Lull in Global Demand Causes Oil Prices to Drop, But Not For Long...

by Tony D'Altorio

Lull in Global Demand Causes Oil Prices to Drop, But Not For Long...

by Tony D'Altorio, Investment U Research

Tuesday, May 24, 2011

Oil prices are in the news again lately. This time, it's because they're dropping, not rising.

Like many other commodities, the price of oil slid on an apparent lull in world demand.

But, as usual, don't read too much into tales of a deeper sell-off. Because it looks like Wall Street is once again looking at only one side of the equation: demand.

Certainly, demand is slowing from last year's torrid pace. The International Energy Agency (IEA) forecasts a growth rate of just 1.3 million barrels a day this year, down from 2011's near record increased rate of 2.8 million.

Still, oil investors should not lose sight of the supply side, which has also slowed. Looking at it from that angle, the oil equation remains very positive over the long term.

Oil Bears Point to Middle East and Iraqi Oil

Oil bears currently like to point at Iraq. The country wants to raise production from 2.6 million barrels of oil per day to more than 12 million by 2017.

But some Iraqi officials now hint that mounting constraints in pipelines and export terminals may make that goal impossible. And the market expects the government to downgrade its oil target soon.

General agreement puts production down to five or six million barrels a day by 2015 - though even this may be unrealistic.

Gati Al-Jebouri, the head of Lukoil (PINK: LUKOY) in the Middle East, said, "Whether that is achievable given the infrastructure is a difficult question to answer." Meanwhile, a senior official from a western oil company in the region reported that Iraq is moving from "propaganda to the reality" regarding output targets.

Even so, Wall Street continues to ignore problems with supplies. It wants to believe in the huge projected increase in Iraqi oil.

It believes that increased production from non-OPEC producers such as Brazil will allow prices to drop, as well. But neither scenario has much chance of actualizing.

Oil Supply Slowing Despite Incentive of Higher Prices

Realistically, oil supplies are slowing despite the incentive of higher oil prices and non-OPEC countries riding high on supply growth from 2009 and 2010.

During that time, they averaged about one million barrels per day, the highest two-year period since 1996 to 1997. And last year's 1.1-million-barrel-growth spurt was the biggest annual increase since 2002.

That significantly helped hold down oil prices as much as it did. But that surge now seems to be ending.

The IEA now forecasts growth from non-OPEC sources at only 750,000 barrels a day. And even that sounds optimistic.

  • It assumes that, despite the turmoil, Middle East oil production will only drop by 100,000 barrels a day until July and then resume full production. But that's not very likely.
  • It also projects troubled Yemen producing its full output.
  • And it expects the North Sea fields - some of which shut down every summer for maintenance - to not shut down at all this year.

Jim Rogers Asks "Where's The Oil" And He's Right...

Wall Street does have it partially right though...

Strong global demand, especially from emerging markets, has played a part in driving oil prices higher in the past decade. Problem is, a lack of supply growth in easy oil is taking a much bigger role.

Famed commodities trader Jim Rogers has asked time and time again, "Where is the oil." And he's right.

There hasn't been a large discovery of easily accessible oil in decades. That era is over.

Barring a major surprise discovery, the supply situation will lead to higher oil - and as Rogers recently told the BBC, prices will rise "beyond expectations."

Good investing,

Tony D'Altorio

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