Big Oil: Boom or Bubble?

May 21, 2008

Today, the Senate Judiciary Committee called a meeting with executives from the biggest oil companies – Exxon Mobil (XOM), ConocoPhilips (COP), Shell (RDSA.L), Chevron (CVX), and BP America (BP) – demanding to know why gas prices are so high. Most of the executives cited the laws of supply and demand. As long as people continue to consume oil faster than it is being produced and bought in the US, prices will continue to rise.

Furthermore, oil prices set a new record above $134 today when the Energy Department’s Energy Information Administration reported that crude inventories fell by more than 5 million barrels last week, even though analysts had expected a modest increase.

The Boom

The five largest US and British oil companies together only account for 11% of worldwide output. The bulk of the world’s current and future production comes from the Middle East, and possibly recent discoveries such as those in Brazil. The American oil companies are not dictating the price of oil; the global market is. It just happens to be their turn to profit.

Global Supply and Demand

China is the world’s second-biggest oil consumer after the U.S., and is the world’s fastest-growing oil consumer. However, whether or not China is really consuming all the oil it is buying and producing is anyone’s guess. China does not report consumption, thus analysts guess this number from production, trade, and inventory data that may not have been accurately reported.

In terms of supply, the 13 nations in OPEC are unreliable in their output reports and may be producing above their quotas in hopes of being allowed bigger quotas.

The Bubble

Because worldwide supply and demand numbers are so vague, much of oil price direction is controlled by speculation. Every time the Energy Department reports a drop in crude inventory, the oil market rallies, driving crude oil prices up to a new record. In a very disproportionate way, oil prices are still following the laws of supply and demand.

The Reality

According to Larry Chorn, chief economist of the energy information unit of The McGraw-Hill Companies [1], even the most expensive wells in the world today can produce oil for $70 to $80 a barrel, which includes the cost of finding and developing the oil fields and a 12-15% profit margin. However, the big oil companies (outside of OPEC) are already producing oil at their maximum rate.

Two decades ago, when oil prices were low and profit margins were slim, big oil companies merged, cut capital spending, and sold off thousands of wells. These large companies seemed to still be stuck in this mindset even as oil prices rose in the last few years, and until recently were hoarding their profits instead of increasing spending to invest in new exploration and drilling.

The Future

It can take over a decade to bring a new oil field online, and the big oil companies are behind. Last year, oil production from the top five oil companies fell 3%. As long as supply and demand numbers remain unknowns, the market will have to rely on speculators to bring oil prices back down. This will likely only happen if local inventories increase. With Big Oil output steadily falling, smaller companies will need to step up to account for the deficit. Last year, the publicly traded energy companies excluding the big five increased their oil production by 16%.

To put numbers in perspective, crude oil imports have averaged 9.86 million barrels a day this year. US crude oil production has averaged 5.10 million barrels a day. Average crude oil consumption in the US has been 20.69 million barrels a day. [2]

While the big oil companies will continue to enjoy inflated profits for some time, the true winners in the next few monhts will be the smaller companies that have invested heavily in production and are just beginning to ramp up their output.

Some of my favorite small oil companies include:

W&T Offshore, Inc. (WTI)

Occidental Petroleum Corporation (OXY)

Anadarko Petroleum Corporation (APC)

Noble Energy, Inc. (NBL)



Energy Basics: Fluctuations in the Price of Oil

August 23, 2007

Hurricane Dean made its way through Mexico for the second time and has been been downgraded from a monstrous category 5 hurricane to a more manageable category 2. Many people in Texas, Oklahoma, and Mexico breathed a sigh of relief as none of us want to see another Katrina or Rita. Asides from the National Hurricane Center and the residents that would be affected by Dean , oil investors also keep a close eye on hurricanes. Hurricanes that go through the Gulf of Mexico may disrupt refining, exploration, or production of oil. Companies like Exxon (XOM), Valero (VLO), and British Petroleum (BP) all may be forced to cut production on a major scale which would lead to an increase in oil prices.

Straightforward supply and demand of oil does not necessarily dictate the price of oil which currently stands at $69.26 per barrel. An actual threat to oil supplies does not even need to exist, only the anticipation or concept of a threat happening is enough to bolster oil prices. The latest news headlines at CNN or Fox News have an effect on oil prices whether it’s about the health of the Iraq war, weather, or relations with Iran. Many energy analysts claim that the price of oil should be lower but about $20 of the current price is expectations of worldwide political turmoil.

Finally, when analyzing oil prices you cannot forget about the influence from the Organization of the Petroleum Exporting Countries (OPEC), an eleven nation oil cartel including Iran, Saudi Arabia, Kuwait, and Nigeria. The primary goal of OPEC is to negate unnecessary fluctuation in the price of oil while creating a level of oil stability. At the same time, OPEC makes sure to keep in the mind the financial interest of oil producing nations. Recently OPEC came out in saying that they would like to see oil not top $80/barrel, but would be very concerned if oil dropped below the $50 mark. Therefore, they believe they have created a foundation for oil to fluctuate in a $30 range, without disrupting worldwide economic growth, barring any extraordinary global events. Below is some of the key news that oil investors look to in deciding whether to buy or sell oil commodities.

Causes of an increase in oil prices:
– Hurricanes that disrupt the oil infrastructure or delays oil production in the Gulf of Mexico
– Terrorism (especially on US soil)
– Extremely hot summers and chilly winters
– Geopolitical influence
– Strong economic growth (with a careful eye in China & India)
– Kidnapping of oil workers in Nigeria

Causes of a drop in oil prices:
– Unexpected increases of oil stockpiles
– Warmer than expected winters
– Majors moves to alternative fuels
– Peace in the middle east
– Gasoline conservation

Hurricane Dean may have not caused the price of oil to spike in the recent week but bear in mind, hurricane season did start June 1, but it doesn’t end until November 30.