2011 was an up-and-down year for oil prices, but don't expect that pattern to repeat in 2012.
No, next year, the trajectory for oil prices will be far more linear – and it's pointed up.
In fact, we could even see $150 oil by mid-summer.
There are two key reasons why:
- Despite the economic crisis in Europe, oil demand proved resilient in 2011. It is poised to remain steady in 2012, and then escalate drastically for the foreseeable future.
- Supplies will once again be constrained, and the potential for political upheaval in major oil-producing nations has increased.
These are the principal reasons oil prices have surged about 30% since dipping below $80 a barrel in early October. They're also why the world's upper-echelon of energy forecasters has oil prices building a floor above $90 a barrel and rising from there.
Indeed, Goldman Sachs Group Inc. (NYSE: GS) recently recommended that traders buy July 2012 Brent crude futures in anticipation of a rally to $120 a barrel. It was one of the bank's top six trades for 2012 published in its "Global Economics Weekly" report.
Barclays Capital agrees.
"Even in the worst case scenario, the downside to oil prices is unlikely to be anything as severe as during the 2008-2009 cycle," Barclays analysts Roxana Molina and Amrita Sen wrote in a report earlier this year. "As a result, we maintain our price forecast of $115 per barrel for Brent in 2012 and expect $90 per barrel to hold as a sustainable floor even under gloomy macroeconomic conditions."
As for West Texas Intermediate (WTI) crude the Energy Information Administration (EIA) expects it to average nearly $94 a barrel next year.
And even that's a conservative estimate.
"Given the oil volume constriction oncoming and the continuing increase in global demand – this drives the price, not North America or Western Europe – we will reach $150or beyond by July 4," said Money Morning Global Energy Strategist Dr. Kent Moors.
Down But Not Out
Of course it's true the global economy will suffer if the European debt crisis is not contained. However, it's also true that emerging market demand will buoy oil prices and eventually push crude beyond the record levels we saw in 2008.
The International Energy Agency (IEA) said in its annual energy outlook in November that oil demand will rise 14% between 2010 and 2035, from 87 million barrels per day (bpd) in 2010 to 99 million bpd in 2035. And what's more is that the net increase in oil demand will come entirely from the transportation sector in emerging economies.
The IEA projects oil prices of $212 a barrel by 2035, as a result.
"It is hard to overstate the growing importance of China in global energy markets," says Fatih Birol, chief economist for the IEA. "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 people in Europe own cars today. In China, only 30 out of 1,000 people own cars. 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 of 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.
Clearly demand is far more likely to grow than shrink.
"In the last five years, worldwide consumption of oil products has grown from 3 million barrels a day to 7 million barrels," Sergio Gabrielli de Azevedo, chief executive officer of Petrobras SA (NYSE ADR: PBR), the world's third-largest oil producer, told CNBC.
"We are going to have a very tight market in 2012," he said. "At the same time, we have low interest rates, which means that by the year 2012 we are [probably] going to see prices above $100 per barrel on average, but very high volatility, because we have a lot of speculative contracts that have been traded in the market right now."
Additionally, the supply side of the oil market is far weaker today than it's been in the past. Even though demand has eased slightly, total supply has fallen as inventories were siphoned off throughout the year.
U.S. commercial oil inventories fell for the third consecutive month in November, declining by 20.3 million barrels. And an11.8 million-barrel decline in OECD supplies in September took the inventory level below its five-year average for a third consecutive month, as well. That's the first time that's happened since 2004. Asia-Pacific inventories are declining, too.
"Falling global demand is unlikely to create large spare capacity," wrote Barclays analysts Molina and Sen.
Plus there's a wild card: Political turmoil could easily lead to an oil price spike that eclipses the one we saw last spring during the Libyan rebellion.
That would be impressive, considering Libya's revolution took oil prices from $83.13 a barrel on Feb. 15 to $113.39 a barrel on April 29. That's a 36% surge in a period of about two and a half months.
And yet, that was simply the result of political upheaval in Libya – which at the time was the world's 17-biggest oil producer. Just imagine the impact on prices of a political crisis in one of the major oil-producing nations of the Middle East.
Remember, U.S. President Barack Obama has vowed to pull all U.S. troops out of Iraq by the end of this year. That's almost certainly a relief for Iran, whose nuclear program has already aggravated tensions with the West.
An International Atomic Energy Agency (IAEA) report on Iran in November accused the country of pursuing a nuclear weapons program. This would violate United Nations sanctions and could lead to military intervention from Israel and the United States.
