David Kotok at Cumberland is sceptical of the oil spike and prospects for ExxonMobil (XOM), et al. His argument hinges on a few key premises, two of which are standard oil-bear fodder: speculators are driving the price and oil demand is now falling.
1. Experts don’t know, so stop falling in love with your favourite oil guru:
“Futures prices are not likely to predict the oil price with much accuracy. A year ago the futures price curve was in contango at about $60. Today it is about the same curve shape at double that amount. Educated guesses about tomorrow’s oil price are still guesses; this is true whether it is Goldman Sachs’s estimate of $200 a barrel or some oil companies’ estimates ranging from $35 to $95. Remember the famous Exxon estimate of $100 (1980) when oil spiked to $30 a barrel at the fall of Shah of Iran. $30 marked the peak in that 1973-1980 cycle; Exxon’s target was reached only this year, 28 years later than the forecast. Enough said for the expert predictions about the timing and degree of future oil prices.”
2. The current spike in prices is driven to a large extent by speculation by institutional investors:
In his Congressional testimony, hedge fund operator Michael Masters was asked, “Are institutional investors contributing to …energy price inflation?” His unequivocal answer was “Yes.” Masters described a “demand shock from Corporate and Government Pension funds, Sovereign Wealth Funds, University Endowments, etc.” He noted that China’s demand for oil over the last five years increased by 920 mbd. During the same period, he also noted, demand by speculators using futures contracts was up 848 million barrels.
3. Demand is responding to the price spike:
Energy consumption as a share of US Gross Domestic Product (GDP) is about the same as it was at the top price of $30 dollar oil in 1980. Likewise, the ratio of the current oil price derived energy cost to disposable personal income is also about at its 1980 peak. As expected, the consumption of gasoline is actually declining now. A decline in gasoline consumption has followed every price shock in the last century, and this time is not any different.
4. Large-cap oil companies have experienced shrinking production for some time now, and that isn’t likely to change any time soon:
In the first quarter of 2008, the combined liquids production of six big publicly owned oil companies fell year-over-year by 700,000 barrels a day to 11.9 million barrels a day (mbd). These six are Exxon Mobil (XOM), Shell, Conoco-Phillips, Chevron, Total, and Eni. As a group the international oil companies (IOC) have experienced a year-over–year decline in production since the second quarter of 2007. The largest IOC is XOM. It produces about 3% of the world’s oil. Given the decline in mature and existing fields, there is no reason to believe that this situation will reverse in the near future.