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Online Extra: Oil: The View from "a Long-Term Bull"


Crude-oil prices have remained stubbornly high, topping $50 a barrel in recent trading. That's thanks to strong demand from the industrialized world and China, along with widespread fear about supply disruptions in oil-producing nations such as Iraq. So far, efforts by OPEC and non-cartel producers alike to ratchet up output have had little impact on crude prices. And that has been a boon to the shares of major oil companies.

But will prices stay at their highest levels in two decades for the foreseeable future? And what's ahead for the stock prices of the big oil outfits? BusinessWeek International Finance Editor Chester Dawson spoke recently about the outlook with Timothy Guinness, chairman and chief investment officer of London-based Guinness Atkinson Asset Management, which launched a new global energy fund in June. Following are edited excerpts:

Q: Where do you see crude-oil prices headed in 2005?

A: My best guess is that they're going to correct down to the mid-$30 [a barrel] by January. I am a long-term bull on oil. And I believe we're headed into an even higher trading range [longer-term]. But the reason prices [are headed lower in the short run] is that price elasticity of demand is very low. And the rate OPEC is pumping oil is above 1.6 million barrels a day in excess of demand.

That tells us world oil [inventories] will rebound -- even at a high-consumption time of the year. And that will trigger a correction, which will [in turn] cause OPEC to cut back on production. So we'll have a period early next year when oil trades at $30 to $40 a barrel, but then it will start trading over $50 [as OPEC slashes production]. And it'll be closer to $100 [a barrel] by decade's end.

Q: What does that mean for the stock prices of major oil companies?

A: Oil stocks have risen about 20% to date, while oil prices have risen 50%. I expect in a similar fashion when oil prices fall by one-third [from current levels] that oil stock prices will decline [only] 10%. That's because the value of oil stocks depends on your long-term view. The market is now pricing in $25 to $28 a barrel.

Q: How do you explain the gap between crude prices and oil stock prices?

A: The market is correctly reading that there's a fundamental sea change going on [in the demand and supply balance] -- but maybe it's [reflecting that] a little too soon. But the stock market is finding it hard to believe in higher oil prices long-term. The [price-earnings] ratio average of the [oil company] stocks in my portfolio is only 10.4. In my view, oil stocks should command an average p-e ratio of 18, which would price them in the market [reflecting crude prices of] $35 a barrel.

Q: What lies behind your forecast for higher oil prices later this decade?

A: We have forgotten how strong the growth in demand for energy tends to be when a region begins to experience a surge in demand for autos and consumer durables. China and the rest of Asia are beginning to run into this period [of economic development].

The question is: Can we now find 2 million more barrels a day in extra production to meet this [new] demand? A lot of our oil production today comes from mature areas, which are now in decline. [For example,] at the very least the [oil reserves] situation in Saudi Arabia is opaque.

Q: Can't other oil-producing nations increase output as demand grows?

A: Iran could take up some of the slack, and so can Russia -- which has come to our rescue [by rapidly increasing production] in the last few years. The former Soviet Union was running at 12 million barrels a day in the mid-1980s and then dropped down to 7 million [immediately] after the fall of the Berlin Wall. It's now back up to 10 million a day.

But [consider that] China currently consumes about 6 million barrels a day, and America consumes about 20 million. China is making a valiant and determined effort to raise its standard of living to that of America. It can probably get to a quarter of [American living standards] in 20 years.

So given its larger population it's entirely possible that China could consumer 20 million barrels a day in 20 years' time. Where will that come from? Now China has only one car for every 600 people. You have to go back to 1910 to reach a similar ratio in the U.S.


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