How Will the Gulf Oil Spill Affect Oil?

U.S. Global Investors Weekly (05/25/2010)
"Last month's tragedy in the Gulf of Mexico and the ongoing fallout from the oil spill has left many of our investors asking, what does this mean for energy?

Though offshore drilling off of California and most of the Atlantic coastline has been banned since 1981, expansion of drilling in the Gulf of Mexico has increased offshore's share of total U.S. production to nearly 30% from just 11% in 1990. This is because offshore seems to be where the deposits are. Last year, the industry recorded its highest level of new discoveries in a decade and many of these were offshore.

But the April accident illustrates just how difficult and hazardous the task of obtaining additional sources of oil has become. In most cases, deepwater reserves lay under a mile of water and multiple miles of sand and rock. It's like trying to drill on the surface of the moon.

Not only is the physical environment difficult, the regulatory one is nearly as treacherous. President Obama's offshore plan announced in March is likely dead in the water and many people are calling for a complete halt of offshore production. However, alternative options to oil are limited. Alternative energies, like solar, wind or even electrical cars aren't currently effective for large numbers of people and in an environment where keeping costs low is imperative, alternative energies are viewed as a high-cost alternative.

This is why we see oil continuing to be the main driver for energy going forward. In the past ten years, China went from being the 20th-largest oil-consuming nation to 2nd behind the U.S. Fueled by urbanization, better jobs and higher wages, a jump in per-capita incomes has resulted in explosive car sales and more energy consumption. Other emerging markets, like Brazil and India, have begun to follow suit and it's only a matter of time before they begin moving up the consumption scale.

Over the next few months, we believe oil will remain in the $60–$80 a barrel range but the uncertainty around global markets is going to cause some near-term volatility in both equity and underlying commodity prices. However, this volatility opens up some opportunities to acquire additional exposure to those companies that are generating significant earnings, cash flow and returns on capital.

Once the fear subsides and the global economy gets back on track, we expect to see a dramatic increase in the price of oil back toward $100 a barrel next year."

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