Oil Prices Get Rocked - Again!

It's been a tough couple of trading sessions for oil, as it's gotten walloped both days.  This is not a pretty chart towards the right, at least for oil bulls: 

Source: Barchart.com

Make no mistake, Peak Oil or not, the black goo has had a helluva run - from the $35, all the way up to $85 recently.  That's nothing to sneeze at, though less impressive when viewed with respect to it's freefall from $150.

If you believe that a severe stock market decline is on the horizon - as I do - then you probably also find oil's recent price action quite disconcerting.  It's gotten clobbered right along with equities.  If you're looking for a commodity that has held up fairly well, check out gold's recent performance.

PS: If you're not getting our Daily Investing Updates, you're missing out!  You can sign up for FREE here.  These updates are courtesy of our new blog that features Contrarian Investing News.

Peak Oil Update: Why the US is in Dire Energy Straits

How's the oil supply looking in the US?  Not particularly good, writes our good friend and colleague David Galland.

After a brief respite during the Great Deleveraging, as oil dropped to $35/barrel, it's been on a relentless climb back up.  David dives into the supply and demand fundamentals facing America here...

***

Three Mile Island for U.S. Oil

By David Galland, Managing Director, Casey Energy Report

Willie Shakespeare may have summed it up best when, borrowing the voice of King Richard III, he penned “A horse! A horse! My kingdom for a horse!”

History is replete with examples of how, but for the proverbial horse, kingdoms have been lost.

My reference point is an accident that will almost certainly lead to tragic miscalculations and havoc down the road. And, I might add, an exceptional opportunity for the patient and attentive investor.

It has to do with an impending shortage of easily accessible (read: inexpensive) oil to quench the insatiable thirst of the United States.

It’s also connected to the inroads the cash-rich and geopolitically ambivalent Chinese – among others – have been making in building strategic relationships, and making direct investments, with the world’s major energy providers.

With only so much oil to go around, every new off-take agreement signed by the Chinese with the Saudis or Venezuelans, for example, is a net loss in supply to other bidders, notably the world’s largest energy consumer, the United States.

That the Chinese, and other countries, are aggressively securing long-term energy arrangements, coincidental with what appears to be an official U.S. diplomatic initiative to actively offend all the major energy producers, makes the securing of U.S.-controlled reserves and production critical.

The problem with cheap oil can be seen in the chart here.



And it has been confirmed in a recent report issued by the U.S. military, conveniently summarized by DailyFinance: “A recent Joint Operating Environment report issued by the U.S. Joint Forces Command suggests that the U.S. could face oil shortages much sooner than many have anticipated.

“The report speculates that by 2012, surplus oil production capacity will dry up; by 2015, the world could face shortages of nearly 10 million barrels per day; and by 2030, the world will require production of 118 million barrels of oil per day, but will produce only 100 million barrels a day.”

Bottom line: The U.S. needs secure oil sources, and “on the double,” as a military type might say. And so the pressure has increased for the U.S. government to remove its actual and effective regulatory bans on offshore drilling.

While it’s more smoke than fire, the Obama administration recently made a tentative step in that direction – because even though its most ardent supporters may hate the extractive industries, Team Obama is not stupid enough to think that the energy gap is going to be closed by solar or wind power anytime soon.

Which brings us to the lost horse in this drama – the messy sinking of an oil rig off the coast of Louisiana, resulting in a spill of about 5,000 barrels, or 210,000 gallons, a day into the Gulf. It is estimated that it could take a month or more to cap the well.

The damage caused by this untimely sinking will extend far beyond wreaking havoc on the wildlife – the real importance is that it hands the luddites and enviro-fanatics just the ammunition they need to stick a brick wall in front of the baby steps underway for expanded offshore drilling. It is the equivalent of the accident at Three Mile Island, which set the nuclear power industry back by decades.

And that means precious time lost, and a near certainty that America will find itself hostage to the oil-producing nations in the years just ahead. That, in turn, means higher and higher prices, and hundreds of billions of dollars flowing overseas. Which, in turn, means a persistently high current account deficit, adding yet more weight to the pressure building on top of the U.S. dollar.

