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We are pleased to present the following excerpt from the book

Black Gold: The New Frontier in Oil for Investors

by George Orwel

Wiley - June 2006


Oil Prices Will Stay High and May Even Rise to $100 a Barrel

The world is experiencing its first demand crisis in more than two decades. We can blame China, OPEC, Iraq, and the oil peak for that, but we must also admit that the industry has gone through some structural changes that have had enormous influences on energy prices. Certainly, a case can be made that oil and gas have become asset commodities that are attracting more investors at a time when equity returns aren't great. In fact, that's why the American Stock Exchange introduced the first exchange-traded fund (ETF) tracking crude prices in April 2006. Exchange-traded funds have become hot on Wall Street because they give individual, average investors the opportunity to have control over their investments, by taking positions in crude oil rather than investing in shares of energy companies or mutual funds. In a kind of cyclical effect, these new investors have added, and will continue to add, market liquidity, causing oil prices to continue soaring, and energy companies also to make more money.

Oil prices had climbed to $75 per barrel in April 2006 and were set to hit a new record, while gasoline prices passed $3 per gallon, double what they had been two years earlier in December 2004. Oil was trading at $40 and we thought that was high. Now, in retrospect, we were so wrong. In fact, we probably won't see oil that cheap again, unless there's a temporary glut caused by OPEC, which is unlikely. The sharp rise has nearly everyone scratching their heads about where oil prices may be headed next. Consumers are paying through the nose and traders are asking how they can get a piece of that boom. Some think it won't be long before we get to $100 oil, while more aggressive analysts are setting their sights as high as $180 per barrel.

The oil boom has made headlines across the globe recently. Strong demand from China and India, a lack of spare capacity, or more accurately, the inability of OPEC countries -- particularly Saudi Arabia -- to increase oil supply by any significant margin, as well as weather-related supply shocks have fueled the crude oil rally. As a result, we have seen windfall earnings for oil companies and painfully high fuel costs for the consumer, all of which has forced politicians and oil executives into a corner as public outrage mounts.

The U.S. Senate Committees on Energy & Natural Resources and Commerce, Science, and Technology heard executives of the world's five largest oil companies at a public hearing amid charges of gouging in November 2005. But the executives offered strong defense of their companies' high profits, as national politicians pressed them to account for soaring gasoline, diesel, and natural gas prices in the months after Hurricanes Katrina and Rita struck the Gulf Coast. Later, senators heard from state officials who urged Congress to pass a federal anti-price-gouging law. The Bush administration, however, cautioned against such laws, saying competition was more effective in controlling prices.

While admitting that high oil prices were hurting consumers, the executives said their profits were not out of line, arguing in fact that prices were being driven by larger forces often out of their control. "Today's higher prices are a function of longer-term supply and demand trends and lost energy production during the recent hurricanes," said James Mulva, chairman and chief executive of ConocoPhillips. But several senators, mostly Democrats along with some Republicans, appeared unsatisfied by those responses, and they demanded to know what the industry was doing to increase supplies, and whether oil companies would help promote conservation measures. "Most Americans and most of the polls show that our people have a growing suspicion that the oil companies are taking unfair advantage of the current market conditions to line their coffers with excess profits," Pete Domenici, Republican of New Mexico, said during the televised hearing. Senator Barbara Boxer, Democrat of California, added: "Working people struggle with high gas prices, and your sacrifice, gentlemen, appears to be nothing." She noted that the executives were making millions of dollars in salaries, bonuses, and stock awards. Still, calls for a windfall profits tax on oil profits that would help families pay high heating bills and other energy costs were beaten back.

Oil, gasoline, and natural gas prices soared in the weeks after Hurricane Katrina struck the Gulf Coast and shut down the vast majority of offshore production sites and 18 percent of domestic oil refining. Gasoline prices spiked past $3 a gallon in many parts of the United States, though they retreated to pre-Katrina levels by October. It was clear the economic impact across the country was going to cause problems, and it was not long before politicians such as Senator Conrad Burns, Republican of Montana, began saying high diesel prices were squeezing farmers and making American agricultural products too expensive for world markets. "Let the American people understand, agriculture is going to get shut down," he said. "We're not going to turn on one tractor to produce food and fiber for this country under these kinds of conditions. We have to do something different."

The executives of Exxon Mobil, Chevron, British Petroleum (BP), ConocoPhillips, and Royal Dutch Shell noted that they have been investing most of their profits in new production and refining. Lee Raymond, chairman and chief executive of Exxon Mobil, which reported a $9.92 billion profit for the third quarter of 2005, said that the industry's profits measured as percent of revenue were no greater than other industries. "We are in line with the average of all U.S. industry," he said. "Our numbers are huge because the scale of our industry is huge. How are these earnings used? We invest to run our global operations, to develop future supply, to advance energy-producing and saving technologies, and to meet our obligations to millions of our shareholders."

The oil chief executives asserted that in the past decade their capital investments matched their profits. Asked what they were doing to increase domestic oil refining capacity and bring on additional sources of energy, they said investments in their industry can take decades to come to fruition. Mr. Raymond said that even if the government streamlined the approval process for constructing new refineries, a move the energy industry sought, it would still take years to build new plants. Instead of building new plants, Exxon has chosen to expand existing plants.

"It is much more efficient because the basic infrastructure is already in place," Mr. Raymond said. "Over the last 10 years, Exxon Mobil alone has built the equivalent of three average-sized refineries through expansions and efficiency gains at existing U.S. refineries."

Raymond's argument is rather lame because acquiring another refinery doesn't increase the overall refining capacity. There has not been a new refinery built in the United States since 1976. Companies have expanded existing plants, which are also being operated closer to full capacity, but they have been coy about building new plants from scratch. In 1980, there were 425 refineries across the country; there are 176 today.


Excerpt copyright © 2006 by George Orwel. Reprinted with permission.

George Orwel is an Oil Analyst and Senior Writer for both the Oil Daily and Petroleum Intelligence Weekly. Previously, he covered the oil market for six years as a staff reporter for Dow Jones Newswires. Orwel has appeared on key media outlets, including CNN, BBC, and NPR, and contributed articles to the Los Angeles Times and the Christian Science Monitor, as well as other publications. He lives in Brooklyn, New York.

Black Gold: The New Frontier in Oil for Investors, by George Orwel

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