In early 2003, with oil prices around $30 per barrel, the media incorrectly attributed the “high” prices to the existence of a “war premium”. At that time, I correctly pointed out that the opposite was true, that $30 oil reflected a “war discount”. I also made the controversial, yet highly accurate prediction, that even a favorable end to the Iraq war would produce higher, not lower, oil prices.
In December of 2003, with oil trading near $30 per barrel, I was invited by the Orange County Register to a round table discussion with local experts. Nearly every participant predicted oil prices declining to $20 or lower – I was alone in calling for the price to rise to $50 by year end 2004. In June of 2004, when oil first broke through the $40 level every supposed expert called a top, and has repeated this cry with each new high. I continued to dissent, saying no top had been reached. In making these predictions, I did not merely pontificate, as I put my own and my clients’ money where my bullish mouth was, having invested heavily in the energy sector for the last five years. In fact, other than mining shares, oil and gas stocks have been the only domestic investments I have recommended during that period.
As the current price of oil is now within a dollar of $50, the very experts who did not see this rally coming, are now calling the current oil market a bubble about to burst. I do not know what is more pathetic, the fact that they all have been so consistently wrong in their predictions, or the fact that the media continues to seek out their opinion. Far from being in a bubble, oil is actually in the early stage of a new bull market, with significantly higher prices yet to come.
The reaction to the current “high” oil price is similar to the reactions in 1982 to what appeared to be “high” stock prices, when the Dow Jones Industrials finally breached 1,000, a barrier that had capped every rally since 1966. When it finally broke through, it did so within an environment of extreme skepticism and cries of a bubble. Over the next eighteen years the Dow increased almost twelve fold, finally ending the biggest bull market in U.S. history at 11,750. Similarly, $40 has ended every major crude oil rally for the past fifteen years. From a technical perspective, this break-out is just as significant as the Dow breaking though 1,000. It therefore makes perfect sense that this new bull market is being greeted with the same degree of skepticism.
Supply and demand, not terrorists or speculators, are the primary reasons why oil prices have risen so sharply, and why they will continue to rise. Let me elaborate on each.
Supply: For the past decade Wall Street has been virtually unanimous in the false belief that oil prices would either stay low or fall sharply. As a result, oil and gas companies were not able to attract sufficient capital to finance exploration and development. This unwarranted pessimism largely resulted out of the fear that OPEC would cap any price increase with higher production. Ironically, producers’ false expectations for lower future oil prices helped create the current supply shortage. By not developing additional supplies for fear of lower prices, oil and gas companies actually helped create a situation exactly the opposite of the one they feared.
Demand: Oil consumers reacted to their false expectations of continued low oil prices in exactly the opposite manner. Secure in their expectations of sustained low oil prices, consumers altered their behavior. They traded in economy cars for gas-guzzling SUVs, and abandoned any conservation efforts, seemingly unnecessary in a world of abundant and cheap oil.
Increased demand has also been fueled by the most inflationary monetary policy in U.S. history. As the Federal Reserve has been printing dollars far faster than the world has been pumping oil, oil prices are being bid higher. In fact, higher oil prices in many ways merely reflect the erosion of the purchasing power of the dollar. As the Federal Reserve diminishes the dollar’s value by increasing its abundance, oil prices rise to reflect this loss of value.
As the factors that have fueled rising oil prices, the universal expectation of lower future oil prices (that simultaneously reduce supply and increase demand), and the Feds inflationary monetary policy, show no sign of reversing course, it is therefore foolhardy to conclude that prices will decline in the foreseeable future.