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A top analyst expects crude prices to start plummeting. If you don't believe it, you're not the only one, and a few stocks look good if you're in the skeptics' camp.

By Jon Markman
August 15, 2008
If you're frustrated over the high cost of gasoline at the pump, don't trade in your Hummer for a Vespa just yet: A leading energy analyst is telling clients these days to prepare for crude oil to retreat back below $65 per barrel over the next three years.

How could it happen? He says conservation, new drilling, efficient new vehicles, alternative energy sources, a rising U.S. dollar and a global recession will combine to blast prices back to the Stone Age -- or at least to last year's levels.

"The match has struck, the fuse has been lit, and four or five years from now OPEC producers are going to be drinking their own oil and choking on it," says Tony Kolton, the founder and president of Logical Information Machines, a provider of research to most of the world's major energy-trading companies for two decades.


Plenty of smart analysts disagree with this point of view, figuring that emerging-market demand will pump up fossil-fuel prices and that North Americans will blithely forget all about conservation if gasoline prices trend lower. But since Kolton's view is deeply out of consensus and at least minimally plausible, it does deserve our attention.

Speculators unmasked
Kolton, a specialist in the history, composition and psychology of the energy market, believes that speculators were without question behind the run-up of prices to $147 per barrel in July and that government threats to expose and punish their behaviour spooked them out of their positions in a hurry.

He says his data on open interest of non-commercial positions in crude trading, as well as conversations with professional traders at big oil companies, clearly show that speculators, and not rising demand from Asia, pushed the market to extremes.

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In contrast to people who say the oil market is too big to be pushed around by hedge funds, Kolton counters that in fact it is much smaller than the bond, currency or equity markets. The oil market "can be easily manipulated," he says.

The reason for the misconception is that while the market is large in dollar terms, most of the oil companies' hedging positions are pointed the same direction and set for months at a time. So marginal new positions that point the opposite way can have an outsize impact, much like a 5-foot rudder can change the direction of a 500-foot ship.

"I would ask all the fundamental guys why oil was $147 a month ago and $114 today," Kolton says. "Their opinion that crude moves purely on real demand is BS. When the fast money comes out, there's a giant sucking sound."

The swift exit of the fast-money crowd has pushed oil back down to its March level, around $110. Kolton's research on seasonality and demand suggests oil prices will rebound back to the $125 area and then resume their crash. The $100 level will be hard to crack, but he expects energy bears to prevail over bulls within six months and launch crude on a journey below $65.

"You had a perfect storm of pre-Olympics demand in China, a plunging (U.S.) dollar, speculation, cold weather and fear of supply disruptions in Nigeria and Iran pushing it up, and now they've all swung around on a dime," Kolton says, observing that U.S. recession and conservation are gutting demand, Iran is at the negotiating table, the U.S. dollar is soaring against the euro in reaction to the worsening European economy, and the summer has proved milder than normal, sapping the use of air conditioning thoughout North America.


"People who don't trade the futures markets don't realize that this is typical for commodities, which always trade on emotion. Look at silver in the late 1970s, which went from $4 to $50 and back to $4 in two years," Kolton says.

Diminished demand
What about all that talk of how supply is running out? Well, it's funny: The spike to $147 seems to have really got people thinking about scarcity, and they've started making plans that could be very long-lasting.

It's sort of like the day a person realizes it's time to stop smoking -- a light-bulb moment of alertness to a long-simmering crisis. Oil bears now think the $147 level was a slap in the face that made major corporate users consider changing their behaviour in persistent and fundamental ways.

Auto companies became focused on creating smaller hybrid cars; individuals are discovering the joys of public transportation, car pools and bicycles; churches are lecturing on the need to turn out the lights in vacant rooms; and American presidential candidates are debating the merits of inflating tires. And perhaps most importantly, going green appears to have emerged from fad to lifestyle as the cool dads now drive Mini Coopers instead of gas-guzzling Suburbans to their kids' soccer practices.

Big private-equity and venture-capital funds, and industrial titans such as General Electric (GE.N), are throwing billions of dollars into creating better batteries, advanced materials and vehicles that run on plug-in electric power and plentiful U.S. natural gas. Meanwhile, oil giants from Brazil to Beijing are exploring for new oil and finding it offshore a lot more easily than expected, with payoffs to come a lot sooner than most skeptics now believe possible.

All of this is coming at a time when a credit drought has seriously impaired economic growth and blunted employment levels in developed nations in Europe and the Americas, and threatens to spread to Australia and much of Asia. When people are commuting and consuming less, and when companies are making less, they collectively use less energy. The U.S. Energy Information Administration reported Tuesday that oil demand during the first half of 2008 fell by an average 800,000 barrels per day compared with the same period a year ago -- the biggest volume decline in 26 years.

Bad news and other views
Of course, we should probably be careful about what we wish for. While stock prices have risen smartly as energy prices have cracked in the past month, stocks are likely to fall steeply along with oil prices if a global recession is the major driver behind demand destruction. Just in case you're wondering, Kolton's historical and economic research and his gut instincts as a veteran trader lead him to think that the Dow Jones Industrial Average ($US:INDU) will sink to the 9,500 level next year -- retracing the 2003-07 bull market -- before the bear has had its fill.

