Given yesterday’s pop to $62 in Crude — up from $53 when last month’s Futures’ contracts expired — its worth taking another look at energy

I am friendly with David Kotok, Chief Investment Officer of Cumberland Advisors. Like me, David remains Bullish on the Energy Sector, and has had some rather astute comments on Oil recently. Back in September, he wrote:

"Many folks are bailing out of oil.  Some forecasts now call for a price decline to under $30 per barrel.  One extreme forecast suggests the oil price could go as low as $15.   We do not agree.

The recent drop in the oil price from the high $70s to a few pennies under $60 per barrel is the result of the lessening of two risk premia.  1.  The hurricane season seems to be passing without incident.  2.  The Chavez/Ahmadinejad bluster is known and the market is assuming that we have seen the worst.   Some players are suggesting that the European initiative with Iran will succeed and lessen the tensions over Iranian development of nuclear enrichment facilities.

Oil risk premia are estimated by computing the cost of adding a barrel to inventory.  This helps explain the pricing of oil in the futures market.   When the risk premia declines as it is doing now the nearest term oil price declines the fastest.  That is what we have seen in the August/ September period.  Longer term futures prices are suggesting that the current decline is nearing an end.  Oil for delivery 18 months from now is trading near $68 per barrel."

David’s view is that "energy prices are going higher and that our overweight ETF investment position should continue in this energy sector."   

He also recently criticized what he termed "the ethanol mess" and offered how it didn’t help the energy price — but it did help create shortages in grains. He notes that some folks in this world are going to starve because of it.

Why does he want to stay overweighted Energy? These factors suggest higher oil prices:

• The dollar has declined about 10% (trade weighted) from where it was a year ago.   Oil is about the same price per barrel as it was a year ago.  Oil is priced in dollars.  Therefore, we in the US have had a price run up to near $80 and back to $60.  The rest of the world has had a smaller price run up and is now looking at an oil price 10% lower than it was a year ago. 

• The relative price is important because it allows us to estimate the stimulus that occurs from the oil price change in various parts of the globe.   In the rest of the world that stimulus has spurred demand.  Oil consumption is about 1 ½ million barrels a day (mbd) higher than it was about a year ago.   In the US the change has been nearly flat.  Our oil consumption is not the growth area.  Look to Asia to find it.

• Oil futures prices suggest a return to nearly the $70 level in 18 to 20 months.   McKinsey & Co. forecast continuing rise in world oil demand at about 2.2% a year until 2020.  We agree.   Oil could easily be $100 before then as world consumption rises between 1 ½ and 2 mbd each and every year.

• The unrest in Nigeria continues and may be worsening.  Press reports usually do not include this in the top of the list.  They should.  Nigeria is becoming an increasingly dangerous place for the folks who work in the oil industry. Investors need to keep an eye on this geography.

• Speaking of geography, the Middle East is deteriorating and the market has ignored it. In Iran, we see Russia supplying missile defense material to protect Iranian nuclear sites. We see the breakdown in Lebanon and the Syria-Hezbollah connection strengthen.  The Israel-Hamas battle continues unabated. Clearly we see a murderously intense civil war in Iraq. Soon we will witness the forthcoming pullout of the British.  What will that mean?  They are in the Basra region; that is where a lot of Iraqi oil exports originate. Basra is Shiite and close to Iran which is also Shiite. Instability in Basra is almost certain to rise when the Brits depart. Right now Iraq still exports about 1.6 mbd. As much as half of it is at risk if the civil war spreads and intensifies in Basra.   Also, only about 1600 of the 2300 oil wells in Iraq are working. The civil war prevents regular maintenance and precludes development. So every time a well loses functionality it goes offline.  We expect that to continue and intensify.

• All this leads to a strange alignment. In Iran, the Shiite center of power, there is an interest in the higher oil price. Iran has no love for the west and would spend the money on the mischief it spreads in the region and on domestic social spending so as to endear the Ahmadinejad regime to the populace. In Sunni Saudi Arabia, they wish to maintain the present oil price or see it a little higher. They do not want to kill the west but they would welcome the higher oil price if the source of the pressure was from other than OPEC cartel price maintenance. So we have both the Sunni power and Shiite power supporting their respective allies who are the combatants on one side of the Persian Gulf while enjoying the benefits of any higher oil price and attendant risk premium. This bodes ill for Basra and any other place where the civil war might spread.

