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FIRST CALL RESEARCH NETWORK
06:25am EST 30-Sep-04 Bear Stearns US (Leuffer,Frederick 212-272-6344) BP AHC
The Oil Bubble ... PART 1
Frederick P. Leuffer, CFA 212 272-6344 [email protected] 9/30/04
Nicole L. Decker 212 272-3962 [email protected]
Subject: Industry Overview
Industry: Integrated Oil \ Rated: Market Underweight
BEAR, STEARNS & CO. INC.
EQUITY RESEARCH
The Oil Bubble
__________________________________________________ ____________________________
Bear Stearns Does And Seeks To Do Business With Companies Covered In Its
Research Reports. As A Result Investors Should Be Aware That The Firm May Have
A Conflict Of Interest That Could Affect The Objectivity Of This Report.
Customers of Bear Stearns in the United States can receive independent, third-
party research on the company or companies covered in this report, at no cost
to them, where such research is available. Customers can access this
independent research at www.bearstearns.com/independentresearch or can call
(800) 517-2327 to request a copy of this research.
Investors Should Consider This Report As Only A Single Factor In Making Their
Investment Decision.
PLEASE SEE THE ADDENDUM OF THIS NOTE FOR IMPORTANT DISCLOSURES AND ANALYST
CERTIFICATION.
__________________________________________________ ____________________________
Key Points
*** Oil Prices Have Soared From $32/bbl (West Texas Intermediate Spot) at the
Beginning of the Year to an All-Time High of $50/bbl at the End of
September Largely on Fear of Supply Outages Stemming From Terrorism and a
Series of Odd Events. Interestingly, Virtually Every Fear So Far Has Gone
Unrealized.
*** Our View is That Fundamentally Oil Prices Should Be in the High-$20s/Bbl
Range Today, and Eventually Should Decline Into the Low $20s as Oil
Inventories Rise Based on Our Assessment of Supply/Demand Economics and
Current Inventory Levels (Adjusted for Hurricane Effects). We Believe the
$20/Bbl-plus difference between a High $20s/Bbl and the Current Price
Reflects Speculation.
*** We Believe Three Factors Will Put Pressure on Oil Prices -- A Continued
Rise in Inventories, Absence of a Supply Shock, and Negative Momentum.
*** We Have Raised Our Oil Price Projection For This Year (From $37/Bbl to
$40/Bbl) to Reflect the Strength in Oil Prices in the Past Month.
However, Our 2005 Projection is Unchanged at $25/Bbl. Our Sector Rating
for the Major Oils Remains Market Underweight.
We believe that speculation pervades the oil market and that oil prices are
excessive. Oil prices have soared from $32/bbl (West Texas Intermediate spot)
at the beginning of the year to an all-time high of $50/bbl at the end of
September largely on fear of supply outages stemming from terrorism and a
series of odd events. Interestingly, virtually every fear so far has gone
unrealized -- terrorism has not removed a single barrel of oil production; oil
output in Saudi Arabia, instead of falling due to terrorism as some have
feared, has increased by more than one million b/d this year; OPEC has steadily
increased production (by a total of 1.7 million b/d since January) and
consistently outpaced analysts' estimates of its capacity; Yukos' oil
production has not fallen -- it is up 6% so far this year; and, despite a
difficult war in Iraq, production in that country has averaged 2 million b/d
this year, a 900,000 b/d, or 78%, year-over-year increase -- production
currently is estimated at more than 2.5 million b/d.
Although we have seen labor strikes at various oil installations, ethnic
violence in certain oil producing countries, guerilla attacks on Colombian oil
pipelines, and mechanical problems at producing oil fields -- all typical
events for the oil industry -- non-OPEC production has been higher and less
volatile than in the past. The only meaningful event to hit the oil industry
has been four back-to-back hurricanes in the southeastern U.S., which caused
temporary interruptions in oil and oil product flows. Experience shows that
inventories tend to rebuild quickly after the storms subside. Yet, oil traders
continue to speculate that oil supplies, in large quantity, will be cut off.
Perhaps there will be a supply interruption, but we continue to believe the
likelihood of a prolonged outage is low.
