Make no mistake, recent low oil prices are only a function of the recession.
During a recession, production of goods is slowed across most sectors. This means fewer factories buzzing, fewer workers driving, and fewer deliveries being made.
All this implies subdued oil demand, and that’s been reflected in the price. Oil’s price has been more than halved in the past year.
But don’t think $60 oil is here to stay. Two factors will ensure its imminent rise.
Slowed Oil Investment
It’s a well-known fact that capital investment slows during a recession. This means less money is spent looking for new sources of oil and ramping up existing sites.
That’s fine for now, while demand is subdued. But as the recession fades and demand returns to normal levels, we’ll realize that failure to maintain oil investment has its consequences.
The missed period of investment during the recession will mean supply won’t be able to keep up with demand when normal market conditions return.
And oil prices will climb much higher.
Here’s what Saudi Arabian Oil Minister Ali Naimi had to say about the situation and his country’s involvement:
"We are maintaining our long-term focus rather than being swayed by the volatility of short-term conditions. However, if others do not begin to invest similarly in new capacity expansion projects, we could see within two-to-three years another price spike similar to or worse than what we witnessed in 2008."
He’s been warning about the lack of oil investment for month.
Changing Oil Sources
The recession has done oil prices another disservice. It’s delayed the realization that "cheap" oil is becoming more scarce.
Post recession, we’ll quickly realize (again?) that consuming 86 million barrels per day and producing 85 million barrels is not sustainable.
As we work through the hundreds of millions of barrels displaced by the recession, it will become apparent that the light sweet stuff we’re used to is fading fast.
Sure, there’s plenty of oil left. But it’s harder to get: offshore, shale, oil sand.
And it’s much more expensive. And it takes longer to produce.
I’d say we’re in for an oil wake-up call by years’ end.
Saudi Arabia, according to the Financial Times, thinks that oil "could spike to beyond the near $150 record high of 2008 within three years."
I’ve been playing the trend through bullish oil ETF (NYSE: DXO). But alternative energy will also benefit as high oil prices serve as a catalyst for investment in that sector.
Stick with Energy & Capital as the energy market continues to evolve and change.
Call it like you see it,
—Nick
