Here's the latest analysis and opinion on oil & fuel prices. Enjoy it while the "gas price holiday" lasts...
http://www.energyandcapital.com/newsletter.php?date=2008-12-24
Oil Prices are Wrong--Very Wrong
By Chris Nelder | Wednesday, December 24th, 2008
Everybody seems to have the same question for me lately: What's the deal with gasoline prices?
How could it go from $2 a gallon to over $4 and then back to $1.66 in a single year? Was it speculators? The evil machinations of OPEC? Badly-timed fills and draws of the Strategic Petroleum Reserve (SPR)? A financial calamity engineered by the masterminds of a shadowy wealth conspiracy?
It's never an easy question to answer, but I can easily say "none of the above."
The price of oil and gasoline is set daily and globally by a complex interaction of many factors, including the relative valuations of currency, speculation in oil futures, the fact that oil is "priced at the margins," delayed supply and demand feedback to the market, economic growth rates, money flows of hedge funds and big institutional investors, geological factors, geopolitics, and many more.
Oil shot to $147 this year because of a particular highly-leveraged alchemy of those factors, and it fell as the leverage unwound. It's down now because the world is heading into a major recession and traders are, as usual, overdoing their bearish reaction.
OPEC's responses this year have been mostly late to the game, so they were regularly ignored by the market. Last week's production cuts by the cartel, and the subsequent sell-off in oil, was a fine example of this.
Filling the SPR is too negligible to move the markets either. In May, the debate over filling the SPR raged on with hardly anyone seeming to realize that its 68,000 barrels per day of demand is a mere blip against the US consumption of 21 million barrels per day. Traders ignored it.
Much more to the point is an analysis of over 100 studies on gasoline price elasticity by the trade magazine Energy Journal, which found when gas prices increase 10%, they cut demand by 2.6%. When prices fall, consumption picks back up.
Anatomy of a Frenzy
Oil and other commodities shot up in the first part of the year as investors sought a safe haven against the financial calamity stemming from the subprime meltdown and levered up their bets with wild abandon.
That trend reversed course in June as the world's central banks began cutting interest rates and the US flooded the markets with dollars. The global deleveraging that ensued caused a rout in the commodity markets, and absolutely everything was sold indiscriminately as money managers scrambled to meet redemption calls and raise cash.
The progressively worsening news about the health of the global economy has only fed the selling frenzy, pushing down oil prices further still. It's now more profitable to store oil than to sell it immediately, and OPEC has made yet another belated and ineffectual move to curb a supply glut.
The Asian tigers that were widely expected to support demand, even as OECD demand fell, have reported extremely bearish numbers in the last week as their economic growth stalls.
Oil consumption is off 3.2% from a year ago in China, the world's second-largest consumer of oil, and its crude imports are now at their lowest levels this year.
Japan's oil exports fell to record lows in the sharpest monthly decline since such records have been kept; meanwhile, imports to the world's third-largest oil consumer are down 17% year over year. South Korea's oil imports are also down 6.5% year over year.
Oil consumption by the world's top oil consumer, the US, has led the global decline with an expected 1.2 million barrels per day decline from past levels through 2009, according to the latest EIA report.
And voila: after thirteen straight weeks of price declines, gasoline is back to $1.66 a gallon.
Some have even suggested that oil in the $40s, and the current glut of oil supply, is proof that fears about peak oil supply were wrong.
Nothing could be further from the truth.
A False Sense of Complacency
A sub-$40 fill-up only lulls us into a false sense of complacency. As I have written repeatedly in recent weeks, we are setting ourselves up for a serious supply problem in the future with oil prices now below their replacement costs.
The facts are sobering:
Current petroleum stocks in the US are still within the average range for this time of year, according to EIA. They're now about 8% higher than this time last year, but that's really nothing to write home about, and it's not much of a "glut."
