Crude Oil Prices: The Best Way to Play the Coming Oil Rebound
by David Fessler, Advisory Panelist
Thursday, April 23, 2009: Issue #984
Crude oil prices are at a one month low, and lately it’s done nothing but drift lower and lower.
Sadly, that’s about to change.
It might seem counter to what the markets are telling us right now. Because the lack of global demand and strengthening U.S. dollar – that oil is priced in – are keeping prices depressed.
There seems to be no reason why oil prices should do anything but flat-line for the next few months. And it’s why most have missed the signs.
And if you’re hoping for a similar drop in gasoline, forget it. The summer driving season is just around the corner, and gasoline prices will likely rise (as they nearly always do) ahead of it.
The small increase in summer driving demand aside, the stage is currently being set for oil prices to skyrocket, even as global demand continues to weaken.
OPEC Shuts Off the Crude Oil Spigot
First, our good friends at OPEC – and I use that term loosely – decided to cut the supply, shutting the crude oil spigot on 4.2 million barrels since last September. This is equivalent to roughly 5% of the world’s supply.
According to Mohammed-Ali Khatibi, OPEC may agree to even more cuts when it meets on May 28, if – in its view – the market continues to remain over-supplied. The OPEC ministers feel some countries are actually hoarding oil.
Why would countries hoard oil? One reason: they feel that prices are going to go much, much higher.
- China is quietly buying oil from Oman – 12.7 million barrels in January and February alone – more than any other country.
- The United States is getting in the act, too. According to the U.S. Department of Energy’s website, the federal government is quietly topping off the strategic petroleum reserve, pumping in 17.2 million barrels since the beginning of 2009.
This gesture is more symbolic than anything else, since the 727 million barrel capacity represents a mere 62 days of protection from having to import oil. The thing that’s most interesting about this activity is that the reserve now holds the highest level of inventory in its history, 717.2 million barrels as of April 21.
Bottom line here is that even with OPEC cutting supply, demand is dropping even faster, as the global economy is in stall mode. The strong dollar is just an additional weight on oil prices.
Mature Crude Oil Fields’ Output Declining
Second – and this has been reported ad nauseum in the press for the last several years, but it bears repeating – mature crude oil fields are declining in output.
- Mexico’s Cantarell Field is probably experiencing the most dramatic decline. As a result, Mexico is probably in its last year of exports. Saudi Arabia’s Ghawar Field – the largest oil field in the world – is also near the end of its life.
- The Canadian Athabasca oil sands – environmentalists refer to it as the world’s dirtiest oil – is an environmental disaster in the making. Deposits are still being mined, but only at minium rates in existing fields due low oil prices. Nearly $100 billion in expansion projects are currently on hold.
- And the big Tupi field off the coast of Brazil? Retrieving this oil from six or seven miles down makes no economic sense unless oil is over $90 to $100 a barrel.
Oil Drilling Stocks Were Once All The Rage… Not Now
Two years ago, oil drilling stocks like Apache Corporation (NYSE: APA) and TransOcean, LTD (NYSE: RIG) were all the rage – and for good reason.
When crude oil was at $147 a barrel, these oil companies couldn’t make their day rates high enough to quench the seemingly insatiable drilling demand from oil companies. Rig drilling contracts and new rig orders were backlogged for years. Then the bottom fell out.
New drilling and exploration ground to a halt – to date, nothing’s changed.
The result is the reserve to production ratio – a measure of the world’s ability to maintain current production – which has been relatively stable for the last 10 years – will start to decline in the absence of any new exploration.
Taken together, all these events and scenarios are combining into a perfect setup for higher oil prices that most analysts have failed to comprehend.
Crude Oil Price Increase Will Be More Dramatic Than ’07 – ’08
And when the scramble to increase production in response to skyrocketing demand increases – just like it did several years ago – the increase in crude oil prices will be far more dramatic than it was in 2007 to 2008:
- There will be less overall supply able to come on-line quickly.
- Few new fields will be available to tap, and those that are will take years to ramp up to meaningful capacity.
- New exploration will have to restart from scratch.
- Tar sands expansion will take four to five years to bring on-line.
- China and India are quietly signing contracts for many of the world’s excess reserves, further limiting U.S. options.
The bottom line is that the very companies that are today’s losers will likely be big winners as demand returns. We’ll be watching for specific opportunities.
If you decide you must get in early, easing your way into a position in the PowerShares DB Crude Oil Double Long ETN (NYSE: DXO). Trading down nearly 90% from its one-year high, DXO could be just the ticket to stellar returns down the road.
Expect some volatility in the short term, as oil prices will likely bounce along in a narrow range for the next six to 12 months before heading higher.
