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US Economy Still on Life Support

Could Obama Push Crude Oil to $300 Per Barrel

Commodities / Crude Oil Mar 02, 2009 - 06:17 PM GMT

By: Q1_Publishing

Commodities Best Financial Markets Analysis ArticleJohn Maynard Keynes is one of the most influential and controversial economists in history. He warned of the huge burden war reparations placed on Germany and its allies after WW I. He played an integral role in establishing the post-WW II financial world. His economic theories established the impetus for governments to spend like mad during downturns. He made, lost, and made back a massive fortune in the stock market. He counted Pablo Picasso and Virginia Wolf as friends.


He's done a lot. His impact on the world is extensive. But today we'll look at one of his truly lasting legacies. And the invaluable lesson it teaches us about investing. It's something so many investors fail to ever learn.

You see, Keynes was prone to change his mind. He was often openly accused of being inconsistent. Had he ever ran for political office, he surely would have been called a “flip-flopper.”

One day he was approached about his repeated inconsistencies. His simple response was, “When the facts change, I change my mind. What do you do, sir?”

The Facts are Changing

It's a bit of simple wisdom most investors so often forget. An investor who refuses to change when the facts change will lose out big. Just think of anyone you know who rode oil stocks all the way down to current levels. The were citing peak oil theory or the $60 per barrel cost of production of the 85 th millionth barrel per day all the way down. Or agriculture sector stocks. Or shares in pretty much any sector - now that I think about it.

When the facts change, you've got to change with them.

Right now, the facts are changing – fast.

Now, at the Prosperity Dispatch , we've been pretty much spot on when it comes to oil over the past few months. With the exception of OPEC managing to stick together (which will last over the short-term, but has never held out over long periods of low oil prices) we've watched from the sidelines as oil prices plummeted and oil stocks got crushed.

We've focused on both the supply and demand side of the equation. Which, when taken in tandem, still paints a pretty ugly picture for oil over the short-term. The state of the U.S. economy and mounting problems in emerging markets, isn't going to spark a quick rebound in oil demand. And swelling oil supplies sitting round in tankers will be there to be sold into any rally in oil prices.

Those are were the facts.

Change Oil Execs Don't Want to Believe In

President Obama's budget proposal is changing everything. We've already been over some of the changes coming to the healthcare sector and the impact on stocks in the sector (medical insurer Humana (NYSE:HUM) is down 30% since the healthcare system changes were announced).

Now “Change we can believe in” is heading for the energy industry.

The budget proposal Obama submitted reveals a lot about who the winners and losers will be. One of the big losers will be oil companies. According to the Houston Chronicle, “President Obama proposed a $31.5 billion tax increase on oil and gas producers.” Clearly, he has his sights aimed squarely at the “wealthy” (which still isn't a crime – yet!) oil industry.

It's not an upfront tax though. That would be too simple and may sound unfair. Even the most ardent tree hugger might consider forcing the oil industry to pay higher tax rates as excessive. That's why it's all in the form of increased fees and accounting rules changes.

Included among the proposals to squeeze $30 billion out of the oil industry are:

•  Establishing a new excise tax on Gulf of Mexico resources

•  Creating new fees for permitting process of development projects on federal land

•  Eliminating tax deductions for repair, site prep, and transportation costs of drilling

There are five or six more which will have a significant impact on the domestic oil industry. These changes will each have price tags of a few hundred million dollars for oil companies. When added all up, the eventual cost is around $30 billion.

The impact of them will be much greater than that though. They will help make some oil projects less economical. They'll reduce oil companies' available cash to invest. They're going to slow down an oil industry which has already ground to a halt.

Now, I'm not about to set up some sob story for the oil companies. They're coming off record years for profitability and cash flows. And most of them have piles of cash built up. The important thing here is we're starting to see how alternative energy is going to become economical once again.

How to Make Alternative Energy “Work”

As long-time readers of the Prosperity Dispatch know, I'm not a very big fan of alternative energy. Most of the technologies have a lot of room for improvement. The oil bust has only slowed the rate of advancement. And to top it all off, I don't see how $8 billion in direct government aid and tax breaks for alternative energy will be enough to get the industry back on its feet.

