Is Saudi Oil past its peak? Are Saudis really on our side? Are we?

by Stephen Leeb

***** Steady as she goes on the market.

***** Geopolitics is getting funnier all the time … except the joke may be on us.

***** Is Saudi Oil past its peak? Are Saudis really on our side? Are we?

***** More buying opportunities.

***** Alternative energies – even the wrong ones may soon be right.

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As you may have guessed from last week’s 1-1.5% gain in the overall markets, nothing has altered our generally bullish stance. Our indicators remain so positive we practically need a microscope to find any flaw in the short-term picture, at least from a technical perspective.

Small cap stocks remain in the lead. Specialist shorting remains historically low. Virtually every average has confirmed all-time highs. It’s as though Santa Claus has overstayed his visit by an extra two months just to give investors more presents.

Even oil prices, if we look at the 4-week moving average, are below where they were last year at this time, which is a powerful bullish intermediate-term indicator.

If you’re as used to looking for problems as we are, you’re probably feeling equally frustrated. But so what? We’re making money, and that’s what counts.

Meanwhile, back in the desert …

THE IRONY OF GEOPOLITICS

I was having dinner the other night with some extremely intelligent friends when one of them made a suggestion worth quoting. He said, “Maybe the low price of oil means the world is doing a lot better than we think. After all, if things were really that bad, especially in the Middle East, oil prices would be a lot higher and the market would not be rising.”

It didn’t make sense to him that stocks would be rising and oil prices tame if the world, and especially Iraq and other ME nations, were in such dire straits as the newspaper headlines suggest. I hope he’s right, but I found it difficult to agree. Since my friend is a doctor, here’s how I explained it to him …

Let’s say oil prices are like a thermometer. Just as the temperature shown on a thermometer can indicate a patient’s health, so oil prices both reflect and affect the degree of the world’s geopolitical tensions. The more endangered the world seems, the higher oil prices climb. And the higher oil prices climb, the more investors become afraid.

The trouble is, as every doctor knows, temperature isn’t everything. A patient can have any number of life-threatening illnesses underway that will not be revealed by a thermometer. (It’s also true that some patients will run a thermometer under cold water in order to fool the doctor, but let’s not speculate in that direction for the moment.)

As we’ve mentioned before, the current bull market began last year just as oil prices began to retreat. Trading around $60, oil prices still suggest that geopolitical tensions are under control. However, we must consider the possibility that there could still be threats which are not apparent and have yet to send oil prices skyward, but may do so in the near future.

For example, although we’re not political scientists, when we look at Iraq we can’t help wondering what is going on. Every day it seems, we read reports of Shiites being killed by explosives in Iraq.

Shiites make up the majority in Iraq, while the minority Sunnis are the group that formerly held the most sway in government when Saddam Hussein was in power. However, in the Middle East as a whole Shiites are the minority, except in one important location – Iran. At the risk of oversimplifying the situation, it seems unlikely to us that Shiites would be conducting a campaign of terror against their own people. So we doubt that Iran is financing or otherwise encouraging the killing of Shiites. More likely, it is Sunni groups who are detonating most of these bombs.

So who could be financing these Sunni bombers? If it’s the old guard from Saddam’s government, we’d have to ask ourselves why. With the recent executions, there’s no chance the former regime is returning ever again.

Iran has recently accused both Pakistan and the U.S. of helping Sunni bombers in Iran. Unfortunately, we think the most likely candidate to support such acts is actually Saudi Arabia. That’s the wealthiest Sunni government in the region, and one which has gone on record saying they will protect their Sunni brothers in Iraq. The effect of this campaign is to put American soldiers in the role of fighting Saudi Arabians in order to protect Iranians and their allies – even though Saudi Arabia is our ally and Iran is part of the “Axis of Evil.”

One thing is true about geopolitics … it has a warped sense of humor. How this all will end, we have no idea. We know that Saudi Arabians are of mixed opinion regarding Americans. Some love us; some hate us. The House of Saud that rules the nation is in the “love us” camp, but how long it will stay in power, we cannot say.

We hope there is no hidden anti-American, anti-Shiite virus in Saudi Arabia that will bring further chaos to that part of the world. Because if such a problem were to burst into full view, it would mean the end of moderate oil prices, and the bull market to boot. But apart from the geopolitical considerations, there’s another factor to consider …

PEAKED OIL?

We have a hard time believing supply/demand factors will favor moderate oil prices for much longer. The argument that Saudi oil production reached its peak sometime around 2005/2006 seems increasingly persuasive. At least, production in 2006 was less than in 2005, despite considerably higher prices.

The world’s increasing demand for oil suggests that OPEC may have a very difficult time matching that demand with higher supply.

Although oil prices may remain calm, at least until refiners begin building gasoline supplies for the summer driving season, we think they could easily begin a new uptrend.

The reason we’re going into such detail regarding oil in today’s update is that oil stocks, especially oil service stocks, have been under pressure lately. This can only be a sign of great complacency by investors who cannot conceive of an oil shortfall occurring.

What we have today are investors who are intent on ignoring the real underlying problems in energy. They are like the incompetent doctor who mistakes a normal temperature for good health, while ignoring the patient’s screamingly high cholesterol levels. The day our patient experiences a heart attack, it may be too late for the doctor to do anything.

OUR CHOICE OF ALTERNATIVES

While we’re on the subject of energy … let us draw your attention to a recent article on alternative energy that appeared in Science. The article gives much good information on solar energy, which everyone agrees is not cost effective, except for powering individual houses, particularly in remote areas. Solar energy is unlikely to drive the wheels of industry anytime soon. Wind energy was not well covered in the article, which was unfortunate since wind is economically viable.

We continue to believe that biofuels are a non-starter, so long as they are made from expensive commodities such as corn. With corn headed for $5 a bushel, oil prices would have to truly skyrocket for ethanol to be a cheaper option. Biofuels made from otherwise unusable plant materials might work, but so far that policy has yet to be initiated.

Until we see real efforts being made to develop viable alternative energy supplies, we’re going to stay bullish on oil and oil service stocks. We’re also bullish on alternative energy, even solar, and even though they depend on subsidies to generate profits. The political wind is blowing in their direction, and we expect those subsidies to persist and grow. And even if they don’t, higher oil prices will eventually make them very profitable.

Until next week,

Stephen Leeb, Ph.D
Editor

The Complete Investor

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