PIRA. The same is true off South Korea. However, China reached the $5,000 GDP per capita mark in 2007, and oil demand has only grown at a 7% compounded annual growth rate.
Oil demand is also growing briskly in other economic hot spots around the globe.
India consumed nearly 3 million bpd in 2009, making it the fourth-largest consumer of oil in the world. The Energy Information Administration (EIA) expects approximately 100,000 bpd of annual consumption growth through 2011.
India has the second-largest proven oil reserve in Asia – behind China – but the EIA expects that subcontinent to become the world's fourth-largest net importer of oil by 2025, behind the United States, China, and Japan.
A Looming Supply Squeeze
Of course, increased demand has led to tighter supplies of crude oil – even in the United States, which has yet to fully emerge from its economic malaise.
U.S. inventories declined by 1.5 million barrels, or 0.4%, in the seven days ended Dec. 3 from 359.7 million a week earlier, the Energy Department will report today (Wednesday), according to a Bloomberg survey.
"In the U.S. itself the excess in inventories has come off very, very quickly," Amrita Sen, an analyst at Barclays PLC (NYSE ADR: BCS) told the news agency. "Over the last five or six weeks, you've eroded about 40 million barrels of inventories. It's tightening, and it should continue to erode as we progress into the New Year."
On the producer side of the equation, OPEC will do its part to influence higher oil prices – and it certainly has leverage. The cartel controls 40% of global crude production and that share will grow to 50% by 2035, according to the IEA.
Not wanting to hurt fragile demand in the depths of the financial crisis, OPEC was comfortable with crude prices of $70-$80 a barrel. But as demand rebounds, the cartel is showing an interest in making $100 a barrel the new standard.
Mohammad Ali Khatibi, Iran's representative at OPEC, in November said that the current price range of $70 to $90 was a "suitable" range, but noted that the global economy was capable of absorbing higher prices.
"Oil prices increasing to $100 (per barrel) would not hurt the global economy," Khatibi told the oil ministry news agency SHANA. "Not only producers, but consumers have reached this agreement that $70 to $90 is a suitable price for oil because it encourages investment and does not hurt the global economy."
Saudi Arabia's oil minister, Ali Al-Naimi, also has mentioned a range of $70 to $90 a barrel, which is a deviation from his previous target of $75 a barrel.
"Al-Naimi spoke of a $70-to-$90 range for the first time," Francisco Blanch, head of global commodity research at Bank of America Merrill Lynch Global Research, told Bloomberg. "The next threshold is $90 if Al-Naimi says he won't be putting any more oil in the market until we get to that level."
Indeed, OPEC has indicated that it's comfortable with higher oil prices – as any contingent of major crude suppliers would be – and would be reluctant to increase supplies barring a major spike in prices.
"We think OPEC is unlikely to raise output ahead of its June 2011 meeting unless oil prices push above $100 [per barrel], leaving inventories to draw over the first quarter, pushing Brent crude oil into backwardation, a structure that is likely to remain in place for much of 2011 and 2012," analysts at JPMorgan said Friday.
Oil will breach the $100-a-barrel level in the first half of 2011 and $120 before the end of 2012, JPMorgan said.
A Speculative Surge
Finally, the key oil-price catalysts transcend the simple "Econ 101" arithmetic relating to supply and demand. Other factors are at play, including investor sentiment and the value of the U.S. dollar.
Because oil is priced in dollars, it is vulnerable to changes in the greenback's value relative to other currencies. A stronger dollar makes oil more expensive for foreign countries that have to convert their domestic currencies into greenbacks to buy crude.
Conversely, a weaker dollar makes it cheaper for countries that import oil.
Currently, the U.S. Federal Reserve's commitment to a loose monetary policy has undermined the value of the dollar. Furthermore, the Fed has effectively flooded the system with cheap money, meaning there are more investment dollars available for commodities such as oil.
The price of oil has climbed 7% since the Fed on Nov. 3 announced it would buy an additional $600 billion of U.S. Treasuries through June, and it's surged some 17% since mid-August, when the Fed first indicated it would consider a second round of quantitative easing.
