Cheap oil means better returns for oil companies
Wednesday, August 8, 2007, 12:19 PM
Stocks by John
Something odd has happened in the oil sector. They have hit a point where cheaper oil is boosting their stocks. Why?
First off, despite a rocket ride into the upper $70 range for crude, gasoline has tried to stay below $3 a gallon. Something odd there, huh?
The oddity is that the oil companies are scared that oil over $3 a gallon will dent demand. In other words, as oil goes up, and gasoline refuses to go over $3, the oil companies have to be eating the difference in price. Advertisements
The unsurprising outcome of this is that now that the price of oil is going down into the lower $70 range, oil stocks are bouncing back up. Hmmmm... makes you wonder. Have oil companies become mortal? What was once an easy buck because of unlimited demand has suddenly become unhinged.
The oil companies have hit a capitalistic wall. They cannot raise the price of gasoline nationwide above $3 a gallon. It will kill demand. But, like all publicly held companies they will be under huge pressure to deliver increased earnings.
They only have a handful of resorts:
1. Cheaper oil. How? Technology improvements, reduced international tension, a lot of futurist outliers.
2. Diversify. Start getting out of oil while the getting is good. Alternative energy divisions are already supplying billions to the oil companies.
3. Ride it out. History says this is a long bull market for oil and will stay as such until tensions in the Middle East cool down. Keep in mind the last time tensions spurred in the Middle East after the Yom Kippur War in 1973 things didn't settle down until after the Gulf War ended in 1991. That's a looooooong bull market. We're only approaching year six of the current bull market.
I am a pragmatic market believer. That is to say I think the market is very good at fixing most problems. I do think you have to be careful about cost disease, but given the American consumer has never even joked about trimming his oil consumption, we're a long way from actually seeing a demand-driven cost disease in the oil market.
The energy market, in some fashion, is going to fix whatever needs fixed in the oil market. My suspicion is that long term oil backs off $70 a barrel. This however may not be such a bad thing for the oil companies. If they can turn higher profits with cheaper oil, then the oil market may finally compelled to embrace something weird: efficiency.
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