Where is crude oil heading in the next 12 to 18 months?

[HenryTo]

In the spirit of the recent supply/demand "issues" in the oil markets, I would like to know my readers' opinions on where crude oil is heading during the next 12 to 18 months. Please ignore all my previous commentaries on this topic - be objective and please come up with your own price targets!

Please also note this is intended to be more of a short-term to intermediate term forecast.

[findfreegold]

Middle Eastern crude oil producers may continue to increase production to discourage conservation. Crude oil may remain in the $60-70/barrel range as a result, but US gasoline prices may still climb until refining capacity is increased. If the production is not allowed to keep pace with demand from China and US and becomes too over priced, a conservation backlash may reduce demand below projected levels. At some point, alternative energy sources will become economically viable if crude oil is allowed to climb to high too fast.
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[HenryTo]

Hello SRmanager,

The underperformance of Chinese equities is very interesting. On the one hand, there is the profit issue. On the other hand, the "high-quality" companies such as NTES, SINA, SNDA, SOHU, and now Baidu are choosing to list on the NASDAQ, not the Chinese exchanges - which is a reflection of how undeveloped the financial and legal infrastructure is in China.

However, China is definitely heading in the right direction, exemplified with the gradual opening up of its financial infrastructure to foreign banks such as BoA. That being said, China is still stuck as an industrial economy and it can only move to the next phase (such as the US, Hong Kong, and British models) by developing a legal structure that can handle and respect property rights. Before they can do so, I am still not entirely convinced that they will emerge out of the 20th century in better shape than, say, Argentina in the late 19th century (when it was one of the most prosperous regions in the world).

[SRmanager]

Hi Henry,

I'm glad you brought up the China profitability issue. Isn't it amazing that there is virtually no correlation between Chinese GDP and Chinese Equities (a proxy for corporate profits)? And there are people here in the US calling for a Chinese currency revaluation?

Chinese companies can't even make money with a devaluated currency. How will they ever make money with a stronger currency?

I should've probably started another topic. Oh well

Best

[HenryTo]

There has been a huge positive correlation between the S&P 500 and oil ever since the October 2002 bottom. And if one has been keeping track - a huge positive correlation had emerged with the Dow Transports and oil as well - that is, until the last four months.

My guess is that the leading indicator of whether the U.S. economy can withstand higher oil prices is the Dow Transports - this that group represents the heaviest users of fuels and contain some of the more marginal companies among the major stock market indices. Already, we are seeing some breakdown. My guess is that the damage has already been done - and if oil prices is to penetrate my "max level" of $62.50 a barrel, then the Dow Transports will head down in earnest.

Your point regarding the U.S. "exporting" our sensitvity to oil prices is definitely right on the money. The ability of our "platform companies" to outsource and to transition costs to the lowest-cost producer has resulted in both higher margins and less susceptibility to the worldwide business cycle.

In a globalized world, the company margins of the "producing country" (e.g. China) will take the hit - as they all compete for the business of the platform companies. That is why I don't think oil produces will do much to "eat into" the profits of companies such as Dell, Apple, Intel, GE, Wal-Mart, etc. This is what is unfolding in China right now, especially given the huge overcapacity in the various manufacturing sectors in China. No wonder the Chinese stock market is near a seven year-low even as the GDP of the country is still increasing at a blistering pace.

[SRmanager]

I believe oil will be below $40/bbl in the next 12-18 months. But in the long run (>3 yrs), oil above $100/bbl will be the norm.

The only reason it hasn't fallen yet is because of long-term value buyers, which includes businesses as well as speculators. Regardless, I am very suprised (and impressed) at the resilience of the US consumer. And as the US shifts industrial production to low-cost producers, I suspect the risk of oil shocks will also shift to these nations. But then, we have the risk of "importing inflation!"

[HenryTo]

Agric,

Your views are pretty much in line with Matt Simmons' views. The guy is so famous that he actually gets a mention on the EIA website:

http://www.eia.doe.gov/emeu/cabs/saudi.html

Aramco claims that the average total depletion for Saudi oil fields is 28%, with the giant Ghawar field having produced 48% of its proved reserves. Aramco also claims that, if anything, Saudi oil reserves are underestimated, not overestimated. Some outside analysts, notably Matthew Simmons of Houston-based Simmons and Company International, have disputed Aramco's optimistic assessments of Saudi oil reserves and future production, pointing to -- among other things -- more rapid depletion rates and a higher "water cut" than the Saudis claim.

In the ST, everything is still up in the air but over the longer-run - as I said in our commentary - I agree with you - oil prices should be substantially higher for years to come!

[Agric]

At best, oil supply and demand will be in approximate balance for the next couple of years. The oil price will be a function of supply disruption, geopolitical upsets, economic activity (eg recession), speculation, during that time.

So, unless the US or China has a significant economic downturn the price of oil will pop higher in response to the other effects. Oil will top $75 in 2005, will top $100 if any significant supply disruption or geopolitical upset occurs. In 2006, unless a global recession intervenes, oil will average over $60, peaks above $100 likely, if peak oil happens and is noticed $150 is plausible.

If you think I am daft please consider: there has been no major adverse (increasing) effect on oil prices during 2005 yet the price has increased by 50% in less than 7 months. What do you think will happen when such an effect occurs?