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Why Energy Investors Will Get Crushed If They Fail To Look Towards Dubai (USO, BNO, MES, XOM, BP, HAL)

January 26th, 2012

Keith Fitz-Gerald: The way I see it, U.S. and European energy traders will be  lucky if the door doesn’t hit them in the backsides as everybody heads for the  doors.  Like so many Western investors, they still have their  blinders on.

They think that if demand in the U.S. and the European Union (EU) begins to slide that oil prices will fall into the toilet right along with  it.

But what they don’t see is that Asian oil demand is what actually “drives” the global oil market.


This is why today’s investors need to adopt an energy  investment strategy focused on what is happening on the other side of the  Pacific.

Because what happens there is critical to higher prices and profits here.

Here’s why.

First, consider Asian demand.

In the fourth quarter alone, Asian demand increased by  400,000 barrels per day even as consumption in the rest of the world fell by  700,000 barrels a day, according to the International Energy Agency (IEA).

Meanwhile, Chinese demand in particular is so strong that  the Red Dragon is set to import more oil than the United States within two  years, according to my projections.

And don’t take my word for it. Goldman Sachs Group Inc.  (NYSE:GS) thinks the U.S.  will be overtaken by China this year, while the IEA believes it will happen in  2020.

I think that’s splitting hairs frankly.

What matters is that Asian oil demand growth is likely to  represent a staggering 70% of the world’s total oil demand growth this year. Or  more depending on which studies you believe.

US China Oil

As China Rises the World Shifts Toward Dubai

Second, consider the effect Asia has on how oil is priced.

U.S. investors have focused on U.S. and Brent oil prices for  years, and with good reason. North American markets have been the largest in  terms of both consumption and growth.

Now, however, Asia’s demand growth of more than 720,000  barrels per day dwarfs our own.
By comparison, U.S. demand growth is only 310,000 barrels  per day while Europe’s demand growth is positively anemic at only 260,000  barrels per day, according to the IEA.

That means Dubai’s Mercantile Exchange is rapidly becoming  the new pricing standard -quickly displacing the traditional Brent.

That’s where countries like China, Japan, Indonesia, Vietnam  and others in the Asian Rim increasingly price their oil for delivery.

Sadly, most investors can’t even find Dubai on a map, but  they’d better learn in a hurry.

Today, the differential between Dubai crude and Brent crude  is dropping quickly, and now stands at a 14-month low of $2.73 a barrel,  according to the Financial Times.  Last April the spread on the Dubai crude was 237% higher at $7.61 a  barrel.

Critics note that this is because Dubai crude is of lower  quality and the Libyan revolution left world markets without sweet crude.

True, but they’re missing the point – Asian demand is  shifting commodity pricing from London, New York and Chicago to Dubai, and even  Shanghai, where traders believe it more accurately reflects regional pricing  influences.

And as China’s demand grows, prices head higher.

China Oil Demand

Emerging Markets: As Simple as Supply and Demand

Third, consider infrastructure development in the emerging  markets.

China and India are both constructing new refineries  estimated to have more than 1 million barrels a day of processing capacity  between them.

Admittedly, bringing an additional 1 million barrels a day  of production capacity on line doesn’t sound like a lot in the scheme of  things, especially when we’ve become numb to trillion-dollar deficits and  bailouts. But think again.

The world consumes approximately 89.5 million barrels a day  yet has production capacity of only 90 million barrels a day give or take.

This means the amount of production capacity being brought  on line exceeds total current global excess production. It also means that the placement of that new capacity – in  China and India – is likely to have a significant impact on global pricing.

Think about it. Supply and demand determines prices. It’s  one of the most basic of all economic principles.

If demand increases or there is a disruption in supply,  there is upward pricing pressure. If demand falls relative to supply, prices  drop.

By the same measure, if there is a limited supply and  growing demand coupled with new capacity, pricing power shifts from markets  where demand has dropped to markets where demand is rising.

You see this in your own neighborhood on a much smaller  scale already.

