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Where is Crude Headed?

Energy and Capital's Weekend Edition

Written by Brian Hicks
Posted June 24, 2012

As I write this, oil has broken the $80-a-barrel mark.

This is the first time crude has traded below $80 since last October.

Many oil market observers are rejoicing, pronouncing "the era of high oil prices" over as new supply comes to the market from the Bakken and Eagle Ford. Some are even calling for oil to hit $40 a barrel.

And who can blame their enthusiasm?

This is a win-win for the economy and the consumer alike. Lower gasoline prices mean more cash available for discretionary spending!

Not so fast... Yes, lower oil prices are good for everyone (except drillers in shale oil), but it doesn’t mean they’re permanent.

In fact, one particular market action by the Chinese may predict where oil prices are headed in the future. According to a recent report by Bloomberg:

Taking advantage of lower oil prices, China is hoarding crude at the fastest rate since the Beijing Olympics four years ago as the slump in international prices prompts it to import unprecedented volumes even as refining slows.

The world's second-biggest oil consumer built up a surplus of about 90 million barrels of crude in the first five months of the year, government data show.

China, which imports more than half its crude, is constructing about 200 million barrels of storage capacity in the second stage of a plan for strategic reserves to help it manage price swings. Overseas purchases rose to a record last month even as processing by refiners including China Petroleum & Chemical Corp. (600028) and PetroChina Co. slackened.

China is one of the main reasons I believe oil prices will remain high.

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Last year China overtook the United States as the world’s largest energy consumer. China is now the world’s second largest oil consumer.

In 2010, China also overtook Japan as the world’s top automaker and Germany as the world’s largest auto exporter.

The following chart shows how fast the Chinese automobile manufacturing industry is growing:

chineseautomanu_chart

But this is only part of the story...

The fact remains that car ownership in China is insanely low compared to the industrialized West. China has roughly 52 automobiles per 1,000 people, while the U.S. and Europe have approximately 457 automobiles per 1,000 people.

carownership_chart

So even though the sector is growing at a robust clip, the automobile culture in China is still very young. Think of it as the U.S. in the 1930s.

If China were to catch up with the trend of other industrialized nations, the ratio would roughly be 10 cars for every 100 people. The same is true of other countries where incomes are rising, such as Brazil and India:

catchuppotential_chart

So even though the global economy is slowing down, the Chinese are gobbling up oil at what they consider to be bargain-basement prices.

China, whose overseas oil purchases are second only to the United States', plans to have stockpiles equal to 100 days of net imports by 2020. That's about 600 million barrels (roughly three years' worth of North Dakota production at current levels).

The U.S. held 696 million barrels in its Strategic Petroleum Reserve as of the week ending June 1, according to the Energy Information Administration.

So right now, the world is facing the equivalent of two United States when it comes to oil demand...

Oil prices will double from current levels.

The original bull on America,

Brian Hicks Signature

Brian Hicks
Publisher, Energy and Capital

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