We were not planning on doing this post today but after a few conversation that I have had with people that consider themselves informed I thought that it would not hurt.
Oil is in the headlines again as both West Texas and Brent crude have been consistently over $100 for a while now. Of course this isn’t the whole story as we are also in an election year. The price at the pump matters more than normal around elections as voters like to blame or praise whoever is in power for any and everything that is going on.
This is a good time for a disclaimer-Some people might call me right of the right wing when it comes to personal views and voting. When it comes to trading politics absolutely need to be put aside. I take a pragmatic view of things and never confuse politics with policy.
Getting back to oil we keep hearing that when Obama came into office prices at the pump were so low. Well that is a half truth. As you can see in the chart below the price of Crude is in fact higher than when Obama took office.(Click on chart to enlarge)
What we never see however is what oil was doing before Obama took office. If we pull up a 10-Year of crude we can see that not only was oil at its cycle lows when Obama came in but it had just dropped from its all time high of $150 a barrel. Oh and do you remember why oil dropped like a rock? There is a thing called demand destruction. It tends to happen when the globe loses about a third of its wealth inside of a year. Since then we have had a recovery, even if it has not been as robust as we would like, the central banks of the world have pumped in trillions of dollars into the global economy, the Middle East has been in its “Arab Spring” for over a year, and we still have no long term energy policy.(Click on chart to enlarge)
No energy policy? Hah Obama must be doing this to us. If he had that much power then unemployment would be at zero. Fortunately the President while the most powerful man in the world is not that powerful. Until the office of the Presidency includes some grand wizard of alchemy he, no matter which party he is in, will have that power. Obama is responsible for higher prices only to the extent that he like his predecessors have failed to formulate any type of long term energy policy. Just like the developed worlds central banks and their debt can, we keep kicking the energy can down the road as well. T Boone Pickens is not lying when he says that every President since Nixon has declared that we will be energy independent and then has proceeded to do nothing.
So while there are definitely several shorter term issues driving oil such as the problems in Iran and current supply issues to both coasts, the biggest issue is that long term supply is not as strong as we once thought it to be. Most of the world has always thought that Saudi Arabia would always be able to boost production in times of crisis. Well as we saw when Libya had their revolution Saudi Arabia either does not have, or just doesn’t want to use, any spare supply. That fear coupled with more immediate issues is what is keeping oil above $100 and what will likely keep it above $80 for a long time if not forever. What’s that you say? Saudi Arabia can never run out of oil you say? In the chart below we present Middle East oil as a percentage of total global production. As you can see their share of production has not moved since the late-eighties.(Click on chart to enlarge)
What about the rest of the world? Brazil and Russia have a lot of oil don’t they? Well to certain extent they do but that does not mean they have enough to supply the world or to make up for missing supply in times of war or crisis. Here is a chart of global oil production along with the average annual price of crude oil. As you can see during the entire rise in price, production levels were not able to rise to keep prices in line, or to further enrich whatever country has this huge hidden supply of oil the world seems to be banking on.(Click on chart to enlarge)
Getting back to the United States can’t we just drill our way out of this mess? If we got rid of Obama we could drill everywhere and then we would have all the oil we would ever need. As much as some pundits would want you to believe that the truth is that our oil production peaked back in 1970. If in 40 years we have not been able to find enough oil to keep up with our demand then good luck finding all of this supposed oil today. Yes, there is untapped oil but do you really think that it will be enough? Peak oil people could be wrong and we could find Ghawar 2.0 in your backyard?(Click on chart to enlarge)
Oh but what about offshore production? Can’t we just go drill of the coast of California? They have already tried that and while they definitely did find some oil and some is not currently being pumped there was nothing to lead oil experts to think that there were any mega-wells out there. While on the subject what was happening to offshore oil drilling before the BP spill? Yes, as you can see in the chart below even before the spill oil production was dropping like its hot for almost five years. Not only that but that is coming off levels not surpasses since 1995, an entire 15 years earlier.(Click on chart to enlarge)
So while Solyndra is obviously not the solution to anything, except how to lose taxpayer money, the President can not just wave a wand and have oil start seeping from the ground. Global peak oil is as real as United States peak oil. We are not working towards a long term solution which means that every time anything happens in the Middle East, Russia, or even Brazil the price of oil will rise. Because of global energy uncertainty oil probably has a long term floor in the $80 area.
What can we do to change this? Well some items that would fit into an energy policy would be natural gas, rail, solar, etc. But until we admit that oil doesn’t grow on trees we will continue to revisit the spot where we now stand and it will happen more often and probably with more force each time. In our work and model portfolio we have a bias towards being long of energy as the long term risk reward is definitely slanted to the upside.
Disclaimer-In our model portfolio we are long OIL, XOP, and short some refiners.