Wednesday, September 19, 2007

Oil: It Isn't Really That Expensive Currently

As the price of a barrel of crude marches higher each day it makes headlines, but is not really effecting our day to day lives all that much. In fact where oil to approach the 1980 recession levels, its price would need to rise another 25% to $100 a barrel (adjusted for inflation).

Now, do not get me wrong, the 41% gain we are sitting on in our US Oil (USO) investment since January is great, but I do not see another 25% coming soon. Gas prices have come down and heating oil prices are not much higher than last year at this time when oil was in the high $60's and low $70's. Why?

The price of crude is being influenced by traders, not necessarily supply and demand. Currently, that sentiment is towards the upside. When that sentiment changes, coupled with the demand reduction that is inevitable when the US economy slows, prices ought to fall, and fast. It has been another benign (non existent)hurricane season and for now, middle east tensions have subsided. Yes, I know there is a war going on but, isn't there always? It will take more that a few gunshots over there to make a difference.

Demand from China and India is surging and this is a long term story, but, not 41% in 8 months. The Us ethanol industry lead by ADM (ADM), Bill Gates backed Pacific Ethanol (PEIX) and Verasun (VSE) will produce an additional 1 billion gallons of the stuff this year and that is cutting into demand for gasoline. Which is why despite oil prices surging, the price you pay at the pump has been stagnant or dropping. Further, as people have paid more for food, and other items and fear an economic slowdown, they have chosen closer vacation and are driving rather than paying for plane tickets. no matter what you may think, 250 people packing up and driving on vacation uses a fraction of the oil it takes to make enough jet fuel for the same number of people to get into a plane and fly there.

Now, Boone Pickens will be on CNBC soon and he will tell us the price is going up. Well, Boone is an oil man and high prices are very good for him. I am sure they will go up over time, it is inevitable barring a cellulostic ethanol breakthrough in the next few months that triples our ethanol yield overnight from 7 billion to 21 billion gallons making E85 an immediately viable option. This scenario will happen but it time frame is a few years, not months away.

Am I selling out of my USO position? No, but I do not see much upside from here for a while. Why not sell then? After 8 months I will pay short term capital gains taxes and lose 28% of that gain. Is oil stays flat and I sell in 4 months, that drops to 15% so I can gain 13% even if the price does nothing. Neat...

Long term oil is going up, it just is not the huge story it is made out to be now..


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