The S&A Digest: Oil Supply on the Rise After 20 Years?

Hola from Nicaragua... This could spell the end of oil's bull market...

 We've landed in Nicaragua... and are enjoying a round of Toña beers (one of two Nicaraguan brews) and the views from 3,000 feet above sea level. Expect a full report – and some photos – tomorrow.

In the meantime, our resident quant, Ian Davis, has crunched the numbers on U.S. oil supply... and what it means for oil's bull market.

Regards,

Sean Goldsmith

Outside Managua, Nicaragua

May 27, 2008

Oil Supply on the Rise After 20 Years?

By Ian Davis

The U.S. crude oil supply has finally stopped falling...

According to the Energy Information Administration, between 1982 and 2004, the supply of crude oil in the U.S. fell from 34.2 to 17.2 days... In other words, at the then-current rate of demand, it took about 34 days for the U.S. to use up its existing inventory of crude oil... But by 2004, that time was almost cut in half.

The following chart shows the U.S. crude oil supply in relation to the price of oil.

The 20-Year Decline in U.S. Crude Oil Supply

Soaring oil prices are finally having an effect on supply. The supply is currently at 21.5 days... and it just posted a higher low for the first time.

This makes sense economically. As oil prices rise, people become thriftier, and the demand for petroleum products decreases.

Ron Planting, an analyst with the American Petroleum Institute, recently told Bloomberg, "Consumers are reacting to higher prices by reducing demand for gasoline and other fuels. The airlines are using fuel more efficiently because of higher costs. Demand for jet fuel is down in spite of increased passenger miles."

Not only are consumers becoming thriftier, but the increased price of oil is also encouraging exploration for new oil wells and making oil wells that were previously economically unfeasible, feasible.

So what does this mean for you as an investor?

If the supply of oil continues its slow rise, it could mean an end to the bull market in oil. However, even if the bull market does end, I don't foresee a return to $50 oil any time soon...

Most of the new oil discoveries are occurring in places that are geologically difficult and expensive to tap. So if the price of oil falls significantly, oil companies will stop pursuing these new wells and supply could quickly return to its 2004 lows.

I expect the oil price to level off in the coming years. I also believe an oil bear market is unlikely (though a short-term correction may occur). If you've got your money in oil, just be aware: This indicator doesn't point to any impending crash, but with supply rising, oil's roaring bull market probably won't continue for much longer...

Good investing,

Ian Davis

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