By way of disclosure, Cumberland maintains an overweight position in energy, with the Vanguard energy ETF (VDE) as their first choice. VDE has 118 stocks, with the heaviest weighted components being ExxonMobil (XOM) Chevron (CVX) and ConocoPhillips (COP) Schlumberger (SLB) and Occidental Petroleum (OXY). 

Thanks, David.


David Kotok
Cumberland Advisors.November 29, 2006

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  1. Barry Ritholtz commented on Nov 30

    Oh, and Snow is expected in NY this weekend.

    So much for 60 degrees in November and December!

  2. SINGER commented on Nov 30

    I know …The intermediate term weekly charts are looking insane right now…

    I was on the phone with a buddy this morning and he’s like, “why am I walking through C.Park and I don’t have a jacket on, it’s almost december?”

    I told him there are huge storms and snow in the midwest…

    “It’s snowing in Dallas”

    “Dallas? You mean in Texas?”

    “Oh,” he said, “thank God there’s no global warming”

    whatever you call it were killing the planet…and ourselves….

    the world is like the lungs of a heavy smoker….

  3. mh497 commented on Nov 30

    Not to mention this rather subtle piece of Saudi diplomacy.

  4. alexd commented on Nov 30

    alj Refiner (value play) I have a minor order in below yesterday’s close

    hrz (synth fuels value play) I have owned this and I am considering repurchase.

    Make up your own mind if they are rigth for you.

    The Israeli’s have figured out how to get high quality almost diesel out of oil shale but that is 3 years for them and five years for anyone else away and no it is currently privately owned.

    Be well.

  5. D. commented on Nov 30

    What we’ve been seeing in the last 5 years is a consumer frenzy.

    Rates dropped, the housing market took off globally. Americans have been spending their retirement money: their home equity!

    The whole world sees this and dollar drops but no one can really believe that the US can lose it’s super power status and most think they can just keep on dropping their rates to prosperity. Let’s face it, at 4%, we’re hitting the wall.

    Most other countries boom like crazy because:
    1. US lower rates permits them to drop their own rates… drastically
    2. Their MUCH stronger currency fuels this consumer led bubble even more.

    For example, the Canadian dollar has increased about 50% in the last few years. We’re net exporters but net importers of consumer goods. Since we’re going through a consumer led bubble, the higher dollar has made us much much richer! Ironically, prices have stayed flat so imagine the margins at the retailers or whoever it is along the product line!

    At one point consumers will be maxed out and margins will come down. People will lose their jobs, less cars will be produced, less stuff will be purchased. Industry will use up less oil.

    CF break even oil price is 30-40$. Commodities ALWAYS go back to CF break even because input princes must be lower than output prices over the long term and obviously this has not been happening.

    Nickel has gone from 3$ to 15$ per pound. Inflation is not reflecting this. Somebody is assuming this cost but who?

    Inflation is coming and it will increase with a drop in the US dollar. All the imported stuff will get more expensive and all the exported stuff too because of the new competitive advantage from a lower dollar. The US dollar has been overvalued for so long that there has probably been underinvestment in export industries so when these take off, costs will follow.

    Anyway, if rates increase by a couple of percentage points, many pension funds will become funded and take a load off many companies… and the government.

  6. V L commented on Nov 30


    Most of the factors are speculative in nature. (if, could, etc…)

    You forgot to add some bearish factors (to name a few):

    1. The possibility of a recession next year.
    2. Demand for diesel from trucking companies is declining
    3. OPEC cuts provide a cushion against future possible geopolitically related shortages
    4. … etc.

  7. ilsm commented on Nov 30

    Yes, the Saudis have it made.

    Extract oil at $5-10 a bbl.

    Sell it at 30 to 60.

    And have the Americans defend them too.

    Let the Saudi royals pay the Egyptians to stabilize Iraq.

    How ’bout some democracy building in Saudi?

    Or in the USA.

  8. Chief Tomahawk commented on Nov 30

    Chicago PMI weaker than expected…

    dollar falling, oil rising…

    But congrats on the page viewership, BR.

  9. tjofpa commented on Nov 30

    Sorry Barry, but this sure has the sound of a Stephen Roach capitulation moment. :)

  10. Scott Frew commented on Nov 30


    You might want to consider the following factors which David didn’t mention in his bullish analysis.

