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Monday, September 11, 2006

Energy Beat

By WIlliam Trent, CFA of Stock Market Beat

On Friday, oil prices continued their downward movement. With two large finds announced this week, resumption of service at BP’s Prudhoe Bay pipeline, and the end of the summer driving/air conditioning season the commodity is taking a bit of a breather. Already down on the notion that a global economic slowdown would curtail demand, the latest knocks have broken important technical resistance levels (see chart for oil ETF below.) Is the commodity bull run now officially over?

We don’t think so. We aren’t believers in oil for seasonal reasons, or on the basis of supply disruptions, or even for technical reasons. We believe oil will continue to rise because capacity is nearly fully utilized, demand will continue to rise (even if interrupted briefly by an economic slowdown) and because it is hard to find and utilize new energy sources, whether they be new oil reserves, oil sands or even alternative energies. These sources will not replace five percent of world demand overnight, but with global demand rising at roughly five percent every year that is what would be needed to get oil prices down for an extended period.

Maybe it’s just a function of T Theory, which states that a bull run will last as long as the preceding “rest” period - in this case oil has had a 20+ year rest period, so the bull run should still have legs if the theory holds. Or maybe it’s an Elliot Wave type of event. Or perhaps it falls on behavioral patterns - the long period of low oil prices led to underinvestment that will not be reversed for a long period of time. Whatever theory you want to point to for explanation, we just think oil will generally go up for the foreseeable future.

The action last week was starting to get nonsensical. Take Conoco Phillips (COP) for example. On Friday they announced a major gas find in the North Sea adjacent to one they are already exploiting. However, the shares fell nearly 2%. It’s not like the new find will be the straw that breaks the oil camel’s back and floods the world with supply. It will take years to exploit the find and it will barely affect total energy supply when it is up and running. But for Conoco it has a more meaningful impact, and not the type that should send the shares down.

As to the rise in inventory, there was one. For total crude products, there are now 50.4 days of supply, up from 50.0 days last week (see chart.) We are even flirting with the long-term downtrend line again, potentially signalling that we are wrong and that the world (or at least the US) truly is awash in oil (the two gas stations we tried today, both being out of regular gas, tell another story). But we are also still 10% below the average inventory level of the last 15 years, and well below the levels in 1990.

During the stock market run of the 1980’s and 1990’s the common advice was to buy the dips. During the commodity run of the 2000’s and 2010’s that is our advice for investors in oil.

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