Good investing,
David Fessler
Any investment contains risk. Please see our disclaimer.
14 Responses to “Crude Oil Prices: The Best Way to Play the Coming Oil Rebound”
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David Fessler is the energy and infrastructure expert for Investment U.
My wife & I traded DXO several times, but now we are considering holding it specially thru this summer season. Excellent choice.
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I have heard for a year or so, regarding BAKKEN oil field in AMERICA. A friend of mine ows acreage and they currently are drilling. (small) ampunt now but….I have been told of the emormous size of BAKKEN fields 100s of million b arrels available. I know it takes time to prepare for drilling but when are we going to take advantage of our own oil, and quit bowing to Middle Eastern and Russian BS. We need to quit being weenies….Nels Larsen
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What is the latest On the BAKKEN I got money invested in NOG they have the pipe lines Look foward to hereing from you Thanks
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Dear Mr. Fessler:
DXO is a terrible way to invest in oil. First, Deutsche Bank is not out of the woods, and as an ETN, DXO could become worthless if DB runs into capital problems. Not likely, but a risk, and one that ETFs don’t share.
Second, double-long funds commodity like this (i.e. UCO and DXO) are very poor long-term investments, and should only be used by short-term traders. You may know this, but you’re just inviting your subscribers to lose money; in volatile markets like oil that don’t rise sharply soon, shareholders will lose money and will not even stay even with the underlying commodity. It’s an industry scam to benefit the in-the-know traders at the expense of investors.
Dave
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Mr. Fessler’s analysis of oil price prospects seems dead on to me. Real conservation will probably take three to five years to get going and be spurred by the next couple years of price increases. But I’d use margin and USL rather than a double-long oil fund for a play of more than a few weeks (or months at most). I’ve been in DXO and am in UCO now (a mistake), which is down 25% despite oil prices being up 25% from when I bought it. The leverage looks free, but its not and because its done with swaps, you’re at the mercy of the traders every day if you hold for any length of time. It may be innocent or intentional on the part of UCO, but you can’t see what they’re doing that’s affecting the price. – Dave
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Dave is right, Leveraged funds do not make sense for most investors and are certainly not a long-term investment. If you want to use them, you need to match holding them to the time frame they are supposed to double up or down in (in most cases daily, in some commodities funds, upto a month)– using them for longer terms, you loose more money than simply investing in the regular index fund.. http://www.morningstar.com/cover/videocenter.html?bctid=18862653001&lineup=etfs explains some of this (watch both part 1 and part 2).
I’m surprised that Mr. Fessler does not respond to Dave and correct himself.
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What about the risk of loosing all investment in this leveraged product if crude prices drop further before rebounding ?
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I think Dave, above, makes a good point and I would like to see a comment from the Mr. Fessler regarding this.
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Dave is right about DXO being an ETN, not an ETF. As a holder of DXO, one becomes an unsecured creditor of DB. As bad or worse, the way DB has structured the Note, if oil prices fall enough in a month, DB can call the Notes at a price of $0.
Would not DIG (even though it is selling at almost 10x the price of DXO) be a “safer” option?
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I think it is a good idea should we see a change in the current rally or some type of supply disruption. I checked out what the third respondent had to say had some good point double longs and shorts are dangerous but buy low sell high seems to work, however I do understand the value of the underlying options and volitility prices come into play, so if oil goes to 100 and volitility sinks to 20 the price of DXO could remain stagnant. This is a gamble like any other. I have a lot still in cash this is also a risk.
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hi
good analyzing what i think u told this is
the first time i read ur article its really
and accurate once again thank u and exp ur
articles to read
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Mr. Kessler said “The Canadian Athabasca oil sands is an environmental disaster in the making.”
Where does he get this from? Is he an expert is such matters? No he isn’t. He is just another newsletter writer trying to scam a buck where ever he can – such as making outrageous and false comments about the oil sands.
I can say with certainty that Canada’s oil sands are less dirty than any other oil sand operations in the world, less dirty than some of the major conventional oil production facilities, and less dirty (by a wide margin) than countries using coal to produce electricity such as the USA and China.
What do I know about all this? I helped design and build the first and second oil sands plants and continue to consult on their maintenance.
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Apache Corp. (APA) is NOT a drilling stock. They are a large, independent oil and gas exploration and production company. As such, they PAY the drilling rates charged to them, NOT set the drilling rates. Mr. Fessler’s opinion definitely lost any credibility with me.
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It seems Mr. Fesslers play on rising oil is playing out well, even as a long term trade;) Normally double leveredged etf’s/triple leveredged are used short term/as a hedge to other exposure.
Playing PBR is another way to play it, with less rist on the downside. Great article.
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