Opposing point of view? Yeah, I've got that. David Anderson, an energy portfolio manager at Palo Alto Investors, who has been my go-to guy for years on the subject, thinks the idea of crude oil falling below $65 per barrel is ludicrous. And, frankly, he says he doesn't even care when it comes to his energy-industry positions.

"We never base our view on energy-industry stocks on the direction of oil prices," he says. "We are buying growth companies in a growth industry and always have at least a five-year horizon. The fundamentals of the business -- increasing demand and decreasing supply over the long term -- favour higher stock values over time."

Anderson says energy bears are just not facing reality. He points to U.S. Department of Energy research that forecasts global growth in demand rising to at least 110 million barrels of oil per day in a decade from the current level of 85 million. "To get to that level while supply from the best and biggest fields in the Middle East, North Sea and Gulf of Mexico is shrinking will be very tough," he says. "Oil prices are going up to ration supply, short of a total global economic meltdown."

If you want to invest along with Anderson instead of Kolton, here are the large and medium-sized companies he likes best on the recent pullback, with expectations that they will roar back starting in September: Petrohawk Energy (HK.N), Plains Exploration & Production (PXP.N), Chesapeake Energy (CHK.N), Apache (APA.N), Southwestern Energy (SWN.N), EOG Resources (EOG.N) and Range Resources (RRC.N).

Anderson is always good with the small caps, and among his favourites now are Canadian Superior Energy (SNG.TO), Arena Resources (ARD.N) and Gastar Exploration (GST.N).

With any luck, Kolton and Anderson can both be right. These energy companies were going to be very profitable with $75 crude oil a year ago, so they must be minting money now. Short of an expectation for the lights to go out worldwide over the next year, consider buying at these levels, while the pessimism lasts.

At the time of publication, Jon Markman did not own or control shares of any company mentioned in this column.
 

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THE Democracy Doctor
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If oil prices fall that much, would those EVIL oil companies have to MOVE OUT of the White house?! :confused: Maybe that Cheney is the anti-Christ!? :rolleyes:
 

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Actually, it will be interesting to see how Bush leaving the White House and the price of crude falling end up getting spun by the moonbats. I can see the conspiracy theories already.... Dammit, where did I leave my tinfoil hat?
 

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On the radio the other day was some "Industry Expert" (on a talk show, don't recall his name) saying that gas is going to free-fall to less than $2.00/gal.

He gave some reasons that I won't re-hash here. Some made sense.

I'm not buying that prices could tumble that far, but GAWD I hope I'm wrong! :D
 

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There are two things that will cause the crash of oil...

1) conservation and greed by the producers cause a huge glut
2) Iran announces possession of nuclear weapons.

#1 is a no-brainer - supply and demand drive prices. Producers, in their desire to maximize the per barrel price will overproduce. It's happened in EVERY instance where oil has skyrocketed -- what goes up, must come down (when greed is involved)

#2 is an interesting thought. Most people would consider that to drive prices through the roof; however, I see the opposite. Why? Because Saudi Arabia and other worried parties will pump the hell out of oil to drive prices into the basement as an economic weapon against Iran.
 

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I put 10% of my portfolio in refinery stocks last month - they have been beaten up so badly by the crack spread I could not resist. Although there is no EFT for refinery stocks here's what I bought: Sunoco, Valero, Tesoro and Holly.

Every time the price of crude falls even a little bit my net worth increases dramatically.

It has been a GOOD month. :dance:

I don't think we'll ever see $65.00 a barrel oil again - but I won't complain if it happens!
 

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grifscoots said:
China and the evolving third world companies sucking every resource they can afford was a bad dream?
Yeah, and China has HUGE reserves of oil in the ground. However, they are not about to use THEIRS, until everyone else's is sucked dry, then they will have the only large reserves left, just for THEM! They may be magnanimous, and sell us a little, for astronomical prices.

China is going to take over the planet, one way or another. Don't see much to stop them at this time. The USA is going to be a second rate power sooner than anyone ever realised.
 

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RonKMiller said:
I put 10% of my portfolio in refinery stocks last month - they have been beaten up so badly by the crack spread I could not resist. Although there is no EFT for refinery stocks here's what I bought: Sunoco, Valero, Tesoro and Holly.

Every time the price of crude falls even a little bit my net worth increases dramatically.

It has been a GOOD month. :dance:

I don't think we'll ever see $65.00 a barrel oil again - but I won't complain if it happens!
Help me understand this please. If crude oil prices fall dramatically, how does that help the stock prices of the refineries you bought? Will they be busier because consumers can afford to buy more fuel?


EDIT: The prices of those stocks have plummeted in the past year. Why is that when crude oil companies are making record profits?
 

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I was going to ask the same question.

Re China not using it´s own oil, Norway is also, quite rightly too, doing the same thing.

