Goldman Calls a Top on Oil -- Can That Be Right?

Commodity prices are cyclical. Or, so goes the wisdom. Considering the fact that crude oil prices are floating above $120, reversion to the mean type thinking is starting to come in strong? Are we facing a long-term retrenchment of higher energy prices or are we merely just at the top-end of yet another speculation-fueled commodity bubble?

From the master
We know where one legendary firm stands. Goldman Sachs (NYSE: GS  ) called on investors to close several commodity trades, including those in oil and to lock in profits before prices begin to move in the other direction.

The investment bank notes that signs of a fall in demand for oil in the US and speculation resulting due to a potential cease-fire in Libya "has begun to offset some of the upside risk" leaving the price risk more symmetric, and leaving the oil investor more vulnerable.

It's a bold call for sure and I agree with Goldman's observations in general. In my mind, however, when you're talking oil stocks and you're properly keeping the long term in perspective, it's not exactly clear why the bank made the top of the oil market call right now. Allow me to explain why.

The real reason behind the hike
Rises in oil prices this year have generally been a phenomenon based more on speculative rather than fundamental rationale. Speculation about shortages in supply due to geo-political crises in Egypt and Libya that would soon spread to main stream oil producing Middle-Eastern countries was the primary reason for the initial price rise. And, given what we've seen out of the major oil-producing nations (Iran, Saudi Arabia, etc.), many believe these incidences are not the type that will have a long-term effect on the supply curve.

I disagree. I don't see these fears about instability -- and speculation in general -- subsiding anytime soon. In fact, in my mind, the Middle Eastern crisis looks more like a contagious disease than a temporary blip on the radar. And, if this is true, there isn't much fundamental justification for a fall in the speculation driven prices in the near future. Speculation may just have preceded a new fundamental pricing structure here.

Bear in mind, that even a single significant event involving one of the major oil producing counties is capable of shooting up the prices past $150 per barrel. While Goldman may have its own private reasons for including oil in the list of commodities that needs to be sold off, I believe it is too early to make a general call against oil.

Rising demand and a growing economy
Another point that supports my view is Economics 101: The demand for oil is on the rise like never before. Period. Just look at the U.S. first. Despite the unrest in North Africa and last month's devastating earthquake and tsunami (coupled with the nuclear crisis) in Japan, the U.S. economy has yet to truly falter on its path to recovery. An overwhelming number of economists expect the economy to grow by a minimum 2% in 2011, which translates into increased consumer and corporate spending of all sorts.

Plus, let's not forget that peak travel season is upon us once again. Given this, I doubt American markets on their own are going to help drive down the cost of fuel.

Also, globally speaking, the demand for oil is on a huge upward trend. According to the Energy Information Administration, world crude oil and liquid fuels consumption grew by an estimated 2.3 million barrels per day (bbl/d) in 2010 to a record-high 86.7 million bbl/d. Demand for energy in emerging economies like China and India is staggering.

China, which ranks second only to the US in terms of consumption, has and will have an increasing appetite for oil. India ranks fourth in terms of current consumption that number will only increase under prolonged economic expansion. According to an EIA report, the total world consumption of marketed energy is forecasted to increase by 49% from 2007 to 2035. So where exactly is the fall in demand other than a very short-term correction in prices?

Out to make a killing
Shot-term prices will fluctuate, but I believe in the long term, they are going up and will be doing so persistently. I won't be surprised if oil majors, including Royal Dutch Shell (NYSE: RDS-A  ) (NYSE: RDS-B  ) , ExxonMobil (NYSE: XOM  ) and Chevron (NYSE: CVX  ) , make a killing for foreseeable future. The other day, Chevron's CEO came with up with an interesting view that "price creates incentive, and energy will be developed if there's demand for it at the price you can develop it."

With President Obama stressing increased domestic oil production, especially through advanced technology, things look bright for operators like Kodiak (AMEX: KOG  ) and Denbury Resources (NYSE: DNR  ) , working in the shale oil reserves and oil sands in the Bakken Formation. This is a real long-term trend to latch on to.

A Foolish take-away
Despite short-term fluctuation, oil will be running strong for a long period to come. Goldman has its own motivation to move its clients around like cattle in pens, but I think long-term it's safe to say that Fools should stay bullish on oil.

With $100 oil in mind the Motley Fool has created a new, special report; you can download it today at no cost to you. In this report, Fool analysts cover three outstanding oil companies, including the stock Fool analyst David Lee Smith calls the "energy king." To get instant access to the names of the three oil stocks, click here -- it's free.

Isac Simon does not own shares of any of the companies mentioned in this article. Chevron is a Motley Fool Income Investor recommendation. The Fool owns shares of Denbury Resources and ExxonMobil. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (9) | Recommend This Article (18)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 21, 2011, at 5:23 PM, BryanS83 wrote:

    I can only hope that the government stops the middleman trading of oil. Yes, I am all for making money, but what goes on with oil is ridiculous. Artificially increasing the price of a major necessity of most Americans is shameful, at the very least. Those who are engaged in this practice are helping to destroy the lives of their fellow citizens, as well as destroy the economy of their country. I hope that not only does the oil price top out, but it freefalls into an area where once again gasoline is at $1 per gallon, and all those plastics that utilize petroleum are able to be gotten at cheaper prices as well. I realize that, considering the subject of the website that I now post on, I will be in the minority around here with this opinion, but, alas, so be it.

