Up, Up and Away

4 Forces Driving Oil Prices Higher

by Sean Brodrick

Oil prices pushed near the top of their recent range this week, and the usual suspects trotted out on the TV to tell us why this rally couldn't last. And on the face of it, their argument seems to make sense. It boils down to ...

1. Crude has been trapped in the same range since June.
2. U.S. oil demand is lackluster at best.
3. There is plenty of oil in storage.

That sounds pretty solid to me. So why, then, are oil prices trending higher? Look at this chart ...
 

Source: Stockcharts.com

Indeed, I'll give you four solid reasons why crude oil is going higher — and I could give you a lot more. I think forces are in play that could send crude oil prices surging up to $92 or even $105. And that's a move worth playing!

I'll give you some trading ideas, as well. First, here is a triple-shot of bullish forces in oil.

Force #1: Global Demand Is Rising

To be sure, America is using less oil. The Energy Information Administration expects America's oil demand to fall by 330,000 barrels per day (bpd) in the fourth quarter from a year earlier. And oil refiners including Valero and Sunoco have shut plants to cope with a glut of fuel.

However, all gluts end. The EIA recently revised upward its estimate for U.S. oil consumption in 2010, expecting demand to increase by 320,000 bpd over 2009.

And demand is recovering faster elsewhere in the world. In fact, the International Energy Agency expects global oil demand to rise to 86.1 million bpd in 2010 from 84.6 million bpd in 2009.

And in its October Monthly Oil Market Report, OPEC jacked up its estimate of global oil demand for next year. "The risks to the forecast are seen on the upside," OPEC said in a statement. "Should the U.S. continue to show healthier oil demand levels, then world oil demand could increase by another 200,000 barrels per day before year's end."

OPEC expects the emerging markets will run rings around developed countries when it comes to oil demand growth. And international experts agree that there's one country in particular that will likely use a LOT more oil ...

Force #2: China Is Shifting Into Higher Gear

China's oil consumption doubled in the last decade, rising to 8 million barrels a day last year from 4.2 million barrels in 1998, according to BP Plc's Statistical Review. And that trend continues.

Chinese oil demand was revised upward to 8.17 million bpd for 2009 from a previous estimate of 8.08 million bpd, according to the International Energy Agency. Crude oil imports in January-August period went up 7.4% from earlier. And demand is accelerating. China's oil imports rose 18% in August.

Looking at next year, China's crude consumption is expected to increase 1.4 million barrels per day to 86.1 million, according to the IEA.

Even these raised estimates may not be high enough. China's car sales are booming — up 78% in September from a year earlier. Overall vehicle sales totaled 1.33 million units, while passenger car sales climbed 84% to 1.02 million units, the China Association of Automobile Manufacturers reported.

So far this year, China has seen 9.66 million cars sold — far ahead of the U.S., which has seen auto sales of 7.85 million. What's more, most cars sold in China are first-time owners. In the U.S., most car sales are replacement vehicles.

So, those revved-up China auto sales mean much higher gasoline consumption and oil consumption.

Force #3: The Cheap Oil Is Going ... Going ...

Peak production is already receding in the rear view mirror for dozens of nations. World reserves are being depleted by about 4% a year, according to the Association for the Study of Peak Oil. That leaves the world margin of error far too small, and vulnerable to disruptions such as rebel attacks on pipelines or saber-rattling disputes in the Middle East.

As reserves of cheap oil run lower, competition for remaining assets becomes more frenzied. The global financial crisis barely slowed China down in its quest to outbid western oil companies for global assets. For example, ExxonMobil recently made a $4 billion offer for Ghana's Jubilee oil field. But then China National Oil Company opened its own talks with Ghana to make a rival bid for a stake in Jubilee.

The Jubilee field is estimated to hold 1.8 billion barrels of oil. According to the Energy Information Administration, the world's 15 largest oil producers delivered about 64 billion barrels per day in 2008.

