Energy Prices Can Shoulder the Load

This column was originally published on RealMoney on Aug. 23 at 2:08 p.m. EDT. It's being republished as a bonus for TheStreet.com readers.

For crude oil investors, the shoulder season is close at hand, and that means more hand-wringing over the future price.

It is true that peak driving season -- the period in which many Americans take to the roads for family vacations -- will officially end with the passing of the Labor Day holiday.

That will likely provide marginal relief for gasoline prices, which were lower midday Wednesday, after the Energy Department's weekly inventory report showed an unexpected increase of 400,000 barrels vs. expectations for a decline of 2 million barrels. But the increase in gasoline inventories is a result of increased refinery utilization and imports, rather than a meaningful reduction in demand.

Crude futures were down as well after the government said inventories dropped by 600,000, but remain nearly 5% above year-ago levels.

However, those who are hopeful for a precipitous fall in crude oil and gasoline prices need to consider not only the fundamental figures, but also a couple of very important data points unique to the 2006 fall shoulder season.

Supply and Demand

Some argue there is now plenty of oil coming to market and that the acceleration in drilling will add even more in the coming months. However, a careful read of the fundamental oil barrels (the tea leaves of the petroleum business) suggests otherwise.

The argument that there is a plethora of crude sitting in tankers around the globe ignores the crude-quality argument. While the Saudis, for example, may well be producing crude that is not currently used in global markets, it lacks a market because it is heavy and sour and not readily usable by most refiners.

Moreover, the argument that the world will be awash in crude in the coming months (and years) as a result of increased drilling overstates the impact of additional drilling. As we have discussed in these pages before, rig intensity -- the number of rigs needed to produce an additional increment of crude oil or natural gas -- continues to increase as the decline rate in current wells accelerates.