How Will China Affect The Oil Market And Price Of Oil?

The Hungry Dragon: China’s New Oil Market

By Marin Katusa, Chief Investment Strategist, Energy Division
If you ever happen to eavesdrop on a conversation between energy investors, two words are sure to crop up – China and oil. Usually, they’re used together and usually, it’s about China’s increasing presence on the global oil scene.

It’s a pretty safe bet that, as one of the world’s fastest growing economies, China needs a lot of energy. And with an oil appetite that grows by 7.5% each year, seven times faster than the U.S., the country’s reserves don’t even begin to compare to the consumption.

But fuelling the blistering pace of its economy is China’s number one priority, and it is on a mission to lock down its energy interests all around the world. The emerging powerhouse has often felt that it was the last one onto the energy playing field with a lot of catching up to do.

Today, Chinese national oil companies (NOCs) are setting up shop everywhere from the Middle East all the way to the oil sands of Canada, and they’re open for business. The three NOCs – CNPC/PetroChina, Sinopec and CNOOC Ltd – are slated to produce a record breaking one million barrels daily. That’s Australia’s daily fuel consumption!

It isn’t just their oil production that’s going through the roof. Since 2009, China has committed nearly US$25 billion into corporate and asset acquisitions. China isn’t going it alone either, and fully realizes the importance of forging partnerships with other international oil companies to develop oil fields.

And with Beijing firmly behind them, they’re only doubling their efforts this year. Chinese NOCs accounted for nearly 20% of all global deal values in the first quarter of 2010. This share will only get bigger as the year carries on and energy security continues to dominate the agenda.

Armed with strong finances, an aggressive approach, and implicit government backing, Chinese companies are well placed to spearhead the nation’s mission of diversifying its international energy portfolio. The latest thing to catch their attention: the mysterious oil elephants of East Africa.

Hunting for Elephants: Fortune Favours the Bold

Africa might be the last place left on Earth where elephant deposits – very large oil and gas deposits – remain to be found. But contrary to popular belief, the real money in African oil is not in the West nor the North, but thousands of miles away in East Africa.

It is here that one of the last oil elephants of the world waits. A lack of significant discoveries and long-term instability left the region largely unexplored and ignored for the last 50 years. Until last year, when Irish giant Tullow Oil found over two billion barrels under the waters of Lake Albert, Uganda.

The excitement running through the region’s oil market at the moment is palpable. The first annual Eastern Africa Energy Week held this year in Nairobi, Kenya, was resplendent with the heavyweights and superstars of the oil business; prominent amongst them were delegates from China’s CNOOC, who were out in full force. That they were all there to study strategies, policies and regulation, and the critical issues facing companies in the market shows exactly how seriously they’re taking East Africa.

In a region where the market is populated largely by smaller-cap firms hoping to get in on the ground floor of emerging energy-nations, the takeover potential is enormous. It’s no surprise then that CNOOC is jostling with the big names of oil exploration in Africa – Tullow, Total SA, and Anadarko – to get a slice of what could be an energy goldmine.

But East Africa will be no cakewalk for oil explorers. They will face a multitude of challenges and there is risk by the bucket in each venture. Only those companies with the right project locations and the right people to execute business plans in the difficult working conditions of East Africa will survive to win the jackpot. So pick your portfolio wisely and buckle up for this jungle ride… it’s going to be intense.

[Ed Note: If you aren’t already investing time in understanding the developing opportunities in energy and energy-related investments, you risk missing one of the most important big trend profit opportunities of the next 20 years. Casey Research offers several research services that are dedicated to the sector, including our baseline Casey’s Energy Opportunities. Sign up today and you’ll get 12 issues, including Chief Investment Strategist Marin Katusa’s carefully researched picks, for just $39 a year – just over $3 for each issue. Add to that a 90-day 100% money back guarantee, and it’s a no-brainer. Details here.]

What Will Happen To The Price Of Oil?

Is the price of oil going up? Is it going down because the economy is in the tank (pun intended)?

Experts differ. Peak oil, I feel, is real. Billions of people on this planet will drastically increase their usage of petroleum products, even if they do drive electric cars.

