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Despite a recent price pullback, my "oil constriction" approach for how to profit from high crude oil prices has not gone away.
In fact, it is right on track.
But to profit from rising prices you need to understand what's happening in the oil market – and you need to remember that the constriction in oil availability will not hit all oil sector shares the same way.
There are four overriding elements in what is coming.
1) Crude Oil and Gas Prices on the Rise
The markets have witnessed a rise in both crude oil and gasoline prices – West Texas Intermediate (WTI) prices are up 37% since Oct. 4, while RBOB (the gasoline futures contract traded on NYMEX) is up 29% since Nov. 25.
The constriction, however, is not simply reflected in the price.
We have a very different dynamic underway than the one experienced in 2008. Three years ago, it was a speculatively driven rise in oil prices that came crashing down when an outside crisis hit (the subprime mortgage mess and the corresponding credit freeze).
This time around, the constriction results from the rapid decline in prices from the third quarter of 2008 through a sluggish leveling-off through the fourth quarter in 2009. This period produced a significant cutback in new drilling.
Consider this: The top 15 oil producers in the world have replaced barely 70% of the extractable reserves they extracted over the past three years.
With conventional production, therefore, the constriction is already in place.
However, we have moved quickly into accelerating unconventional oil production.
That is element number two.
2) A Rebalancing Act in Crude Prices
Here we are speaking of shale, tight and heavy oil, bitumen, and oil sands. These are providing a major new domestic sourcing that is lowering our import requirements. But the largess is producing dislocations in some areas, while increasing prices in others.
The new infrastructure requirements following this rising unconventional production affect everything from the wellhead, through the transport system, to the massive refinery investments necessary to upgrade and process this lower quality crude.
The upside to the situation is that there is a great deal of this unconventional supply in the U.S. and Canada. The downside is the upward pressure on prices resulting from the more expensive volume.
This requires some significant rebalancing of the market – both in terms of product and distribution. Yet a balanced market will still result in higher prices. That is because of two pervasive considerations: the higher overall cost of the new sources and the reliance on imports for any of the U.S. needs.
For reasons I've mentioned on a number of occasions in the Oil & Energy Investor, Brent will remain priced higher than WTI for some time. That higher price is reflected whenever the imported volume makes it into the American domestic market.
3) Global Demand Swelling as Summer Approaches
Third is the demand level.
We continue to see only modest recovery rises in U.S. demand figures. As the economic recovery gains strength (and despite a very gun shy market of late, there are developing indications that the recovery is setting in – led by intensifying levels in the forward-leading economic indicators), those demand figures will be increasing. In addition, the summer driving season will do that by default.
Global demand, on the other hand, continues to rise. Both OPEC and the International Energy Agency (IEA) continue to see increasing usage, now closing in on 89 million barrels a day. This remains centered in the developing, not the developed, nations.
By mid-summer, this is all going to be coming together.
4) Geopolitical Tensions are Heating Up
Finally, there's the wildcard of geopolitical events and tensions.
Oil is traded on an international market, and what happens in one region impacts every domestic market open to global trade, regardless of how much internal oil a country may possess.
There is also another mistake consistently made about the geopolitical factor. Crises such as the current tensions with Iran, the Libyan civil war last year, or the ongoing "Arab Spring" are still regarded by many as exceptions to some "rule" of stability.
They are not.
This is the new reality of the global oil market.
All four of these elements are colliding to increase crude oil prices, intensifying the constriction now firmly in place.
To discover the best ways to profit from this perfect storm, take a free look at Kent's latest research by clicking here.]
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About the Author
Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk assessment, and emerging market economic development. He serves as an advisor to many U.S. governors and foreign governments. Kent details his latest global travels in his free Oil & Energy Investor e-letter. He makes specific investment recommendations in his newsletter, the Energy Advantage. For more active investors, he issues shorter-term trades in his Energy Inner Circle.