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 July 05, 2009
A Critical Junction for Oil Prices

 

If oil prices continue falling, we're going to be right back where we started. More projects will be shelved and future supply will be put on hold. We'll simply end up with another supply crunch from the lack of new investment.

And right now, we're staring at a huge buying opportunity for investors, but I'll get to that in a bit.

I simply can't see oil prices falling below $60 per barrel for very long (assuming the latest sell off drives prices that low). The reason? For starters, hindering new supply much longer will only lead to another crunch.

Let's be honest, the cheap, easy-to-get oil is nearly gone. Even the mighty Ghawar field looks more like a gigantic wishing well, considering the amount of seawater they're pumping into it.

Unfortunately,the U.S. can't afford to wait around much longer. If you haven't noticed, our domestic production has been spiraling down the drain lately. And last year turned out to be quite a year for U.S. oil production.

In fact, last year our domestic production fell below 5 million barrels per day (4.95 million barrels per day, according to the EIA). The last time our production fell below that mark was in 1946. If you don't want to take my word for it, check it out for yourself. Meanwhile, our consumption levels grew to more than 20 million barrels per day.

Understandably, much of that production loss can be attributed to oil prices' collapsing to $30 per barrel in 2008. However, that price collapse took its toll. Companies across the board were forced to slash drilling budgets.

According to oil-field services company Baker Hughes, there are approximately 908 rigs drilling for oil and gas across the U.S. To put that into perspective, there were over 1600 rigs operating last September.

But the problem isn't just our declining production. Remember, the U.S. is importing approximately three-quarters of our demand. Nearly half of our imported oil comes from various OPEC countries (Canada remains the leading source, but our addiction is still mostly dependent on OPEC as a whole).

And trust me, OPEC knows exactly how valuable their crude is to the market. . .

OPEC Oil Production

If you need any more convincing, look no further than Iraq.

The latest round of bidding to develop several of Iraq's oil fields ended up in disappointment. Due to tough pricing (set at $2 per-barrel payout for new production), only one bid was awarded. Trust me, Iraq's oil ministry knows how important their oil will be to future supply.

Although the first round of auctions only resulted in one successful bid, another round is slated for later this year. This time, oil execs will have some time to think the terms over, and I have a feeling we'll see more than one bid. We know Iraq's fields will eventually be developed. They're simply too good to pass up.

The last time I talked about OPEC, prices were pushing higher, and the Saudis were calling for $75 a barrel. That was last March. Oil prices nearly hit that mark, reaching as high as $73.90 per barrel nearly a month ago.

Don't hold your breath waiting for OPEC to boost their production. Even with the latest sell-off, I wouldn't expect OPEC to open the taps suddenly.

As if on cue, Kuwait reiterated that fact on Sunday, stating oil prices won't go below $60 per barrel. So, if $60 is the bottom, how much is too much?

According to the same Kuwaiti oil minister, $100 per barrel would hurt the world's economy. However, he was quick to point out that even $100 per barrel would not lead to an increase in OPEC production.

If we don't see oil prices rebound within the next week, expect OPEC to continue warning us on the danger of future production.

Assuming the world's economy eventually gets its act together, we'll begin to see demand rise. In their latest Medium-Term Oil Market Report, the IEA projected global demand will reach 89 million barrels per day within the next five years.

The times, dear reader, they are a-changing.

Is This the Next Buying Opportunity?

So, where does that leave us?

Like I mentioned before, we're staring at another buying opportunity. Even if oil prices were to fall below $60 per barrel (currently trading higher at $64.56 a barrel this morning), it won't be for very long.

And the next rebound in prices will certainly boost those undervalued stocks that have been unfairly beaten down. For example, if you had told me a few months ago that I could buy my favorite offshore drillers at this much of a discount, I wouldn't hesitate for a second. A lot of those companies have been extremely oversold lately, and most of my readers are on the verge of picking up more.

As we move towards the backside of Hubbert's peak, things are going to be a lot different.

And one simple fact remains: in order to keep new supply flowing, oil prices cannot fall much lower. Every day oil trades under $60 a barrel (some argue $70-$80 a barrel) will only cause problems bringing new supply online.

I believe we're going to see oil prices move higher, making today the next buying opportunity.

Anyone care to take me up on that bet?

Until next time,

keith kohl

Keith Kohl