    China’s cutting long term deals at below market prices with a number of the less savoury (Sudan) and tweak-their-noses-at-the USA (Venezuela) countries out there, effectively taking supply off the market from those countries.

    David’s correct about Iran’s position as a defender of Shiite interersts in Iraq, but it’s worse than that. See Nawaf Obaid’s op-ed in yesterday’s W Post; Saudi Arabia will surely come into Iraq on the side of the Sunnis if there appears to be a vacuum created by US withdrawals or US siding with the Shia, as has been suggested–rumor has it that Cheney’s trip to Saudi Arabia was in answer to a summons to let him know that Saudi position. If that happens, the potential for the Iraq conflict to extend into conflagration across the Middle East, as Niall Ferguson has outlined, would seem more than an outlier.

    On the other side of that argument, there’s inelasticity not just on the demand but also on the supply side, given the number of national companies who are revenue rather than profit maximizers–when the price goes down, Venezuela and others pump more rather than less. As a result, volatility should be expected on the downside as well as the upside–I’d think we could conceivably see $30 as well as $100 oil over the next 18 months, although I certainly expect the volatility to be around a rising mean/median priceline.

  11. cleanupDSNY commented on Nov 30

    the funny thing is the S&P has a lot of Earl stocks now in the weighting so when oil goes up the oil stocks pull the market up as well. go figure…

  12. Gary commented on Nov 30

    The enviromental groups would like to scare everyone into believing that we are causing global warming (that’s how they get their funding). But the cold hard truth is that there is no conclusive evidence one way or the other. The fact is that the earth has been going through cycles of heating and cooling for billions of years. So has our use of fossil fuels raised the mean temperture of the planet .2 of a degree or is it just the normal cycle of heating and cooling? All I know is nothing different is happening now that hasn’t happened a million times before. I will concede that we are polluting our planet though.

  13. 23 commented on Nov 30

    Why use the vanguard ETF and not the USO ETF?

  14. V L commented on Nov 30


    Agree 100%. There have been at least four major documented ice ages in the Earth’s past (all were followed by warming), well before humans had a chance to pollute the Earth with greenhouse gases.

    These are normal cycles can be explained by:
    1. Variations in Earth’s orbit (Milankovitch cycles)
    2. Variations in the sun’s energy output
    3. Volcanisms
    4. …etc

  15. M1EK commented on Nov 30

    Gary and V.L.,

    Take your crap somewhere else, please. Equating natural long-term variation with observed short-term anthropogenic warming is just this side of bald-face lying.

  16. V L commented on Nov 30


    How do you know that your “observed short-term anthropogenic warming” is not a “natural long-term variation”???

  17. cleanupDSNY commented on Nov 30


    you are absolutley right. but i understand as well that solar radiation affecting the earth’s magnetic poles is what causes the changes in the weather patterns. It all folllows the sunspot cycle. M1ek must be having a bad day. ignore him.

  18. Brendan commented on Nov 30

    Gary, V L,

    While your hypotheses COULD be true (at least according to Exxon-Mobil) the statistical likelihood is slim compared to the statistical likelihood that the current global warming trend is mostly related to anthropogenic carbon dioxide. At this point, the only people who are well informed on the subject that believe that humans aren’t having an effect on climate change are extremists with an agenda. Even the other oil companies have given up the fight. If you want to keep denying it, I’ve got some cigarettes that I hypothesize COULD not have ill-heath effects (at least according to Philip-Morris). Smoke a few cases a day and let me know how that turns out. But I digress.

    Regardless, the ability to produce more oil is vanishing while demand keeps increasing. I don’t need to tell you what that means. We’ve already seen the tremors before the big one over the last few years. You’re either very brave or very stupid to be standing on the side of that volcano preaching that oil is going to remain cheap while the ground shakes beneath you. I can’t make a prediction on what prices are going to do in the next 12 months, but in the next 60 it’s only going skyward. The factors listed above are just kindling for the big fire. Now it’s just a matter of seeing when the big one catches flame.

  19. alexd commented on Nov 30

    The warmest (fill in the blanks) have mostly occured in the last decade.

    The rate of increase is the fastest we have seen in the last…..

    I live in the midwest and had a guy tell me there was no air pollution. I suppose his arguments sounded good to him. I pointed out that when I lived near NYC I witneesed a day where from across the Hudson river I could not see the WTC.

