Crude Oil Supply and Demand
Research for Online Investors

by John Dalt

8/31/10

Crude oil is bouncing along in the low $70’s per barrel.  We are seeking direction.  Is the world economy going to continue to grow, with consumers increasing their transportation energy usage, or are we sinking into a morass of slow growth that will respond to higher energy prices with even slower growth?

Many U.S. based traders check the Energy Information Agency (EIA) inventory reports when considering a play on oil prices.  I am guilty of this, as we tend to think world prices revolve around our use. No doubt U.S. demand and inventory affects prices, but it would be a mistake to think our economy is the only driver on energy prices.

The U.S. consumes over 20% of world crude oil resources every day.  Much has been made of this by the environmentalists and other world improvers that want to shame the U.S. population and politicians into reducing our use.  The statement is usually coupled with our population as a percentage of the world.  For example, “The U.S. consumes 20% of the world’s oil supply with less than 5% of the world’s population.”

This simple sneering accusation ignores the fact that our economy has the largest GDP in the world, and has led the world for the past 100 years.  In other words, productivity takes energy.  The U.S. population at less than 5% of the world’s population, produces over 20% of all goods and services in the world.  The U.S. also has a highly developed transportation grid that utilizes individual autos because of the vastness of the country.  Smaller countries have mass transit, as the U.S. does in metro areas.

In a perfectly ordered supply and demand market, supply would increase to meet demand as higher prices rewarded those that provided the increased supply.  Prices would rise to encourage additional supply during times of demand expansion.

Environmentalists and world improvers have worked hard over the years to throw wrenches in the free market for energy.  Restrictions on domestic exploration and production plus a cartel (OPEC) that controls a large block of crude oil supplies creates a market that either cannot or will not respond to demand increases.

This creates a market that prices at the “fringe.”  Small increases in demand are met with spikes in price because there is not additional capacity that can be accessed.  Current increases in demand are not taking place in the U.S.  The increases in demand for crude oil are occurring in China and other Asian countries.

These country's citizens are buying cars at a record pace as they have more disposable income and strive to improve their lives.  China became the world’s largest automobile market in 2009.  Anecdotally, you may have heard about the 90 mile traffic jam in China.  Traffic is stuck on the freeway between Beijing and Tibet for up to 10 days.  This follows an earlier traffic jam that backed up traffic over 300 miles.

Our interpretation of U.S. crude oil inventory is that it reflects the available WORLD supply at the fringe.  Since 75% of the U.S. consumption is imported, tankers can go where the demand pays the most premium.  The current oversupply situation in the U.S. reflects world supply/demand imbalance, not just our market.  It can disappear in a few short weeks as demand increases around the world.

Commentators on business shows that solemnly tell us that crude oil prices could crash to $55 per barrel are making headlines, but not sense.  We are not buyers yet, but the crude oil market will respond to positive economic news, perhaps dramatically.  With any reassuring economic news we expect crude oil to be priced over $90 per barrel by years end.

Editor’s note:  Have to run to the store to get popcorn.  The teleprompter in chief is going to be on TV tonight!  We wonder, will he thank the past president for initiating the troop surge in Iraq?  Even bigger, will he be able to hold the peace in Iraq our soldiers paid for in blood?

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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