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Experts try to divine the direction of oil

After recent drop, long-term price scenarios for energy range from bleak to bright

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By Jeff Benjamin

September 1, 2008 6:01 am ET

As Gustav threatened last week to become the first major storm to disrupt oil and gas production in the Gulf of Mexico since 2005, market analysts, financial advisers and money managers hunkered down with the latest theories on where energy prices might go from here.

Despite the lack of a clear general consensus and forecasts ranging from dark to rosy, the recent downward trend in the price of oil has at least reintroduced the notion that energy prices can go down as well as up.

"I don't think anybody really has a good handle on what has driven this turnaround trend, but it seems to me that it's mainly a demand story right now," said Bill Cheney, an economist at John Hancock Financial Services Inc. in Boston.

"At the very least what this [recent decline in oil prices] has done is break the psychology that prices will inevitably go higher," he said.

Last week's modest oil price increase of a few dollars per barrel from the Aug. 15 low of $111 represented a logical market reaction to the Gustav threat, according to some analysts.

Other observers, however, said the price of oil was poised for a short rally regardless of the storm, but that the general trend would continue downward.

The immediate impact of Gustav notwithstanding, the fact that the price of oil had fallen 22% from its July 11 high has re-ignited discussions over the realities of supply and demand, and shed fresh light on the impact of alternative energy and the weakening global economy.

"Ultimately, the price of oil will be just like any other commodity and it will adjust to the cost relative to any alternative," said Ron Altman, a partner and portfolio manager at MB Investment Partners Inc. in New York.

"We're going to see incremental exploration for oil or whatever comes out of the ground, and both political parties will jump on board," he added. "And the public is going to demand more fuel-efficient cars regardless of what the car makers say, because if they don't retool they'll be out of business."

All the increased focus on alternatives, combined with a rolling global economic recession, is quickly putting to rest those scary notions of oil at $200 per barrel, according to Mr. Altman.

"There are a lot of little pieces of evidence of changing patterns," he added. "And the equity and commodity markets are reflecting the collective wisdom of all of us."

The increase in the price of oil since Aug. 15 is nothing more than a short-term rally in the midst of a larger downward trend, according to Paul Schatz, president of Heritage Capital LLC in Woodbridge, Conn.

"I think oil would have rallied regardless of Gustav and I'm emphatic that the peak of July was the peak and that the Aug. 15 low was not the low," he said. "The price of oil could easily drop to double digits this year."

Mr. Schatz, who oversees $18 million for his clients, pays careful attention to the price of energy in relation to a variety of macroeconomic trends.

While he said the current oil rally could drive the price as high as $130 per barrel over the next few weeks, a longer-term trend toward the $80 range could derail any momentum toward alternative energy.

'MULTI-PRONGED APPROACH'

"As a population, we're so short-sighted that if oil hits $80, people will forget all about alternatives," he said. "That's why we need a multipronged approach, which means we need to throw everything at it, including the kitchen sink, right now."

The recent dip in oil prices did not surprise Clyde Harrison, president of Brookshire Raw Materials, a $50 million private commodities fund based in Chicago.

"This year everybody made sure they had enough supply, but then the demand fell off a cliff," he said. "I could see the price of oil dropping to $100, but we've still got less and less oil every year."

Longer-term, Mr. Harrison sees oil at $300 per barrel within 10 years, "unless we start doing serious things like building nuclear power plants and punching holes in the ground.

"Right now, we've got the Osama bin Laden energy plan," he said. "He would love for us not to drill, which is why we need everything, including wind, solar and nuclear power."

Others believe that while the supply and demand argument has merit, it has a limited and short-term impact on oil prices, according to Diane Pearson, a financial adviser with Legend Financial Advisors Inc. in Pittsburgh.

"I think the downturn was temporary and I would expect to see oil at $150 a barrel by this time next year," she said. "Consumption was down in the U.S., but consumption will continue to increase globally."

Ms. Pearson, whose firm oversees $370 million in client assets, said her clients are gaining exposure to the energy markets through investments in companies involved in the "entire production process."

The "range bound" theory, suggesting that any number of circumstances and events could drive oil in either direction over the near term, has led to a limited energy sector exposure for Darren Beck, a wealth manager at Pathway Financial Advisors LLC in Atlanta. The firm oversees $130 million in client assets.

"Right now you've got geopolitical risks related to Russia and Georgia arguing for an upside in the $130-a-barrel range, and you've got slowing global demand arguing for a downside range of around $100," he said. "We're keeping our exposure light in the portfolio right now because oil has had a pretty good run and the upside potential is not that great."

E-mail Jeff Benjamin at jbenjamin@investmentnews.com.

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