The low P/E ratios of oil company stocks indicates that oil stocks are undervalued compared to the rest of the market. Apparently investors believe they are somehow going to become less profitable in the near future. If you believe crude oil prices are going to remain near current levels or go up, oil company stocks are a screaming buy. I suppose the current depressed valuation of energy stocks makes sense if you really believe the dollar is going to suddenly rebound and crude oil prices decline as a result. I think that speculation is fanciful. I see the dollar continuing to inflate and lose value for the foreseeable future, both in real terms and in terms of most foreign currencies. If the dollar by some miracle strengthens, I believe, nevertheless, that oil prices must continue to rise in real terms, because of supply and demand fundamentals.
There is a danger of not seeing the forest for the trees. How high will the price of crude oil have to go before more dinosuars die and create more petroleum? The big picture is that long term global oil production is in unavoidable decline, at the same time that inexorable demand from highly populated developing countries is coming on line.
The little picture is that foreign currency valuations are relative. In most countries the price of gasoline will not appear to be going up as fast as it is in America because of the weakening dollar.
Americans think in dollars as though dollars had a constant value, which they do not. As monetary inflation eats away the purchasing power of the dollar, most salary increases will not keep up with actual inflation. The higher dollar price of gasoline, airline tickets, etc will result in carpooling, video conferencing and other means of reducing expenditures for energy. Demand for oil in America will have to decrease. Remember it is a zero sum game. If the new middle class in China and India is going to drive more, somebody is going to have to drive less. It is foreign demand that is driving up the real price of oil. In America the weak dollar is making those price increases look even bigger than they really are.
True, oil producing nations can buy less drilling activity per dollar, but they are getting a lot more dollars. The price of oil is going up faster than the value of the dollar is decreasing. I don’t see where this is an issue other than as a misperception. But, again, I don’t see this as a bubble driven by speculators. Inventories are thin.
I remember during the housing bubble, I kept meeting people who owned multiple houses. Most of them nobody was living in. They were just being held, as investments. And they kept building more! That was a bubble. It had to burst because there was and excess of housing and only unrealistic speculation was supporting real estate prices. Remember the telecom bubble? Ninety percent of the optical fiber laid by telecom companies was dark, unused. But people kept investing in companies like JDS Uniphase to make faster photonics when we already had excess capacity. That was a bubble. Remember hurricane Katrina? The streets of New Orleans flooded and people couldn’t drive and the price of gasoling plummeted. No. Wait a minute. I’m remembering wrong. A few rigs went off line in the gulf and energy prices spiked and parts of the country had gasoline shortages. Not a bubble.
If the Fed raises interest rates to strengthen the dollar any time soon, we’re likely to have an economic depression worse than the 1930s. That will decrease U.S. demand, but not necessarily global demand. The U.S. is no longer the 400 lb gorilla in the energy market. It is more likely the Fed will eventually work to stem the decline of the dollar, though I agree, no time soon. Actually increasing the value of the dollar? That’s a different thing. I don’t see any inevitability there. For the indefinite future, supply and demand will continue to increase the value of oil faster than anything is ever again likely to increase the value of the dollar.
For every futures contract bought, one is sold. Speculators can over the short term influence prices to the low side as well as the high side, but those who make unrealistic speculations lose huge amounts of money fast and are driven out of the game. The main thing they contribute to the market is liquidity. These are paper contracts to deliver. They aren’t flooding sombody’s basement with crude oil, removing it from the market. You are talking short term influences at best by people who are highly motivated to be realistic or go broke. All the oil that is being pumped is being used. More would be. As quality of life improves in the third world, demand for oil will increases as supply remains constrained. Four dollars a gallon for gasoline is one of the greatest bargains of your lifetime. It won’t last long.
