Is Crude Demand Slip-Sliding Away?

I strongly believe that, particularly following a long-running tendency in a specific direction, one deviation or apparently cycle-changing data point does not make for a trend. Indeed, all too often, after some sort of correction, the original tendency seems to return almost uninterrupted to continue on or near its original path. But then, The Wall Street Journal and I may not be in sync regarding this belief.

The state of global energy markets
I'm referring to a front-page article that appeared in the Journal on Friday, describing data released late last week by the International Energy Agency showing that, for the first time in a couple of decades, demand for crude oil among the developed nations probably declined ever so slightly in 2006. According to the article, the 30 members of the Organization for Economic Cooperation and Development (OECD) -- that's the U.S., Germany, and Japan, for instance, and not China, India, or the rest of the developing world -- saw their collective appetite for crude dip by about 0.6% last year.

Since the OECD nations account for about 60% of the 84.4 million barrels of crude the world now consumes daily, and in light of the 20-year hiatus since the last time the industrialized world experienced a dip in demand, that data may be significant -- or not. But for the present, the Journal contends that this newest data point "may be adding up to a cycle-turning downdraft in demand." It adds, "The resulting shift in global cash flows could mean a big boost for oil consumers' economies at the expense of producers and exporters."

But then, as the article points out further, with China and the Middle East leading the way, total global oil demand was up by 0.9% last year. The increase was, however, smaller than the 3.9% hike in 2004 and the 1.5% demand growth in 2005.

Indeed, there are several other salient points in the Journal's analysis of the crude-oil demand situation:

  • Many analysts believe that crude prices will rebound to $60 per barrel -- the February delivery contracts closed at $51.99 on Friday, up $1.51 -- because that's the level they believe OPEC is willing to defend. However, Saudi Arabia's oil minister, Ali Naimi, may have undermined that argument last week when he said he saw no reason for more output cuts.
  • The paper quotes Frederic Lasserre, head of commodity research at Societe Generale in Paris, who believes that crude prices close to $70 a barrel -- the 2006 price averaged $66.22 -- marked a turning point for demand in the industrialized world. "People wanted to know the point at which oil prices would affect demand; now they have the answer," he says.
  • Recent OPEC production cuts, however small, may actually have helped to prevent a worldwide crude price rebound by increasing the cartel's productive capacity cushion, especially in Saudi Arabia. In fact, once the planned Feb. 1 cuts are implemented, the Saudi gap between capacity and actual production may reach 3 million barrels a day, or a half-million barrels more than is exported daily by Iran, the cartel's second-ranking producer.
  • Biofuels probably will be used more and more to assuage Western petroleum demand. In fact, forecasts indicate that biofuel output could reach the equivalent of more than 5 million barrels a day by 2011, or nearly three times the 2005 level of 1.95 million equivalent barrels daily from such fuels.

The other side of the coin
So the industrial world's demand for crude has slowed, perhaps temporarily, and the rate of total worldwide demand growth appears to be slowing, as well. From the standpoint of the economic health of the consuming nations, it's difficult to argue that those trends are not favorable. But it seems that the Journal's reporters may have jumped off the figurative deep end when they said that "a lasting downdraft in oil prices would trigger a profound redistribution of wealth around the world, putting more money in the pockets of consumers in the West and ending the bonanza enjoyed by oil-company investors and by petro-states such as Venezuela and Iran."

In fact, as I ponder the newspaper's overall take on the IEA data, I'm also confronted by a few clear truisms:

  • The 35% slide in crude prices since midsummer has occurred in the face of exemplary -- and unusual -- behavior on the parts of some of OPEC's notorious miscreants. Now, however, Venezuela's Hugo Chavez is threatening a nationalization of his nation's energy production and facilities, Nigeria remains a political day-to-day crapshoot, and Iran's leadership is more than capable of making Chavez look like Little Lord Fauntleroy.
  • The Journal's article waits until its last one-sentence paragraph to note that Deutche Bank's respected energy analyst, Adam Sieminski, wonders whether people will return to their profligate energy-consumption ways in the face of a return to $2-a-gallon gasoline. I personally believe that all bets are off at that level, and it likely will become a case of letting the good times -- and the Suburbans -- roll.
  • Much of energy demand relates to global economic growth. If, as the IEA numbers maintain, 2006 total demand grew by just short of 1%, and OECD consumption actually declined by 0.6%, it's likely that the developing nations' usage aggregated an increase of something approaching 2%. Barring a worldwide economic slide, it's difficult to envision that 2% figure declining appreciably in the years to come.
  • Forecasts indicate that that current aggregate demand of 84.4 million barrels a day will increase to about 120 million barrels a day by the year 2030. It's also difficult to see how an increase of more than 40% over less than two and a half decades can occur without a fair amount of price volatility, most likely in the context of a general upward bias. This, I believe, will be the prevailing circumstance, despite the probability of increasing contributions from ethanol, biofuels, and other alternative energy sources.

Foolish bottom line
While it's difficult for Fools to know how best to approach their energy investments today, my advice would be the same as it's recently been: I would continue to be represented in the sector by the strongest players that operate internationally. Among the exploration and production companies, I would opt for the size and scope of ExxonMobil (NYSE: XOM  ) , with its massive $428 billion market capitalization and its 1.7% forward dividend yield, or Chevron (NYSE: CVX  ) , which -- although its market capitalization is a "tiny" $158 billion -- starts you off with a nearly 3% forward dividend yield.

On the energy-service side, I continue to like the group's big daddy, Schlumberger (NYSE: SLB  ) , which on Friday reported that it had increased its fourth-quarter net income by fully 71% year-over-year. I'm also partial to Transocean (NYSE: RIG  ) and Diamond Offshore (NYSE: DO  ) , the two key players in deep-water drilling. With all this in mind, however, the only other caveat that I believe should be issued to energy-investing Fools is that the group almost certainly will continue to carry with it more than a little volatility. That's the sector's history, and I see no reason for it to change -- or for Fools to avoid investments in the group.

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Interested in braving the waters of international investing? Consider a 30-day free trial of Motley Fool Global Gains.

Fool contributor David Lee Smith does own Schlumberger, but doesn't have shares in any of the other companies mentioned. The Fool's disclosure policy rides its bike whenever possible.


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