With all the talk of natural gas and the ineluctable pull of King Coal, oil still matters and will for a very long time to come, observes Robert Rapier of Personal Finance.
I expect oil prices to rise for years, but natural gas prices are unlikely to hit new highs any time soon.
Why am I bullish on oil? Reason one: no scalable, economically viable replacement for oil exists. Oil became the world's dominant transportation fuel thanks to three key qualities- cost, convenience, and abundance. No alternative fuel meets all three criteria, although some fulfill one or two. That may change someday, but it won't happen quickly.
Reason two: rising demand from developing countries. Note that between 2005 and 2010, oil consumption fell by 1.6 million barrels per day (bpd) in the US, by 1.2 million bpd in the EU, and by 900,000 bpd in Japan.
However, outside of Japan, the rest of the Asia-Pacific region increased its oil consumption by 3.6 million bpd over this period, and other developing regions showed the same trend: consumption rose 1.6 million bpd in the Middle East, 1 million bpd in South America, and 450,000 bpd in Africa. The net result: overall global oil demand increased by more than 3 million bpd over this time period.
Some of this increased consumption occurred because oil-exporting regions, such as the Middle East, were reaping windfall profits and had more to spend. But developing oil-importing countries also experienced consumption growth, despite high prices.
Demand growth in developing countries in the face of $100/bbl or higher oil may at first seem counterintuitive. After all, when oil and gasoline prices rise in developed nations, we tend to drive fewer miles, buy more fuel-efficient cars, and make other lifestyle changes-and per-capita oil consumption falls. Wouldn't that be even truer in less affluent areas?
The answer is no, because demand for oil in developing countries is much less elastic. The first barrel that someone in a developing country consumes might allow him to drive his very first mile or have light or heat for the first time. Such consumers are willing to pay much more for those initial barrels to find and extract. This is a recipe for higher oil prices, regardless of economic cycles.
It certainly won't be a straight climb from $100 to $300/bbl oil, and we may not reach that level until the next decade. In the short term, I expect West Texas Intermediate crude to continue trading in a wide range of $70 to $120/bbl. But when oil prices do break out, the new range has the ultimate potential to go much higher than current prices.
I recommend the following stocks of integrated oil companies as good long-term beneficiaries of higher demand for oil: Chevron (CVX), and Eni (E), and new Income addition Total (TOT). The most direct beneficiaries will be companies for which oil production is their primary business, including Growth Portfolio holdings EOG Resources (EOG) and Linn Energy LLC (LINE).
My outlook for natural gas is less bullish. Gas prices have rebounded strongly of late, and may continue to recover for a while, but I think this trend is unlikely to evolve into a sustained bull market-and extremely unlikely to take gas back to the lofty levels of 2005 to 2008.
The price of any commodity goes through cycles. Simply put, when prices are low, demand starts rising faster than new supply comes online. Prices rise as a result, and companies increase investments into more production capacity and new exploration and production technologies.
After the lag time that is required for new projects to come online, supplies then climb faster than demand grows, and prices crash. Low prices spur demand, and the cycle begins again.
With oil, growing global demand has prevented gluts even as supplies continue to expand. But gas is not a global commodity-it can't be easily transported across oceans. Consequently, US production is much less influenced by energy demand from developing countries. And thanks to investments in new technologies, we are experiencing an historic gas glut that will take some time to resolve.