"The additional liquidity pumped into the markets by the Fed's Treasury purchases should also reach commodity markets and is thus leading to increasing oil prices," said analysts at the Frankfurt-based Commerzbank AG (PINK: CRZBY). "What is more, the higher price level reflects the weaker U.S. dollar which is a direct consequence of the ultra-expansive U.S. monetary policy."
When oil reached its record high in 2008, it was largely because speculators had piled into crude – and a host of other commodities – to hedge against the beleaguered greenback. Similar behavior could exacerbate oil's 2011 ascent.
"As for speculation, it is the nature of the beast," says Money Morning's Dr. Moors. "Oil is both a commodity and a financial asset in its own right. That means its trading impact is much broader than the oil for delivery alone."
The bottom line: Both the short and long-term outlooks for oil prices are bullish.
2012 and Beyond
Demand, already buoyed by strong emerging market growth, will continue to accelerate as the global economy continues to mend and mature. Supplies will tighten as a consequence, and OPEC will be slow to increase production. Finally, speculators looking to both capitalize on the Fed's expansive monetary policy and preserve their wealth in commodities will add fuel to fire, taking crude oil prices higher.
The result will be a surge in oil prices that tests the record highs set by "black gold" in 2008.
"Oil will just continue to get stronger as the fundamentals improve, things really begin to look good in 2012, 2013, 2014," Deutsche Bank AG (NYSE: DB) Chief Energy Economist Adam Sieminski said in an interview with Bloomberg Television.
One of the simplest ways to profit from surging oil prices – outside of investing in futures on the NYMEX exchange – would be to invest in an exchange-traded fund (ETF) that tracks the commodity's movement.
If you're looking for specific companies, it may be best to look in China, where the most growth is currently occurring. To that end, China National Offshore Oil Corp. (CNOOC) (NYSE ADR: CEO) is one option.
CNOOC is often referred to as the most "Western" of China's oil majors because it was founded with a mandate to form joint ventures with foreign companies. CNOOC is the vessel through which China is acquiring foreign expertise in the energy sector.
CNOOC in October announced it would pay $1.08 billion for a 33% stake in Chesapeake Energy Corp.'s (NYSE:CHK) Eagle Ford shale acreage in Southern Texas, a deal that highlighted China's desire to develop its shale-gas extraction techniques.
China has 26 trillion cubic meters of shale-gas reserves that are largely unexplored due to a lack of drilling ability. Chesapeake is a pioneer in the shale gas industry.
Domestically, ExxonMobil Corp. (NYSE: XOM) remains one of the safest and most consistent energy plays in the United States. The company has a market capitalization of $363 billion and its stock yields 2.45%.
"Like Goldman, Exxon has a distinctive ‘best-and-brightest' corporate culture, and relentlessly focuses on return on investment and efficiencies at the expense of egos," Barron's said.
Exxon's position has been strengthened by its takeover of XTO Energy Inc., the largest U.S. natural gas producer, and 11% of the company's 2009 earnings came from its fast-growing chemicals segment.
The company set a world record with $45 billion in after-tax profit in 2008, which is a big reason why 2009 was something of a disappointment. Exxon's earnings in 2009 dropped for the first time since 2002. But 2010 has already topped last year's take, and the company's earnings are expected to increase further in 2011, according to Argus Research.
"Exxon should remain in a strong position thanks to its fortress balance sheet. Although its earnings and cash flow declined year-over-year in 2009 for the first time since 2002, its year-to-date cash performance in 2010 already exceeds that for all of last year. We expect even stronger results in 2011," said Argus, which maintains a "Buy" rating on the energy giant.
Indeed, Exxon could be in for another record-breaking year – as could oil prices in general – if there's a reprise of the 2008 summer oil frenzy.
Don't bet against it.
[Editor's Note: If there's one thing top global investors understand, it's that you have to "follow the money" to reap the benefits of the best profit opportunities that are available at any one time. Money flows point out the next profit opportunities. Sometimes that means "following the money" from one sector to the next. Other times that means moving from one geographic market to another.
To make those moves successfully, investors need a compass or, better yet, a guide. And successful investors will tell you, one of the best guides out there is The Money Map Report.
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