  • Report this Comment On April 22, 2011, at 11:32 AM, Risky88 wrote:

    BryanS83

    Your totally right dude,it will never happen, corporations run this country not politicians.

    It should be one person one vote 50$ per cand max no other can donate, not 50,000 to a cand and avg joe only got 50$. Its easy to manipulate when they dont want you educated and are doing a good job at it.

    My opinion:

    goldman is NOT calling a TOP,

    goldman is sounding a WARNING.

    If oil continues to rise demand WILL be crushed.

    then all that global demand will be GONE

    POP goes the bubble and 1$ gas again.

    Goldman wants to make money (they obviously know how to do it well) they're not going to publish a darn thing that is not going to benefit them.

    China Subsidizes gas for they're consumers:

    Oil continues to rise the subsidy will slowly be taken off and passed onto they're consumer especially since they have rising wages and middle class growing due to all of our used to be jobs.

    If your credit card if maxed out and you don't have the cash

    you just plain won't buy it-that simple

    Does anyone agree with my opinions that at all?

    I'm just a 22 year old college guy that loves stocks but studies Law Enforcement(much funner work day)

  • Report this Comment On April 22, 2011, at 11:38 AM, Risky88 wrote:

    O and because the BUBBLE will pop

    I think the country will go into double dip mode but

    very short lived

    Will not happen though until oil start free falling

    why?

    thats what happened in 2008

    market was caught off gaurd and actually fell behind not ahead 6 months

  • Report this Comment On April 22, 2011, at 2:44 PM, ky0ung wrote:

    To the people who think gas is going to go to $1,

    false, it will never go that low again.

    Personally I think Goldman is playing it on the safe side because oil prices are probably not going to go down for a little while. I agree with this article that oil prices are not going to go down for a while. However I do feel that there is a lot of speculation going on with oil prices due to the simple fact that the demand for oil is not on par with the current price of oil. China, the world's largest manufacturer, is currently trying to slow down its economy and therefore the growth of production is going to falter. Even though the economy may grow a minimum of 2%, does that justify the near 20% oil price increase in the last couple of months?

  • Report this Comment On April 23, 2011, at 10:54 PM, ershler wrote:

    I think there are many things the government should do but determining the price of gasoline isn't one of them.

    Oil is an openly traded commodity and over the long term price is set by supply and demand. Just like any market there will be short term fluctuations caused by any number of outside factors but these are minor compared to the decisions we have made that cause the US to consume 21,000,000 barrels per day. Cheap energy has been great but it is by no means a birthright.

  • Report this Comment On April 24, 2011, at 6:52 PM, KOzNOz wrote:

    I agree with the article also. Oil is a commodity available to the highest bidder. With many other countries "spreading their wings," and growing larger middle classes, they want the same things we want. I think the easy to get oil is already used, otherwise why would they be drilling in sand and shale? Sorry folks, supply and demand is going to make oil more and more expensive.

  • Report this Comment On April 29, 2011, at 11:54 AM, 4spiel wrote:

    I do not think China is trying to slow down its economy -to start with unemployment is the last thing they want. However they do seek to restrain inflation -that kills jobs -they seek to restrain property prices -bubbles in property are potentially very destructivel Thealso seek to rebalance their economy and this will mean spending on infrastructure spending on the military -spending on home production to improve the quality of life. There is no downside for oil in any of this. I notice quite a lot of emphasis on the big oil companies but must not overlook smaller ones that might go a long way. Of the smaller ones VOG in UK source of considerable frustration -some hesitancy over Afren there are a few in Europe -will NOP ever realise expectations -higher oil prices are of course important to keep up the momentum for small companies and of course they are not where you put too much money not paying its way with dividends

  • Report this Comment On April 29, 2011, at 12:30 PM, ddohack wrote:

    I wouldn't go against Goldman on this one. They have access to many sources of information which includes what the movers and shakers are saying among themselves (as opposed to what they are saying for "Don't go against the Fed"

    Goldman isn't exactly at the bottom of the chain.

  • Report this Comment On April 29, 2011, at 3:18 PM, OlJim wrote:

    I agree with the first post, and wish Oil could be removed fromthe commodities markets. At a minimum, the CFTC absolutely must go to a 1:1 investment ratio, and stop allowing greedy buzzards to manipulate ("kill") our national economy at a ratio of 16:1. All these hacks and greed heads are able to put up $8 to twist the futures of over $100 worth of oil, which they have no plans to actually buy! Another change that should be mandated: Buyers must actually take delivery of the oil they are "buying". You watch, folks, this is without a doubt already sending our fragile "recovering" economy into a major tailspin. This story grossly overstates the increased demand for oil. I hope it tanks and wipes out all the greedy speculators. Fundamentals would put oil around $40-50/Barrel, and pump prices at about $1.50. Right where it NEEDS to be for our economy to really flourish.

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