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.
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