How to Bet on Oil Prices in 2012

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"Higher costs mean higher prices. And the poorer the quality the world adds to the mix, the more it will cost."

Truth be told, forecasting higher oil prices in the long run feels a lot like shooting fish in a barrel.

Two years ago, the light sweet crude coming from Texas (WTI) averaged $61.65 per barrel. A year later, that average was 30% higher, slightly below $80 a barrel. And this year, the EIA expects WTI to average nearly $94 a barrel.

A return to triple digits is a guarantee—and we may see $100 before New Year's Day.

While the EIA is predicting a 3.1% growth in global oil consumption next year—reaching almost 91 million barrels of oil per day—this can be a bit misleading.

Months ago, we talked about the bigger decline picture.

Thanks to the average field decline rate of 6.7%, this doesn't mean we need an extra two million barrels per day lying around. . .

In total, we actually need to find an additional 8 million barrels of new oil per day—and that's just to break even!

In 2012, I see crude prices averaging about $95/bbl for the year. I don't expect crude prices to fall below $75 per barrel for any extended period of time.

And even though a sudden severe price spike next summer is unlikely, we'll certainly spend more time above $100 per barrel than we ever have before. . .

Masking an Oil Crisis

To start with, the oil we are producing today is not the same as it was years ago.

When Italy's multinational oil and gas company Eni released its tenth and latest World Oil and Gas Review that fact really hit home for us.

It wasn't the imbalance of oil reserves (72% of which are controlled by the OPEC and 90% by NoCs), nor was it the 3.4% demand increase projected for 2012. . .

It was the degrading quality of our oil supply.

In 2010, medium sour crude from Russia, the Middle East, and Central Asia accounted for more than 40% of the world's oil production. Crude oil of the light, sweet variety only accounted for 16% of the total.

It's been nearly eight years since we saw an increase in conventional oil production.

What's worse is that these types of reports often mask this fact. Read between the lines and you'll find much of the production data now includes not only oil, but total liquids production. This makes for an easy way to confuse the situation.

It boils down to is this: Higher costs mean higher prices. And the poorer the quality the world adds to the mix, the more it will cost.

As I mentioned above, pumping oil today is a whole new ball game.

The cost to drill a well on U.S. soil has climbed well over 400% in the last eleven years.

Oil, Gas, Investing, Keith Kohl

Unfortunately, $60/bbl oil just won't cut it any longer.

In the United States, this has become a reality during the last decade.

Make no mistake; the "drill, baby, drill" mentality has taken a foothold here, evidenced by the 2,026 active oil and gas rigs. I've seen this boom firsthand. . .

The Next Generation of Oil Booms

There's a good old-fashioned oil boom happening right now, right here in the United States.

Today it's easy to find the hot spots—as well as where the major players are placing their bets: One out of every five rigs drilling for oil in the U.S. is located in North Dakota.

Nearly every single one of them is drilling horizontal wells into the Bakken formation. (Compare that to our second largest oil-producing state, Alaska, where just nine rigs are operating.)

The increase in North Dakota's production alone can replace our total imports from two of our largest OPEC suppliers.

And it doesn't matter if oil prices edge lower in the short term. . .

Higher oil prices in the future are an inevitability: It's costing us more money to pull the oil out of the ground, and the oil we are extracting is of poorer quality.

Luckily, a tremendous investment window is opening. . .

Right now, we know that many of the best drillers on U.S. soil are sorely undervalued.

If you're looking to finally turn a profit during the recent economic turmoil, it doesn't get much better than this.

Until next time,

Keith Kohl
Editor, Energy and Capital

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