Oil: New Bull Market or Last Gasp?

Is there a stealth oil supply crisis in the works?

Bob Woodward tells the world that the Saudi foreign minister promised President Bush that the Saudis would begin to increase oil production as the 2004 U.S. Presidential election got closer.

State attorney generals have for months been questioning whether high gas prices at the pump are the result of price gouging by the oil industry.

Oil analysts are mostly in agreement that oil prices will hit $40 per barrel.

And newspaper headlines as well as the nightly news are running nearly daily stories about the price of gasoline hitting new all time highs on a daily basis.

Supply not demand
Market contrarians know that traditionally, these kinds of occurrences are the usual hallmarks of a major top in the oil market. And yet, all we see on a daily basis are either steady prices above $35 per barrel or moves up to the $37-$38 area.

More important from a predictive point of view, the Amex Oil Index, made a five-year high when it closed above 610 on April 16, with little fanfare from the major media.

Bellwether stocks such as Exxon Mobil and Occidental Petroleum are breaking out to multiyear highs.

Recent mergers in the oil exploration sector point to a sudden interest within the industry to expand oil reserves.

Thus, it is obvious that we are at a major inflection point in the energy markets, and that this time, may indeed be a bit different.

The widely accepted reason for oil prices remaining high is that demand from China is the driving force, even as the rest of the world is starting to show economic growth.

But, oil traders know that the main reason for higher prices is supply.

Thus, based on this tenet, while the mainstream looks for demand as the reason, we wonder if indeed, the world is on the brink of a significant oil shortage, because, oil producers won't go after the oil that is there, or because there is a lot less oil there than most would believe, and oil companies and the markets are suddenly having to factor that into the equation.

To be sure, risk of a terrorist attack is part of the price increase. And it is well known, as I described in "Successful Energy Sector Investing: Every Investor's Complete Guide", that the United States has a significant problem with its refining capacity.

Other, more political reasons, such as the frequent threats from Venezuela to cut off U.S. oil supplies are also contributors to the current prices of oil.

A nasty surprise?
If oil prices are being kept high mostly by demand from China and global economic recovery, eventually the evidence will start to leak out, and the market will adjust, especially when the Chinese economy hits the inevitable bump in the road.

But, if it is a supply problem, we could be in for much higher prices in the not so distant future.

My opinion is that the easy oil has been found and is being used up as we speak. Oil companies are increasingly wary of going into politically unstable areas, including the Middle East, Russia, Africa, and South America to explore and produce oil.

That means that any new exploration, due to both geological complication of having to drill deeper and at more obtuse angles, as well as political risk are going to cost more.

And if the situation at Royal Dutch Shell, where proven reserves are less than companies are reported, is repeated, it could be the signal that indeed big trouble on the supply side is the reason for the steady prices.

New parameters
Finally, I find it interesting that the major media and analysts get excited when oil prices fall to the $35 area, and trumpet the fact as a relief for consumers.

What they fail to note is that they are now becoming used to the fact that a barrel of oil is likely to stay above $30 per barrel barring something very dramatic.

Sure, $1.50 per gallon is better than $2.00. But when you look back to the early 1970's, gasoline price wars had the price of a gallon at 0.19. That's 19 cents or lower.

If the same rate of rise were to be evident over the next thirty years, we could be at $20 per gallon.

This is not a Cassandra call, and I'm not predicting $100 per barrel oil.

The fact is that the oil market is as unpredictable as any other market, and it is possible that we are near the breaking point of a bubble that may have been in place for too long.

But what is increasingly evident to me, is that the days of $25 per barrel of crude may be gone for good, and nobody seems to be paying attention as to why this is happening.