We have seen the oil price well above $60 for nearly a year; its
$70 right now. The futures prices have continued above $60 as well; five
year NYMEX is at a record high near $68. All the forecasts of a break
in the oil price have been wide of the mark. I specifically recall Steve
Forbes $35 target made on CNBC; our rebuttal and our previous energy related
commentaries are archived on our website, www.cumber.com .
Why is this $60 plus price persisting if inventories seem high? Some
have blamed a terrorism or geo-political risk premium that is in the price.
They claim that a balanced or neutral oil price would be $10 or $15 dollars
a barrel lower. But that analysis misses the whole story.
Reason: one of the ways oil is hedged against geo-political risk is to
raise the inventory level. There are several methods and one of them is
slow steaming. This is the term used to describe the slowdown
in the movement of oil by tanker. Taking more time to transport oil means
a company has to maintain a higher inventory on the water. Thus inventories
rise even as the price stays higher than expected. Clearly that force
has been at work for the past year.
Remember; the cost to the oil company is the added interest on the debt
to finance the higher inventory. At the low global interest rates we have
seen, this cost is quite small. Consider that a $70 dollar barrel of oil
financed at 6% means a $4.20 annual interest cost. That is the risk premium,
not $10 or $15.
Higher inventory hedging is likely to continue for a while because the
latest bad actor on the oil risk stage is Iran. They sit on the Straits
of Hormuz and could significantly disrupt world oil flows at any time.
We conclude that higher inventories of oil go hand-in-hand with the higher
oil price. They are an effect or outcome of the rising risk and not a
cause in the pricing formula.
We think that the oil price is headed higher. The worlds demand
is rising at the rate of nearly 2 million barrels a day per year. China
has maintained a decade long increasing rate of oil consumption at 7 ½%
per year. India at 6%. We, in America, should not be US-centric and focus
on our 1.5% rate. We are a mature economy. The worlds rapid growth
and increasing energy consumption is away from our shores.
At Cumberland, we have maintained an over-weighted energy position for
several years. We have watched the valuation of the oil sector rise from
a low of 6% of market weight to about 10%. We believe that is headed higher.
Furthermore, we believe that the question asked by the media about $3
gasoline is not the correct one. $3 is already baked in the cake. The
issue is whether or not we will approach $4. Remember that we have had
a mild winter weather pattern and that we have only stabilized the hurricane
shock from last year. We must also remember that American refining capacity
is not yet materially improving. Stabilizing from the hurricane shock
is not the same as rebuilding and expanding.
We are an oil importer of major proportions in order to satisfy our demand.
We have not changed our behavior and we are still profligate consumers
who use little alternate energy sources in comparison with others in the
world. We also do not tax energy heavily as others do. Oil is nearly $70
in spite of this and not because of it. Give us a cold winter or another
hurricane season that is disruptive or a geo-political shock and oil could
easily spike to $80 or $90 a barrel. On the other hand, a bird flu pandemic
would cause economic contraction and the oil price would then fall precipitously.
Cumberland would immediately sell on any indication of a pandemic.
In our view it will take a sustained gasoline price near or above $4
to really cause Americans to change their behavior and alter consumption
patterns toward more conservation. That could occur with higher taxes
but it is unlikely to happen because of politics. Thus it will have to
come from market forces. Be prepared; they are coming.
Cumberland remains over-weighted in energy. Our preferred ETF is still
the Vanguard Energy VIPER (VDE). We believe it is still too soon to sell.