The Commodity Investor Q&A
With Matt Badiali
April 30, 2008
Q: Why are oil prices so high? – M.
A: I can tell you the answer, M, but I don't think everyone is ready to hear it. Let's just keep this between us, okay? The truth is a lot like finding out the Earth isn't flat (it's not) or the sun doesn't rotate around the Earth (it doesn't).
Take a look at this chart:
This chart shows the price of crude measured against the money supply. What it means is the price of crude oil hasn't increased all that much... It's just kept pace with the supply of dollars trying to buy that crude. (Click here to read more about this chart.)
So that's why oil prices have climbed. But why haven't they fallen back as the U.S. economic slowdown puts a damper on demand? CNN, Fox, CNBC, and all the talking heads assured us demand in other countries would dry up as the U.S. slipped into recession.
Well, I'm afraid the U.S. isn't the center of the economic universe anymore... and we've got a lot of competition.
Back in the 1930s, the U.S. was a country of small towns separated by vast farmlands. Tiny, unreliable roads were the only link between those towns.
That's where India and China are today. However, they don't want to stay that way. They want to progress from poor agrarian societies to modern (dare I say more Western) societies. Unfortunately, they aren't patient. They want it right now.
That means huge infrastructure projects – new power stations, railroads, power lines, water systems, and sewer lines. All that development requires raw commodities like iron, copper, gas... and oil.
As these countries grow, transportation demand grows as well. That requires more gasoline for cars, diesel for trucks, kerosene for jets, and bunker fuel for ships. Along with transportation comes electrification, which requires more natural gas for electrical power.
It all adds up to serious competition for oil and gas on a world stage.
It doesn't look like the Fed is going to stop the printing presses anytime soon. So don't expect to see $40 oil again. Add in exploding international demand, and prices are set to climb into the foreseeable future. In the meantime, the U.S. needs to decide where the next 100 years of oil are going to come from and focus on making deals... because that's what China and India are doing right now.
As I've written before, I think Canada will likely be our "gas station" for decades. Already, billions of dollars are pouring into Alberta's vast oil sands. But I think the big story is another huge deposit most investors haven't heard of. Click here to read the full story.
Q: Why can't Americans buy our own oil for less than the OPEC price? – D.C. Cab Driver
A: This question needs some explaining before I answer it. I caught a cab from my hotel to Reagan International Airport yesterday morning. On the radio, some blockhead proposed that our domestic crude production should be sold at a radical discount to world prices.
His hypothesis was that domestic oil belongs to all of us, and it should be used to lower fuel prices. My cabbie was nodding as if this knucklehead on the radio just told us the secret of life.
Let's think about how markets work. If you make something and can sell it in Italy for a $50 profit or down the street for a $10 profit, where are you going to sell it?
But if your neighborhood demands that, since you live close by, you must sell your goods at an 80% discount... that would be extortion. You'd call the cops, right?
If the government demanded U.S. oil be sold at a massive discount to domestic markets, oil producers would stop investing in the U.S. And we'd end up buying all of our oil abroad.
So the answer to higher oil prices is the one thing Americans are terrible at: dieting.
If you don't want to pay high oil prices, go on an oil diet. I'm thinking about doing it myself. We bought a big Ford when we had our second daughter. While we like the room, we don't need it. And when it costs $60 to $70 a week in gas, we really don't need it.
I'm not going to sell my Ford out of a misplaced sense of environmental angst. I'm going to sell it because gas is expensive. I'd rather spend that money on something else... like oil company stock.
Good investing,
Matt