Let’s hear how we can profit on our investments by knowing what will happen with oil and its price over the next year or two.

Marin Katusa is head honcho of a high quality investment newsletter with a pretty darn good track record of making money for his subscribers.

Cheap Oil is Gone, and That’s Good News

By Marin Katusa, Senior Energy Strategist, Casey’s Energy Report

Over the next year or two, you will likely find yourself paying a LOT more at the gas pump. Big changes are taking place in the oil industry. With increased global demand and declining supply, easy oil is not so easy anymore.

Everything is about to get more expensive. From gasoline to anti-freeze, life jackets to golf balls, and eye glasses to fertilizer. There are very few things in the modern world that aren’t made from oil, made by machines dependant on oil, or shipped by vehicles powered by oil.

The implications, at first glance, appear to be the opposite of good news. In fact, it’s enough to strike panic in the hearts and wallets of the average consumer.

And that’s exactly why the International Energy Agency just released its annual World Energy Outlook, clearly rejecting the possibility that crude output is now in terminal decline. Their attitude seems to be, what you don’t know won’t hurt you. For now that is.

The truth however, is beginning to surface, and from an investor’s perspective, the truth can mean money in the bank. Right now, the IEA’s claim that oil production will be ramped up from its current level of 85 million barrels per day to 105 million barrel per day by 2030 is receiving harsh criticism.

Cheap Oil ChartThe Guardian reports, “The world is much closer to running out of oil than official estimates admit.”

This comes from a whistleblower inside the International Energy Agency who states the fear of triggering panic buying has caused them to intentionally underplay the inevitable shortage.

Kjell Aleklett, professor of physics at the Uppsala University in Sweden, and co-author of a new report ‘The Peak of the Oil Age’, states “oil production is more likely to be 75m barrels a day by 2030 than the ‘unrealistic’ 105m used by the IEA.”

According to Professor Aleklett’s research, they are making a dangerous and unjustified assumption. One that is dependent upon the oil industry’s ability to ramp up production to levels never before achieved.

Are you beginning to see the opportunity here?

Whistleblowers and scientists are not the only ones disputing the IEA’s report. The folks who pump oil aren’t buying its rosy scenario either.

  • Total SA, the French oil giant, that is making its move into the Alberta oil sands, doesn’t accept the IEA’s optimistic claims. The company runs on the belief that oil production won’t surpass 95 million barrels.
  • Former chief executive officer of Canada’s Talisman Energy, Jim Buckee, agrees the IEA prediction is nonsense.
  • Sadad al Husseini, energy consultant and the former exploration and production chief of the world’s largest oil company, Saudi Aramco, recently said, “Oil supplies have reached a capacity plateau and will not meet a growth in demand over the next decade.”

The Globe and Mail recently joined the debate stating, “New [oil] fields, generally smaller, are less productive than old ones – note the virtual freefall in production rates from the North Sea fields, which reached peak output in 2000. Another reason [for the decline] is development pace, or lack thereof. The yet-to-be-developed reserves in the WEO report cover 1,874 fields of various sizes that would have to come into production in the next 20 years.”

That works out to almost eight new fields being brought to production each month. A realistic target? Only time will tell. Even if the oil exists, the next question becomes one of money, and where it will come from in order to keep this pace of development on target.

When you add in professor Aleklett’s conclusion that production will shrink to 75 million barrels per day by 2030 — almost one-third less than the IEA’s figure and 10 million barrels less than current production, it’s easy to see why investors need to take notice.

Shrinking supply and ever-growing global demand are creating the perfect storm for oil prices.

The current price of crude could be the bargain of the century. Understand this and every increase at the pump will give you reason to smile.

If you’re looking for the best way to capitalize on the end of cheap oil, there’s no better time to sign up for my advisory service, Casey’s Energy Report.

Subscribers have been handed 19 consecutive winning stock picks in 11 months. Now you have the opportunity to learn which stocks I believe will profit from the looming oil shortage. For more information  click here.

Price of Oil – Is Oil Going Up or Down and How to Profit

Oil: Black Gold, Texas Tea.