    Most environmental scientists believe global warming is real. Wonder who has them all paid off? Please remember all the crap we are releasing is on top of what ever natural processes are occouring. Our actions are either decreasing ,doing nothing to, or increasing natural effects. For two of them it is a matter of magnitude.

    As far as the
    Earth is concerned it is like markets, we see what we want to see. Hopefully what we want to see coincides with reality but if it does not we can go along with our postions for a long time.

    Ever notice how Shakesperean and hedge fund tradgedies usually incolve people fooling themselves or not seeing what is right in front of their eyes?

    Am I right or am I right? (that is the probelm, no?)

  20. BDG123 commented on Nov 30

    Given the general market is lower and the indices haven’t moved any higher since Kotok announced his long and hard commentary a month ago, I’d say this call should be viewed cautiously. Not that he isn’t a bright guy. I have no doubt he is.

    Let’s see energy profits rise if we hit a hard global slow down. Frankly, let’s see energy stocks rise if we hit a global slow down. While energy itself may be rising, energy stocks, in general, are NOT following the same strength they were before this major dump.

    We can surely expect significant volatility in oil. ie, The markets never go in one direction too long before a counter move as we are seeing now, but there is zero precedence historically for energy stocks to continue to rise if the general market is going the opposite direction. ie, You can’t be bearish on stocks and bullish on energy stocks unless we are breaking with stock market action over the last one hundred years.

    So, you are either bullish on stocks, and therefore energy stocks, or you are bearish on the stock market and bearish on energy stocks. Energy stocks were decimated in the last oil push of the 1970s when the markets tanked and this time will be no different if we see a recession.

  21. V L commented on Nov 30


    I do not need Exxon-Mobil or lunatics like Al Gore to tell me about the global warming.
    I just simply have not seen any solid and logical evidence supporting the greenhouse gases hypothesis.

    P.S. There are randomized clinical trials showing that smoking increases the incidence of coronary artery disease and lung cancer. There are no well designed studies showing that greenhouse gases alone (and not other factors) cause this questionable tiny little temperature increase. You cannot compare them.

  22. bob commented on Nov 30

    The price of oil is NOT INCREASING!

    This is the dollar falling. Falling pretty fast in the last 10 days. The oil price in old dollars IS THE SAME.

  23. bob commented on Nov 30

    >>> Oil for delivery 18 months from now is trading near $68 per barrel

    Exactly! The market expects that $68 18 months from now will be the same as $62 today. This has nothing to do with oil.

    Look at gold.

  24. BDG123 commented on Nov 30

    So, the argument is dollar is dropping so everything dollar denominated will go up? Hmm.. Well, that’s convenient until it is no longer convenient. Or, it’s Wall Street bullsh*t or perma-bear blather. That works until it no longer works. When will it no longer work? When prices bust demand just like every other time in history.

    In other words it’s perfectly logical but it has no precedence in all of the years of a fiat money system that has seen massive money supply growth over decades. Remember gold and oil and commodities were flatlining at near zero until a handful of years ago. But, wait a minute. It’s different this time. Why is that? We are running out of oil or copper or iron ore or coal or whatever? Sure.

    As far as $68, it is normal for commodities which require delivery to have a future price higher than the spot price. That doesn’t mean anything. Future delivery for oil was also at near $80 before it went to $50. If it was that easy, we’d all just load up on futures contracts.

  25. Macro Man commented on Nov 30

    Oil is in contango for a number of reasons. A falling dollar is not one of them. Indeed, the futures curve went into contango during a period of relative dollar strength in late summer. A plausible hypotheisis for the contango of the futures strip is a combination of a) overhang of stale longs , exacerabted by the Amaranth fiasco, b) evidence of a moderation of US and , to a lesser extent, global growth, and c) a signficant build in inventories, particularly at the WTI storage depot in Cushing.

    The gold move is more speculative than financial in nature; otherwise, TIPS spreads would be widening instead of pricing CPI at 2.25% for the next 10 years.

  26. DavidB commented on Nov 30

    There are two things that stop me from investing in the oil to $100 hypothesis.

