For the past little while I have kept a closer eye on energy. So I am thinking that maybe I should create a regular blog column about energy? If you like my previous blog entry at Investor Geeks, and liked my other articles regarding energy, please tell. And if you are interested, tell me what you would like me to keep an eye on and what questions should be answered.

In a previous blog entry I talked about the price of oil. A couple of days ago I was watching Boone Pickens on CNBC. He was commenting on what direction oil will take, and in his words, “I think you’ll see $70 before you see $50.” This was the same individual that said, “80 before 60.” History has shown that oil did not reach 80, even though it was only a few dimes away from 80. I am going to cut Boone some slack in that oil did reach 80 before 60, but I will take Boone to task in that he was also saying oil would reach 100 USD.

Now Boone is saying 70 before 50 and many in the industry including myself are saying the trading range will be 55 to 60. Actually, I am on record stating that oil will drop to 45. I am a bit hesitant that oil will reach 45, but am sticking to the trading range around 55. When Boone was making his comments Samuel Bodman part of the Bush administration made a comment that the price of oil does not depend on Boone, but the traders. I completely agree with Mr Bodman, and thus let’s look at what the traders are saying (1,2).

The traders are saying for the next three or four years we are going to be in a trading band above 60, and below 75. Look closer at the puts and calls, of Jan 2007. Calculating the strike price, the cost of the options and some profit the calls are predicting a price around or over 70. Looking closer at the puts they seem to be indicating a price in the low 50’s to low 60’s. There is a discrepancy in that the calls and puts seem to be far apart from each other, and that makes me wonder. I think the traders are hedging themselves using some synthetic option magic and thus they probably don’t care one way or the other. Or somebody is going to be loosing quite a bit of money.

What’s interesting is that North Korea is threatening the world, and yet the price of oil has not flinched. This tells me that bad news has already been discounted into the price of oil. Of course if there were something catastrophic the price of oil would sky rocket. OPEC seems to be rattling their quotas saber to increase the price of oil. Though one wonders if it will have any effect.

There is an interesting piece of news that seems to have had little coverage. The news piece is interesting because it says that the oil companies expect the price of oil to be above 40 for some time in the future, and that the Shell Oil president finds the price of oil at 58 high.

UPDATE: Oil broke the 60 USD barrier and dropped back down. Cramer thought that we should be bullish regarding oil prices as Exxon is bullish. As I mentioned in my Shell Oil example big oil is investing in oil projects assuming a price above 40. I think Cramer fails to realize that if oil stays above 60, with bursts above 70 a recession will result.

I want to address a comment made in a previous oil blog entry:

Good analysis, but you forgot something important.

what happens when the dollar is devalued another 20% and oil companies demand payments in euros?

it might not affect world oil prices but it will affect US prices. I’m betting on higher oil and gas prices. i think oil will go back up to $75/bbl within next 12 months.

The USD will not in the near future devalue 20% against the Euro. If this happens then the price of oil is going to be the least of our worries. My sister lives in Quito, Ecuador and for those that do not know, Ecuador is a US Dollarized country. Such a huge drop in the dollar would not only affect American’s, but also other nations like Ecuador.

To understand the scope of the issue let me tell you how many countries depend on the USD and Euro. America has trading bi-lateral trading partnership with Canada, Mexico, Europe, and most of South America. When I say bi-lateral trading partnerships I am referring to trade moving in both directions and not just a single direction. Trade with China is in a single direction and that is from China to the US. With countries where trade moves in both directions the US is exporting a significant amount of goods.

Look at the list of “fair trade” countries and notice that countries from the America’s and Europe top the list. With “fair trade” countries have an interest in not disturbing the relationship. Since most of the countries involved have a very close relationship to the dollar or euro a significant drop by one or the other would have devastating effects. EU industry leaders have said that the ECB should not pursue a strong Euro policy since it would hurt exports. Less exports mean less work, means less imports, means a slowing consumption. Thus there is absolutely no motivation for the ECB or the Fed to commence a currency war. I sooner think that the dollar and euro will have a trading range.

Interesting post. I love hearing the analysts weigh in on oil. Very entertaining.
Do you play energy directly as a commodity trade or indirectly through companies?
I play energy extremely indirectly through service providers. Stock price attached to the price of oil, but the earnings not so much.