Exxon's $4 billion bid would buy it a 23.5% stake in the Jubilee. According to some experts, oil would have to sell at $100 a barrel to make this stake profitable for Exxon.

Deflationists — people who argue that the big trend in prices going forward will be down, not up — would argue paying that kind of price for oil is just pig-bitin' crazy! So how crazy is it that China is willing to trump that bid? How high of an oil price is China planning on?

And Ghana is just the beginning. Chinese oil companies have announced plans to spend at least $16 billion to gain access to African energy assets.

Meanwhile, the big American oil companies, outbid by foreign competitors with deep pockets, are facing a future of steadily dwindling production. Let's keep the focus on ExxonMobil. It has been producing a little over 2.4 million barrels of oil a day for the last year and a half, its lowest rate of production over the last decade.

Source: Econbrowser.com

In 2001, ExxonMobil's annual report predicted 3% annual production growth — the red line on the chart. Instead, it fell short of its production growth target. In 2006, it predicted it could hit 3% annual growth by 2011. That's the blue line on the chart. The dark line below the others is Exxon's actual production growth. Good luck hitting those targets, boys.

I'm not saying Exxon is a bad company. Many oil companies are running up against the limits of growth. This is something that is affecting the entire Western oil industry, and will probably eventually spark a resource war in the Arctic, as the U.S., Canada, Russia and other countries fight over oil and gas resources literally at the end of the Earth.

But that's a longer-term problem. Let's look at something that could send oil higher in a real hurry ...

Force #4: The Falling U.S. Dollar

This is the part that is difficult for me to write. Because when I write about the dollar, my spine tenses up, my fingers curl into fists, and I get a nearly uncontrollable urge to scream. And if that scream was articulate at all, it would go something like: "We're ... so ... screwed!"

Some facts ...

• The budget deficit hit $1.4 trillion in 2009. It looks to go higher in 2010, and we could see budget deficits of well over a trillion dollars for years to come.
  
• The U.S. Federal Debt is a ticking time bomb. It is now at $11.9 trillion, or $38,000 per person. That means if you have a family of four, your portion is $152,000 of pure debt.
  
• The debt continues to increase. In fact, the U.S. government is moving closer to its $1.21 trillion debt ceiling. Congress will likely vote to raise the debt, taking us into uncharted territory. Congress has raised the U.S. debt ceiling by varying amounts 76 times since 1960. There is only one way to get rid of unsustainable levels of U.S. debt — inflation. And the prevailing U.S. policy is clear — we are going to inflate our way out of this (that is, devalue the dollar).
  
• And here's exhibit A — a chart of the dollar ...
  

Source: Stockcharts.com

While as American citizens and consumers we may hate this, it would at least be endurable if it is manageable. The problem is it may not be manageable.

Why? Well, when we create all this debt, we have to sell it to someone. The answer for years has been to sell it to foreigners, especially foreign central banks. But now they're wising up. Bloomberg recently reported that central banks are switching out of dollars and into euros and yen. The U.S. dollar makes up only 37% of new central bank foreign reserves, down from an average 63% since 1999.

If this trend away from the dollar increases, the slippery slide of the dollar could become a plunge — and give the dollar a haircut of between one-third and one-half very quickly.

Now if you were a big-pocketed investor, and you wanted to get some insurance against such a potential plunge, where would you put your money? You might use your rapidly depreciating greenbacks to buy hard assets — gold, silver, copper, tin — CRUDE OIL!

And beyond the usual suspects ... the banks, the big individual investors, the small-time speculators ... there is approximately $3 trillion in sovereign wealth funds — government controlled investment funds — and a lot of those governments are becoming more wary of dollars. Do you think they might be buying commodities, including oil? Heck, yeah!

So go back and look at that chart of oil I had at the top of the page. Considering all I've told you, what would you say the odds are of oil going to $92 a barrel or even $105?

I'd say the odds are better than average.

Yours for trading profits,

Sean