Oil prices are going higher.
It may happen today, tomorrow or next month. In your lifetime, I believe oil will be much higher.
This statement may seem crazy given the recent decline. Last month, the price for West Texas Intermediate Crude concluded a 29% decline to around $78.
Though drops like the one in May are painful, prices always find a way to recover. Oil has already rallied back above $90. And prices will continue to ascend for one reason …
Some day, oil wells will run dry.
Because oil supplies are limited, oil prices must rise so long as demand doesn’t vanish. It’s Economics 101 – decreasing supply will result in higher prices, holding everything else constant.
Though those economic equations add up, oil wells don’t have to dry out before oil prices rocket higher. That’s because drilling expenses also continue to rise.
While it will take many, many years to consume all of the oil, the cheap supply is mostly gone already. There are very few places in the world to extract oil for less than $20 per barrel.
Cheap oil has already been extracted and used.
A slowdown or recession may send oil lower in the near term. But over the long term, prices are heading higher because drilling costs will rise.
This chart shows how long-term supply concerns and drilling expenses kept oil moving higher despite many short-term pullbacks…
Recessions are in gray.
Oil prices have experienced recessionary drops and subsequent price recoveries before. The recession that followed the dot-com bubble took oil prices down to just $17 a barrel from a high near $37. However, two years later, oil was back above $39 as the U.S. economy recovered and drilling costs rose.
As the economic recovery continued into 2004, oil prices rallied to $56 and then all the way up to $147 per barrel in 2008. That year’s recession dragged oil down to $45. But by 2011, it was back above $100.
The recessions of the past have always dragged oil prices lower. However, the recession lows were never seen again, and higher oil prices followed for many years.
As I discussed about oil earlier this month:
“Since so many economies are dependent on oil and because the price to extract oil from the ground is increasing, oil prices will always be moving higher in the long term.
While more reserves are found each day, it may cost $50 to $70 just to remove that oil from its bed. At oil sands properties in Canada, it may cost $100 or more to skim a barrel of oil from the ground.
When oil is trading at over $100 a barrel, these sites can be quite profitable. However, drillers will stop pumping oil when prices fall below extraction breakeven points.”
The lack of drilling will result in greater draws from existing crude inventories. This drawdown creates a supply imbalance that will eventually stabilize the price. Afterward, the price will rise to a level where it is profitable to drill.
With crude prices down considerably in the last few months, now is a good time to be adding to favorite oil holdings.
United States Oil Fund (USO) is an ETF married to oil and a decent way to gain exposure to it. Other stock favorites are Patterson UTI Energy (PTEN), ConocoPhillips (COP) and SeaDrill (SDRL).
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