I look at energy, and resources (water, lumber, etc) indirectly and use it as macro indicator on where things are going. I don’t look at edible commodities (wheat, oranges, etc).

Whenever I look at energy I see how busy, or what companies are investing in. For example, if companies are investing in more efficient machines then it means companies are looking optimisticly at the future. If companies keep buring energy using the status quo then they are not investing in the future of their business. If people keep buying SUV’s then it means they are not interested in changing.

When you look at what and how we consume the raw non-edible resources I tend to see the mood of the consumer and industry.

empty spaces: There are a couple of things that I think you need to look at when comparing the USD to Euro. The first is that currently it has devalued to 20%, but the dollar has become stronger. The low point was at the beginning of 2005. Before that the USD was much stronger than the Euro.

You are saying, “Heck its dropped 20%, another 20% is no problem.” Yes it is a problem, as illustrated in the article from when the USD was at an alltime low.

http://www.findarticles.com/p/articles/mi_qn4188/is_20050211/ai_n11500958

Notice the paragraph, “The dollar, which hit an all-time low against the euro in December, contributed to Mercedes’ problems, as did competition from Munich-based Bayerische Motoren Werke AG and Toyota Motor Corp.’s luxury brand, Lexus. The weak dollar has decreased profit margins in the United States, Mercedes’ No. 2 market.”

Just like I said that oil will not reach 100 USD, the USD will not drop another 20%. If you look at the trade between the mentioned countries there is no desire to devalue the USD against the Euro. Euro countries are exporters to USD countries, and any increase in the Euro will hurt the export business. European businesses have made it very clear they do not want a stronger Euro.

Interesting point of view.

Just two short comments. First, North Korea declaring war (seriously taken or not) would not have an effect on oil as they do not produce and can not disrupt the supply from the Persian Gulf. If anything it might have had an affect on currencies and perhaps gold.

Second, when the Euro was first introduced the exchange was pegged at $1.17 to 1 Euro. The Dollar then appreciated to 0.85 to 1 Euro, went back to parity and is now around 1.28 to 1. From the Euros inception the Dollar is currently devalued vs. the Euro about 10%.

Disclosure: This comment was written by a CrossProfit analyst and does reflect the opinion of CrossProfit.com.
http://www.crossprofit.com

>Just two short comments. First, North Korea declaring war (seriously taken or not) would not have an effect on oil as they do not produce and can not disrupt the supply from the Persian Gulf. If anything it might have had an affect on currencies and perhaps gold.

Interesting read here. Though my point was that very often entirely unrelated events would cause something else to spike in price. You know the *logic* of the markets. But I like your idea about the currency and gold.

When you say gold do you say that because North Korea produces gold?

Regarding the pegging of the Euro. From talking to people we always felt the peg was 1 to 1. But your little insight on 1.17 peg is interesting. Does this mean that the Dollar could fall another 10% before panic sets in the ECB?

North Korea is not a gold producer per se. The flight to safety causes fluctuations in currencies and gold. Gold and in this instance the U.S. Dollar are perceived as a safe haven during times of crisis. The Yen is considered to be more problematic due to geographical proximity; however a true crisis has not materialized.

As for the Euro/Dollar, I’m not sure that the ECB would panic were there to be additional 10% erosion in the exchange rates. Neither would the Fed as it all depends on how fast and under what circumstances this occurred.

Disclosure: Comment written by a CrossProfit analyst and may not reflect the opinion of CrossProfit.com.
http://www.crossprofit.com

Ok I can buy the flight to safety argument.

The reason why I mentioned Gold in the context of North Korea is the following: http://www.indiadaily.com/editorial/9259.asp.

On CNBC European Squawkbox they had the guy in for an interview and if I remember correctly he said that North Korea had some resources like Gold.

Though, the ECB argument I cannot buy. The reason is trade, and the pressure by business, and the people: http://www.timesonline.co.uk/article/0,,6-2421880,00.html.

The guy making the comment is making things a bit over-dramatic, but the ECB does have to take into account the economies. Their talk will be tough, but they can only be so tough. If exports were to drop off then things would get very very hard for the ECB.

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