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Markets: Oil Spill
New York: August 04, 2008
By John R. Stephenson

So, is it over? Just when it looked as if gasoline and crude oil prices had nowhere to go but up, a full fledged retreat appears to be underway. Politicians and pundits have been quick to declare victory, that the worst is over and that we have turned the corner on high energy prices. But are they right? Is it time to take the For Sale sign off your SUV and to hit the open road with abandon?

Likely not! While the recent pullback in prices is welcome relief for consumers who have been feeling the pinch from rising food and fuel costs, it's just too early to declare mission accomplished on rising energy prices. For starters, fuel prices are just below their all-time highs - hardly a cause for celebration.

Not only that, but the very the recent price decline suggests that we are operating in a very tight energy market with little slack in terms of available supply. This tightness is precisely why crude oil and gasoline prices are so volatile. If insurgents in Nigeria were to blow-up part of a crude oil pipeline, the price for crude will skyrocket. If Israel were to do a little saber rattling over Iran then, presto... oil prices are headed higher.

Lately, prices have fallen as investors became concerned about a slowing U.S. economy. With talk of recession in the air and plenty of gloomy economic statistics floating around, investors are becoming very pessimistic and selling just about anything they can get their hands on - including oil.

Figure 1: The Roller Coaster Ride of Energy Prices!

Source: First Asset Investment Management Inc.

But old habits die hard. It takes years for people to change their lifestyles in response to higher oil prices. If oil prices are headed up, up and away, you drive a little less, but it probably takes at least six months to sell your gas guzzling SUV and purchase a hybrid - if you're lucky!

For now, oil prices are in retreat and for the pundits who have been saying, " I told you so". It is a sweet victory. Unfortunately, it is likely to be a short lived victory. It was only a year ago that oil prices were taking a twisty route higher. On the way to $140/bbl oil prices soared and swooned. In early 2007, oil retreated rapidly from $77/bbl to $50/bbl, a drop of 35%, before continuing its march higher. But as it is today, a retreat of 35% meant nothing then in terms of oils longer term climb and July's pullback is likely to seem like a great buying opportunity for oil and oil stocks in hindsight.

In a world where oil supply has been growing slowly and demand, particularly from the developing world, has been voracious, the balance of outcomes is shifted toward increases in crude oil prices, rather than decreases. While there is no doubt that for Americans $4.00/gallon or $4.00 per latte seem to be the tipping point where consumers say enough to overpriced gasoline and coffee it isn't our demand that matters. Rather, in this increasingly global world, what matters is each additional driver in the developing world that is for the first time ever able to experience the joy of driving. And these new drivers are driving for a lot less than you and I. Thanks in large part to cheap domestic auto prices and subsidized gasoline at the pumps.

With supply tight and demand strong we are even more susceptible to higher, rather than lower, oil prices particularly when you consider where the world's energy is coming from. Increasingly, the vast majority of our energy is coming from areas in the world with huge political risk or exposure to challenging weather conditions. Our crude oil is increasingly coming from places such as Nigeria and Venezuela which have proven difficult places to operate in and as such there is an increased likelihood of a production disruption from those oil basins. The Gulf of Mexico , another prolific producing basin, is notorious for its hurricane activity which can impact the production rigs working offshore.

For our money, the pullback in crude prices provides investors with an ideal opportunity to pick up some first-rate energy stocks at a discount. Until supply can grow, or global demand for oil can moderate, we believe that there still exists a substantial opportunity for investors to profit from oils likely future rise. While these stocks have yet to receive a premium stock multiple in the marketplace the continued deterioration of the banking sector seems to be setting the stage for higher future multiples for these stocks. When the next price spike upwards for energy will occur is anyone's guess, but rather than fret, now may be the time to get your portfolio in shape for a future rally in energy stocks.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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