Sponsored Link:

Crude Oil Prices

The Smart Profits Report: Issue #472
Monday, November 12, 2007

Crude Oil Prices: Here’s What An Industry Insider Says Is Next For The Runaway Oil Market
By Marc Lichtenfeld
Senior Analyst, Mt. Vernon Research

I guess this is what Goldman Sachs meant when the bank predicted a “super spike” for crude oil prices.

It was April 1, 2005 when the world’s biggest brokerage and highly respected investment bank predicted this for the oil market, boldly forecasting $105 a barrel by 2007.

Many people scoffed and accused Goldman of scaremongering. But as crude oil prices race towards $100, the bank’s projection is looking uncanny and investors are searching for clues. Are we ever going to see $50 again? Or is the next stop $150?

For answers, I turned to the frontlines…

Crude Oil Prices Says $95… But The Fundamentals Say $60

Having known Paul since we were four years old, he’s one of my closest friends. And when it comes to oil, he’s also the best market analyst I know. Although he doesn’t work for an investment firm, he does run one of the largest heating oil companies on the East Coast.

So with crude oil prices shooting to a record $98.62 on Wednesday - a 47% surge since the end of May - he’s obviously a very valuable source of information for me right now - and for you, too.

I asked him where he thinks oil prices are headed next and he confirmed that the fundamentals only support $60 oil. While there are still clear supply and demand issues, what we’re seeing at the moment is more the result of rampant speculation, as billion-dollar hedge funds have bid up the price to crazy levels.

And at the mention of these private partnerships, Paul grew impassioned…

Hedge Funds Turn Up The Heat On Oil Prices

“Everyone gets upset with Exxon (NYSE: XOM) and the other Big Oil firms for making all this money,” he said. “But at least they’re producing something. These hedge fund guys are making billions from the market and don’t do anything other than push oil prices higher. Essentially, hedge fund managers are asking me to collect money from Mr. and Mrs. Smith and send it to them.”

Simply put, the equation centers on supply and demand. Just like a stock, the more buyers there are, the higher the price goes. One U.S. congressman blames oil pit traders for driving the price up so high. Eventually, however, these guys will stop bidding, start taking profits, and the market will correct.

But investors want to know when this could happen and how far the market could drop. Don’t expect much. Even though Paul believes the oil market is experiencing prime bubble conditions, he notes that demand is still strong at $90 a barrel.

And if you’re holding out for a return to $50 oil, forget it. He states: “I don’t think we’ll see $50 oil unless there’s a global economic meltdown. People can buy hybrids and energy efficient appliances, but that only puts a tiny dent in demand. We need to see half the amount of planes in the sky and the BRIC countries (Brazil, Russia, India and China) to experience a significant slowdown.”

Speaking of demand, how are American customers reacting to the price spike?

A Winter Of Discontent

I asked Paul if he’s seeing a drop-off in demand, given that he must pass the higher prices on to his customers.

“Not really. Just like people still need drive their cars, they also need to heat their homes.” And this winter is shaping up as a winter of discontent for Americans. Gasoline prices are rising, with the national average price per gallon already around $3 a gallon.

And as we noted last week, the U.S. Department of Energy says heating oil costs will climb this winter, too…

  • Oil heating costs will jump 22% over 2006 this winter. That’s an extra $319.
  • Natural gas prices are set to climb by 10% ($78).
  • Electricity costs will rise 4% ($32). Almost one-third of U.S. homes use electricity for heat.
  • Propane costs will increase 16% ($221).

Averaging out the costs for all types of fuels, Americans will pay $977 to heat their homes this winter - 10% more than the $889 last season. And even if the Fed cuts interest rates again, it probably won’t provide enough relief.

Bad Things Come In Threes… And Heating Oil Costs Have Tripled

With heating oil costs rising, Paul is noticing that customers are taking longer to pay. He tells me that a few years ago, a 400-gallon delivery typically cost his customers around $400. Today, it’s over $1,200.

As he explains, this is a problem. And companies like his need to adjust and be flexible: “When customers get a bill that’s three times higher than a few years ago, they call us and say, ‘how about I pay you half now and half next month?’ I understand their situation and I really have no choice. If I say no, they’ll go to one of my competitors. So as a result, margins suffer.”

But while Paul says he’s extending more credit to struggling consumers, his vendors aren’t doing the same for him. It’s not just his customers who are paying three times more for oil… it also costs him three times more than it did a few years ago. But his credit line remains the same, meaning he has to pay (and borrow) more up front. So his cost is going up, too.

Okay, so I know you’re probably not going to throw a pity party for a guy who owns an oil company (although it is a family-owned business with 100+ employees). But it’s a good illustration of the impact that expensive oil is having on everyone.

So where to from here?

Higher Oil Prices May Break Wallets, But These Three Investments Could Help

Long before higher oil prices kicked in and sent shockwaves throughout consumers’ wallets, Americans were already heavily in debt. They still are. And times could get worse as maxed out consumers struggle to make ends meet each month.

While the subprime mess gets all the press these days, the average “man on the street” is feeling the burn. Credit card debt now total a record $915 billion in the U.S. Even the banks are worried. American Express (NYSE: AXP) recently saw its credit card division loss reserves jump by 44%. And Citigroup’s (NYSE: C) beleaguered management said the increase in balances and first time cash advances is a sign of economic stress.

Keep watching CNBC and you’ll hear all about the impact of high oil prices on the U.S. economy every 7 seconds or so. They can’t stop talking about it. And if indeed the market is in the midst of a speculative bubble the way my friend describes, I fear energy prices are headed even higher. The thing about bubbles is that they tend to inflate much more than people expect. That’s true whether we’re talking about oil, dotcom stocks, or even Dutch tulips.

Where it stops, nobody knows. But I have a feeling crude oil is not going to recede in a meaningful way for quite some time.

If you’re looking for a simple way to profit from both oil and the rise of alternative energy as crude oil prices head higher, consider ETFs. Among the most common:

  • U.S. Oil Fund (NYSE: USO): Tracks the price of oil prices directly.
  • PowerShares Wilderhill Clean Energy Fund (NYSE: PBW): Tracks the performance of the Wilderhill Clean Energy Index, investing in companies focused on producing clean energy and environmental conservation. The stock hit a 52-week high of $26.49 yesterday.

Hoping your longs go up and your shorts go down,

Marc Lichtenfeld

Sign Up for The Smart Profits e-Report!

Today’s Smart Profits Action Center

  • Despite another negative day for the stock market today, for once, crude oil prices weren’t responsible for the selloff. The oil market ended a record-setting week on a quiet note today, trading relatively flat (in the mid $95 a barrel area) for most of the session. But with both the latest Producer Price Index data and Consumer Price Index numbers due out next Wednesday and Thursday respectively, we should have more idea of exactly what kind of impact oil’s surge is having on the nation’s manufacturers and consumers. Be prepared for volatility and make sure your stop-loss/trailing-stops are in place.
  • Have you made money on the red-hot oil market? Many investors have - but sometimes, it’s tough to know which investments offer the best risk-reward ratio - even in a market that keeps climbing. That’s why the team of professional traders at the Xcelerated Profits Report not only positions investors in the right sectors and stocks, but also goes a step further than ordinary investors by showing exactly how the pros make “accelerated profits.” Technical and quantitative analyst Jim Stanton did just that with BP (NYSE: BP) earlier this year, giving readers two ways to play the company. Result? A 45% profit in less than three months. To find out more, click here to continue.

Related Articles:

Smart Profits Report Archives

Sphere: Related Content

Written by admin · Filed Under 2007 

Comments

Comments are closed.