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Record-High Oil…and Other Good News

• Wall Street’s heavy hitters place their oil bets…so who will take the prize?
• Oil prices and money supply: a not-so-slippery relationship,
• Drilling for profits among Big Oil’s key producers and plenty more…

Joel Bowman, reporting from Abu Dhabi in the Persian Gulf…

Lehman Brothers say $80…Goldman Sachs says $200…Rude says, at least one of you will be wrong.

In pleading their case for the lower of the two prices, Edward Morse and James Crandell of Lehman Brothers cite a slackening in demand from the U.S. and a ramp up in production from Saudi Arabia as the main two driving catalysts.

As the world’s largest oil consumer enters into an economic slowdown, demand will wane, assures Morse. And all the while, the world’s largest producer, Saudi Arabia, will find another 1.3 million barrels per day capacity to woo the new president elect.

Don’t worry that we haven’t seen those extra barrels from the Saudi kingdom yet. Lehman’s men assure us the secretive nation is, “likely to keep its political tool, excess production capacity, close to its chest until it has a new U.S. president to win over.”

Perhaps.

Over at arch-rival, Goldman Sachs, the experts are singing quite a different tune. Days before Lehman made the case for $80, Goldman warned that a “super-spike” could send oil to $200 a barrel.

“As the lack of supply growth and price-insulated non-OECD demand suggest, a future rebound in U.S. gross domestic product growth or a major oil supply disruption could lead to $150-$200 a barrel oil prices,” Goldman said at the time. Even the most incredulous oil bears must have felt the jitters when the price surged above $126 a few days later.

Here at Rude, we have no idea whether oil will become more or less expensive tomorrow…nor do we know whether higher prices will dissuade Soccer moms in the U.S. from driving their Escalades to the mall…or if a President Obama, McCain or Clinton will inspire a flood of freshly pumped crude from the sands of Saudi’s oilfields.
  
We only know that record prices are here today and, as Chris Mayer explains in the following column, it might not be such a bad thing after all…

—- Investing in the Era of “Peak Everything” —-

Oil hit a new record high… Gas could soon be $4 a gallon… silver, wheat, corn, you name it — all the “resources” of daily life are soaring in price!

Yet there’s a way to protect yourself and profit in the days ahead…
 
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Record-High Oil…and Other Good News
By Chris Mayer

Has oil hit its peak price or not? Within the answer to that question lies the answer to a related question: Is the bull market in commodities a bubble that is about to burst? To offer a preview of my conclusions, it doesn’t look like the commodity party is over just yet. But even if it is, there is still money to be made in commodity-related investments.
 
Barry Bannister, an analyst at Stifel Nicolaus, delivered an interesting talk in Baltimore recently. Bannister asserted that the commodity bull market still has room to run, and he shared a series of compelling charts to support his case. I’ve borrowed a few of these charts for today’s column. The first one tracks the remarkably similar trends of the oil price and the U.S. money supply since January 2001. Clearly, as the money supply has grown, the oil price has soared. In fact, almost 87% of the move in the price of oil can be explained by the increase in money supply.

Basically, $100 per barrel oil is what we would expect to see, given this relationship between the oil price and money supply. And since we are still in the midst of a credit crisis of sorts, it seems unlikely the Fed will restrict the money supply any time soon.

That leaves a clear path for the price of oil and commodities to continue to rally in dollar terms.
 
The other thing to remember is that the demand story for oil is no longer a U.S.-centric story. You’ve surely heard about how the rapid growth in China and other emerging markets drives oil demand.

China and India are only beginning to consume oil at a meaningful level. Right now, they are consuming oil at a rate the U.S. did in the early years of the 20th century. But look, we don’t need India to start guzzling oil like we do. Even if it moves half the distance between its consumption and Hong Kong’s, the total world demand for oil would increase by about 6 billion barrels per year! That would be about a 20% jump in world demand. I look at the global demand question this way: What’s more likely, China stays at 1910-level U.S. oil usage or moves somewhere closer to, say, 1950s U.S. oil usage? I think the latter.
 
Net-net, the surging global demand for oil, coupled with the surging U.S. money supply, strongly suggests that a rising oil price will remain the path of least resistance. But even if the oil price has already peaked, that doesn’t mean oil is headed back to $40 per barrel. An oil price “floor” of $100 or more seems very likely. And that price would be high enough to inspire massive capital spending by the world’s oil companies, both to explore for new reserves and to re-develop known fields.

Therefore, even if oil languishes around $100 a barrel for several years, investing in exploration and production companies could still deliver solid investment gains. But oil services companies seem like the better bet. The nearby chart shows the historic capital-spending cycles for ExxonMobil and Chevron from 1928-2007. Spending bottomed in 1948, 1974 and 2005. After the first two bottoms, there was a long run of spending.

Spending peaked nine years after the 1948 low and seven years after the 1974 low. So if 2005 proves to be the bottom on capital spending - and it seems so, since Exxon only recently announced it would increase its capital spending to $25-30 billion over the next few years, a 25% increase -we won’t see capital spending peak until 2012 at the earliest.

Now, why is this important? Think about what the oil companies spend money on. Where do they go shopping? They go shopping at the oil field services and equipment companies.
 
So that is where we want to be. Because even if oil has peaked, we’re still looking at years of strong spending by the oil companies. You want to have some exposure to the receiving end of all that spending. Such companies will mint cash. And they give you a little different payoff than owning a producer. As Bannister pointed out, it can sometimes be better to own the picks and shovels.

He used Newmont Mining, the big gold producer, as an example of a producer that has profoundly disappointed investors amid what may be the greatest gold bull market in history. Newmont’s costs rose so fast and so much that it never really enjoyed (at least not so far) the higher price in gold. But the mining equipment manufacturers have been making plenty of money.
 
So the key takeaways here are these: The price of oil has room to run yet, in part because of the growth in money supply and in part because of pressing international demand. Secondly, even if oil prices simply languish around $100 for several years, the capital spending boom by the big oil companies will continue booming.

That’s why I recommended T3 Energy Services (Nasdaq: TTES) to my subscribers about a year ago. The stock has more than doubled for us. But I still think this sector will continue to grow at a rapid pace. That’s why I just recommended another oil services company last month, and why I continue to examine this sector for additional opportunities.

The oil price might cool off for a while, but the oil services sector is still warming up.
 
Joel’s Note: As we post today’s issue, Chris Mayer is putting the finishing touches on a special report that will be available to Executive Series members in a few hours. We’ll forward a copy to you the minute info comes to hand (later today) so be on the lookout for its arrival. All we can mention right now is that a royalty program that has been dormant for the last six years has just reopened…and Chris reckons he’s found the perfect way to play it.

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Rude Endnote: Care to place a virtual wager on the future price of oil? Send in your own two-cents to the address below and keep an eye out in future Rude’s for your fellow reader’s responses.

As for today, you can grab a barrel for June delivery for the “bargain” price of just $125.63.

We’ll be back with more Rude ramblings tomorrow but, until then…

Cheers,

Joel Bowman
Rude Awakening