Is Speculation All That Is Keeping Oil Near $50

I’m scratching my head over $50 oil in the face of unprecedented levels of inventory both on land and at sea and with ample spare capacity of “underground inventory.”   Talk about speculative influence - speculation seems to be the only explanation for why oil is not, say, $35.  Speculators in oil futures are betting on an economic bottom begetting a recovery begetting greater oil demand.  Along with limited expansion capacity due to reduced investments in oil production and high rates of decline for older wells.

Of course all that will happen.   Just maybe not in our lifetimes.  I’m kidding.  I’ve predicted that this exact scenario will play out with inventories starting to decline by 2010, spare capacity starting to decline in 2011, and oil prices getting back to 2008 levels and beyond at least by 2013.

But, hey, all of that doesn’t say the price of oil today should be so high.  After all - some OPEC oil with probably $5 costs are being shut in.   Doesn’t the law of supply and demand suggest the world should not be pumping out high-cost non-OPEC oil at the same time that there is much lower cost oil being shut in?  I should think the current oil glut combined with the fact that demand is continuing to fall and is forecast to go lower would bring the oil price down into the low $40 if not lower, just based on marginal cost.

Part of the speculative push to current oil prices relates to the near-universal view that in “the future” oil will sell for more, probably a lot more.  Hence the present contango that has oil a year out selling for $10 more than today and oil in two years at a $16 premium to current prices.  I don’t argue with those future prices - they could be right.  It’s just that  supply and demand seem irrelevant to  today’s price.  So I guess the arbitrage between a “justifiably” higher future price and today’s price keeps the latter from falling to where the “supply and demand” of the physical product in the present time frame “should” have it selling.

Maybe the speculation equation will be changed by a “black swan” event.  One such surprise could be a decision by Israel to bomb Iran’s nuclear facilities.  That would advance the price of oil pretty quickly and justifiably.   Another possible event that would move the oil price in the opposite direct, i.e.down, might be the discovery of a game-changing technology that could substantially reduce future demand for oil.

Game changing technology? Huh?  Well, a couple of stocks come to mind.  They’ve had substantial green moves over the past few weeks and are energy technology plays that hardly anyone follows.  One is Lynas Corp (LYSCF.PK), about which I’ve written a few times.  It’s a mining venture focused on Rare Earth Elements which are used for hybrid-car batteries among many other things.   Lynas had traded as low as $0.09 cents while it was struggling against big Wall Street firms that were trying (and succeeding) in welching on their bond deal that provided $90 million of financing to Lynas.  That’s been resolved.  I would guess that progress on the financing front accounts for the stock’s recent surge to $0.23.   That price makes my investment at $0.10 look good but it doesn’t get me back to break-even on all my shares.   I started buying when the stock was over $0.50.   But my guess is that the Lynas share price moves don’t say much about future demand for oil, just about company-specific developments.

The price of Zenn Motors (ZNNMF.PK), on the other hand, could be a different story.  Zenn is a zany sort of company.  It produces very light electric vehicles - not much more than upgraded golf carts - and not very many of them.  It’s name expresses the company’s ideals: Zero Emissions, No Noise.  Over the past week the stock has moved from about $1.50 to about $4.40 and the reason has nothing to do with its car sales.

Zenn has moved because it is the only public way to participate in a privately held company called Eestor that is developing a new technology for energy storage - a sort of cross between a standard battery and an ultracapacitor.  I’ve also written about Eestor in the past.  Many people have opined that the company’s product is just vaporware, that it will never become real.  Others have noted that if the product does work as advertised and can be produced in volume at a reasonable cost (which is part of Eestor’s business plan) it could be a game changer.

Eestor’s new battery would provide huge jolts of energy at a touch plus long length of storage plus very rapid re-charge time and (are you ready) virtually unlimited numbers of recharges.   As you can easily imagine, it would be useful in huge numbers of devices, not least hybrid cars.  If it is cheap enough, in fact, it might even make hybrid cars cheaper to buy than those with internal combustion engines - not to mention being a lot cheaper to operate.

If all that were to happen, companies that make other sorts of batteries or provide lithium, for example, might not be seen as quite so attractive.  Or not.  It’s not at all clear whether the Eestor battery would be sufficient by itself or would work in tandem with other energy storage devices.

Now back to Zenn.  It turns out that Zenn has two connections to Eestor.  The first is an exclusive right to use the Eestor battery for certain sizes of cars.   The second, and I suspect more potentially valuable connection, is that Zenn owns about 2% of Eestor stock.   Now if - and I repeat if - Eestor can produce this battery as it promises one can easily imagine that the company would become another Polaroid, Xerox, Microsoft, Google - you get the idea. So that 2% might be quite valuable.  The current market cap of Zenn is about $130 million.  2% of, say, $50 billion is $1 billion.  The current market cap of Google is about $125 billion.

I own some shares of Zenn.  What caused the excitement in Zenn this week was an announcement of test results of the Eestor battery.   They were good.  Here’s a link.  Incidentally, the company is financed by one of the most successful venture capital outfits in the world, Kleiner Perkins, and it is said to have already signed a supply contract with a major aerospace company.

I can’t predict the impact that a successful product introduction by Eestor would have on either battery companies or on the price of oil.  In the former case I suspect it would be rapid, powerful and negative.  In the latter, it’s hard to believe that the global fleet could be replaced rapidly enough to have any appreciable impact on the demand for oil by, say, 2015.  On the other hand, such a battery might well impact expectations for future, longer-term oil demand and oil prices.   And as we have seen from today’s oil price action, such future price expectations would inevitably filter back to more current prices via the futures markets.

The success of Eestor would be a black swan, to be sure.  Maybe one of the largest to ever hit.

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