Looking at Oil Again….

Oil has “peaked” (peak oil pun intended) my interest again, especially after the fall today and the way it has risen with an irrational market.

Today T. Boone Pickens said:

Texas oil billionaire T. Boone Pickens on Monday reiterated his prediction that crude oil prices would hit $75 a barrel this year as producers scale back production. Pickens said about OPEC producers: “They told you they want $75 by the end of the year, I would count on that, I believe them.”

OPEC has scaled back output to help support crude prices, which have dropped from record highs over $147 a barrel in July to around $47 a barrel on Monday.

“I think you are going to clean up the stocks because the people who have the oil are cutting supply,” Pickens said at an alternative fuels and vehicles conference, referring to the nearly 19-year high on U.S. inventories of crude oil reported last week by the federal government. The United States would likely burn through its supply overhang in three months, he told reporters.

Now, I know Boone was also very wrong last year on oil and it cost him dearly as he was caught long with options as prices cratered. I also know he has made billions in oil so he clearly has been right far more than he has been long.

For all issues oil I tend to turn to Gregor.us for information. He recently posted the following information:

World oil production for the past 4 years has remained stagnant at essentially 73.5 mbpd. If the production of any item has not risen over a 4 year span despite demand for it continuing to do so and a historical price spike, it isn’t ever going to and thus the long term price trend must be up. Period

That information followed this from Gregor:

Each barrel of oil contains about 5.8 million BTUs. Each American uses about 25 barrels of oil every year. Considering that it takes an adult one hour of work to generate about 300-500 of their own BTUs, our lives are clearly transformed each day by a “helper” known as oil. That oil is dirt cheap even at 100.00 dollars a barrel is pretty obvious.

But when oil was trading at 35.00 earlier this Winter, the price barely reflected the global average costs of extraction and transport. This average cost level often appears to some as a complex issue, because oil comes out of the ground so cheaply in the Middle East, and more expensively elsewhere. But it’s frankly not that complicated. The journey to 35.00 dollar oil was part of a supply crash that caused voluntary cuts in OPEC, and involuntary cuts in non-OPEC production. When the world offers 35.00 dollars for a barrel of oil, that is simply not enough value-in-exchange to keep global oil production at a steady level. Let alone growing.

Because I regard 35.00 as the level where oil is essentially free–the level where the supply chain recoups its costs and then hands you 5.8 million BTUs of black stuff as a free stub–it’s now appropriate to mark the oil price from that starting point. Should there be a new dislocation in the purchasing power of the USDollar, this could change my 35.00 dollar level. Probably to high side. Until then, you should generally view the spread between 35.00 and the trading price as the price of oil.

The price of oil has no place to go but up, long term. The math is pretty simple, we will have stagnant production and increasing demand, that means higher prices. That being said, over the short to mid term, it can drop, significantly especially in our current manic markets (witness today’s 7% fall) .

I think oil is something I have to own again. I first owned it from Jan 2007 to May 2008 through USO and it was a spectacular play. The last time I did it was Dec. 2008 to March 2009 and while it was again nicely profitable (I averaged down), using DXO (the 2X monthly price change ETF) was stressful for me and caused too much anxiety for a trade destined to be profitable.

With all that being, I expect the current general market rally to subside and fall and when it does, take current $48 oil prices down with it. For a long term play, I will use USO again as a vehicle to hold oil for a year or two and then use DXO to play the occasional dips as a far shorter term play. Holding the 2x or 3X ETf’s long term is a losing game in anything but a spiking market.

What price? I think we could see oil near $40 again. At or near those levels would have me be a buyer again of USO this time.

Disclosure (“none” means no position):none