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2006-09-11 :: Energy Super Cycle Still Intact

Below is an article from an energy analyst that outlines why the energy investment cycle is still in full swing.  I liked it so I thought I’d share it with you.

The Oil Cycle Is Intact
By Christopher Edmonds

9/8/2006 2:00 PM EDT Image

Image With crude oil trading around $67 a barrel, skeptics are arguing that the bullish part of the oil cycle is over. After all, prices are down nearly $8 from their highs and are near five-month lows. If you’re a worrier, it’s time for some perspective. So far in 2006, the average price for a barrel of crude is $59.44. In 2005, the average price of crude oil was $50.04. The last two bullish cycles for crude — 1999 and 2001 — occurred with oil prices at $16.56 and $23.00, respectively. As a result, it’s hard for me to characterize $67 oil as bearish. In fact, as I’ve argued on this site for more than a year, $60 crude is, in the long term, more bullish than $70 crude, because it lessens the impact of high crude prices on the consumer and the economy. The recent decline is the result of several issues:

  • Gasoline demand is seeing a seasonal slowdown as summer driving season comes to an end.

  • Heating oil (another refined crude product) faces a lack of demand before cold winter winds blow.

  • There’s been a lull in geopolitical events that have placed a supply risk premium on crude prices.

  • The 2006 hurricane season has, to date, been uneventful.

Each of these factors should contribute to a decline in the price of crude oil, but that shouldn’t suggest crude is headed straight back to $40 a barrel.

The Cold Shoulder

In the past decade, crude prices typically weaken in the shoulder months, which are the periods in the spring and fall during which demand slows. In the fall, consumer demand shifts from gasoline to heating oil. In spring, consumers start to demand gasoline instead of heating oil. Shoulder months are also a popular time of the year for maintenance. Many refiners perform routine, seasonal work on their plants to ensure they’re in peak operating condition and to prepare for the turn from gasoline to other distillate products. This year could see more refining downtime than normal. Many refineries that were online after hurricanes Katrina and Rita have been running full tilt since last fall to make up for plants that were damaged in the storms. As a result, the need for longer turn times and outages becomes more prevalent as they play catch-up. Valero (VLO) , the nation’s leading independent refiner, said this week that it was hoping to keep its maintenance schedule as light as possible. However, the company hinted that certain refineries — including its Houston, Memphis, Tenn., and Port Arthur, Texas, plants — would be down at times for equipment upgrades. Valero had a handful of unexpected second-quarter outages, which allowed it to complete a portion of its regular maintenance ahead of schedule. Other refiners, such as Tesoro (TSO) and Sunoco (SUN) — and integrated companies such as Exxon Mobil (XOM) — may all face similar maintenance schedules as the turnaround season begins.

The World as We Know It

The world stage will also continue to present challenges to crude supply. Although violence and instability remain, the bigger long-term issue is the ability of the world’s largest producers to sustain production. The need to maintain existing production levels should support oil prices at or above $60 a barrel, which is the average price for oil so far in 2006. Then, add the ebb and flow of geopolitical events that provide a boost to crude prices. While the urgency of the situations in Iran and Nigeria has dissipated for now, it is almost certain to reappear. The U.N. Security Council will consider sanction language in the ongoing Iran nuclear issue, which will draw traders’ attention back to the potential threat to oil supply. Moreover, the situation won’t be resolved anytime soon, so Iran will continue to play the West against China and Russia. That will affect oil prices for months to come. Nigeria also remains a concern, as rebels keep trying to undermine the oil trade in the Delta region. Headlines have slowed in recent days, but the autumn months are typically ripe for skirmishes that tend to affect production. Any event that disrupts supply — either through production or pipeline sabotage — will affect global crude prices. Oil prices are unquestionably due to moderate, as they nearly always do in the shoulder months. However, challenges to production, combined with the high probability of additional geopolitical headlines, should keep prices from slipping much below year-to-date averages. As winter spurs demand for heating oil and other distillates, prices will probably firm. That should signal to equity investors that the cycle is intact.