We could make a fortune if we knew for sure what the price of oil was going to do and the time frame it was going to do it in. Many fortunes have certainly come about from finding, drilling, refining and delivering the stuff.

The only thing we really know for sure is that oil is what fuels the economy of the West, and more and more the East, and that all of the easy to get, high grade stuff has been gotten.

I was in the oil business for 10 years a few decades ago, back at the end of the era of “big oil”. So I have a keen interest in the gooey black stuff, and watch the price of oil fairly closely. But when it comes to investing in oil stocks and oil exploration stocks, I rely on the experts at Casey Research through their excellent investment newsletters on the topic.

Here is an essay from Joe Hung, one of Casey Research’s oil researchers.

Oil: Short-Term Bear, Long-Term Bull

By Joe Hung

On October 21, 2009, oil broke US$80/bbl for the first time this year, more than double from the February low around the US$35 mark. Here at Casey’s Energy Confidential, Casey’s Energy Report, and Casey’s Energy Opportunities, we are frequently asked for our outlook on the price of oil.

Our response typically is this: we are short-term bears on oil and believe in a general market retreat to knock the price of the commodity back down, yet we are long-term bulls due to the fact that we believe the supply of cheap oil is running out.

These two views are definitely not contradictory. In fact, if we are correct (and we have every reason to believe that we are), our subscribers will be able to grab the chance of a lifetime when the price of oil dips down once again and ride the upside that is inevitably to come. So first let’s look at our rationale for being a short-term bear on oil:

1. Short-term equity markets

During a panic, as we saw in the past year, all the boats in the water sink, not just the leaky ones. Quality companies were trading below the cash they held in hand, and people were selling indiscriminately. We do expect that the “second dip” of the recession is coming soon, and at that time, commodities such as oil that are intently tied with the industry of developed countries will fall hard. As people reduce their risk appetite in the short run during this panic, the U.S. dollar might have a short-term bounce, which will again drive down the price of commodities that are denominated in U.S. dollars, such as oil.

2. Near-term fundamentals

Looking at the OECD data from June, we see that production is at 2007 levels, but consumption is down by 7.2% when we compare June 2007 to June 2009. Inventories are also up by 200 million barrels since then. When we focus on the United States, the numbers become more apparent. In July of 2009, the U.S. consumed just 581.9 million barrels, 9.5% less than 2007. In fact, the last time the U.S. consumed so little oil in the month of July was back to 1997! Inventories, though much lower than in the months of April and May, are still much higher than their 5-year average. Clearly, in the short term, we should see a retreat at least 10% below 2007 levels, which would peg oil at US$65 within the next year.

Now let us look at why we think oil will take off after this drop:

1. Diminishing supply of cheap oil

Unfortunately for the gas-guzzling world that we live in today, the days of oil gushing out of the ground hundreds of feet into the air are over. Today’s oil is getting harder and harder to extract, as most of the easily pinpointed and extracted oil has already been taken advantage of. The best deposits are now generally now either locked in offshore waters (Gulf of Mexico, Brazil, West Africa), or in politically unstable regions (Libya, Iran, Iraq). Oil sands are another huge reserve, but they can be expensive to extract (at least $30 a barrel). This means as we use more and more oil, oil prices will be rising due to the increase in costs that are involved.

2. The long-term depreciation of the U.S. dollar

At the present, oil is denominated in the U.S. currency. This situation could last for quite a while until the other countries of the world agree to have it changed. This means if the Federal Reserve continues with its expansionary monetary policies, oil will continue to rise.

3. The emergence of developing countries

Right now, the OECD (Organisation for Economic Co-Operation and Development), the collection of most of the developed nations in the world, account for about half the oil consumption in the world. This number will decrease as countries like China and India begin to raise their standards of living, thereby increasing the amount of oil consumed by their denizens. This can only be an upward, not a downward pressure on the price of oil, especially combined with No. 1 summarized above.

