Not the Same Old Oil Story

The Oil Factor: Protect Yourself-and Profit-from The Coming Energy Crisis
by Stephen Leeb, PhD., Donna Leeb

(Page 4 of 4)

You may have noticed that in detailing the history of oil prices, the economy, and the stock market, we began our narrative in 1973 and seem to have halted it somewhere around 1999. You might wonder if on some psychological level this represents wishful thinking, a desire to linger in that relatively trouble-free period forever. Maybe so, but there is more to it than that. For toward the end of 1999 we began to move on to a new paradigm involving oil, a qualitatively different situation that requires that we look at the years since then separately.

You'll recall that in the 1990s, oil prices were stable, until 1998 averaging just a touch below $20 a barrel and quickly coming down anytime they ventured above the $20 level. Then they fell, as OPEC miscalculated and raised output just as the Asian economies were tanking. Once OPEC got its act together, prices rose once more, supported by the surging economic growth of 1999.

And then something out of the ordinary happened. Oil kept rising. By the third quarter of 2000, even though worldwide economic growth had begun to slow and the stock market was retreating, oil climbed above $35 a barrel, more than three times the lows of late 1998.

With the advent of winter and the threat of cripplingly high home heating oil prices, oil entered our consciousness, becoming a front-and-center crisis for a while. President Clinton authorized the release of oil from the Strategic Petroleum Reserve (SPR), the first time this emergency reserve had been used in peacetime. The only time prior to 2000 that oil had been released from the reserve was during the 1990-91 Gulf War. Clearly, the decision to use the SPR to curb soaring energy prices in the winter of 2000, whatever its political motivations, was an acknowledgment of the fact that oil prices were so high as to constitute at least a mini-crisis.

Why didn't oil prices come down in the early 2000s, when, as the result of slower worldwide economic growth, demand for oil was, if not lessening, growing at a very sluggish pace? Economic growth during those years was just 2.5 percent, about 20 percent slower than the average rate of growth during the preceding fifty years.

In fact, other than the recessions of the early 1980s and the 1990-91 period, it was the slowest-growing four-year period in postwar history. During those earlier recessions, oil prices dropped sharply. Indeed, until 1999, oil prices always fell during periods of economic weakness, rising only when demand was rising or as a result of ephemeral political disturbances. In other words, for most of the postwar period, oil prices were demand-driven.

But in 1999-2002, even though demand was weak, prices remained at historically high levels. This was due to a momentous transformation that had occurred in the dynamics of the oil industry:

oil prices had become supply-driven. And the reason that had happened was that for the first time since its formation, OPEC was no longer just another player, albeit an important one, in the oil arena. It had become the controlling player.

Between 1982 and 1998, the oil-producing world outside of OPEC had been able to increase oil production enough to accommodate economic growth. In 1999, however, Britain and other non-OPEC oil producers hit the point where any increases in production were minimal. The only area outside of OPEC capable of meaningful increases in production was the former Soviet Union (FSU). And increases by the FSU were little more than sufficient to satisfy the world's marginal increase in demand.

To put it differently, by 1999 the world was using all the oil that producers outside of OPEC not only were generating but that they were capable of generating. Supply was barely keeping up with demand. The upshot: as the world steps up its need for oil-and as we'll explain, it is a given that it will, unless we enter a protracted worldwide recession-the only countries that can supply the extra barrels are OPEC nations.

The result is that since 1999, OPEC, through relatively small changes in its production quotas, has been able to exercise almost complete control over oil prices. Oil demand in the world has over-taken the ability of all but a small group of nations to supply the oil that is essential for world economies to survive.

One key question is whether this is a temporary imbalance or a new and more permanent reality. As we'll discuss in chapter 3, all the evidence points to it being the latter. Nothing the West can do- other than end its reliance on oil altogether by developing alternatives on a large scale-will free it of its dependence on Middle Eastern oil. And nothing other than the development of alternative energies (or permanent recession/depression, an unacceptable outcome) will forestall oil soaring to ever higher levels, though possibly with temporary periods of retrenchment. The tragedy is that because we have waited so long, nothing but soaring oil prices will push us to develop those oil alternatives on a grand enough scale.

So there you have it-an overview of the fateful dance between oil, the economy, and stocks. Next chapter we look in more detail at the relationship between oil and the stock market and give you precise rules for using oil prices to get in and out of stocks.

Key Points: Oil is essential to all we do.

Since 1973, the economy and stock market have danced to oil's tune. Sharp rises in oil prices have led to recession/stagflation and plummeting stocks, while declining prices or prices that are just mildly uptrended have led to good times.

For most of the 1990s, whenever oil prices rose above $20 a barrel, they came down. But starting in 1999, prices remained uptrended as the world reached the point where it was consuming all the oil that non-OPEC producers could provide.

Rising oil prices will likely lead to an inflationary economy punctuated by occasional deflationary scares.

Copyright © 2004 by Stephen Leeb and Donna Leeb

About the Author

Stephen Leeb is the president of Leeb Capital Management and editor of the prestigious newsletter The Complete Investor. Renowned for finishing among the leaders in the Wall Street Journal's and Forbes's annual stock-picking contests, Leeb is the author of four previous books. His wife and longtime collaborator, Donna Leeb, has a diversified background in business writing and holds a master's degree in journalism from Columbia University.