It is always impolite to ask a lady her age. But the oil bull market is certainly no lady, besides which, we know she is about ten years old.
Earlier this week, NYMEX crude oil futures, in un-lady like fashion, bolted to an intra-day high of $127.27. It capped an exuberant dash which saw oil gain over 8 per cent in six trading days, 30 per cent since the beginning of the year, and 100 per cent in the last 12 months. It's just the sort of thing you'd expect from a ten-year old.
Here is an astonishing fact: on December 10 1998, the spot price for a barrel of West Texas Intermediate crude was exactly $10 and ninety eight cents.
Nearly 10 years and one thousand and sixty two per cent later, it is time to ask some impolite questions about oil.
Impolite questions are not always obvious questions, though. The obvious question is to ask how high oil can go. Arjun Mutri and his team at Goldman Sachs have told us a disruption in supply could send oil to another 'super spike' over $200. Two years ago, the "super spike" was supposed top out at $100. Maybe it will be $500 two years from now.
It is easy to keep raising the figure, but is probably more useful to ask a different question. The important investment question is not how high oil can go from here. The impolite but important investment question is where future global oil production will come from at all.
The answer, according to a new report from UBS, lies with just eight oil companies, one of which investors can't even buy. Below, I'll look at where future production may come from, who stands to profit the most, what investors can do now, and three "Black Swan" possibilities for the oil market that no one has prepared for.
Why are oil prices so high? An obvious question on the lips of anyone who buys petrol is, 'Why are oil prices so high?' Consumers trained in the ways of the free marketand used to cheap clothes and electronics made in China -- are right to ask the question.
In a fully-functioning free market, rising demand tends to attract rising supply. The reason? Profit.
When a market is imbalanced and demand exceeds supply, prices rise. At that point, opportunistic new producers tend to rush in and grab some of the profits by brining on new supply. Prices fall and, for awhile anyway, equilibrium is restored.
That's how it works in textbooks. That is not how it's been working in the real world. According to the International Energy Agency, world oil demand has increased in each of the last three years, from 84.9 million barrels per day in 2006, to 86mbbl/day in 2007, to this year's rate of 87.2mbbl/day.
The IEA's most recent forecast calls for global demand of 87.8mbpd for the rest of this year.
In response to this increase in global demand, OPEC oil production promptly declined by 265kbpd in February (the latest period for which official figures are available) to around 32mpbd. Not exactly helpful. And latest survey from Platts predicts a March decline in production of 347kbpd from the February figure. This brings average OPEC production below 30mbpd for the month.
This past weekend, U.S. President George Bush travelled to the Kingdom of Saudi Arabia, politely requesting the Saudis increase oil production to bring down gas prices in America. The Saudis demurred, and told the President oil production was more than sufficient to meet global demand.
OPEC blames the oil price on the weak U.S. dollar, but admits prices could go higher still. OPEC President Chakib Khelil explained the situation to journalists in late May, saying:
The prices are high due to the fact of the recession in the United States and the economic crisis which has touched several countries, a situation which has an effect on the devaluation of the dollar, and therefore each time the dollar falls one percent, the price of the barrel rises by $4, and of course vice versa.
In other words,