The UK made a quick buck and have used theirs, or the Scots would say, theirs.
 

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I love the so called experts. Weren't they predicting $5.00 a gallon gas and $150.00 a barrel only a few weeks ago by Labor day? I've been predicting all along that prices would drop after July 4 and believe me I'm no expert in this field. It just is common sense we are by far the largest consumers of oil in the world and as of June we are using 800K barrels of oil less each day. I think when the summer driving season is over you'll be surprised that figure will go higher. I have a bet right now with a buddy of mine that prices will go below $100.00 a barrel, he didn't think that will ever happen in our lifetime. He's starting to get a little nervous right now! The Saudis have said all along that oil should be somewhere around $89.00 a barrel and that's taking into account the emerging countries usage.
I doubt that China is going to be as big a problem as some fear with their consumption of fossil fuels. Just look what's going on right now with the Olympics and the pollution that's going on. My fear is that China, who by the way is investing billions of dollars in training engineers and scientists are going to come up with an affordable alternative to fossil fuel and we'll be buying that technology from them! Just my two cents!
 

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Ted Shred said:
Help me understand this please. If crude oil prices fall dramatically, how does that help the stock prices of the refineries you bought? Will they be busier because consumers can afford to buy more fuel?


EDIT: The prices of those stocks have plummeted in the past year. Why is that when crude oil companies are making record profits?
...and that is EXACTLY why you wanted to buy them when crude was so expensive. They represented an incredible value. Refiners make a LOT more money when the price of crude is low.

"A key element of determining the degree of crack spread has to do with not only the range of end products that are created with the use of a core product, but also the current market demand for those products. This can sometimes involve considering the current level of demand within a given country or even with a geographical region of the country. Using the example of the crude oil, the investor would choose to acquire crude oil futures at the best possible price. At the same time, the investor would attempt to sell futures options involving gasolinehttp://www.wisegeek.com/what-is-polypropylene.htm when the current market demand is on the upswing, but before the demand begins to level out. By understanding the current difference in value between the core product and the end products, it is possible to determine the crack spread, and engage in buying and selling to best advantage."

My current position will change dramatically if the price of crude starts climbing again. I think what we've seen is a temporary correction in a bull market for oil. I am seriously considering buying into oil stocks at this time on the pullback since I think we've hit another bottom in a looonnggg run on energy prices.

None of this is ever a guarantee though - just yesterday when crude fell yet again my refiners took a sizeable hit. :kaboom:

I think it may have more to do with inflation expectations and the general dismal state of credit. :(
 

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RonKMiller said:
...and that is EXACTLY why you wanted to buy them when crude was so expensive. They represented an incredible value. Refiners make a LOT more money when the price of crude is low.

"A key element of determining the degree of crack spread has to do with not only the range of end products that are created with the use of a core product, but also the current market demand for those products. This can sometimes involve considering the current level of demand within a given country or even with a geographical region of the country. Using the example of the crude oil, the investor would choose to acquire crude oil futures at the best possible price. At the same time, the investor would attempt to sell futures options involving gasoline when the current market demand is on the upswing, but before the demand begins to level out. By understanding the current difference in value between the core product and the end products, it is possible to determine the crack spread, and engage in buying and selling to best advantage."

My current position will change dramatically if the price of crude starts climbing again. I think what we've seen is a temporary correction in a bull market for oil. I am seriously considering buying into oil stocks at this time on the pullback since I think we've hit another bottom in a looonnggg run on energy prices.

None of this is ever a guarantee though - just yesterday when crude fell yet again my refiners took a sizeable hit. :kaboom:

I think it may have more to do with inflation expectations and the general dismal state of credit. :(
So would you consider these refinery investments something to hold onto for a longer term (over a year) or will you sell them if there is a sizable gain in the next 4-6 months?
 

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http://www.streettalklive.com/

These guys have forecasted just about everything correctly in the last two years. Mortgage melt-down, banking crisis, oil price, and the current (according to them short lived) stock market and dollar rally. As well a several individual stocks that I follow. They also predict $75 barrel again, as a short term dip.

There might be something to it...
 

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Ted Shred said:
So would you consider these refinery investments something to hold onto for a longer term (over a year) or will you sell them if there is a sizable gain in the next 4-6 months?
I never fall in love with a sector - I will sell them in a heartbeat if oil starts climbing again - and look somewhere else for an opportunity.
 

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RonKMiller said:
I never fall in love with a sector - I will sell them in a heartbeat if oil starts climbing again - and look somewhere else for an opportunity.
Gotcha
 

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Wolfgang said:
http://www.streettalklive.com/

These guys have forecasted just about everything correctly in the last two years. Mortgage melt-down, banking crisis, oil price, and the current (according to them short lived) stock market and dollar rally. As well a several individual stocks that I follow. They also predict $75 barrel again, as a short term dip.

There might be something to it...
These guys are really good, about $83 and falling this morning.
 

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Wolfgang said:
These guys are really good, about $83 and falling this morning.
This must be horrible news for "The EVIL W"/Cheney conspiracy theorists!
 
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