Given yesterday’s pop to $62 in Crude — up from $53 when last month’s Futures’ contracts expired — its worth taking another look at energy
I am friendly with David Kotok, Chief Investment Officer of Cumberland Advisors. Like me, David remains Bullish on the Energy Sector, and has had some rather astute comments on Oil recently. Back in September, he wrote:
"Many folks are bailing out of oil. Some forecasts now call for a price decline to under $30 per barrel. One extreme forecast suggests the oil price could go as low as $15. We do not agree.
The recent drop in the oil price from the high $70s to a few pennies under $60 per barrel is the result of the lessening of two risk premia. 1. The hurricane season seems to be passing without incident. 2. The Chavez/Ahmadinejad bluster is known and the market is assuming that we have seen the worst. Some players are suggesting that the European initiative with Iran will succeed and lessen the tensions over Iranian development of nuclear enrichment facilities.
Oil risk premia are estimated by computing the cost of adding a barrel to inventory. This helps explain the pricing of oil in the futures market. When the risk premia declines as it is doing now the nearest term oil price declines the fastest. That is what we have seen in the August/ September period. Longer term futures prices are suggesting that the current decline is nearing an end. Oil for delivery 18 months from now is trading near $68 per barrel."
David’s view is that "energy prices are going higher and that our overweight ETF investment position should continue in this energy sector."
He also recently criticized what he termed "the ethanol mess" and offered how it didn’t help the energy price — but it did help create shortages in grains. He notes that some folks in this world are going to starve because of it.
Why does he want to stay overweighted Energy? These factors suggest higher oil prices:
• The dollar has declined about 10% (trade weighted) from where it was a year ago. Oil is about the same price per barrel as it was a year ago. Oil is priced in dollars. Therefore, we in the US have had a price run up to near $80 and back to $60. The rest of the world has had a smaller price run up and is now looking at an oil price 10% lower than it was a year ago.
• The relative price is important because it allows us to estimate the stimulus that occurs from the oil price change in various parts of the globe. In the rest of the world that stimulus has spurred demand. Oil consumption is about 1 ½ million barrels a day (mbd) higher than it was about a year ago. In the US the change has been nearly flat. Our oil consumption is not the growth area. Look to Asia to find it.
• Oil futures prices suggest a return to nearly the $70 level in 18 to 20 months. McKinsey & Co. forecast continuing rise in world oil demand at about 2.2% a year until 2020. We agree. Oil could easily be $100 before then as world consumption rises between 1 ½ and 2 mbd each and every year.
• The unrest in Nigeria continues and may be worsening. Press reports usually do not include this in the top of the list. They should. Nigeria is becoming an increasingly dangerous place for the folks who work in the oil industry. Investors need to keep an eye on this geography.
• Speaking of geography, the Middle East is deteriorating and the market has ignored it. In Iran, we see Russia supplying missile defense material to protect Iranian nuclear sites. We see the breakdown in Lebanon and the Syria-Hezbollah connection strengthen. The Israel-Hamas battle continues unabated. Clearly we see a murderously intense civil war in Iraq. Soon we will witness the forthcoming pullout of the British. What will that mean? They are in the Basra region; that is where a lot of Iraqi oil exports originate. Basra is Shiite and close to Iran which is also Shiite. Instability in Basra is almost certain to rise when the Brits depart. Right now Iraq still exports about 1.6 mbd. As much as half of it is at risk if the civil war spreads and intensifies in Basra. Also, only about 1600 of the 2300 oil wells in Iraq are working. The civil war prevents regular maintenance and precludes development. So every time a well loses functionality it goes offline. We expect that to continue and intensify.
• All this leads to a strange alignment. In Iran, the Shiite center of power, there is an interest in the higher oil price. Iran has no love for the west and would spend the money on the mischief it spreads in the region and on domestic social spending so as to endear the Ahmadinejad regime to the populace. In Sunni Saudi Arabia, they wish to maintain the present oil price or see it a little higher. They do not want to kill the west but they would welcome the higher oil price if the source of the pressure was from other than OPEC cartel price maintenance. So we have both the Sunni power and Shiite power supporting their respective allies who are the combatants on one side of the Persian Gulf while enjoying the benefits of any higher oil price and attendant risk premium. This bodes ill for Basra and any other place where the civil war might spread.
By way of disclosure, Cumberland maintains an overweight position in energy, with the Vanguard energy ETF (VDE) as their first choice. VDE has 118 stocks, with the heaviest weighted components being ExxonMobil (XOM) Chevron (CVX) and ConocoPhillips (COP) Schlumberger (SLB) and Occidental Petroleum (OXY).
Cumberland Advisors.November 29, 2006
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