Oil Should Continue to Be a Strong Buy

Physician's Money Digest, November 2007, Volume 14, Issue 11

The bull market in oil is looking stronger than ever. There's been a lot of hand-wringing in the media lately about prices at the gas pump. If they think it's bad now, just wait.

But how long will the oil bull run? I believe we have a long, profitable ride still ahead of us. Here's why.

  • There is a struggle with ethanol. President Bush wants to make ethanol from switch grass, and this would be wonderful if it worked. Unfortunately, it doesn't. So far, nobody can figure out how to economically break down the cellulose into usable starches. Therefore, our only real option is to use corn, which has the starches already. However, it takes energy to make ethanol from corn. Among other things, you use a lot of petroleum in the fertilizer, and more in the trucks, tractors, and combines used to grow and harvest the grain. Many scientists believe that it takes as much energy to produce a gallon of ethanol as the ethanol itself contains; even the most optimistic ratio is 1.3 to 1—a mere 30% increase in the energy invested. Ethanol's drawbacks may turn people back to oil, even as they use oil to produce ethanol from corn.
  • The second-largest oil field is dying. The oil industry is buzzing: Cantarell is dying. Its daily production plunged from 1.99 million barrels per day (bpd) down to 1.5 million. According to oil industry consultant David Shields, we'll probably see a further drop down to 900,000 bpd by the end of this year. Why is this shocking? First, Cantarell currently produces one of every 50 barrels of oil globally. A 20% fall in output is a serious blow to the markets. Plus, nearly one quarter of the world’s oil comes from the 20 largest fields. But they're dying at an alarming rate. Twenty years ago, there were about a dozen fields producing more than 1 million bpd each. Today, there are only six—and Cantarell is one of them.
  • Venezuela is resisting change. Hugo Chávez, the dictator of Venezuela, has ejected Western oil companies from their properties in his country. After a decade of work and a $17-billion investment from the Western companies, production from the region is now 600,000 bpd. Here's why this matters to us: Chávez's decisions have already slashed Venezuela's oil output, from 3.5 million bpd down to 2.5 million. Among other things, he fired 20,000 experienced oil engineers and workers. Chávez controls a significant oil resource; Venezuela is the fourth-largest supplier of oil to the United States. His government is a strong bullish force on oil.
  • There may be Middle East conflicts. Current and possible future conflicts in the Middle East could cause Iran to close the Strait of Hormuz, through which 20% of the world's oil supply passes every day. If Iran declared the strait closed, our ships would be immobilized and we'll see oil hit $150 overnight. It looks as though we'll be able to ride the oil bull markets for some time to come.

James DiGeorgia is editor and publisher of the Gold and Energy Advisor Newsletter (www.goldandenergyadvisor.com) and the author of the popular books The New Bull Market in Gold and The Global War for Oil.