Even if the U.S. were to adopt the equivalent of a war footing in its quest for new offshore discoveries, the size of our steady demand assures that any new finds would still be insufficient over the medium to long term. If the military’s assessment is even close to being on target – with global shortages appearing in four short years – then even the most urgent action taken today would prove woefully inadequate.

But the U.S. is not adopting anything remotely close to urgent action in the quest for new oil supplies. Quite the opposite. The administration and its well-meaning but ill-advised allies are advancing legislation to hinder and penalize virtually all the base-load power providers. And thanks to the poorly timed sinking of the Deepwater Horizon rig, the opponents of “dirty” energy have been provided with a powerful weapon to be used in challenging all new offshore drilling initiatives.

How to play it? First and foremost, you’ll need to be patient. Oil prices aren’t going to skyrocket overnight, and the base-load power industries – oil, coal, gas, and nuclear – will still have to struggle through the coming onslaught of politically motivated regulatory hamstringing. Between now and the time that the depth of the nation’s energy problem becomes apparent to all, the energy sector will remain volatile.

The time to begin buying is when new legislation, coupled with a next leg down in the broader economy and markets, results in an across-the-board sell-off in the energy sector. That will be the time to get serious about building your energy portfolio. Between now and then, your goal should be to learn as much as you can about this critical sector.

And don’t forget to include the oil services sector in your studies. That sector could be the poster child for “feast or famine.” While the sector has bounced off its 2009 bottom, as the inevitable scramble for new offshore discoveries begins, the better-run companies will reward patient investors with multiples.

But first, thanks in no small part to the sinking of the Deepwater Horizon rig, the U.S. will take several steps back – away from anything that looks like energy security.

The single best way to stay closely in touch with energy and the many opportunities to profit available is with a subscription to Casey’s Energy Report, headed up by the hard-charging Marin Katusa in close collaboration with Dr. Marc Bustin, arguably one of North America’s top unconventional oil and gas experts. It is no coincidence that of 19 stocks Marin recently picked, 19 were winners… a 100% success rate. Click here for more.

Ed. note: I am a Casey Affiliate and an Energy Report subscriber - the publication is excellent, and a really great value.

Why OPEC's Reports of Oil Reserves are ALWAYS Inflated - Big Time

Many regular readers I know are big fans of Jim Rogers.  I remember in his book that got me hooked on the juice, Hot Commodities, he joked about OPEC's reserve reports when analyzing the supply/demand situation for oil.

The numbers that come out of OPEC's members are quite comical - it's like asking an extremely drunk guy at a bar to impartially evaluate his own looks, and his chances for getting laid that night!

In this piece, mathematics genius Marin Katusa takes a deeper look into OPEC's reported exports.  Read on to learn more...

***

One for All and All for... Myself


Why you shouldn’t believe OPEC’s reports

By Marin Katusa, Senior Editor, Casey’s Energy Opportunities


In December 2008, after OPEC warned of “substantial cutbacks,” I voiced my strong opinion that the members of the Dirty Dozen would cheat, because cartels always cheat. Sure enough, despite all the talk about production cutbacks, even more oil flowed out of OPEC.


The harsh truth is that the whole honor and brotherhood thing may work for the Three Musketeers, but it’s a non-starter when, like the OPEC members, you have to foot the bill for hefty social programs. 


On April 19, the Algerian energy minister said that OPEC would probably do nothing to restrain rising oil prices, despite concerns that persistently high energy costs would hurt the fledgling global economic recovery.


Take his comments with a pinch of salt.


With OPEC members currently violating production quotas at the same time that demand from industrialized nations is stagnating, our bet is that the 13-month rally in crude will soon come to an end and prices begin to fall over the next month.


What does this mean for investors? For reasons I’ll explain, get your dancing shoes on – the profit party is about to begin.


Prisoner’s Dilemma: Why Do Cartels Cheat?


Imagine you and an accomplice have been arrested for a crime that you did commit. The police lock you up in separate rooms and take their time in talking with you.


While you’re nervously waiting for the interrogator to arrive, you wonder what’s going on with your accomplice. Is he or she spilling the beans and sacrificing you in order to save their own skin? Or are they sticking to the prearranged story?


