Crude Oil Running Higher
Research for Online Investors

by John Dalt

12/28/10

We have been watching the price of crude oil climb, and our charge card is suffering every time we fill the car with gasoline.  Where will it end?  We checked the Energy Information Administration (EIA) website to understand where this market is heading.

The U.S. Crude oil etf (USO) hit its 52-week low on May 25th  Since then it has bobbed and spiked its way higher, generally following the latest economic news. The last major test of the low was August 25th, just as the general equity market was ready to begin climbing.

Since August, the USO etf has risen almost twenty-four percent, and looks like it can go higher.  Crude oil is presently trading over $90 per barrel.  Much of the rise in crude oil has occurred based on better economic news, and anticipated demand increases.

The supply of crude oil is relatively static.  Research must be done, leases signed, wells drilled; completion and infrastructure upgrades have to occur to increase supply.  Remember all of this has to happen in a certain regulatory environment.  The U.S. has not had a ‘certain’ regulatory environment since the Horizon disaster in the Gulf of Mexico last April.

We know that crude oil can go where the demand is greatest.  We know that the Gulf oil spill has increased regulations on deep-sea drilling activity in other parts of the world.  These facts further complicate increasing supply.

We know that the world runs on energy.  Crude oil is the preferable form of energy for transportation.  Crude oil is used for other industrial uses such as electricity generation and heating where coal or other cheaper forms of domestic energy are not available.

Crude oil is the ‘feedstock’ for plastics and 1000’s of other items that developed societies depend on.  As economic activity increases, the demand for these products increases.  We could say that crude oil is ‘fungible.’  It can easily replace most forms of energy and because it is easily transported it can be delivered where it is in highest demand.

The U.S. crude oil market is a proxy for the world market.  We import almost twice as much crude as we produce.  Those imported barrels of oil are on ships and can be sent anywhere in the world for a better price to meet demand.  Here is what crude oil stocks looked like eleven days ago.

We have higher inventory than the average range, but the trend is heading lower.  Crude oil inventory is 6.7% lower than at the beginning of November.  The other interesting observation is the apparent trend of our average inventory moving lower.  This means the U.S. will be operating on fewer days of supply.  In fact this is already happening.  While our inventory is currently higher than the average (and 4% higher than last year), our usage is up.  The supply in terms of ‘coverage’ is less than last year.  Here is the chart showing our days of supply.

John Hofmeister, former President of Shell Oil Company, told Fox News the U.S. will face significant shortages of oil and five dollars for a gallon of gasoline within two years.  He also believes the supply will become so short that some regions of the country will run out of gasoline.  Those states without refineries will be the first to feel the pinch in supply.

The Oh! Bama administration now has control of energy exploration.  They announced the end of the moratorium, but have not permitted any deep water wells.  Shallow wells are facing increased regulation.  Shale oil and gas exploration is subject to regulatory pressure on “hydraulic fracturing.”

Higher gasoline prices now are just a warning shot of the future.  Which raises the question, what will the Fed do when four dollar gasoline chokes off the economic recovery?  Since the Fed is stoking the fire to make the economy heat up, what happens when high energy prices cool things off?

It would be unfair to blame the Fed for high crude oil prices.  They are propping up our economy and thus much of the world, but China and much of Asia are not dependent on the Fed.  After all, China raised interest rates this past weekend to try to SLOW their economy.

Ben Bernanke might want to call the White House and let them know what is coming, and how they can avert it by expanding energy production in the U.S. now, not in seven years.  This is the timeline Ken Salazar has given for renewed deep-water drilling in the eastern Gulf.

Make sure you own good energy producers going into 2011, they should make you money.  We like XOM, HK, CHK, LINE, HGT, SU, and ARLP.

To the mailbag:
My brokerage will not let me short the VXX.  They said they don’t have any shares available and will have to borrow externally.  Is this normal?--- gulch member L.K.

John’s reply:  At different times they may not have shares to short.  I always enter my order in the morning as a limit order.   If it says they do not have shares, I try again 30 minutes later, and then just keep trying throughout the day.  I entered my order this morning just after market open.  I think you can even enter a short sale before the market opens, but I have not done it.  These shares available to short are first come first serve so you want to get in early.  I never have the broker locate the shares for me because then they charge more.  I just keep trying every thirty minutes, sometimes I never get any shares to short but generally do.  Schwab will even let you short GTC, Scottrade will not, they only allow a day order.  I hope this helps.

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

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