Our three oil plays have been putting in bullet-proof performances lately — and I believe they are a must have for any serious investor...

Don’t give a second thought to what is going on in Saudi Arabia this weekend; it is just a politically-motivated talking shop. I don’t believe it will have any effect on oil prices - and the outlook for our oil and gas plays remains secure. All three stocks are still rated as a buy.

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The Americans have been blaming the Saudis for the high oil price, accusing them of holding production back. The Saudis have blamed the US’s soft-dollar policy and speculation for the price rise. The looming US election has increased political rhetoric, so the weekend meeting in Jeddah is about being seen to be doing something — but it’s really a waste of time.

The truth is more complicated than what both sides suggest — there are many, many factors driving the oil price... but the main causes are bad planning, underinvestment and over consumption.

The investment needed to find new reserves simply hasn’t happened, there is a lack of global refining capacity and Middle Eastern oil-producing nations are seeing unprecedented demand for energy as their populations soar.

To be fair, even the US government have been starting to talk down the prospect of any meaningful effects from the weekend shindig. At a press conference yesterday, White House spokesman Tony Fratto said: "There won't be any immediate impact on prices. There are no short-term magic wand solutions."

Well, quite.

Peak power could well mean peak profits

Saudi Arabia is the only country that could realistically up its production. However, it has been increasing its output for the last two months — with little effect on prices.

I also question how much extra production the country could squeeze out of its oil fields anyway; investment in infrastructure in the kingdom has been extremely sluggish too.

In March, the Middle East Economic Digest (MEED) warned of an imminent power and water crisis across the Gulf nations. It said there was a serious supply and demand imbalance caused by a lack of infrastructure investment earlier in the decade.

The GCC is currently building a Gulf power grid that will connect the six member states, paving the way for a regional electricity market. But this grid will not come online until 2009 — and even that is in doubt.

"With contractors in short supply new build costs spiralling, and growing concerns over gas feedstock availability, utilities have enormous challenges to overcome in their quest to keep the lights on and the [oil] taps running."

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According to MEED, an additional 60,000 megawatts of new power capacity, around 80% of currently installed capacity, will be required across the Gulf by 2015, while desalination capacity will have to double to over 5,000 million gallons a day to meet projected demand for potable water. Desalination is an extremely energy inefficient process.

Increasing oil supply looks set to BOOST the price

Then there’s also the question of capacity.

I would also like to remind you of the view of Ohio Northern University Energy Economist AF Alhajji. His studies are very important and highlight why the high oil price has been caused by a lack of investment in finding new reserves... it really is a supply issue. Alhajji believes that the main cause of the oil price spike is Opec’s vanishing excess capacity.

When considering global oil stocks, he argues that this excess capacity needs to be considered in conjunction with total global oil reserves.

"The historical relationship between total oil stocks and oil prices has an embedded assumption in it that analysts are now ignoring: excess capacity should not decline below a certain level," Alhajji argues.

He believes the main determinant of the oil price is TOTAL oil stocks. These include inventories in the industrial countries and excess capacity in the oil producing nations. So, vanishing capacity makes current total stocks so small that the increase in oil prices is the necessary result of market fundamentals.

This theory implies that if Opec started to pumping more oil — and this oil is used by the market - then this would be a BULLISH sign for the oil price.

The good news is that the US government has taken some action on the supply front —the bad news is that it is a decade too late.

Yesterday, President Bush proposed a lifting of the ban on drilling off the US coastlines as part of a plan to boost oil supplies. This is a sensible move, but there is no guarantee that the Democrats in Congress will support the legislation due to environmental concerns.

Annual American oil production is around 1.8 billion barrels, and the US government reckons that as much as 19bn barrels remain untapped in coastal areas that are currently no-go areas. Tapping these supplies is vital.

So, even if the Saudis say they will pump more oil, it’s not going to impact the oil price to any great extent. The only solution is to find more reserves or find effective alternatives... and none of these things will happen for a very long time.

Our investments in this field are designed to be a foolproof way to play the energy market. So far they are paying off... Learn more about these and the rest of our portfolio right now...

Garry White
Editor
Smart Commodities UK

Please note: Past performance is not a reliable indicator of future results.

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