The free market is needed to get the alternative energy ball rolling again and the administration knows it. For better or worse, they're making the changes necessary to tip the scales in favor of alternative energy once again (read: drive oil and energy prices higher).

It looks like that's the plan. We'll tax oil companies so they make less money and marginal oil projects become less economical. We'll increase fees and royalties to reduce the upside for exploration and development. Then we'll add a “cap and trade” carbon emissions program to add an extra cost to all fossil fuel energy producers.

As a result, oil companies will produce less oil and search less for new sources of oil. There will be very little investment in new or upgraded power plants. Higher oil and energy prices will inevitably follow. Alternative energy will be viable once again.

It's genius!

But wait, won't an electorate be frustrated when energy costs soar? Heads in Washington will certainly roll when gasoline is $4 at the pump and monthly electric bills are two or three times higher, right?

Well, not exactly.

Playing Politics 101

The plan, if executed properly, is setting up to work out perfectly from a political perspective. More importantly, there will be an opportunity to both take some quick profits on a trade and to play this plan over the long-term.

First, one or two of the proposed taxes on the oil companies will be voided. This will allow the representatives from oil producing states to go home and claim victory.

Then the government will take the initial taxes and “guarantee” they will go to something politically acceptable. In this case, the oil companies' money will be taken and given to alternative energy researchers. Of course, all the government's revenues go into one big fund and parceled out from there so that's all just a bit of good political marketing.

Finally, when oil prices do start to rise again and climb back to $100, $300, or higher (it's impossible to tell where oil prices will be in 10 years, but it's a good bet they'll be much higher than they are now) the public will demand to know why energy costs are so much higher.

Yet again, there's an easy solution here too. When the average American's disposable income takes a big hit, the government will simply point to the impact of peak oil, evil OPEC, and some energy security statistic like how “we import less oil now than we did 20 years ago” even though, on a percentage basis, the U.S. reliance on foreign oil will have actually increased.

Then we should thank our lucky stars we have miles of (by then) outdated, marginally efficient solar panels, thousands of wind turbines, and geothermal plants sitting all along western United States. It's perfect.

How to Play It

Now, I'm not trying to agree or disagree with the policies. That's a topic for another day. I'm just trying to predict the impact of them and invest accordingly.

That's why I'm looking at the stocks which took a beating when this plan was announced for short-term rebounds. Because when a congressional “victory” is achieved and a few of the proposed taxes/fees are rejected, the companies who were hit hardest should bounce back.

For instance, shares of Goodrich Petroleum (NYSE:GDP) have fallen 25% in the two days since the administration's plans were announced. And Petrohawk (NYSE:HK) took an 18% hit over the same time period.

The drops were surely exacerbated by a sharp drop in oil prices as well and Petrohawk's announcement it will be selling new shares, but a good part of the downturn is from the selloff following the new taxation scheme. I'd look for the bounce in the next month or two when the negotiation process really gets going.

Over the long-term, it looks like alternative energy is on its way to becoming economically viable again.

From a short-term perspective, I don't see much changing though. There are just too many roadblocks for oil to significantly head higher.

The market is starting to realize what 10% unemployment is going to look like. China is a disaster – and getting worse. The banks are still begging for billions of dollars. The major automakers are on life support and could, if approved, be on the dole for months to come. The market declines are wiping away trillions more dollars in paper wealth.

It's ugly out there and there aren't too many safe haven investments . And there's been no sign of a bottom so far. But rest assured, higher energy prices are coming - eventually. The politicians are going to make it so.

So, I'm going to heed Keynes' wise words when it comes to the energy market. The facts have changed and I'm willing to change with them. That is, of course, when the time is right. I hope you will too.

Good investing,

Andrew Mickey
Chief Investment Strategist, Q1 Publishing

Q1 Publishing is committed to providing investors with well-researched, level-headed, no-nonsense, analysis and investment advice that will allow you to secure enduring wealth and independence.

© 2009 Copyright Q1 Publishing - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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