    1. It costs about $50 per barrel to convert coal to it’s oil equivalent

    2. There is a lot of coal

  27. jj commented on Nov 30

    Macro Man

    good call on Cushing … when it went offline , you knew that this week would see a bigger than expected drawdown on gas and distillates , but the tell is , the utilization is still not high enough for price decreases … once this weather pattern moves through and Cushing’s up for more than 2 weeks , i expect a downdraft

  28. Gary commented on Nov 30

    If you will reread my post. I clearly stated that there is no conclusive evidence to support the claim that fossil fuels are causing global warming. I didn’t say that they are not. There is just simply no clear evidence to support the claim one way or the other. Although the enviromental groups would like everyone to believe the evidence is indisputable. There is some slight evidence that the large areas of concrete and asphalt in some of the worlds large cities may indeed cause slightly higher ground surface tempertures in those areas. Although there are also many towns like Albany where the mean temperture has dropped over the last 30 or so years. Heck in the period from 1940 till 1980 the mean global temperture dropped. I’m pretty sure we were burning plenty of fossil fuel during that time. As I remember people used to burn their trash in a barrel. You would think that 40 years of rampant burning of fossil fuels would have raised the global temp during that period but instead the average temp declined.

  29. ari5000 commented on Nov 30

    I’ve read so many compelling reasons why oil is going to $100 and also going to $50

    I’m guessing with the way things work now — markets dominated by fulltime daytraders — nobody/everyone will be right… up to 70 for now… then warm weather plus recession drops it back down to 50 — then OPEC cuts — back to 60 — but they didn’t really cut — 58 — article about China growth — to 65…

    There’s really nothing to do but trade the swings. You can’t put a price on it… just a lot of crowd behavior.

    ALY has been a hot stock the past few days but it’s always interesting to note there’s been quite a few insider sales this week. It’s all just pumpage and dumpage. T. Boone Pickens must be having another banner year trading the swings.

  30. wunsacon commented on Dec 1

    Gary, we can’t wait for Perry Mason to coax fossil fuels into admitting their guilt. The success of the environment that sustains us as a species depends on us acting on the best information available. Let’s please not wait for the news sources you rely on to concur and not wait for anecdotal evidence about certain cooling microclimates to be placed into context of an increase in *average* global temperature. At least, I’d rather play it safe.

    >> The enviromental groups would like to scare everyone into believing that we are causing global warming (that’s how they get their funding).

    And the professional scoffers you watch and read get *their* funding from you. No? How do you know who has the bigger ulterior (financial) motive? You can’t. You have to evaluate each individual’s or group’s claims on its merits. The ad hominem attacks reflect partisanship.

  31. abe commented on Dec 1

    Year over year, the middle east is not deteriorating and nigeria is not getting more dangerous. I agree with the overall view, but if you talk to people in the industry, in the region, both these assertions are utterly false. And a mckinsey price projection for 2020 is crap, akin to the idiots talking peak oil.

  32. alexd commented on Dec 1


    What about quantity? The amount of inefficent hydrocarbon usage?
    i suspect the sheer volume going up might have an effect. Also is there a critical volume? I do not know but there might be. If one be stings me it is not good. But if I suffer many stings in short order I might suffer terribly.

    These are questions. It is difficult for a individual to periceve trends and it is even more difficult to know the effects of culmutive changes without some method to acheive anaylisis that takes statistical certainty into account. Now I am willing to think that a few scientists can be wrong, but when 99% of the enviromental speacialists point in one direction I am inclined to suspect that the odds are with them. Then there is a the risk reward scenerio. The loss of a viable environment is such a big price to pay verus the inconvienance of getting our house in order.

  33. Gary commented on Dec 2

    Don’t get me wrong, I am in total agreement that reducing greenhouse gases and cleaning up our enviroment is in our best interest. I would have to disagree that 99% of enviromental specialists think that fossil fuels are causing global warming, maybe 60-40. I suspect that if one were to look at who is funding each and every enviromental study you would find an exceeding large percentage conclude exactly what the organization funding the study would like them to find whether the study be pro or con on global warming. As to quantity, the world was much less efficient at controlling fuel emmissions in the 40-80 period than we are now and during that period the population incresed 74%(94 million). From 80 to 2000 the population has only incresed 24%(55 million). There were no auto or factory emission standards during most of that period and yet the mean temp. dropped. This was the era of the muscle car for heaven’s sake. I’m just saying there is no concrete proof either way. The enviromental groups have done such a good job of scaring the public that people are very passionate about defending an idea that they really have no idea is true or not and are just believing what the media wants them to believe.

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