HardAssetsInvestor

This segment was taped at the American Stock Exchange, which offers trading across a full range of equities, options and exchange-traded funds.

Robert Hormats is the Vice Chairman of Goldman Sachs International. He recently talked to Mike Norman about the year ahead and what may be in store for the U.S. and China.

Mike Norman (Norman): Let’s talk a little bit about commodities now. 2007 was a fantastic year for commodities, led by oil, almost up to $100/barrel. We’ve seen some pullback recently and some steps by OPEC to raise output, yet there are many who feel this is just a pause in the trend toward higher prices. Ultimately, we will see $100/barrel and then some. What do you think?

[Editor’s Note: This interview was conducted before oil prices hit $100/barrel.]

Robert Hormats (Hormats): I think there is a continued strong demand for oil around the world, particularly in the emerging economies. That is likely to continue, barring some sharp downturn in the global economy or places like China and India. But if you also look at the supply side, there are a lot of alternatives that are beginning to come on screen. Still, the magnitude of those is simply not sufficient at this moment.

Norman: What about the ethanol story? And we’ve just got a new energy bill, which boosts the mandates for ethanol substantially. It’s not going to have an impact?

Hormats: That will have a gradual impact, but given the overall size of world demand, it’s not going to have a very substantial one. And look at how difficult it is to get new oil around the world—you have to invest a huge amount of money. The majors do not control the supply; for the most part, it’s controlled by national oil companies in the Middle East and Russia and other parts of the world, and many of them are not as aggressive at developing new sources as some of the majors are. Some of them use their money for other things, rather than putting it back in the oil patch.

Norman: Isn’t that an aspect that we don’t often hear? There’s almost a monopolistic force within the world’s oil market: You have a cartel like OPEC, which produces 40% of the world’s oil, and you have a leader like Putin who has shown no inhibition about going out and nationalizing or taking over Russian oil production. It’s hard to argue that there’s a free market out there.

Hormats: You’re absolutely right. One of the things that I find ironic is that every time a price goes up there’s a hearing in Congress. The oil companies are brought in as if they control the price of oil. The big majors are really not collectively or individually the major players in the global oil production scene; it’s mainly these national oil companies, mostly in the Middle East, Russia (to a degree), Venezuela, and places like that. It’s not really a free market; it’s certainly not controlled by the major oil companies. So you’ve got a combination of oil companies, private sector oil companies, national oil companies and OPEC interacting.

The price is in large part a result of supply and demand, but there’s also the risk of disruption from time to time. And that feeds into the price of oil, because people don’t want to be caught short if there is a disruption in supply. Fortunately, I think relations with Iran look like they’re not getting worse, and that helps to stabilize the market. But the demand is still strong, and it’s hard to invest large amounts of money in new supplies for the majors, because they don’t have access to a lot of this oil.

Norman: We have seen the emergence of new players in the oil markets on the buy side; for example, large institutions like pension funds and endowments that are coming in, buying up oil in the hundreds of billions of dollars. It’s a new source of demand not necessarily related to a real physical need but a speculative need.

Hormats: That’s right. The interesting thing is oil and commodities in general are a new investment category. They weren’t really a big investment category 10 years ago. To a degree, it’s a hedge; to a degree, it’s also a way of anticipating. It’s a market like anything else, but now you’ve got a lot of players in it. There are people who say, “Well, it’s the hedge funds and the others who are pushing the price up, maybe on a given day or a given week.”

Norman: You don’t think that distorts?

Hormats: It may over the near term, if everyone starts deciding they want to speculate or if they see it as a good investment, like investing in a given stock. But over the medium term, it’s much more supply and demand, or anticipation of supply-and-demand changes, or political risk anticipation.

Norman: Bob, it was a pleasure having you here today.

Hormats: Thank you very much.

Make sure to check Part I of HardAssestsInvestor.com’s interview with Robert Hormats