Analysts Preparing for Permanent Triple Digit Oil Prices

Jim Brown
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The analyst community is slowly coming to the realization we are facing higher oil prices in the not too distant future and those prices will probably be here to stay.

I would argue with that headline a little because I think we will see a return to double digit prices initially because of sticker shock at the pump. I do agree that prices are headed up and will eventually remain in the triple digit stratosphere.

Global oil demand is slowly recovering. Obviously it is recovering a little faster in some areas than others but the plain truth is rising demand will eventually equal production supply. It is not magic but a simply mathematical fact.

You already know demand in China and India is rising rapidly. It is also rising in Latin America and all across the OPEC nations. The main area where demand is not rising would be Europe. The European countries are mired in a mess of debt that is forcing austerity programs on its citizens causing rising unemployment and depressing oil demand. This will eventually correct itself but Europe is not going to be a major demand center in the coming years. Even if economics improve the European demand is crippled by high fuel prices thanks to government taxation and a civilian population that is far less individually mobile than citizens of the U.S., China and Latin America.

Demand in the rest of the world is rising slowly and already being hampered by higher prices but this time around the prices have been much slower to rise. It has taken all year for crude prices to rise from $79 to $90 so the rise in fuel prices has been much more gradual.

Investor bets on higher crude prices have been increasing steadily. Since July the net long futures positions have nearly tripled according to the CFTC. Hedge funds and energy funds continue to be strong buyers of crude on the dips.

Consumers remember the high prices of 2008 so they are still relieved to be paying under $3 per gallon even with oil at $90. That $3 sticker price appears to be the psychological pothole everyone would like to avoid. When 21 states saw prices move over $3 in early December the MasterCard Spending Pulse report showed a -3% decline in demand.

As long as gas prices move up gradually consumers will deal with the problem. A rise of 3-5 cents per month is like a vaccination against the current price. $2.95 is not really that much worse than $2.90 and since prices fluctuate every fill-up could be a few cents higher or lower. As long as the monthly range remains 3-5 cents consumers will slowly become accustomed to seeing the higher prices and not decrease their consumption. They will slowly become immune to the gradually higher prices until a big price shock spikes prices by 10-20 cents and demand destruction will be immediate.

In the long-term chart below the year long consolidation appears ready to breakout to a new level.

Prices last four years

The big brokers are unanimous in their expectations for triple digit prices in 2011. Goldman Sachs, JP Morgan and an entire list of energy trading banks have raised their expectations into triple digits. Mark Waggoner, President of Excel Futures believes we will see $130 in 2011.

OPEC, with the exception of Saudi Arabia, is happy with the current price and many would love to see $100. Iran, Venezuela and Libya would like to see that $100 level. Saudi believes a price between $70-$80 is fair. The oil minister from Saudi Arabia said a price spike to $100 would have to be accompanied by a sharp increase in demand before OPEC would change their current production quotas. Saudi believes there is plenty of oil in the market and the prices are rising on speculation. At least that is what they are saying in public in order to keep up the OPEC charade.

I have written reams of articles about the real excess capacity in OPEC so I won't repeat it here other than to claim I believe it is more in the range of two million barrels per day than the six million OPEC claims. Secondly very little of that excess capacity is light crude so that makes the actual usable excess capacity even less.

Fueling the speculation in prices today are the improving economics around the world. Ten percent GDP growth in China and India, 7% GDP growth in Latin America and 14% demand growth in OPEC nations. If the U.S. catches fire in 2011 we could see our demand in the U.S. increase by more than a million barrels per day. The economic will is there and all we need is some fuel to feed the economic fire. Hopefully the tax deal signed on Friday will be that fuel.

Regardless of where the U.S. finds significant traction in 2011 or we have to wait until 2012 the stage is set for triple digit prices simply because of the increasing demand in China and Asia. Every IEA monthly update should show increasing projections and every one will feed the speculative fever we are seeing in the future markets. Energy is going to be the preferred sector for investors for the next several years and while there will be some price cycles the overall trend should always be higher.

Jim Brown

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