What makes oil analysis difficult is that in addition to speculation and fear,
there has been improvement in oil demand and so fundamentals have played a role
in oil's rise. This has led to concern about the level of spare production
capacity and a debate about how much of the upswing in oil prices is due to
speculation and how much might be due to fundamentals. While demand has been
strong (according to the International Energy Agency, world oil demand rose
3.8% in the first half, more than twice the historical growth rate), supply has
been stronger. IEA figures for the first half show an increase in world oil
demand of 3.0 million b/d against an increase in supply of 3.5 million b/d,
with about 60% of the supply increase coming from OPEC and 40% from non-OPEC
sources. Excess supplies are borne out by rising inventories. In the U.S.,
crude oil inventories increased by 50 million barrels in the first eight months
of this year, the second-largest build in history, and OECD oil inventories
increased by 83 million barrels in the first seven months (latest available) of
this year.
Recently, oil demand growth has begun to slow in response to high prices and
slower economic growth. According to the American Petroleum Institute, U.S.
oil demand rose only 0.5% in August, owing to a fall in gasoline demand. Oil
demand through August is up 1.7%, compared with growth of 2.9% in the second
quarter. Chinese demand growth in August, at 10%, was less than half the rate
estimated in the first half.
Our view is that fundamentally oil prices should be in the high-$20s/bbl range
today, based on our assessment of supply/demand economics and current inventory
levels (adjusted for hurricane effects), and eventually should decline into the
low $20s as oil inventories rise. We believe the $20/bbl-plus difference
between a high $20s/bbl price and the current price reflects speculation.
What will cause oil prices to fall? We believe three factors will put pressure
on oil prices. First, a continued rise in inventories should justify a lower
price fundamentally and reduce the fear premium. We believe OPEC production
exceeds fourth-quarter 2004 and full-year 2004 demand by 2.55 million b/d and
2.75 million b/d, respectively. Second, absence of a supply shock also should
reduce speculation. In other words, no news is bad news for oil prices.
Third, a weakening price will feed on itself. Traders are driven by momentum.
A break in the oil price could trigger liquidation of large speculative
positions which, in turn, could lead to even lower prices. These are the
things that usually cause bubbles to burst.
We have raised our oil price projection for this year (from $37/bbl to $40) to
reflect the strength in oil prices in the past month. However, our 2005
projection is unchanged at $25/bbl.
FIRST CALL RESEARCH NETWORK
06:25am EST 30-Sep-04 Bear Stearns US (Leuffer,Frederick 212-272-6344) BP AHC
The Oil Bubble ... PART 1
Frederick P. Leuffer, CFA 212 272-6344 [email protected] 9/30/04
Nicole L. Decker 212 272-3962 [email protected]
Subject: Industry Overview
Industry: Integrated Oil \ Rated: Market Underweight
BEAR, STEARNS & CO. INC.
EQUITY RESEARCH
The Oil Bubble
__________________________________________________ ____________________________
Bear Stearns Does And Seeks To Do Business With Companies Covered In Its
Research Reports. As A Result Investors Should Be Aware That The Firm May Have
A Conflict Of Interest That Could Affect The Objectivity Of This Report.
Customers of Bear Stearns in the United States can receive independent, third-
party research on the company or companies covered in this report, at no cost
to them, where such research is available. Customers can access this
independent research at www.bearstearns.com/independentresearch or can call
(800) 517-2327 to request a copy of this research.
Investors Should Consider This Report As Only A Single Factor In Making Their
Investment Decision.
PLEASE SEE THE ADDENDUM OF THIS NOTE FOR IMPORTANT DISCLOSURES AND ANALYST
CERTIFICATION.
__________________________________________________ ____________________________
Key Points
*** Oil Prices Have Soared From $32/bbl (West Texas Intermediate Spot) at the
Beginning of the Year to an All-Time High of $50/bbl at the End of
September Largely on Fear of Supply Outages Stemming From Terrorism and a
Series of Odd Events. Interestingly, Virtually Every Fear So Far Has Gone
Unrealized.
*** Our View is That Fundamentally Oil Prices Should Be in the High-$20s/Bbl
Range Today, and Eventually Should Decline Into the Low $20s as Oil
Inventories Rise Based on Our Assessment of Supply/Demand Economics and
Current Inventory Levels (Adjusted for Hurricane Effects). We Believe the
$20/Bbl-plus difference between a High $20s/Bbl and the Current Price
Reflects Speculation.
