After tumbling last week, crude oil prices rebounded hard this week. So who can blame investors for being confused? Are oil prices going to march higher again, or slump back to more “reasonable” levels? And what is reasonable after crude oil’s 30% surge higher this year?
Let me give you my reasons why I think crude oil prices are likely to stay high and go higher — and how you can play it.
Reason #1: Iraq Cuts Future Production Target in HALF.
Over the weekend, Iraq announced that it will now pump between 6.5 million and 7 million barrels per day (bpd) by 2017 — way, way down from its original plan of 12 million bpd.
It’s not because of low oil prices — oil prices have doubled since the 12-million bpd target was set two years ago.
Currently, Iraq produces about 2.68 million barrels a day, barely higher than under Saddam Hussein.
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Iraq was one of the great hopes of the oil cornucopians — those folks who think we’ll always find more oil. Apparently, we aren’t finding it in Iraq.
Reason #2: The Saudis Failed to Cover Libya’s Shortfall.
You’ll remember that when Libya — the world’s 17th largest oil producer, 3rd largest producer in Africa and that continent’s largest holder of crude oil reserves — fell into civil war in February, its 1.6 million bpd production was quickly cut in half. Saudi Arabia said it would make up the difference.
Saudi Arabia DID pump more oil in February — but that was the culmination of long-term projects. But more recently, Saudi oil minister Ali al-Naimi revealed that the country’s crude oil production for the month of March fell by 833,000 bpd from February’s production level.
The Saudis blame lower demand for their sour crude. And maybe that’s true. But if so, this doesn’t do much to reassure the oil market that the Saudis can make up the difference when producers of light sweet crude falls short.
Also, before the Libyan crisis, the Saudis claimed they could tap 4.2 million bpd of spare capacity at any time. During the Libyan crisis, the Saudis downsized their claimed spare capacity to 2.5 million to 3.5 million bpd.
And some analysts believe the Saudis only have 1 million bpd in spare capacity. That’s really not a lot of wiggle room if something else goes wrong … and something always goes wrong.
Reason #3: The Mystery in the Desert.
The Saudis are always up to something. Recently, Saudi Arabia announced it was going to spend $100 billion on solar, nuclear and other renewable energy sources. That is a lot of money for a country that is supposedly floating on all the oil and natural gas it should ever need.
The Saudis say they are doing this to boost the amount of spare oil they have for export. And to be sure, the Saudis currently consume 2.7 million bpd (27% of total production) and that is expected to grow to 8 million bpd by 2025. In case you’re wondering, us fuelhog Americans consume 19.5 million bpd.
Still, if the Saudis have all that spare oil, why don’t they just sink a few more wells? Unless, maybe, they don’t have that spare capacity. Hmm …
Reason #4: The Global Economy Runs on Oil.
The International Monetary Fund (IMF), expects global economic growth for 2011 to be 4.4%, according to a recent report.
This will put more strain on a system that already saw global oil consumption grow by 2.6% in the first quarter of 2011, on top of 4.1% growth in the fourth quarter of 2010, according to the International Energy Agency.
What’s more, the second quarter typically sees an uptick in crude oil demand as refineries come out of maintenance. That should lead to higher oil prices.
Now the good news for U.S. consumers is that we are swimming in oil thanks to oil shale deposits that are coming into play — so much so that U.S. crude oil benchmark West Texas Intermediate trades at a $13-per-barrel discount to an international benchmark like Brent Crude. But that discount will come under pressure as more U.S. oil is shipped overseas to fast-growing economies.
Speaking of which …
Reason #5: Asia Puts the Pedal to the Medal.
While the IMF expects the world economy to grow at 4.4% pace, emerging market economies are growing much faster. The Asian Development Bank expects a growth in the region’s economy, of 7.8% and 7.7% for 2011 and 2012 respectively.
That’s bullish for oil prices because automobile ownership and gasoline and diesel usage is growing at a furious pace in those countries.
According to Financial Times, while European crude oil demand for February was largely flat, and U.S. oil demand might grow 2.9%, Asia as a whole is expected to see its oil demand rise 5.9% and China’s should rise 9.6%.
And it should keep rising. In China, a big driver has been growth in the domestic automobile market. Auto sales increased 2.6% in February, and March data released by the Chinese Auto Association shows sales grew 5.36% on a year-over-year basis.
There you have it — five reasons why oil prices should stay high. Of course, no one can foresee the future. There is a flip side …
Could Oil Prices Go Down? Yes, but You Wouldn’t Like It!
The one potential way that I see crude oil prices could really tumble is if we have a global recession. That would downshift those growing economies in a hurry and should send oil prices skidding lower.
But probably not for long. Why? Because existing oil fields are depleting — the average depletion rate is 5.1% per year, according to the Association for the Study of Peak Oil. So that cheap oil is being used up.
At the same time, the newer oil projects coming online require higher and higher break-even costs. Estimates of break-even costs for new oil projects range from $79 per barrel to $92 per barrel.
You can see the problem here: A “reasonable” price for crude oil gets higher all the time.
So, if oil prices dipped below those prices, the new projects would shut down. Soon, we’d have less supply coming on to the market. That, in turn, would force prices higher, whether the economy was in recovery or not.
How You Can Play the Next Surge in Oil
Oil explorers and producers are leveraged to the price of oil. One of the easiest ways to play what will likely be higher prices — and big fat profit margins for oil companies — is to buy the Energy Select SPDR (XLE). And the stocks that form the backbone of the XLE should also do well on an individual basis.
No one likes paying higher prices at the pump. But you can protect yourself and potentially profit with the right investments.
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