So the conclusion is that though we view oil as a go-to commodity to watch for in the future, in the short term it is very vulnerable to pullbacks in the overall equity markets. We thus have cautioned for conservatism in our energy letters, and use US$40 as the basis for our analyses. If a company cannot be profitable at US$40/bbl oil, it will underperform its peers even when oil is higher. This next drop in the price of oil may be the best time to load up on high-quality oil explorers and producers, and putting money in this sector could be one of the best decisions in your investment career.

Chris again. Thanks Joe, very interesting stuff.

Please note: At just $39 a year, Casey’s Energy Opportunities is a great way to begin building your knowledge of oil and the entire energy sector. More here.

For more experienced investors, check out a no-risk trial subscription to Casey’s Energy Report or our premium Casey’s Energy Confidential alert service, which includes a subscription to all our energy newsletters, as well as special alerts to tip you to fast-moving and very early-stage opportunities, including private placements.

However you decide to approach the energy markets, the key point is to make them a part of your overall portfolio planning. That’s because, regardless of everything else that’s going on in the world, people and businesses need energy… and therein lies the opportunity.

What’s Going To Happen With The Price Of Oil?

The Price of Oil

How did it get here, and where is it going?

By Marin Katusa, Senior Editor, Casey Energy Opportunities

What a difference a year makes.

While March lions and April showers were at work in 2008, so were these factors in the U.S. and global economies:

  • The Dow Jones Industrial Average remained steady above 12,000.
  • The leading indicator of existing home sales was down over 21% from the previous year, and the official unemployment rate was just beginning its upward creep by crossing the 5% mark.
  • The first official admissions of the “R” word. In early April 2008, the International Monetary Fund (IMF) declared a 25% chance of a global recession, and Federal Reserve Chairman Ben Bernanke told Congress that gross domestic product “could even contract slightly.”
  • The novelty of bailouts began. Bernanke also assured Congress that the Fed’s emergency authorization of a loan against $29 billion of Bear Stearns assets wasn’t putting taxpayer money at risk: “I feel reasonably confident that we’ll be able to recover all the principal and indeed some interest, and there is some chance of even upside beyond that.”
  • The dollar’s six-year slide against the euro, hitting its lowest ever at $1.60 in late April. It also fell below the 7-yuan mark in China for the first time.
  • And oil, comfortably above $100/barrel, was heading for its summer crest of $147.

A scant 12 months later, the Dow is trying to stagger back from a plunge to 6,500. Home sales are hinting a possible turnaround, unemployment (even the official, conservative figures) is expected to reach double digits before long, “recession” and “bailout” are household words (often accompanied by four-letter ones), the dollar is recovering… and a barrel of oil is worth half that hundred dollars. Hardly worth pulling out of the ground.

What happened? And even more important for us as investors, what’s going to happen?

The Casey Energy Opportunities team pulled together the pieces of the oil sector picture that other sources tend to scatter or ignore. We’ll give you a broader understanding of the drivers within the oil industry, the markets in which they operate, and how you can use that knowledge to push your profits upward.

The Oil Industry Now: A Rock, a Hard Place, and a Supply Glut That Isn’t

Everyone who drives a car or heats a home with petroleum has welcomed the fall in oil prices from their high in the summer of 2008.

While it’s hard to argue that filling your tank at $2 per gallon is a lot easier on the wallet than $4 or $5 per gallon, the broader economic effects of such low oil prices are troubling.

Leading the concerns is the drop in oil exploration and drilling that accompany a drop in price. Below the $50/barrel mark – and for many companies the bar is closer to $65 even for conventional fields – oil producers typically spend more money getting oil out of the ground than they can recoup by selling it. At the same time, turbulent financial markets have tightened credit. These two factors have pressured producers to allocate exploration budgets away from drilling projects and toward meeting debt obligations and day-to-day operating costs instead.

The plunge in prices has consumed the cash buffers of even the major oil companies. ConocoPhillips, for example, announced in January that along with eliminating 1,300 jobs and writing down $34 billion in assets, it was also planning to cut its 2009 investment budget by 18%. Exploration projects are part of both writedowns and spending cuts. The results of curtailed exploration are two-fold. First, some oil companies will be simply unable to survive the economic crisis. Second, supply in the longer term is being sacrificed to stay afloat now.