*** We Believe Three Factors Will Put Pressure on Oil Prices -- A Continued
Rise in Inventories, Absence of a Supply Shock, and Negative Momentum.
*** We Have Raised Our Oil Price Projection For This Year (From $37/Bbl to
$40/Bbl) to Reflect the Strength in Oil Prices in the Past Month.
However, Our 2005 Projection is Unchanged at $25/Bbl. Our Sector Rating
for the Major Oils Remains Market Underweight.
We believe that speculation pervades the oil market and that oil prices are
excessive. Oil prices have soared from $32/bbl (West Texas Intermediate spot)
at the beginning of the year to an all-time high of $50/bbl at the end of
September largely on fear of supply outages stemming from terrorism and a
series of odd events. Interestingly, virtually every fear so far has gone
unrealized -- terrorism has not removed a single barrel of oil production; oil
output in Saudi Arabia, instead of falling due to terrorism as some have
feared, has increased by more than one million b/d this year; OPEC has steadily
increased production (by a total of 1.7 million b/d since January) and
consistently outpaced analysts' estimates of its capacity; Yukos' oil
production has not fallen -- it is up 6% so far this year; and, despite a
difficult war in Iraq, production in that country has averaged 2 million b/d
this year, a 900,000 b/d, or 78%, year-over-year increase -- production
currently is estimated at more than 2.5 million b/d.
Although we have seen labor strikes at various oil installations, ethnic
violence in certain oil producing countries, guerilla attacks on Colombian oil
pipelines, and mechanical problems at producing oil fields -- all typical
events for the oil industry -- non-OPEC production has been higher and less
volatile than in the past. The only meaningful event to hit the oil industry
has been four back-to-back hurricanes in the southeastern U.S., which caused
temporary interruptions in oil and oil product flows. Experience shows that
inventories tend to rebuild quickly after the storms subside. Yet, oil traders
continue to speculate that oil supplies, in large quantity, will be cut off.
Perhaps there will be a supply interruption, but we continue to believe the
likelihood of a prolonged outage is low.
What makes oil analysis difficult is that in addition to speculation and fear,
there has been improvement in oil demand and so fundamentals have played a role
in oil's rise. This has led to concern about the level of spare production
capacity and a debate about how much of the upswing in oil prices is due to
speculation and how much might be due to fundamentals. While demand has been
strong (according to the International Energy Agency, world oil demand rose
3.8% in the first half, more than twice the historical growth rate), supply has
been stronger. IEA figures for the first half show an increase in world oil
demand of 3.0 million b/d against an increase in supply of 3.5 million b/d,
with about 60% of the supply increase coming from OPEC and 40% from non-OPEC
sources. Excess supplies are borne out by rising inventories. In the U.S.,
crude oil inventories increased by 50 million barrels in the first eight months
of this year, the second-largest build in history, and OECD oil inventories
increased by 83 million barrels in the first seven months (latest available) of
this year.
Recently, oil demand growth has begun to slow in response to high prices and
slower economic growth. According to the American Petroleum Institute, U.S.
oil demand rose only 0.5% in August, owing to a fall in gasoline demand. Oil
demand through August is up 1.7%, compared with growth of 2.9% in the second
quarter. Chinese demand growth in August, at 10%, was less than half the rate
estimated in the first half.
Our view is that fundamentally oil prices should be in the high-$20s/bbl range
today, based on our assessment of supply/demand economics and current inventory
levels (adjusted for hurricane effects), and eventually should decline into the
low $20s as oil inventories rise. We believe the $20/bbl-plus difference
between a high $20s/bbl price and the current price reflects speculation.
What will cause oil prices to fall? We believe three factors will put pressure
on oil prices. First, a continued rise in inventories should justify a lower
price fundamentally and reduce the fear premium. We believe OPEC production
exceeds fourth-quarter 2004 and full-year 2004 demand by 2.55 million b/d and
2.75 million b/d, respectively. Second, absence of a supply shock also should
reduce speculation. In other words, no news is bad news for oil prices.
Third, a weakening price will feed on itself. Traders are driven by momentum.
A break in the oil price could trigger liquidation of large speculative
positions which, in turn, could lead to even lower prices. These are the
things that usually cause bubbles to burst.
We have raised our oil price projection for this year (from $37/bbl to $40) to
reflect the strength in oil prices in the past month. However, our 2005
projection is unchanged at $25/bbl.
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