Higher Crude Means Consolidation Ahead

09/05/2007 12:00 am EST

Focus: COMMODITIES

Peter Way

Founder and CIO, Peter Way Associates

Peter F. Way, editor of Block Traders' Oil & Gold Monitor, says futures traders are looking for higher oil prices for a long time to come-which means more takeover activity in the Oil Patch.

Crude oil prices continue to be the major influence on Oil Patch stock prices. They have now dropped in the front month from a high above $78 a barrel to [the mid-$70s].

Future delivery months continue to be in the normal condition of "backwardation," where gradually lower quotes reflect carrying costs as one goes out in time. (Backwardation is a situation where futures prices for more distant deliveries are lower than for closer deliveries-Editor.) At present the effect is to edge quotes off to just under $68 by the end of 2010, two-plus years from now.

We don't hear much talk now about $35- to $40-a-barrel oil in the future. Most politicians and economists have had their staffs and friends get them educated to reality. The reality reflected by hedging on some $85 billion of crude oil future contracts sees little need for downside protection below $68 [a barrel] between here and year-end 2008. But the upside is quite different.

One month beyond the closest contracts finds protections being bought against a rise above $75. Every month in 2008 sees enough likelihood of prices at $80 and above to cause a brisk business in insurance at those levels.

In short, the crude oil price picture is one of stability to strength from high levels. As with any natural resource, it's always safer to bet on shortage than oversupply.

But this is an industry that has operated globally on a huge scale for decades. There is little they haven't seen or prepared for. Surprises may come, but their reactions will be quick and pretty effective for the bulk of energy users, both here and abroad, to maintain sources of supply.

The energy source industry is not easily flummoxed in the short term. What they don't like is the longer-term supply picture. There may be oil out there five miles under an ocean floor that is under ten miles of intermittently raging water. But getting it is going to cost a lot more than when you crack a geologic structure in a desert where its latent internal pressures drive the liquids to surface transport systems.

Now the easy stuff is mostly used up, committed or politically inaccessible. Going after what may be available at much higher costs makes alternative energy sources more viable, and existing uncommitted reserves very valuable.

Expect to see exploration & production companies acquired by the major integrated companies. Expect to see oilfield-services companies kept very busy as supply continuity issues grow more severe. Expect to see major integrated companies develop interests in energy alternatives of coal and nuclear [power].

How soon overt actions like these will occur is not easy to say, but the value buildup in E&P companies is clearly already under way and is likely to continue.

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