Storage facilities are bulging. The chart below shows the contents of the Cushing, OK, storage facility – where NYMEX deliveries take place – have recently doubled from their average 2008 volume. Along with a host of other facilities around the world, it got this way because of an unusually dramatic contango at the beginning of 2009. (A contango is a kind of market inversion, when the current [spot] price dips lower than the future price.)

crude-storage-levels

In January, the spot price of oil plummeted as low as $37/barrel, while futures for July delivery were trading for $52. That meant if an oil company could buy and store product for seven months, it could lay out $37/barrel and be guaranteed a profit of $15 – or 40%, minus costs – in July. And indeed the buying frenzy took off, reinforcing the decision to turn off the drills.

So for the moment, we are artificially flush with oil, and demand has dropped as the global economy will likely shrink for the first time since World War II. It’s no surprise that oil prices have been staying down.

Many analysts say we won’t feel the effects of declining exploration for a few years. But the numbers are emerging already. According to the U.S. Energy Information Administration (EIA), non-OPEC countries demonstrated an average annual growth in supply of 570,000 barrels/day from 2000 through 2007. In contrast, they recorded a drop last year of some 300,000 barrels/day.

At the same time, OPEC appears to be conforming to its production cuts of 4.2 million barrels/day, begun in September 2008. The oil cartel is known to announce cuts that its members don’t actually follow; it’s in their economic best interest, if only in the short term, to sell all they can. But this time, oil has plunged far below levels to sustain their economies. Even Saudi Arabia expects to run a budget deficit this year.

OPEC, which produces about 40% of the world’s oil, would like to see prices around $75/barrel, at least. But the fragile global economy would have a difficult time absorbing such a price at the moment, and the cartel decided against further production cuts when it met in March. In fact, some three weeks later, Saudi Arabia actually announced a price cut on all its grades of crude to European, North American, and Mediterranean markets – a dramatic attempt to spur demand amidst high inventories.

So, entwined as it is with the economy, the oil industry is currently in a conundrum. The fix it requires – higher prices for its product – will choke the framework in which it operates.

At the same time, we’ve got supply problems ahead.

How Did We Get Here Anyway?

Like many aspects of the markets, movements in price are driven partly by real factors and partly by perception. Rags-to-riches-to-rags-to-riches Texas oilwoman Sue Sanders summed it up when she noted wryly in her 1940 autobiography that “nothing succeeds like reports of success.”

Last year’s run-up of oil was no exception: part real, part report. Some of the real factors:

  • The weak U.S. dollar. The United States is not the only country that buys oil in U.S. dollars. The price per barrel is pegged to it, in fact. When the dollar is weak, the cost of U.S. exports drops; and indeed by December 2008, the U.S. trade deficit had fallen to its lowest in nearly six years ($39.9 billion, according to U.S. Commerce Department data). However, a weak dollar means it takes more dollars to buy a barrel of oil. Global concerns over the strength of the U.S. economy, including America’s ever-rising level of debt, had undermined the dollar to the point that OPEC members began to murmur about dumping it for the euro or a basket of currencies.
  • Geopolitical turbulence in oil-producing countries. The Iraq war, oil-related militancy in Nigeria, and Iran-Israel-U.S. posturing over nuclear issues were hotspots in the first half of 2008. The average nightly news covered casualties in Iraq, but industry watchers tracked attacks on pipelines and oil facilities. Likewise, in Nigeria, sabotage and oil worker kidnappings by militant groups such as the Movement for the Emancipation of the Niger Delta (MEND) regularly shut down facilities to repair, negotiate, or improve security. And as spring warmed up, so did the war of words between Iran and Israel. By early July, Iran had gone so far to indicate it would move against shipping in the Persian Gulf if attacked. The United States would have moved next, of course… thus driving up the price of oil in the jittery oil markets, which depend on Persian Gulf shipping lanes.
  • Unusually low crude and gasoline supplies entering the 2008 summer driving season. In early April, the EIA reported significant drops in supply – gasoline declined by 4.53 million barrels and crude oil by 3.2 million barrels, a one-two blow that surprised and worried industry watchers. Behind the gasoline slump were lower refinery margins, called crack spreads. In mid-March, when refineries would normally be coming off their maintenance schedules to churn out gasoline for summer driving, the margin for turning a barrel of crude into gasoline was negative for the first time in three years. Refineries sought profits in other oil products, and the markets responded to the expected imbalance in supply and demand.
  • High demand. China is a stand-out here, and for more than its usual energy appetite. China has a penchant for aiming to break records – from its goals in five-year plans and building projects to its haul of Olympic medals – and in the first half of 2008, it was visited by some dramatic examples: a great earthquake and major snowstorms, events that disrupted the country’s energy industry. Combine that with the fact that China was also preparing for the Beijing Olympics in August, and it’s easy to understand why it was buying oil very heavily until mid-summer.

