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Retired chief investment officer and former NYSE firm partner with 50 plus years experience in field as analyst / economist, portfolio manager / trader, and CIO who has superb track record with multi $billion equities and fixed income portfolios. Advanced degrees, CFA. Having done much professional writing as a young guy, I now have a cryptic style. 40 years down on and around The Street confirms: CAVEAT EMPTOR IN SPADES !!!

Thursday, January 18, 2007

Oil Market

Over the past four years, my analysis has seen the equilibrium
price for oil rise from $37.50 bl to around $45.00 bl. The actual
price was far stronger than the equilibrium price reflecting
healthy underlying demand growth, a very tight supply situation
and powerful speculative purchasing based on the dimunition
of spare production capacity to an exceptionally low 1 million
barrels a day. The bear market, which began last summer when
crude topped out at $78 bl., has seen the price drop to just
a tad above $50 bl. Cover stocks were built to multi-year highs,
demand growth has moderated, and supply growth has picked up,
creating up to 2.5 million bd in spare capacity currently.

In short, the market has begun to return to balance, and because
new supply comes on in size and not in drips and drabs, there
may be a moderate build up in spare capacity over the next few
years, even as demand grows. These developments have led to a
groundswell of comments by industry observers about how low the
price of oil could go over the next year or so. I'll have none
of that. With demand now over 85 million bd worlwide, the
industry needs a higher margin of excess capacity to provide
assurance to economic growth. Moreover, I could be on the low
side with my cost estimates, as new supply will come on with
higher finding, development and lifting costs embedded. So, oil
at $45 bl. is fine by me as a working assumption.

Ever since the US moved against Saddam's regime in Iraq in 2003,
a number of geostrategists and pundits have been speculating
about a US strike on Iran to cripple its nuclear dvelopment
capabilities. I have viewed this as a crock of BS. However, there
are now two full US battle groups in the Persian Gulf and the
entire theater is under Admiral Fallon's flag. I still doubt that
the US plans a pre-emptive strike on Iran, but the US may go
after overland and ratline supply routes leading from Iran into
Iraq, and such action, should it occur, might give a substantial
goose to anxieties about oil supply from the region at large. So,
we will have to watch for this little saga as the year unfolds.

In the meantime,If oil gets down into the $40's, it will be time
to dust off the oil stock groups for a look. I have avoided this
industry for a couple of years now because the crude pricing
assumptions have been on the generous side. There has been lots
else to trade, so I have not missed it.

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