Rising Oil Prices Series: Part III

Posted by Patrick O'Connor on 6/12/08 11:08 am

This post contains Navellier top-ten energy stock holdings.

This article is the third installment of a multi-part series about rising oil prices. In this column, we’ll review how increasing demand is helping drive up prices. Read parts I and II.

Increasing demand drives crude oil prices higher

Traditionally, in a free market, the law of supply and demand has kept the price of any good at a state of “equilibrium,” where producers are selling everything they make and buyers are getting everything they want. Why then, in the case of crude oil, have prices been rising so consistently—for so long?

First, let’s review how the law of supply and demand works. When there’s a state of disequilibrium, the market tends to correct itself. When supply exceeds demand, producers try to sell their excess supply, often by reducing prices. But when demand exceeds supply, consumers compete with each other for limited resources, bidding up the price of the goods and encouraging producers to create more. Eventually, this takes prices back to equilibrium.

Today, we are clearly experiencing a state of disequilibrium, with demand exceeding supply and prices increasing in response. At root, however, could be rising demand or declining supply. Which is it?

Many experts argue that the problem is clearly continuously rising demand. We’re an oil-dependent world. According to the Energy Information Administration (EIA), if current energy laws and policies remain unchanged, from 2004 to 2030 total world energy consumption will grow by 57 percent. And most of that energy will come from oil. World oil consumption is projected to grow by 1.2 million barrels per day in 2008, from around 86 million barrels per day today to more than 87 million barrels per day by the end of the year. Moreover, that pattern should continue, taking us to 97 million barrels per day in 2015 and 118 million barrels per day in 2030.

So, who’s using all that crude oil? It’s not whom you might think. In its April 2008 outlook, the EIA estimated that U.S. crude oil consumption will decline in 2008 by about 190,000 barrels per day as a result of the economic slowdown and high prices. After accounting for increased ethanol use, the agency says U.S. crude oil consumption will fall even more, by 330,000 barrels per day. While that’s a small decline—around 1% of the 20.7 million barrels per day the country used in 2007—it’s not causing world demand to increase.

What many industry experts believe is causing world demand to increase is usage in emerging markets, such as China and India. In mid-2007, China and India were the world’s most populous countries, with 1.318 billion and 1.132 billion people, respectively, according to the non-profit Population Reference Bureau. By 2050, they’re expected to have 1.437 billion and 1.747 billion people, respectively. In order to support these skyrocketing populations, the countries are becoming more industrialized, meaning they’re using more technology and thus more crude oil. China is also said to be stockpiling crude oil and oil-based products in anticipation of additional transportation and power needs during the 2008 Summer Olympics.

As a result, almost all of the projected world oil consumption growth in 2008 is expected to come from countries that are not part of the Organization for Economic Cooperation and Development (OECD), primarily China, the Middle Eastern oil-producing countries, and Russia, as well as Brazil and India. And that’s a trend that should continue: As noted in Part II of this series, the EIA has said that total energy demand from 2004 to 2030 is expected to increase by 24 percent in OECD countries—but 95 percent for non-OECD countries.

So, if crude oil prices are rising because demand is increasing, why aren’t producers increasing supplies—which, as explained earlier, would take the market back to equilibrium? Partly because the law of supply and demand doesn’t work flawlessly in a market that isn’t totally free—which you could argue is the case today due to the influence of the Organization of Petroleum Exporting Countries (OPEC), a group of 12 countries formed to maintain the price of oil at a level that is beneficial to its members.

In 2006, OPEC—which produced 35.6% of the world’s oil as of March 2008—started to reduce production to stem a fall in prices. Less OPEC oil in the market helped fuel a rally in prices. But today, despite the clear rise in demand, OPEC is declining to increase production, at least not enough to bring down prices. While many nations led by the International Energy Agency have urged the group to pump more oil, it says there is enough in the market, and has declined to do so. Indeed, recent statements by OPEC suggest the group has no plans to review its output until its next scheduled meeting in September 2008.

So, is OPEC right, in which case other factors—perhaps a weak U.S. dollar and speculation—must be driving up prices? Or, is OPEC guilty of price-gouging? In the next installment of this series, we’ll discuss this issue in more detail by examining how limited supply is influencing oil prices.

Navellier Top-Ten Energy Stock Holdings

Vantage Portfolio
Petroleo Brasileiro (PBR); 1-yr Chart; Profile
Sasol Ltd. (SSL); 1-yr Chart; Profile

Power Dividend Portfolio
Noble Energy Inc. (NBL); 1-yr Chart; Profile
Devon Energy Corp. (DVN); 1-yr Chart; Profile
XTO Energy Inc. (XTO); 1-yr Chart; Profile

All Cap Core Portfolio
Occidental Petroleum Corp. (OXY); 1-yr Chart; Profile

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Investment in equity strategies involves substantial risk and has the potential for partial or complete loss of funds invested. It should not be assumed that any securities recommendations made by Navellier & Associates, Inc. in the future will be profitable or equal the performance of securities made in this report. For a list of recommendations made by Navellier & Associates, Inc., for the preceding twelve months, please contact Tim Hope at (775) 785-9416.

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