Oil run based on fundamentals, not speculation: Rubin

There are new bullish, if not bold, predictions on oil prices from CIBC World Markets, says Jeff Rubin, who adds that fundamental demand is driving oil prices, which in turn will power the TSX to a record high of 15,200 by year-end.

According to the latest forecast report from CIBC World Markets, the near doubling of oil prices over the past year has been driven by supply-and-demand fundamentals and not by speculation or the weakness of the U.S. dollar, as others have suggested.

CIBC World Markets is calling for the price of West Texas Intermediate (WTI) to average $115 US a barrel for the year. While this is lower than current prices, it suggests oil prices will remain high, since so far in 2008, WTI has averaged $107 a barrel.

“We estimate that accumulation of ‘paper’ barrels of oil in the hands of speculators has been, at most, one-fifth of the increase in Chinese demand for actual barrels of oil over the last five years,” says Rubin, chief strategist and chief economist at CIBC World Markets. “And even if denominated in a trade-weighted basket of world currencies, the price of oil has still risen to over $100 US a barrel.”

Rubin notes, at nearly $4 trillion US per year, the global oil market’s sheer scale is about 20 times the value of a global commodity index investment — which creates a barrier to market-moving speculation.

Rubin therefore says one way of gauging the role of speculation is to look at the effective diversion of physical supply that would be needed to match the historic rise in speculators’ holdings.

Non-commercial (speculative) long positions for crude oil and oil products have risen by the equivalent of 848 million barrels in the past 5.25 years. Rubin says that only works to an increase in exposure of about 500,000 barrels daily. This is a mere fifth of the rise in Chinese demand, or about 6% of the total pressure on oil supply from some major identifiable factors over the same period.

Rubin also argues that the claim that the rise in commodity prices is largely just the inverse of U.S. dollar weakness is also dubious since oil has risen strongly against other currencies as well.

“Indeed, we estimate that oil would still cost $100 US — five times its 2002 level — even if the US dollar had not declined against a trade-weighted basket of other currencies,” he says.

The report notes that drops in demand will not stall oil’s upward march. The drop in oil consumption in North America, Japan and Europe, due to high prices, will continue to be more than offset by growth not only from the BRIC countries (Brazil, Russia, India and China) but also from highly subsidized consumers in many Middle Eastern countries. China’s policy to partly subsidize domestic oil prices will also continue to boost demand in that country.

“The latest data appears to add substance to our earlier fears that runaway domestic demand is cannibalizing production in the traditional oil-exporting countries, limiting their ability to meet the needs of an increasingly thirsty world,” Rubin says. “According to the U.S. Department of Energy, shipments of petroleum products by the world’s top 15 oil exporters fell 2.5% in 2007, and the weakness appears to be carrying over into the present year.”

CIBC World Markets remains bullish on the prospects for natural gas as well. The firm is calling for prices to average $12.50 US per million BTU this year and $14 US per million BTU in 2009. Rubin bases this forecast on the fact that liquid natural gas imports to America are failing to materialize, which leaves the American market critically dependent on Canadian supply.

This is happening at a time when gas will play an increasingly significant role in electricity generation in North America, Rubin says.

“Outside of a few isolated places like Alberta, there is no new coal generation being licensed in North America. Virtually all of the increase in power capacity over the next decade will be gas-fired, sending North American gas prices well into the teens over the next several years,” he says.

CIBC World Markets’ portfolio strategy remains seven percentage points overweight in energy stocks. Rubin believes energy stocks are still being valued on a per barrel crude price of around $90 US, far below the prevailing spot price.

Filed by Mark Noble, Advisor.ca, mark.noble@advisor.rogers.com

(06/05/08)

Mark Noble