When your interrogator finally arrives, you realize your options boil down to these:

1. You can either confess to the crime before your partner does and go free.  
2. You can remain silent (and pray like mad that your accomplice does too), and you’ll both get a more modest punishment.  
3. You can wait until your accomplice confesses everything before you do, in which case they’ll go free while you’ll go to prison for years.

Now, if you trust your accomplice completely and they you, you know both of you are going to keep your mouth shut because all you’ll probably get is a slap on the wrist.


But what if the person in the other room is Libyan leader Muammar Gaddafi, or Venezuelan president Hugo Chavez, or Iranian president Mahmoud Ahmadinejad? Would you really trust any of them to put the interests of the group ahead of their personal self-interest?



Many readers will recognize this as the classic Prisoner’s Dilemma, but it is equally applicable to the situation in today’s global oil politics. Especially in that, regardless of what your accomplice does, you’re always better off betraying them.


Which is why when a cartel like OPEC sets an artificially high price by restricting the supply of a commodity, each member of the cartel always has an incentive to cheat. By offering the commodity at a slightly lower price, just one member of the cartel can attract all the customers and enhance their profit.


And if you’re Hugo Chavez and have quite a few expenditures to meet, these profits aren’t just a nice-to-have, but essential to retaining your tentative grip on power.


The (Real) Future of Oil


Members of OPEC have no choice but to cheat. They’ve cheated in the past, they have done so recently, and they will do it again in the future. In the current context, global output is rising faster than the demand for oil, even with the rising demand from emerging countries.


While China and India, among other emerging economies, account for a large and growing share of the oil market, the United States remains the biggest consumer of crude oil. And U.S. demand for oil, along with the 30 countries in the Organization for Economic Cooperation and Development (OECD), is decreasing. In fact, the 2010 U.S. daily demand for oil is expected to drop by almost 2 million barrels from last year, while OECD consumption is down 8.3 percent from 2006.


At the same time, OPEC may be creating a surplus in the market, with output rising to 29.2 million barrels a day in March 2010, a 5.6% jump from March 2009. Of course, this doesn’t take into account non-OPEC producers, which are also expected to boost their production this year by about 600,000 barrels per day.


Amongst OPEC members, compliance with quotas fell to 53% in March, with Venezuela, Nigeria, and Saudi Arabia increasing production, even as the organization said it will need to pump less than previously estimated this year.


The Pump Jack of Profit


As you would expect, the combination of rising production and depressed demand is leading to a stockpiling of oil by countries and companies alike. Basic economics dictates that this makes US$87 a barrel unrealistic – prices are set to fall.


Of course, who are we to complain about low oil prices? Lower prices are a big plus for the broader economy, just as they are when you are able to pay less at the gas station.


But it may surprise you to also learn that falling oil prices create a lot of investment opportunities. Case in point, just after the price of oil crashed in the second half of 2008, our subscribers were able to lock in profits in excess of 50% in just six months – through very conservative energy investments such as Nexen (T.NXY).



How? Using Nexen as a good example, we were able to use volatility to our advantage and pick both the right entry point and the right timing to buy the company’s shares just before they took off.


If you missed the boat the last time, don’t worry because the imminent correction in oil prices we expect will again allow you to get positioned in great companies, at great prices. But don’t put off planning your entry into the sector – that should start now, in anticipation of the enormous potential for profits that is coming.


Learn how the future of oil is creating enormous opportunities for savvy energy investors. Take us up on a risk-free 3-month trial of Casey’s Energy Opportunities. Considering the information you get out of it, the subscription fee of $39 per year is a steal. Details here.

Who's Buying Oil Today? The Answer May Surprise You

Peak Oil. Sometimes it sounds sooooo 2008.

What's the real story? Is there too much oil out there, or not enough? Seems like it's tough to get a straight answer on this question - or at least an answer that experts agree on.

In this guest piece, Marin Katusa of Casey Research takes a look at the Strategic Oil Reserves of the world's leading energy consumers. I look forward to Marin's work each month as a subscriber of his, so I'm fortunate to be able to share this piece with you here.

I can't say that this will clear up the energy confusion, but I can say that you should always listen to what Marin has to say.

