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This segment was taped at the American Stock Exchange which offers trading across a full range of equities, options and exchange traded funds.
Stephen Schork is the publisher of the Schork Report, a widely read, subscription-based publication offering insights into the energy financial markets. He spoke recently with Mike Norman, anchor of HardAssestInvestor.com and founder of the Economic Contrarian Update, about the outlook for oil in 2008.
Mike Norman (Norman): We recently saw oil come touch $100 per barrel. This was a forecast that had been out there for a long time. We’re seeing a pullback now. Where are we in terms of this entire oil pricing rise, which as you know, started about five years ago?
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Stephen Schork (Schork): Well, the market now is trying to realign itself. We came into the Thanksgiving Day holiday with oil on the doorstep of $100. In fact, that Friday after Thanksgiving we closed at an all-time high of $98.18. We came in the following Monday and tried to push harder, but as you know, markets follow the path of least resistance. We tried to push up against $100 and we couldn’t get there. So what happened? The market started to push lower, following the path of least resistance. And sure enough, we went from $98/barrel to $90/barrel pretty much overnight.
Norman: Is $100/barrel a justifiable price? It sounds like, from what you’re saying, there was just this great anticipation or expectation of hitting $100/barrel; that it was sort of a self-fulfilling prophecy. Then we didn’t hit it, and we’re pulling back. Fundamentally speaking, is $100/barrel a realistic price?
Schork: No, $100/barrel is not a realistic price based on the fundamentals. The market is in a long-term bull market, but we went from $70/barrel in the beginning of September - before OPEC decided to add more barrels to the market - and in less than two months we were on the doorstep of $100/barrel. Inside those two months nothing changed fundamentally. So to get us from $70/barrel to $90/barrel and then beyond was a major speculative push by the large institutional traders and the hedge funds.
Norman: We’re going to get into that. But let’s go back first to the beginning. I remember reading an article in the Economist magazine back in 1998 which warned about single-digit oil prices. Of course, if you’re a contrarian that was a wonderful time to be buying oil. What has been driving this run-up since then? Because we have seen prices go from literally single digits or $10/barrel up to where we are now, at $100/barrel. Is it really a supply-and-demand story? And if it is, what are the factors?
Schork: When oil was in the single digits in the late-1990s, that was based on the fundamentals. Think about where we were. The U.S. economy was essentially the only dominate economy in the world. The Soviets, or the former Soviets, were still trying to fight their way out of the Communist psyche. You had the Asian currency crisis, and you had Japan Inc. still in the doldrums. All over the Pacific Rim, tiger economies were taking a back seat in the late-1990s. So you really had a lack of demand.
When that happened, you had no money being put into infrastructure, either downstream or upstream, so you had a lack of ability to build supply. Now, of course, after 2000 and after 9/11, the U.S. economy is still going strong, but the Western European economy is also going strong; the Eastern European economy is coming on; and of course the Pacific Rim has returned with a vengeance. So we’ve had a sudden influx of demand in the last five years.
With that demand, we have not invested properly, because the margins weren’t there throughout the 1980s and 1990s to support it. So now supply is trying to catch up with demand, and speculators have realized what is going on here and they’re looking to exploit this chasm.
Norman: To what extent? There are those out there who feel that the high prices will encourage more exploration, which in fact I think is happening. But there is also a contingent out there that says, “Look, we’ve hit peak oil. You’re not going to find any more big discoveries.” What about that?
Schork: I think it’s a common fallacy. We’ve gone an entire generation without looking for oil, and we’re certainly not investing to turn that oil into gasoline. It’s very easy to sit back and say OK, we haven’t had a new oil discovery; but we haven’t been looking for it, so of course we haven’t found it.
There is an old axiom in economics that high prices are the best cure for high prices. Now we are certainly in a high-priced environment, and what is this doing? It is encouraging increased exploration. Look, the state oil company of Brazil just made a huge find off of the coast in the Atlantic. We are bound to hear more stories like this because there is a pot of gold now at the end of the rainbow. People are now incented to go out and look for oil, and to look for alternative fuel sources too.
Norman: That will certainly be good news for consumers. I don’t know if it will be good news for speculators.
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Make sure to check Part II of HardAssestsInvestor.com’s interview with Stephen Schork
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