In a recent interview with Jim Puplava, energy analyst Robert Hirsch commented that a 1 million barrels per day decline in world demand would only move back the global peak of oil production by one month. By that metric, the allegedly huge cutback in oil consumption has bought the world about one month more before we peak—whoop-de-do.
Oil production in Canada, the US's top source of crude imports, is faltering as prices are now too low to justify new projects that tap its large-but-costly and difficult reserves in tar sands and heavy oil.
Our number-three source of imports, Mexico, is in serious trouble. Crude output from our southern neighbor has fallen 7% over last year, and exports are falling much faster, at a 20% decline, according to Pemex. (As I wrote back in June, exports fall faster than overall production. See "The Impending Oil Export Crisis.") Production from its largest field, Cantarell, one of the four "supergiant" oil fields in the world, is crashing at the rate of 33% per year. At the current rate, Mexico's oil exports will cease altogether in just seven years.
Experts at the ASPO and elsewhere believe that, within the next two years, world oil production will go into permanent decline, with depletion removing 2.5 million barrels per day from the world market— that's roughly equivalent to the total oil imports of Germany. There are no oil projects that can overcome a decline rate like that. And yet, no major economy is even preparing for this inevitability.
Saudi oil minister Ali al-Naimi has warned that the world needs $75 oil to ensure future supply, and that current prices "are wreaking havoc on the industry and threatening current and planned investments."
With gasoline now well below $2 a gallon, hybrids and other higher-efficiency cars are staying on the dealer lots. According to an analyst at Edmunds.com, a new hybrid would pay for itself in gasoline savings in two or three years with gasoline at $4 a gallon; but, below $2 a gallon, it's more like seven to eight years. Less than a year ago, you had to get on a waiting list and pay a premium over sticker to buy a new Prius. Now dealers have lots full of them, and Toyota has experienced such a sharp decline in sales that it posted its first operating loss in 70 years. Hopes that we will quickly replace a large percentage of our rolling stock with higher efficiency vehicles are now on hold, along with the hopes for a massive campaign of drilling shale formations and deepwater reservoirs.
A steep contango condition in oil futures is still in place, reflecting the market's near-term oversupply and long-term uncertainty.
Given the evidence, the price of oil is wrong. Very wrong. Crude for under $65 a barrel is a bargain, and crude in the low $40s is a steal. I would not be at all surprised to see a sudden and violent move back up for oil prices within the next year, once the current extreme market conditions revert to the mean.
I am still long oil (United States Oil Fund LP ETF, NYSE:USO) and will add to my position if it goes lower. My expectation is to hold it for a year, in case it further overshoots to the downside before recovering.
I'm also on the hunt for top-notch oil companies with low production costs, sizable reserves, and balance sheets healthy enough to let them acquire smaller competitors at basement prices.
I know it's been a tough year for most investors; but, we're nearly done with this turkey, and I'm setting my sights on profits for 2009. The buying opportunity of a lifetime is upon us. All we have to do now is wait for the right moment to pull the trigger.
Here's to a restful and joyous holiday!
Until next time,
Chris
Energy and Capital
P.S. Although oil prices may not have bottomed yet, that doesn't mean investors should sit back and be lazy. The problem is that the window for finding those up-and-coming energy stocks is running out. Many of your fellow Energy and Capital readers have already begun to prepare their portfolio for oil's comeback. Perhaps it's time you joined them. Click here to learn more about the $20 Trillion Report.
Australians could be driving electric cars by 2012 if Californian company Better Place has its way and introduces its innovative electric car network in Australia. Better Place has announced agreements with financial adviser Macquarie Capital Group to raise $1 billion to develop the initial infrastructure, and with AGL Energy to supply the renewable energy.
Better Place has developed a model for “sustainable mobility”, which allows consumers to own an electric car for a fraction of the cost of a comparable petrol-engine car.
Under the business model, Better Place would own the specially developed batteries that power the cars, and these would be recharged or exchanged at numerous Better Place network stations forming an Electric Recharge Grid. The electricity to power the batteries comes solely from renewable sources; in Australia it would be supplied by partner AGL Energy.