Read on to get an insider's view at what's going on behind the scenes with Strategic Oil Reserves, and how stockpiling, and/or unloading, could affect the price of crude oil going forward...

***

A Look at Strategic Oil Reserves – Who's Buying Oil?

By Marin Katusa, Senior Editor, Casey’s Energy Opportunities

As the U.S. strategic petroleum reserve (SPR) approaches capacity (721.5 million barrels filled out of a total possible 727 million, and will be filled by January 2010), the federal government will fade out of the oil-buying business. Some bearish traders believe that this factor can weigh in on prices, since most petroleum stocks in the United States are government-held rather than private. Bullish traders have also used the filling of the Chinese SPR as a reason that oil should go much higher.

The team at Casey’s Energy Opportunities believe that planned government buying or selling of crude oil for SPRs actually have very little impact in the overall market. However, an overall drawdown of worldwide inventory could put downward pressure on the price of oil. The various countries also have their particular reasons and influences in decisions to tap their reserves.

So which countries are executing preparedness plans to fill their strategic reserves with $70 oil now (as opposed to $140+)? Below are the 10 countries that consume the most oil in the world, as of 2008, the latest figures available from the BP Statistical Review of World Energy:

Russia, Canada, and Saudi Arabia can leave the list, as they are net exporters of oil and thus do not actually require a strategic reserve, at least in the short term. We'll also bump Brazil, because its balance of imports is dwindling every year, and it should become a exporter before it requires a reserve. That leaves six countries to examine.

The United States

Not surprisingly, America has the largest strategic reserve in the world in an absolute sense. Its 727 million barrels are stored in four hollowed-out salt domes (and one pending) along the coastline of the Gulf of Mexico. These add up to some 62 days' worth of imports, according to government sources. The United States government currently has plans to push this to 1 billion barrels, or about 85 days' worth of imports, which would make the reserves equivalent to those of Japan and Korea.

The SPR build-up will be accomplished by expanding two of the current facilities, for an additional 113 million barrels, and (probably) building a new one in Richton, Missouri, for 160 million barrels. The Richton project has met local opposition, because it would require pumping 50 million gallons of freshwater per day from the Pascagoula River to dissolve enough salt to open up another subterranean cavern. The total cost of the program is estimated at US$3.7 billion, not including the cost to fill the reserves. Oil purchases are likely to be slow, at around 100,000 bpd (barrels per day) before 2014 and 150,000 bpd thereafter.

In a real emergency, the combined American strategic and commercial reserves (the latter held by private corporations, especially refiners) may seem unnervingly thin from the perspective of energy security. Add to that the fact that the government can release them at a rate of only 4.4 million barrels per day, or about half its imports.

Still, the 108 or so days' reserve it has between government and commercial sources are considered adequate by international standards. The United States has used this reserve twice in the past 20 years (Desert Storm and Hurricane Katrina) to combat severe demand or supply disruptions. It also has the luxury of importing more oil from Canada in an emergency.

Scenarios that could force a sustained drawdown of reserves:

• Sustained hyperinflation in the United States due to actions by the Federal Reserve that causes oil-producing countries to look for better markets to sell oil.

• A prolonged general embargo by OPEC on the United States, forcing America to look to traditional partners such as Canada and Mexico, though they might not have sufficient oil.

• Another war, potentially in North Korea or Iran, requiring a large amount of oil input from America that it simply does not have.

• A particularly active hurricane season that knocks out a large amount of production capacity in the Gulf of Mexico, and the United States releases from the SPR to help.

China

China's strategic reserves began being built in 2004, when leaders in China began to realize that the country had no adequate government-controlled reserves to combat any disruptions in the supply of oil. China is a large importer and is dependent on the same sources of foreign oil as the United States. China is even more anxious to build such a reserve, as two of its neighbors, Korea and Japan, both have large strategic reserves.

China currently has four government reserves with a total reserve potential of 272 million barrels, which translates to about 30 days' consumption. Two of the four have been confirmed full, and there are rumors that all four are and that China has taken advantage of the recent precipitous drop in the price of oil to buy up. According to Chinese government sources, however, the reserves are likely not to be completely full until 2010, and 2009 buying of oil will be at around 42 million barrels.

