The Buysider: Energy Prices Can't Stay Low Forever

Prices could rise as soon as next heating season.
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About 18 months ago, the oil industry was exhibiting the unmistakable signs of excess that, in the past, have always signaled a peak. Then, some hapless industry analyst actually predicted in print that the price of oil, then at $21 a barrel, would ultimately reach $100 a barrel.

Such silly, unfounded predictions always occur near the end of market extremes. So I did what any conscientious skeptic would do -- I called for a

top in the then red-hot oil boom.

A year and a half (and $10-a-barrel less) later, an equally promising indicator has appeared, courtesy of the

Financial Times

. The headline: "Low Commodity Prices May Not Fully Recover."

What is the source of this example of now-widespread pessimism? None other than the

World Bank

, in one of its recently released reports titled "Global Commodity Prices." Somebody there predicted that commodity prices may remain depressed for a number of years. This is the type of bureaucratic, consensus-oriented, behind-the-curve type of research that can make you a lot of money -- if you just do the opposite of what it recommends.

How? Recall the old adage that "nothing cures low oil prices like low oil prices." You won't get the answer from Wall Street, which tends to simplistically focus on the demand side (Asia, etc.) instead of the supply side (production, deliverability).

On the supply side, the

North American Rig Count

in January was at 562, the lowest level since that particular index started in 1944 -- a 55-year low. This low North American rig count -- and, by proxy, the global rig count -- indicates a severe and unprecedented lack of reserve and production development.

Without development, global production will eventually decline to a point where the current surplus is exhausted and the prices will respond appropriately. The lack of development is certainly evident in Texas, where energy industry layoffs could approach 50,000 this year.

Dan Morrison, energy analyst for

J.C. Bradford & Co.

in Dallas, notes that the adage noted above definitely applies to the natural gas side of the equation.

"The decline in natural gas rig activity is even more dramatic, with that metric now at historical lows. Even with the gas rig counts at record high levels in the past two years, we were barely maintaining deliverability levels in the U.S."

With the recent dropoff in rig activity, a significant decline in U.S. gas deliverability (and a subsequent increase in prices) is just around the corner, most likely by the 1999-2000 heating season.

Critics of the shortage-of-supply theory state that new oil extraction technologies, growth in 3-D seismic surveys and new drilling methods have effectively made the supply of oil infinite.

George Littell, a partner in the Houston oil forecasting firm of

Groppe, Long & Littell

, says that premise may be true, but it's just not that simple: "First you run out of cheap oil, then you run out of moderate oil, then you run out of expensive oil. There will always be oil, but at a price."

On the demand side, there are plenty of reasons to believe that the World Bank study is wrong.

First of all, people on our planet still use roughly 70 million barrels of petroleum a day. That figure isn't going to disappear any time soon. In the U.S., a phenomenal surge in domestic sales of fuel-hungry sports utility vehicles, or SUVs, and pickup trucks have put a lot of gas-guzzlers on our highways. This trend shows no signs of slowing down.

In January,

Ford

(F) - Get Report

, which has the leading market share position for light trucks, saw its sales of pickup trucks, SUVs and minivans increase 22%, while car sales fell 9%.

However, growth on the demand side is what is important -- and that clearly relies on Asia and other emerging economies. Most Asian economies are expected to recover somewhat in 1999, and in the long term they are going to consume a significantly higher level of petroleum products. Noted economist

Paul Krugman

eloquently summarized this point recently:

Asia's growth will resume, driven, as before, by education, savings, and growing labor force participation. It probably won't be as fast as it was: Some Asian economies had already pushed savings, education, and labor participation as far as they can. But there are still a lot of peasants in China waiting to be pulled into the modern world, and there are even more in other places where the process of joining the modern world has barely begun. No doubt that Asia will eventually account for most of gross world product -- but only because most human beings are, after all, Asian.

I can't make an exact prediction of exactly when energy prices -- or commodity prices, for that matter -- will recover, but I can say, with confidence, that the World Bank's prediction that low commodity prices will continue forever is incorrect.

If you're still not convinced that energy prices will recover soon, just think of oil stocks as the last untapped Internet play. How will

Fedex

(FDX) - Get Report

deliver all those

Amazon.com

(AMZN) - Get Report

packages to people's homes? That's right -- those thirsty jet airplanes and gas-hungry panel trucks are going to need a lot of fuel.

Tom Kerr is a portfolio manager and equity research analyst at Reed Conner & Birdwell, a Los Angeles-based money management firm. At the time of publication, RCB held positions in Royal Dutch Petroleum, Unocal and Exxon, although these holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. The Buysider appears every Tuesday on TheStreet.com. Kerr appreciates your feedback at tkerr@rcbinvest.com.