Iran is the world's fourth-largest oil producer, so military conflict there would lead to a spike in oil prices that dwarfs what we saw during the Libya crisis. Iran produces 3.6 million barrels of oil a day, about 5% of the world's total. By comparison, Libya produced about 1.5 million barrels of oil per day prior to its civil war, or about 2% of the world's total supply.
Iran isn't the only political risk in the region, either. Since the Arab spring many Middle-Eastern countries have ramped up social spending to dissuade rebellions of their own. Saudi Arabia alone has unveiled some $129 billion of additional expenditures in recent months.
As a result, the Organization of Petroleum Exporting Countries (OPEC) has raised by $10.00 its estimate for the underlying oil price it uses in its reference case forecast to a range of $85-$95 a barrel. This is the first tacit acknowledgment from the group that the social investment commitments of some key members will necessitate higher oil prices.
"Political unrest is certainly part of why the oil price is getting so supported despite the decline in the macro environment," Sabine Schels, senior director and global commodity strategist, Bank of America Merrill Lynch Global Research, told CNBC. "Iran is flexing its muscles in the region and we have all seen how strongly Saudi Arabia reacted."
The IEA says "consumers could face a substantial near-term rise in the oil price to $150/barrel," if energy exploration and development in the Middle East falls below $67 billion annually.
2012 Oil Price Profit Plays
The easiest way to play the looming rise in oil prices is through exchange-traded funds (ETFs).
There are several from which to choose, including: the iPath S&P GSCI Crude Oil Total Return ETF (NYSE: OIL), the PowerShares DB Oil Fund (NYSE: DBO), the SPDR S&P Oil & Gas Explorers & Producers Fund (NYSE: XOP) and the SPDR Oil & Gas Equipment & Services Fund (NYSE: XES).
Of course, there's also no shortage of companies poised to outperform the market.
China National Offshore Oil Corp. (CNOOC) (NYSE ADR: CEO) is a great way to play growing demand in China.
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.
Last year, the company 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's natural gas production has tripled in the last decade, a growth rate of 13.3%," said Douglas-Westwood's Kopits. "We project this to double in 2015 and nearly triple to 8.6 trillion cubic feet in 2020, implying 10% annual growth."
And just last month, CNOOC shelled out $2.04 billion to acquire Opti Canada Ltd. and increase its exposure to Canada's rich oil sands. Opti is CNOOC's second step into Canada's vast oil sands. In 2005, China's largest offshore oil acquired a 14% stake in MEG Energy Corp. (PINK: MEGEF), which operates an oil sands project in northern Alberta.
Suncor boasts strong and reliable crude oil production from its oil sands operations in Canada. It also has refineries, wholly owned pipelines and specialty lubricant products. The company sells gasoline in retail locations in Canada under the Petro-Canada brand and in the United States under the Phillips 66 and Shell brands.
At a time when the many traditional Middle-Eastern oil producers are besieged by civil unrest, reliable oil production from a country as stable as Canada is especially valuable.
"Of the Canadian oil plays, I most like Suncor because of its position as the most important producer of tar sands oil," said Money Morning Global Investment Strategist Martin Hutchinson. "This is only modestly profitable at current oil prices, but if prices run up or a global crisis restricts supplies, Suncor can be expected to increase hugely in profitability."
Money Morning Global Macro Trends Specialist Jack Barnes likes Suncor, as well. And in recent "Buy, Sell or Hold" columns, he's recommended Anadarko Petroleum Corp. (NYSE: APC), EOG Resources Inc. (NYSE: EOG), and Marathon Petroleum Corp. (NYSE: MPC).
Anadarko has stakes in some of the most prolific U.S. oil fields in Texas, Colorado, Wyoming, Utah, and Pennsylvania. It's also an international leader in unconventional production, employing methods like horizontal drilling to increase productivity rates from deep wells.
EOG has shifted its focus to horizontal drilling techniques, as well, transforming itself from a leading gas drilling company to a major oil producer. Last year, the company increased its liquid production by 49%. The company just reported blowout third-quarter earnings, turning last year's loss into a $541 million profit.
Production from the Bakken shale is soaring. It went from a mere 3,000 barrels a day in 2005 to 225,000 in 2010, and could hit 350,000 barrels a day by 2035, according to the EIA.
All of these companies are worth a look, and paired with the aforementioned ETFs, could conjure up some very big gains in 2012.
News and Related Story Links:
- Money Morning:
Western Oil Majors Will Get the First Crack at Libyan Oil Production
Oil Prices to Hold Up Despite Weak Economy: Strategist
- Money Morning:
Oil Prices Look to Top $150 by Midsummer On Resilient Demand and MENA Turmoil
- Money Morning:
Energy Forecast: Oil Prices Poised to Again Test Record Levels in 2011
Emerging markets will boost oil demand: Petrobas