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Friday, 17 September 2010

Is Oil Heading to $150 a Barrel?

Some people still maintain that it was oil at $147 a barrel that sparked the credit crunch. When U.S. motorists saw how much they were paying for a gallon of gasoline, they stopped spending, the argument goes. The rest is history.

I don't buy that argument. There were a lot of other things going on in the summer of 2008, but I can see how the oil price surge helped to accelerate the looming crisis.

The oil price is a bit more sensible now -- around $75 a barrel of crude, down from $92 in early May, and far below its pre-crunch peak. And a jolly good thing, too, as far as the global economy is concerned.

This might not last. Oil could hit new highs of $150 a barrel within the next two to four years, according to Angelos Damaskos, chief executive officer at Sector Investment Managers and fund advisor to the Junior Oils Trust, a unit trust investing in oil exploration.

The road to Damaskos
That kind of talk is enough to make you step on the gas and fill up your portfolio with BP and Royal Dutch Shell, not to mention the smaller oil exploration companies highlighted here.

I was already looking to top off my small holding in Shell and my once-quite-big holding of BP, so I have a personal interest in what Damaskos has to say.

He argues here that we entered a commodity super cycle at the start of the 21st century, driven by emerging markets and growing demand for energy and raw materials. The last super cycle was fuelled by post-war construction from 1945 to 1975, while the first was at the turn of the 19th century, when the United States was industrializing.

And here we are again. No prizes for guessing which country is behind it: China. It gobbles up commodities like Harry the Flan eats flans in a fast flan-eating competition. Oil, metals, it's not fussy.

But this super cycle has a key difference to the other two. Previously, supply readily increased to meet demand. That isn't going to happen now, Damaskos claims, because years of low prices have led to underinvestment in oil exploration and a potential shortage of the black stuff. Without the financial crisis, oil would cost a lot more than it does now.

Tar very much
If the world runs short on oil, we can't just sink a fresh well and pump out some more the next day. That kind of stuff takes time, especially if you have to drain Canadian tar sands or bore deep under the deep blue sea.

Canada's tar sands and recent Brazilian offshore finds have a marginal production cost of more than $80 a barrel, so they aren't getting exploited at the moment. That may change. Damaskos also points out that for the past decade, oil prices have been on a steady upward trend.

Beutel juice
Not everybody agrees. In August, energy analyst Peter Beutel at Cameron Hanover claimed that if it weren't traded as an investment instrument, oil would cost just $10 a barrel. U.S. inventories are at record highs.

This isn't the only distortion afflicting the oil price. There is the peak oil theory as well, which bolsters the price by playing on fears that we're running out of the stuff (this may be true, but why does the theory find its strongest advocates among environmentalists who want to scare us into using less oil?).

The move to electric/hybrid cars could also put the skids under $150 oil, as could a blow-out in China.

Roll out the $150 barrel
That said, it isn't hard to see oil topping $150 a barrel within the next two to four years.

Just look who owns most of it: Iran, Venezuela, Russia, Saudi Arabia, Iraq, and Nigeria. They're not all friendly, or stable, or politically nice. ("Geopolitical risk" is the phrase investors are familiar with.) And many of these countries could explode if at any time, say, conflict breaks out in the Middle East.

Plus, of course, oil is getting harder and riskier to access. Just ask BP.

Well oil be!
I'm not brave enough to invest in oil minnows. Last year, I was briefly tempted by London-listed oil and gas exploration company Aminex. I kicked myself when its share price doubled just weeks after I added it to my watch list, then breathed a sigh of relief when it tumbled right back down again.

I have been waiting for a good opportunity to drill into Shell's 6% dividend yield (covered only once), but that company's stock has steadily climbed in recent months. If it weakens, I'm in.

I'm also tempted to average down on BP, something I've already tried twice since the Gulf crisis struck, and failed both times. It could be third time lucky, if you're patient.

Oil is a good hedge against inflation. Plus, if oil does hit $150 a barrel, any spike in oil company shares may offset some of your losses from the resultant slowdown in the global economy.

It all depends where you see oil going. $10 a barrel or $150 -- take your pick.

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