If there are two service stations in town and a third one is  built, customers start buying from the third station… particularly if it’s  closer to where they live, has more attractive prices, better gas, or is closer  to the refineries servicing it.

Initially prices will drop in response to increased  competition. But, over time, as the new entrant disrupts the existing supply  and demand balance, prices actually tend to rise,  particularly if the three service stations now have to fight over the same  limited number of tankers serving the community.

Then there is the process of demand building to consider.  New capacity arguably facilitates demand growth.

I think that’s a battle that’s already begun.

Take the Chinese government, for example. Beijing is likely  to use its newly built refinery capacity to boost strategic reserves.

Many people believe this will be a function of China’s  growing military demand, but China’s growing transport sector is far more  important because it moves the goods needed by 1.3 billion people to market.

So they’ll buy as much oil as it takes to prevent a  revolution…even if it means we don’t have any left to buy (except at  exorbitantly high prices). This is why Chinese oil companies have been buying  up oil assets anywhere they can get their hands them.

They know it’s an issue of domestic survival rather than  global domination, as the West prefers to think about their action.

At the same time, the so-called Arab Spring has interrupted the capital investments needed to maintain current oil production, shipping,  and pricing levels.

This is significant because oil markets cannot function without constant capital improvement and investment, at least not at current prices.

Factor in the vulnerable oil transportation routes in the Gulf, the Malacca Straits and one can easily envision $150-$200 a barrel in  risk premiums alone if things heat up…even without open hostilities.

More if the shooting starts.

How to Play the Global Shift from West to East

So now what?

No doubt the United States Oil Fund (NYSEArca:USO) and the United States Brent  Oil Fund (NYSEArca:BNO), long  the domain of both groups of traders will remain viable investments, but it’s  important to understand they’re not the leaders they once were.

The same can be said for the big oil companies like Exxon Mobil (NYSE:XOM), Royal  Dutch Shell PLC (NYSEADR:RDS.A, RDS.B) and even the vilified BP PLC (NYSE:BP).

I think the far more interesting and potentially profitable  game lies directly in Chinese oil companies like Sinopec (NYSE:SHI), PetroChina (NYSE:PTR) and CNOOC Ltd. (NYSE:CEO). Not only do these  companies have the global reach needed to capitalize on the demand shift, but  they’ve got the cash, too.

I also tend to favor companies like Halliburton Co. (NYSE:HAL), which provide plenty of  services to foreign oil companies and oil service providers. Not only are they  quite literally in the middle of everything, but many times services companies  like Halliburton can work for several competitors at once, further expanding  their coffers and their earnings.

And finally, I think the Middle East’s markets are  incredibly beaten down and, next to the Chinese markets, probably the most  hated on the planet at the moment.

That potentially makes financial and property-heavy choices  like the Market Vector Gulf States ETF (NYSEArca:MES) appealing because  all that oil money has to flow somewhere.

Eventually.

Either way, it’s time for western oil investors to take the  blinders off.

Written By Keith Fitz-Gerald From Money Morning

Keith Fitz-Gerald is the Chief Investment Strategist for Money Map Press, as well as Money Morning with over 500,000 daily readers in 30 countries. He is one of the  world’s leading experts on global investing, particularly when it comes  to Asia’s emergence as a global powerhouse. Fitz-Gerald’s specialized  investment research services, The Money Map Report and the New China Trader,  lead the way in financial analysis and investing recommendations for  the new economy. Fitz-Gerald is a former professional trade advisor and  licensed CTA who advised institutions and qualified individuals on  global futures trading and hedging. He is a Fellow of the Kenos Circle, a  think tank based in Vienna, Austria, dedicated to the identification of  economic and financial trends using the science of complexity. He’s  also a regular guest on Fox Business. Fitz-Gerald  splits his time between the United States and Japan with his wife and  two children and regularly travels the world in search of investment  opportunities others don’t yet see or understand.


NYSE:BNO, NYSE:MES, NYSE:USO


 

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