On the perception side of price drivers, it’s hard to overlook the fact that the market push stayed strong in the face of increasingly gloomy economic data. Casey Research was earlier than most in predicting the economic crash (we published reports such as “The Coming Currency Crisis” in June 2006), but by spring 2008, even officialdom was dancing around the word recession.

Normally, news of burgeoning foreclosures, plummeting home sales, spiking personal and business bankruptcies, rising unemployment, and other economic indicators would tend to exert a bearish influence. After all, consumers generate 70% of U.S. economic activity, and if they stop or cut back on driving to work or the shopping mall, telephone relatives or business partners instead of flying out to see them, reduce purchases of items containing plastics, turn down the thermostat, and other weather-the-storm measures, oil consumption should decline.

It took months for all these drivers to realign – but as we all know, they did, and then some. The chicken-and-egg debate, whether oil’s sky shot triggered or portended the economic debacle in the closing months of 2008, will require more distance and data to resolve. But it’s true that the dollar had started its comeback by mid-summer, supply had caught up, geopolitics had settled a bit, China backed off on its buying, no major hurricanes hit – but economic realities did.

Meanwhile, Congress jumped up and down and cried “Speculators!” “OPEC!” “Oil producers!” in tidy sound bites.

The Next Big Plays: Where You Need to Be

Oil companies are influenced by the range of market drivers and economic conditions according to size. The junior oil producers, those with market capitalizations of $250 million or less, have the small-business advantage of flexibility when times are good. These times aren’t good, of course, and even well-managed juniors with good projects are in trouble. Their vulnerability is in the credit market. You’ve likely heard of credit lines being revoked and refinancings denied to people with impeccable credit. Now imagine pitching a drill project without a wallet full of assets ready to lay on the table.

Mid-tier producers, with market caps between $250 million to $2 billion, will look to mergers and acquisitions to survive. The majors ($2-20 billion market cap) and Big Oil (over $20 billion) will also be shopping. With low oil prices shutting down exploration, development, and even production, these companies will be looking to replace their reserves instead by purchasing smaller, solid companies with proven production. It’s simply cheaper.

We see two ways to profit from this trend.

First, we buy shares in undervalued, producing companies that are profitable even below $40/barrel, are best of peer, and own large reserves. These are the companies that Big Oil will be looking to acquire. One such company, an oil sands producer, is currently a part of the Casey Energy Opportunities portfolio.

Second, we believe that owning a potential consolidator is the best position. As debt load and low commodity prices overtake them, junior producers will be forced to consolidate their projects. We currently own one such candidate, and are scouting for others with such muscle. Consolidators will be purchasing projects from the bank at 25 to 30 cents on the dollar.

Our tactics have already paid off handsomely in the last six months: all our recent recommendations have been on fire. A few tripled their value, and one generated a return of 540%.

As we’ve seen, supply problems are looming, no matter what timetable of Peak Oil you may believe in. With increased demand inevitably come higher prices. Our approach at Casey Energy Opportunities positions us to take advantage of the trend in both the short and longer term. And we guide our subscribers not only when to buy or sell, but also when to take profits and a “Casey Free Ride” to eliminate risk.

We’d like to offer you the opportunity to kick the tires of Casey Energy Opportunities RISK-FREE for 90 days, with 100% money-back guarantee. Click here to give it a try.