The Electric Recharge Grid infrastructure “is a massive network of battery charging spots” around cities and in the country. A computer in the car shows the remaining power supply and the nearest charging spot. Changing batteries is said to be quicker than filling up.
Better Place says it will offer several car models and subscription packages that will reduce the total cost of ownership and subsidise the car as part of the package.
Better Place has a partnership for the production of mass-produced electric vehicles with the Renault-Nissan alliance, which it says is the world leader in electric car development.
Nissan, with joint venture partner NEC, has created a battery pack that is suitable for electric vehicles and can be produced in mass volume. Renault is working on the development of exchangeable batteries for continuous mobility.
Renault’s vehicles will run purely on electricity, achieving the objective of zero emissions. They will “offer driving performances similar to a 1.6-litre gasoline engine. Equipped with lithium-ion batteries, they will give driving range and longevity.”
Consumers will have a choice of make and model. “Consumers will buy and own their car and subscribe to energy, including the use of the battery, based on kilometres driven. This model is similar to the way mobile phones are sold, with an initial purchase and a monthly subscription for the mobility service,” Better Place says.
“Combined with the lower cost of electricity as opposed to fuel-based energy, and the vehicle’s lifetime guarantee, the total cost of ownership for the customer will be significantly lower than that of a fuel-based car over the life cycle of the vehicle.”
Better Place expects the first mass market EV models to be available in Australia by the 2012 model year, a year after its mass market launch in Israel and Denmark.
The scaleable model adopted in Israel and Denmark will be used to build the EV network in Australia. Macquarie will assist in business development and help raise $1 billion to build the network.
It is early days and details of the fund-raising should be known in about six to nine months, says David Roseman, head of Macquarie Capital Group’s Infrastructure and Utilities Advisory-Australasia.
The offer is likely to be pitched at professional and sophisticated investors and would suit superannuation funds with their long time horizons, he says. The investment vehicle is likely to be unlisted. Melbourne, Sydney and Brisbane will see the initial infrastructure roll out.
Victorian Premier John Brumby says: “The Victorian Government supports any initiative that will have positive outcomes in reducing emissions in the transport sector and welcomes this innovative approach to help make broad adoption of EVs in Australia possible.”
Shai Agassi, chief executive and founder of Better Place, said Australia is the world’s sixth-largest country and building the network in Australia will demonstrate that the business model works in all countries, regardless of size.
The plan will help Australia take a generational leap forward toward oil independence, said Agassi. “With our commitment to build infrastructure and the federal government’s $500 million Green Car Innovation Fund, there is a compelling case for automobile manufacturers to jump in and build clean, safe, affordable electric cars for Australasia and South-East Asia.”
AGL’s group general manager, Jeff Dimery, says the initiative will accelerate the shift toward renewables that is already under way. “AGL is committed to increasing its renewable energy generation and believes it is important to collaborate and implement cross-industry initiatives to counter climate change. Because EVs charge primarily at night, they can maximise the potential of intermittent renewable energy such as wind.”
Roseman says: “The Better Place business model is game-changing and represents an exciting opportunity for Australian consumers, the environment, domestic automakers, the renewable energy sector, local industry and workers to move to the forefront of the energy revolution.
“Electric vehicles represent a more affordable alternative to the conventional combustion-powered vehicle. We believe the combination of a competitively priced vehicle, being driven by cheaper and cleaner fuel is a compelling business case.”
Better Place was launched in 2007 with $200 million of venture funding. Investors include: Acorns to Oaks II, Esarbee Investments Canada, GC Investments LLC, Israel Cleantech Ventures, Israel Corp, Maniv Energy Capital, Morgan Stanley, Musea Ventures, Ofer Group, VantagePoint Venture Partners, Vayikra Partners and Wolfensohn & Co.
Better Place plans to activate its electric car networks on a country-by-country basis beginning in 2010.
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