Fundamentals Should Keep Oil Pumping

Every now and then you have to get lucky. I recommended EOG Resources (EOG - commentary - Cramer's Take) several times the last few weeks, and it had an analyst meeting on Thursday that blew the doors off. The stock ended up almost $20 to $125 on a very strong production outlook detailed at the analyst meeting. We sold a few shares into the strength, since the position became a disproportionate weight in our portfolios. It is still one of our larger positions.

Nice as the gain was, it leads into a bigger discussion of "whither goest the price of oil?" (EOG is primarily a natural gas producer, but you get the idea.) Very near term, the price of oil is being greatly influenced by Turkey's incursion into Iraq, Iran's nuclear program, Exxon (XOM - commentary - Cramer's Take) vs. Chavez, violence in Nigeria and the consequent geopolitical instability and nervousness. All of these factors can reverse themselves -- but I bet they won't -- and oil prices could calm down. Looking beyond the immediate, I see nothing that would tell me that oil won't stay high in price and move even higher over the longer haul.

Supply and demand is in precarious balance. OPEC's spare capacity is limited, and non-OPEC supply has continually disappointed.

Oil is priced in dollars, and OPEC's income vs. the other currencies they want and use is nowhere near what the dollar price says it is. Saudi oil fields are declining at a faster pace than they will admit. The Saudis have never had as many rigs drilling with apparently little in the way of incremental production being brought on stream.

People who figure such things say the Saudi budget would be balanced if oil were about $65 a barrel. Sixty percent of the Saudi population is under the age of 21. There is huge social network that the Saudis don't dare let fray for fear of stirring even more issues with Islamic fundamentalism. Lip service notwithstanding, the Saudis want ever-higher prices.

Seventy-five percent of the world's oil production is from fields discovered more than 25 years ago. Despite intensive drilling programs, the new fields are significantly smaller than the older discoveries. In other words, the easy stuff has been found. Seventy-seven percent of the known oil reserves are controlled by state oil companies that, generally speaking, don't like us very much. They have no incentive to do anything but maximize the price.

---

Vincent Farrell Jr. is a principal of Scotsman Capital Management. Prior to joining Scotsman in April 2005, Farrell was chairman of Victory Capital Management of Cleveland and chairman of Victory SBSF Capital Management in New York. He was a founding partner of Spears Benzak Salomon & Farrell, which was acquired by KeyCorp in 1995. Vince held a variety of positions in his 23 years at SBSF, including chief investment officer, and he served as the portfolio manager on a number of the firm's largest client relationships. He is a regular guest on CNBC as well as other national print and broadcast media.

Prior to joining SBSF, Vince spent nine years at Smith Barney as a vice president, sales.

Vince graduated from Princeton University in 1969 and received his MBA from the Iona College Graduate School of Business in 1972.