The government has also announced plans to increase the country's reserve from 30 to 100 days of consumption. The next stage of the development will call for an additional 170 million barrels in eight storage facilities. The locations of the facilities are as yet secret.

In an emergency, China would likely turn to Russia to buy oil, though only the naive would be surprised if Russia added a premium for the privilege.

Scenarios that could force a sustained drawdown of reserves in China:

Worldwide embargo on China due to a Chinese invasion of Taiwan.

• High oil prices force Chinese industries out of business, pressuring the government to keep oil prices low domestically by selling some of the reserves to domestic companies.

• North Korea asks for oil from China to support military action on the Korean Peninsula, and China ships it to them on the black market.

• Russia slows or stops its exports as part of the Russian "dominance via energy" strategy, leaving Chinese pipelines trickling and Chinese industries disrupted.

Japan/South Korea

We have placed Japan and South Korea's reserves together, as the two countries have a treaty that allows them to share their strategic reserves.

Resource-poor Japan has one of the world's largest strategic oil reserves, enough for 82 days of imports. State-controlled reserves are run by the state-owned Japan Oil, Gas, and Metals National Corporation. The reserves consist of 320 million barrels in 10 different locations, which makes them second only to the United States in absolute volume. Japan's island geography means that having an emergency supply of crude oil is crucial, and the Japanese government obviously has not ignored this aspect.

South Korea is in one of the global "hotspots" in the world, right beside North Korea. As the country is under an almost constant threat of war, the government has stocked up some 76 million barrels, with capacity for an additional 40 million barrels.

Scenarios that could force a drawdown of reserves:

• Just one at this time, from two possible sources: political instability in the region caused by either the Taiwan or the Korea conundrums disrupts tanker transport, perhaps even forces them to port.

India

India has a small reserve it began to build in 2004. This stockpile is sufficient for perhaps only two weeks of consumption. The country eventually wants to raise this level to 45 days, though the first phase has not even been completed yet. The projects are estimated to come online in 2012, which means it has taken eight years from planning to completion. These figures imply that India will not even have a somewhat sufficient strategic reserve until 2016, given that the expansion project was approved in 2008.

Germany

Germany has the largest reserve in Europe and is among the top in the world as well. Its government has satisfied a federal law that regulates storage be at least 90 days' worth of net imports. More than half of the storage is in Southern Germany, where large salt caverns exist. Germany is well prepared in its strategic oil reserves, and there are no glaring factors that would force a drawdown of reserves, barring a global catastrophe. Furthermore, the reserves of Germany, France, and Italy are pooled and can be used by any of the three countries in an emergency.

So How Much Do the Reserves Matter?

According to the U.S. Energy Information Administration (EIA) estimates, some 2 billion barrels are held in government-owned strategic reserves around the world. Though this seems like plenty of oil, does it really impact the spot price of oil? Collectively, the answer is yes, as this volume corresponds to 23 days' worth of global consumption. If drawn down together over a short period of time, the effect on spot price could be substantial.

For illustration's sake, suppose that countries collectively draw down their entire reserves over the period of a year. This rate would make up for 10% of the daily worldwide trade of crude oil, which could certainly impact price (imagine ConocoPhillips and ExxonMobil both going under at the same time).

Individually, however, even China and the United States have a limited impact on the spot price of oil over a single year. If the United States' inventory were drawn over an entire year, it would only make for a 4% increase in supply. Under normal buying patterns of each country's strategic reserves, the impact is even smaller. Since China's 42-million-barrel purchase is over one year, their purchase would not even make a dent in the daily trade of oil.

Thus, a concerted effort by the worldwide reserves can definitely keep prices down in the short term (within a year, two at best), but cannot make for a paradigm shift in the supply/demand model of oil or the Peak Oil argument. And from the buying side, if governments plan the filling of their strategic reserves, the impact on the spot price of oil is likely to be minimal.

Perception is a tricky horse to ride, however, as we all know. Given a worldwide panic for oil à la the 1973 oil embargo, oil prices could spike in the short term, because government reserves would likely raise purchases 10% or so in a real emergency. This effect would be short lived for the foreseeable future, though, as worldwide reserves are already reaching their limits.

