Crude Thoughts…

In terms of the stock market this past week, we set new all-time highs in both the Dow and S&P500. The S&P folk say that’s 41 times the index has done that so far this year – after having done it 45 times last year. The NASDAQ is also along for the ride, having reached its best level last week since March 2000.

We also had the US dollar continue to demonstrate (sort of) Mr. Einstein’s Theory of Relativity as during the week it continued to move higher in relation to the yen, the British pound and what is referred to as a “basket of foreign currencies.” The main reason for this move over the past few months is the global perception that our interest rates will be rising while they will dropping most elsewhere.

Global markets in such commodities as precious metals and crude oil trade exclusively in US dollars. As a result, and due to the dollar’s increasing strength, the prices of these tend to move lower. This is also one reason for gold and silver trading to lows not seen since early 2010 last Wednesday.
And…why US crude oil has dropped from $105/barrel at the end of June to $75.90 on Friday?

Oil big picture

While the dollar’s strength has definitely played a part in the currently low prices, the real driver(s) in my opinion have been US technology and entrepreneurship. This potent mix combined – yet again – to do something that had previously been seen as impossible…being able to find and extract energy from places and spaces with methods no one had considered or imagined. It’s worked pretty well too. Matter of fact, we took over the top global oil producer ranking from the Saudis earlier this year. (For those of you who were extant in the late 1970s, you may recall the media and administration at the time constantly reminding us that we were in seemingly imminent danger of running out of energy…)

Since that time in the 70s, the Organization of Petroleum Exporting Countries (OPEC) has pretty much driven the crude price by increasing or decreasing their collective production. This US production, along with a lessening of challenges in other oil-producing nations, has changed that situation. (Moreover, these OPEC guys don’t exactly fit in to the best buds category. Their individual national self-interests ultimately are their prime motivators v. the greater good of OPEC.)

As oil prices rose, they managed to move their spending up right with them. Their national economies now require a certain price level in order for them to maintain them – and the subsidies and benefits they provide their citizens. Hence, their meeting on 27 November in Vienna could be quite instructive as to what they’ll be willing or able to do…as a group.

The Saudis are still the lead dog by far in that group. I don’t think they’re interested in or willing to take any production cuts on themselves so I’m sure the meeting will be quite interesting…

The main reason

In my opinion, basic economics are the cause for the oil prices being at these levels.

There have been a lot of bytes burned up talking about “slowing global growth” recently. That’s only kinda true.

For example, over the past ten or twelve years, China itself had accounted for about a third of the world’s annual growth in oil demand. With their challenges in managing their internal economic growth for the time being, this part of global demand growth has been cut back.

The key phrase being “demand growth.” The key here is that global day-to-day demand continues to rise. There hasn’t been a drop below the previous year’s demand levels since the year between 2008 and 2009. So, with annual growth for crude having slowed and with the lows for slowing elsewhere in the world seeming to be close upon us, seems to me we’re getting close to a price bottom.

Investing considerations

Whether the lows are near or not, it’s already evident that we have many opportunities arising from the drop to date. Most noticeable to the public is the cost per gallon of gas.

Those market forecasters at CNN Money said in 2011 that, “Gas prices won’t be lowered by more domestic drilling; domestic production can’t possibly move gas prices from $4 to $3 per gallon.” According to Gasbuddy.com, today, even Hawaii has gas below $4 with South Carolina having the lowest average at $2.65. The Brookings Institute recently reported that the decline, so far, represents what is, in effect, a $500 “tax cut” per US household.

That’s being reflected in the strength of the consumer discretionary sector shares and may have helped retail sales in October come in at a better than expected level. It’s also a major benefit to transportation firms (rails, trucks, airlines) as their biggest expense has been significantly reduced. And, part of the ripple effect has it cheaper to make and ship stuff here, as well as to travel outside the country.

Looking forward, I see an ongoing and likely increasing demand for the build-out of energy related infrastructure projects. Think pipelines, storage, processing and transport. In the interim, it may be a really good idea to revisit the MLP universe, especially with a view toward those entities which are in the infrastructure business. Their shares have also been hit by the oil drop, though, inasmuch as those companies earn fees or have fee-like margins, their real exposure to price fluxes is limited. Values also exist in the name companies, having been marked way down and still paying those good dividends while you wait for recovery.

The two big challenges are, first, not knowing where the real bottom is or when it shows up. That’s always the challenge, so don’t jump all in. Stage in some money so you don’t miss it altogether and add as you see fit.

The other is where does the price of crude go before it really affects drilling.

Well, using data from the International Energy Association (IEA) and Petroleum News, at these levels, US crude prices remain above breakeven for the largest fields. Globally, according to GaveKal Capital, only about 3% of oil production has a breakeven above $80/barrel.

And the frackers in North Dakota? No worries there. ND state officials consider a price of $42 the point at which most production would stop and that’s a good distance below the current market.

Summary

Values seem to abound for long-term energy investors right now. With global demand for energy not going away and history telling us that the market is now at the start of its best performing three month period, investing here in the high-quality companies in the sector could work out to be a great present for yourself.
Cheers!

Mike