Kevin Book Says We Are Not Looking at Another Oil Super Spike
Black Gold's run has been a wild one for investors, sparking oil analysts to recently raise their forecasts. While the U.S. economy and demand are not the drivers behind this rush, the momentum is there (for example as a currency hedge).
The next level everyone is watching is when crude breaks through $100 and many expect it will. I decided to talk to Kevin Book, Managing Director of Research at ClearView Energy Partners about his crude expectations.
LL: Monetary policy is one of the biggest drivers leading investors into commodities. Are we are going to see another 2009 situation?
KB: Last year, the statistical relationship between a linear regression of crude oil prices against the dollar index was almost exactly as strong as our long-term oil price model, which projects prices as a function of changes in global surplus capacity, using bottom-up projections of supply and demand in 182 countries.
Which one explained price better? Our model implied a $72.50/bbl WTI price. Actual prices came in $7/bbl higher.
In other words: the monkey throwing darts beat our computer model. On the other hand, I’d recommend he quit while he’s ahead.
The value erosion from loose monetary policy may explain why dollars are so quick to flee to the barrel, but dollars that trade interchangeably with barrels for long enough won’t interfere with price forecasts; ultimately, they will become two different ways of expressing the same value, and not a predictor of anything.
LL: Price of gasoline popped last week, where do you see prices going?
KB: This volatility makes analysts hedge, too. We moved to year-average prices in 2008, although we still consider quarterly deviations. Our base case (which is gloomy) projects $84/bbl for the year. Our rapid growth case (which incorporates a 1.33 percent global demand growth) projects $89/bbl. In general, we believe the market is overbought and growth is likely to disappoint. If this year’s “summer driving season” looks as weak as it did last year and the year prior — and scant disposable income makes this a likely outcome — we think prices will be lower by mid-year.
On the other hand, we see considerable tightness showing up in 2012, even under our base case ($95/bbl for CY2012), which means that oil prices will probably be rising going in 2012.
LL: Are we looking at another oil super spike?
KB: No. The last five years have bruised our end-users so badly that, even without declines in home values, availability of credit or economic prospects, we think the demand-side collapse will come much faster this time around.
LL: Looking at oil fundamentals—economic growth is not driving prices—US still has weak housing and job growth is non-extistent.
We are also not seeing surging demand right now- U.S. oil inventories have fallen sharply in recent months but they are high compared to historic levels.On the other side of the world, China is trying to put the brakes on rising inflation. What can stop this oil stampede?
KB: Prices are running because hot money is watching cold weather and thinking warm thoughts about economic recovery. Speculators matter, but they’re not the only thing that counts.
I say this with trepidation, given how I earn my living, but let me blunt: it’s a wonderful thing to be able to use spreadsheet models as a way to discuss the real world, but moving numbers on a page doesn’t change reality. Reality is, petroleum stocks are above normal levels and the end-users of energy aren’t using it as eagerly as they once did. When there’s this much oil in the world, moves towards the high end of the normal range shouldn’t be bull signals.
The problem is that it’s not always easy to know what the new “normal” looks like until we get there.
The stampede has a tendency to correct itself when the first barrel for physical delivery into commercial stocks can’t find a home and the spot market bid collapses. If fundamentals are truly as weak as they look to me (and everyone else, too), then the current surfeit of speculative long bets is more likely to be a terrible investment rather than a self-fulfilling prophesy. Real-time markets create the impression that oil information is accurate, precise and up-to-date, but none of those things are true. Ships take four weeks to reach destinations. Storms delay deliveries. Numbers get fudged. Implied estimates get corrected. Then the truth comes out.
LL: Is 2011 a year for oil and nat gas stocks?
KB: Practically speaking, yes, and particularly if investors value them as they used to value them—on the basis of their reserve replacement and reserve growth. Liquids are the rich end of the story (as always), but using cheap money to put Btus on the balance sheet is probably going to be rewarded as supply tightens.
LL: According to the Obama Administration, energy companies may be able to resume deep water drilling in the Gulf of Mexico in the next few weeks.
All of the permits of course are under the new safety standards which have essentially been an unofficial moratorium. Are you hopeful drilling will resume or this just another round of false promises?
KB: Resuming stuck-in-process permits offers political cover for the Administration, but there’s a more practical explanation, too. The August 16, 2010 guidance Interior gave drillers called for site-specific environmental assessments for new deepwater permits. Interior could change this guidance, but yesterday’s announcement doesn’t suggest a change in stance so much as the opposite — making sure that the new environmental requirement doesn’t abrogate existing contracts preserves the Administration’s ability to impose this guidance. All signs point towards a long, slow path back to permitting, and it may be months before the first “organic” new permit shows up.
LL: Fracking is a business here in the United States which can help reduce our nation's dependence on foreign oil. Why isn't this being pursued more?
Harold Hamm's (of Continental Resources ) numbers on the amount of oil being produced in the United States have been solid. To me this is a story that's being buried in the main stream press.
KB: Not in North Dakota it ain’t. The state has doubled its reserve estimates and projects that it will be the second most prolific producer state within five years, displacing California and Louisiana. The technology that’s unlocked these resources? Hydraulic fracturing and horizontal drilling in the liquids-rich Bakken Shale and especially in the Three Forks formation.
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Lori Ann LaRocco is a Senior Talent Producer at CNBC, and author of "Thriving in the New Economy:Lessons from Today's Top Business Minds."