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Author Topic: Why Oil is Headed Much, Much Higher  (Read 1765 times)
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tamo42
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« on: 2011 Mar 01, 09:50:12 am »



You might have noticed that the price of gas at the pump has jumped a bit over the past week. In this post I am going to show you why this is happening, and where this is likely to go.

The fundamental drivers of any market price are supply and demand. The more supply for a given demand, the lower the price. The more demand for a given supply, the higher the price. Oil demand is what we call "inelastic." This means that oil is such a vital resource that the people of the world will buy it pretty much no matter what the price is. That's why demand has been more or less the same whether oil was $30/barrel or $130/barrel.

So if demand is constant, what is happening to supply?

Well, remember those posts I wrote about the revolution starting in Libya? As it happens, Libya exports 2% of the world's oil on a daily basis. Now that supply has been cut in half or even less, depending on which reports you believe. So supply is down.

But wait! Saudi Arabia says it will fill the supply gap! If this were true, there shouldn't be any rise in oil prices, right? Well, yes and no. Libyan oil is actually very high quality light, sweet crude. Essentially this means that it requires relatively little refining and is cheap to bring to market. The additional oil that Saudi Arabia would provide is heavy, sour crude - which means exactly what it sounds like. It takes more work and money to bring it to market as refined petroleum (and the other bajillion oil products).

So there's that factor. But wait, there's more. Jim Rogers goes on CNBC the other day and says that Saudi Arabia has been lying about their reserve figures for years, and that even if they wanted to, they couldn't handle that much of an increase in production. The way oil inventories are calculated, we won't know for a couple months whether Saudi Arabia actually has increased production of the lower quality oil or not. All we really know right now is that they are saying that they are.

And the market's reaction? The market is demanding higher premiums on Saudi bonds. The market is telling Saudi Arabia, "We don't trust you." The Sauds have all kinds of problems. Oil production just being one of them. They have an aging (maybe dead/dying?) king, an unhappy population, and they might be maxed out on their oil production.

Then to top it off, they slightly reversed course this morning saying they will allow the price of oil to rise to $120 per barrel. Is it because they don't have the supply capacity to really make up for Libya's shortage? Only time will tell. Taken all together though as a single picture, and we can see that oil really is black gold.

For the record, I'm long on WLL calls right now and am already just playing with profits.





* oil 2011 03 01.png (42.12 KB, 691x528 - viewed 304 times.)

* oil drum.jpg (35.18 KB, 300x451 - viewed 804 times.)
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Neal McSpadden
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badon
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« Reply #1 on: 2011 Mar 01, 01:12:34 pm »

Wow, nice article. It's on Digg now:

http://digg.com/news/business/why_oil_is_headed_much_much_higher

When oil starts moving up, it will amplify the effects of inflation, and overwhelm any legitimate efforts to control it. This may be an explosive mixture for the markets. Hot cash is going to end up in speculations on the oil market, and in other hard assets like precious metals and coins.

This is going to be an exciting year for everyone who has cash.
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« Reply #2 on: 2011 Mar 01, 04:18:10 pm »

Thanks for the informative article.The problems in the middle east are a nice "excuse" for oil to go up. Now the mainstream media can blame crazy Gaddafi for it. The public will eat it up and will be distracted from real culprit. The real problem is QE1 and peak oil. The inflation we see now is the result of QE1. We have not even felt the effects of QE2, yet. 
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tamo42
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« Reply #3 on: 2011 Mar 01, 05:26:14 pm »

There is definitely some truth to the idea at us inflation is leading to worldwide inflation as the dollar is the reserve currency. But another factor is that emerging economies are, well, emerging. So the demand for oil is also increasing against what appears to be a limited supply.

The Libyan production cut seems to be a (short term at least) catalyst leading to higher prices.
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Neal McSpadden
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« Reply #4 on: 2011 Mar 01, 05:43:04 pm »

The US seems to be "exporting" inflation. The inflation is being felt more in emerging economies but at some point this avalanche of inflation is going to have to come home! Increasing copper and oil prices are indicative of growing emerging economies which includes the mother of all emerging economies , China's. They don't really reflect a slowing China. Do you think China is doing a good job advertising its weaknesses with all the talk about a Chinese bubble economy? If they are doing that, what do you they get out of it?
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« Reply #5 on: 2011 Mar 01, 07:57:16 pm »

Inelastic demand can cause huge increases in prices even if the supply only reduces a very tiny amount. The best way to describe this is if you imagine a group of astronauts in space with a limited supply of oxygen. If there's not enough for everyone, then the only way to solve the problem is to reduce demand. The only way to reduce demand is for somebody to stop breathing...

Same goes for oil. Somebody has to stop using oil. If every nation of the world is dependent on oil simply to survive, then somebody has to stop breathing. This is how wars get started...

There's a Chinese proverb about the lack of a single nail that comes to mind.
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tamo42
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« Reply #6 on: 2011 Mar 01, 10:10:52 pm »

The US seems to be "exporting" inflation. The inflation is being felt more in emerging economies but at some point this avalanche of inflation is going to have to come home! Increasing copper and oil prices are indicative of growing emerging economies which includes the mother of all emerging economies , China's. They don't really reflect a slowing China. Do you think China is doing a good job advertising its weaknesses with all the talk about a Chinese bubble economy? If they are doing that, what do you they get out of it?

I'm not sure what you mean by this.

badon, I like the astronaut analogy.
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« Reply #7 on: 2011 Mar 02, 10:39:30 am »

There have just been reports that Libyan fighter planes have fired missiles on the town of Brega, which is home to a port, a refinery, and oil & gas pipelines. At this point it is pretty safe to say that Libyan oil and gas production will be below capacity for a while.
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« Reply #8 on: 2011 Mar 02, 10:52:25 am »

The astronauts are suffocating...
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The Coin Compendium and the china-mint.info forum, censure, disclosure.
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« Reply #9 on: 2011 Mar 08, 12:32:39 pm »

I feel the need to point out that my analysis here is a long-term picture. In the short term there will be extreme volatility both up and down. At this particular moment, I see more and more reports of everyone calling for oil to hit $150 or $200 or whatever, which makes me think that we are ready for a drop short term.
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Neal McSpadden
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