Wednesday, June 28, 2006

Surprise Drop in Oil?

Larry Kudlow knows economics and oil.

The economic principles at work here are very simple: Markets work. Supply and demand works. Higher prices are gradually slowing consumption. At the same time, those high prices continue to stimulate outsized profits and investment returns. So capital is pouring into all the energy sectors, providing a strong foundation for new energy production. Chevron, for example, is reinvesting virtually all its profits in new oil-and-gas exploration and drilling. The drilling industry, meanwhile, has recovered from last year’s Hurricane Katrina shock and is once again producing near peak capacity.

7 comments:

Rick and Gary said...

Interesting article! Thanks for the reference. On the flip side of the argument, Anadarko Petroleum last week spent $21 billion in borrowed cash to buy Western Gas and Kerr-McGee at a roughly 50% premium to its stock-market value.
The execs at Anadarko, at least, seem to be saying (with their wallets) that either oil will remain high or that natural gas is going to rebound after last year's mild winter.

David M. Smith said...

Hi Rick,

Isn’t Anadarko doing what Kudlow says many investors are doing? There is profit to be made, so investors are pouring capital into the gas and oil industry which will create more supplies, more competition, more choices, and lower prices.

Rick and Gary said...

More supplies, more competition, more choices, definitely. Lower prices, I'm not so sure.

We had really low prices in the 90's in large part because the collapse of the Soviet Union caused a 50% drop in consumption by them, while foreign investment in Russian oil increased production. Now, Putin has scared away a lot of foreign investment, while Russian demand is recovering and Chinese demand is soaring.

David M. Smith said...

Hi Rick,

I’m not so sure either, anymore. When I posted this, I thought it was completely solid, but the last few weeks gone the other way. Let’s give it some time. Maybe lot’s of time. ; -)

Rick and Gary said...

Yeah, if the Middle East didn't blow up, the build up in U.S. inventories could have depressed prices.

But in any event, all the capital investment going into oil right now won't yield increases in supply for years. I hope the new drilling technologies are highly successful! (and that California allows reasonable drilling off shore)

Rick and Gary said...

I thnk your drop in oil is on its way now. Bush won't sabre rattle with Iran until after the mid-terms and, perhaps , the x-mas shopping season. Combine that with slow downs in the U.S. and China and no hurricane damage to the Gulf rigs.

David M. Smith said...

Finally : -)