Thinking About Buying Oil Again

4 Dec 10:16am
Posted by ToddSullivan
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Did well with this trade over the last year and I think it may be time to get back in...$$

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For those who remember in Feb 2007 we bought Oil (USO) when the price of crude was $47 and rode it until we sold this May at $127 (it later peaked at $147).

With the price back to where it all began last year, I think I am inclined to start buying again.

First, watch Paul Kedrosky on CNBC yesterday.


Personally I think Paul may be a bit conservative in both the price level and the time it may take.

Why?

First, I came across this on Twitter yesterday:

My rough estimate says that at any given time in recent years about 600 to 700 million barrels of crude oil are at sea, enroute from exporters to consuming countries.

As a shipowner, about the only cost I have much control over is my fuel cost. Financing and insurance costs are a function of time--so much per month or year. Maintenance is also mostly a function of time, but it might be defered during economic downturns. Crew costs are also a function of time--so much per month, or per shift.

Fuel burned is a function of speed--the drag goes up as a function of the speed--roughly at the square of the speed--double the speed equals more than double the fuel, but half of all the other costs. So at any time, there is an optimum speed--the higher the cost of fuel, the slower to steam to optimize profits. The lower the fuel cost, the faster you show go, up to the limit posed by higher drag on the ship's hull.

We have just had the biggest drop in bunker fuel prices ever experienced, so every good charter captain just started steaming faster--anything else would be to leave profits on the table. How much faster? If 25%, then the amount of crude at sea would have dropped by 100 to 150 million barrels over the past 2-3 months, or about 1.5 to 2 million barrels per day. This destocking at sea would make it look like we have a worldwide oversupply of that amount. By the way, this same factor of ship-speed also explains the weakness in the BDI.

It also says that once oil prices(bunker fuel) starts back up, then that 2 million b/d will dissappear from the markets as the steaming speed slows back down. I happen to think the destocking at sea is about to end, and that, together with the winter seasonal increase and OPEC cuts may remove some 6 million b/d from markets between now and February, and that is why Land-Lubber just might be right in his call for $150 crude by 2-29-2009. Just my 2 cents for discussion. I can sure tell you as a pilot I adjust airspeed to reflect fuel costs, and so do all the airlines.


Now disclaimer: Who knows if the person is really a pilot. But, based on what I could find, the number proposed are fairly accurate as the the #'s at sea and inventory levels.

Second: The dollar.
It reached record low levels this summer (when the price of oil peaked). Its subsequent rise (20%) has inversely correlated to oil's slide (that and demand destruction for oil) of 68%. Here is the rub. The dollar has to come down. The Fed and Treasury are printing money like they think there is no tomorrow and unfortunately, there is. That future will have a falling dollar and which will be default cause oil prices to rise. It will cost more weaker dollars to import anything and oil is imported.

Third. Oil Demand.
Yes we are in a recession. Yes we will come out of it. No there is no tangible extra supply going back on the market. That means when demand begins to increase and the dollar inevitably falls in value, we are due for another super spike in oil. I just do not see anyway around it. We really have not done anything to address drilling or conservation here in the US which would add supply. Even adding natural gas supply would lower its price and cause million of Northeast homes that use oil to heat to convert to gas like they were this summer. With oil prices now low, those conversions, according to several heating companies in my area have stopped.

When?
Hell if I know. My guess is no longer than spring before it starts if we have a cold winter. The time to buy would be now before the winter hits.

I used (USO) before for the trade but I think this time I am going with OIL (OIL) as the correlation to price seems more true. I would also consider the (DXO), it is a double long index. Currently at $3 and change, the down side is limited and upside is substantial.

Thoughts on a better index?


Disclosure ("none" means no position):None
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About

ToddSullivan

A Massachusetts based value investor, I look for companies whose current valuation is at a discount to their true value. When I purchase a stock, my typical holding period is several years. I consider buying a stock purchasing a piece of a business. I am confident once I make a decision to buy that eventually the market as a whole will recognize the true value of the business and value it accordingly. It may take 1 month, 6 months or a year, but if I buy it at enough of a discount to its true value my results will be (and have been) superior to the market as a whole. Of all the disparate investing disciplines, value investing has stood the test of time. The great investors of have all been value investors. Warren Buffett, Ben Graham, Bill Ruane (Sequoia Fund), Bill Miller and Wally Weitz, all have consistently outperformed the market for decades by using various forms of value investing. Currently I am a contributing writer to Seeking Alpha, Vinvesting.com, The Stock Masters and Value Investing News. Posts have been reprinted in The Wall St. Journal, Yahoo Finance, Google Alerts, Google Finance, TheStreet.com. 24/7 Wall St. and Topix.net.

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