In short, if everything goes according to “plan” by the governments, even filling a large reserve such as the Chinese SPR would have little impact on the price of oil. For SPRs to truly impact the spot price of oil, it would have to be a global situation, with war and embargo the two most likely scenarios. Even then, the impact would be mellowed by limitations on how quickly governments can either release or purchase the oil.

Marin Katusa is a math prodigy and the chief investment strategist of Casey Research’s Energy Division. At the age of 31, he is one of the youngest self-made multimillionaires in Canada… thanks to an algorithmic system he developed that alerts him when a company with sound fundamentals has become so undervalued that it’s a screaming buy.

For years, Marin has been advising Casey subscribers on the best energy picks, generating extraordinary returns. Learn how you, too, can profit from his “secret system” – click here to read more.

Huge Oil Inventories Just Reported

This morning, the US Department of Energy reported, well, HUGE inventories in oil. Oil's decline hastened on the news.

I'm wondering if oil has placed in its short term top, on it's way back down to the $40 range, or perhaps lower (maybe even $20 as predicted here?)

After rallying north of $140 last summer, oil will post a decidedly "lower high" if we have indeed already seen the short term top in the black goo. Whether or not it posts a lower low remains to be seen, but I wouldn't rule it out.

Many folks get outright pissed if you suggest that oil could fall...in fact a recent outraged commenter referred to me as a "moron."

Now that very well may be the case, but let me ask, who could have pictured $3 natural gas, when prices looked like they'd never dip below $10 again, and everyone was talking about Peak Drilling in North America?

Peak Oil is not as scary when demand evaporates faster than supply comes offline. Sure, things may get ugly again if and when the global economy actually recovers, but that won't help your portfolio in the interim. If you're thinking long term, I commend you, that's just not for me any longer.

And remember that the last time oil rolled over, the equity markets were soon to follow. It will be interesting to see if a top in oil again precedes a stock market collapse.

Further reading: An energy executive shares his insights on where the price of oil should be.

Hat tip to The Daily Crux for digging out this link.

$20 Oil Just Around the Corner? Energy Expert Predicts It

Crude oil expert Philip Verleger, who correctly predicted oil would hit $100 back in 2007, is now forecasting $20...this year!

Verleger says that supply is outpacing demand by 1 million barrels a day - and with the global economy not really improving, a warm winter could prove to be "devastating" for oil prices.

This jives with the outlook for crude that we looked at last Friday - there's just too much of it right now!

I imagine that $20 oil would probably destroy commodity prices across the board. Be very careful with your long positions, and if you are enterprising/brave, there may be some great short plays to be had in the very near future.

Hat tip to our friends at The Daily Crux for this nice find.

The Outlook for Crude Oil From a Top Industry Exec

Last night I had the opportunity to sit down with PG, who is the head of a small refinery based in Texas. We talked about the economy, and most specifically, crude oil - where the price may be heading, and supply/demand considerations.

(OK it's my father-in-law...we were having an after-dinner beer...but I'll take his insights on the energy complex against any of the talking heads on financial TV! He's been in the refining business for over 25 years, and really knows his stuff.)

***

On the price of oil...

Oil fundamentals don't support $70 crude oil. There is plenty of oil right now. Oil should be priced in the $40's and $50's based on fundamentals.

On the new potential CFTC regulations...

That would be good for refiners, because it would drive the price of crude down as the speculative premium is chased out of the market. (Brett note - looks like they may have started to break in already!)

Break-even prices for crude oil...

Although crude should be priced below $60, it actually needs to stay above $60 to keep North America drilling. A LOT of supply has come offline in the US and Canada, because often it doesn't make sense to drill below $60.

Could we see another price spike...

If and when global demand comes back, the price of oil will skyrocket. The high level of oil and gasoline prices today - with global demand in the gutter - is a testament to how tight supplies are. ANY real move on the demand side could send prices up...very fast!

***

Brett again - I wouldn't be surprised to see crude oil trade between $40 and $60 for some time. Now crude does have a history of going much higher...and much lower...than anyone expects.

I just think that with all the supply on the market, we're going to need to see a real recovery to the global economy to see a sustained rise in oil prices. And I just don't see any signs of that yet. But when oil does start to rise, we could be in for a helluva shock!