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Oil Crisis Worsening! What's Next ...

Sean Brodrick
email: SBrodrick@weissinc.com
Money and Markets
July 2, 2008

I've been pounding the table about an energy crisis for quite some time. As a loyal reader of my Money and Markets column, you might think I've been proven right by gasoline soaring over $4 a gallon in 32 states and oil hitting new record highs.

But most of what I've been talking about is simply the long-term supply/demand squeeze that will transform our oil-addicted civilization in the future.

It appears, however, that the future is happening now. My fundamental and technical indicators are ALL sounding alarm bells.

Today, I'm going to give you an uncensored, no-holds-barred look at the consequences of the energy crisis. First, let's talk about why Peak Oil poses such an extreme economic threat to both Wall Street and Main Street.

The Short-Term Energy Crisis in America!

If oil reaches $200 a barrel, forget $4-per-gallon gasoline. Think $6.64, according to a Rice University analysis of the link between prices of crude and gasoline. And they're optimists in the bunch of experts who study Peak Oil.

What I'm telling you to prepare yourself for is a short-term spike in oil prices where gasoline becomes unavailable. As in, you'll want to buy it, but it won't be available at any price ... or any price you can afford.

You see, the world's producers are pumping flat-out. Saudi Arabia just promised to raise production a little bit, but that reduces their spare capacity to almost nothing. There is no margin of error ... no room for something to go wrong.

But something always goes wrong!

What will spark the kind of gasoline crisis I'm talking about? Take your pick of potential disasters. Here are just the top three ...

#1) U.S. Edging Closer to War with Iran

Last week, the Jerusalem Post reported that former U.S. ambassador to the U.N. John Bolton said that Israel is likely to attack Iran in the time between the November presidential election in the U.S. and the inauguration of the new president. Mr. Bolton also said that he does not believe the U.S. will participate in the attack. Israel may attack because Iran will not give up its nuclear development program.

However, in the U.S., CBS News reported that the Israelis are trying hard to get the Bush Administration to mount an attack on Iran's nuclear facilities. And the U.S. Congress is debating a resolution that slaps new economic sanctions on Iran, proposes a blockade, and seems to open the door for military action. Ron Paul, the courageous U.S. Representative who has long stood up against the Iraq War, calls the new bill "a virtual war resolution."

Do you think the Iranians are sitting on their thumbs, waiting for something to happen? Hardly. According to another Israeli news service, Iran has aimed its Shahab-3B ballistic missiles into launch positions, targeted squarely at Israel ... including Israel's nuclear reactor in the Negev city of Dimona.

What's more, Iran says that if it's attacked, its Revolutionary Guards would mount attacks on shipping in the vital Strait of Hormuz oil route. Two-fifths of all globally-traded oil passes through the Strait of Hormuz. And it's not hard to figure that oil facilities in Saudi Arabia could also be targeted.

If it comes to a new war in the Persian Gulf, don't expect $200 per barrel oil. Expect $400 per barrel oil ... $500 per barrel oil ... maybe higher.

#2) Monster Hurricanes in the Gulf of Mexico

Hurricanes Katrina and Rita proved that the Gulf of Mexico is America's soft underbelly, vulnerable to a devastating punch from Mother Nature during hurricane season.

When a global weather pattern called La Niña is strong, hurricanes are also more powerful than normal. Well, batten down the hatches, because a strong La Niña is expected to last through the summer, delivering worse-than-average storm activity THIS season.

The National Oceanic and Atmospheric Administration (NOAA) predicted above-normal hurricane activity in its Atlantic Hurricane Season Outlook. NOAA projects 12 to 16 named storms will form within the Atlantic Basin, including 6 to 9 hurricanes, of which 2 to 5 will be intense during the upcoming hurricane season.

And that could be a lowball estimate. The average number of Category 4 and Category 5 hurricanes worldwide has nearly doubled over the past 35 years.

Now here's the bad news: The Gulf of Mexico is home to 20% of the natural gas and 30% of the oil produced in the U.S. and 40% of America's refining capacity.

If that refining capacity gets taken out by a massive hurricane, forget $4 a gallon gasoline ... $5 a gallon gasoline ... heck, we might be looking at $6 a gallon gasoline or higher, very quickly. And the higher we go, and the longer we stay higher, the more "normal" otherwise outrageous gasoline prices become.

And refineries are already playing with fire as it is ...

#3) Refiners and Retailers See Profit Margins Squeezed

With the rising cost of oil, America's refiners are taking a gamble by keeping low inventories of crude and lowering their refinery utilization rates at the same time. According to the Energy Information Administration, gasoline stockpiles fell by 153,000 barrels to 208.8 million barrels in the most recent week.

Refinery utilization, which normally hovers in the 95% range at this time of year, is currently at just 88.6%. In fact, it's at the lowest level for early summer in 15 years.

If refinery inputs are at 15.4 million barrels per day (mainly crude oil), a one-percent change in yield is a 154,000 barrel-per-day (4.7 million gallons) change in product volume. U.S. consumption of gasoline is around 388.6 million gallons/day. So those few percentage points mean a real difference in supply ... which means higher prices.

Meanwhile, demand for motor gasoline over the past four weeks declined by an average of 9.3 million barrels per day — down 2.1% from the same time a year ago, and down 5% from its peak of 21.3 million barrels a day on January 4, the EIA reported.

This lessening of demand is the excuse the refiners use for the low run rates. Since American consumers are using less gasoline, they say they need to process less. But less supply drives up prices, so consumers use less gasoline — it's a vicious circle.

While rising input costs have squeezed refinery margins mercilessly, gasoline retailers — gas stations — are also seeing profit margins tighten to the vanishing point.

In 2007, the average markup of gas sold at the pump was 14.3 cents per gallon over what the owner paid, according to data from the National Association of Convenience Stores, the trade group for the stores that run more than 80% of the country's gas stations.

The profit, or net margin after all expenses have been figured in, has now shrunk to a measly 1.5 cents a gallon!

Now, with the price of gasoline rising, charges for credit card transactions are rising as well, and many gas station owners are making no money at all. That's why Exxon, the most profitable company in the history of the world, announced in June that it is selling the 2,200 gas stations it owns.

Will it find buyers for those gas stations? If not, we can expect gas stations to close. And we may see gas stations across America close anyway, as station owners gets squeezed out of existence.

Some rural areas are served by only a few gas stations ... as they start to go out of business, it may become very difficult for some Americans to buy gasoline. And that will lead us to a whole new problem ...

Prepare for Hoarding and a
Recession-Turned-Depression

Why hoard? Well, when the price of gas rises 10 cents in a week, as it did in my neighborhood, it starts to make economic sense to hoard gas. Say you run a lawn service that uses 500 gallons of gasoline a week. If you buy next week's allotment ahead of time, you can save $50 a week.

And if refinery utilization is so low that gasoline stations simply run out — or a massive hurricane takes out refinery capacity — then you'll see hoarding kick into overdrive. This will only deplete stockpiles that are already near historic lows, making the whole situation much worse. Eventually, we may get to the point where you are unable to buy gas.

I'm talking about actual gasoline shortages ... massive unemployment and foreclosures ... evicted families living in tent cities and cars they can't afford to drive ... maybe, if things get really bad, food shortages and food and fuel riots.

At $7 gasoline, those making less than $25,000 a year will see gasoline expenditures go from 7% of their income to 20%. For some people, it simply won't be worth it to drive to work.

Factor in the airlines parking planes, delivery trucks no longer running, fishing fleets staying in port, and car manufacturers going out of business.

Wait a minute — car makers going out of business?! Yep, GM is on deathwatch now, and it's not getting better. In fact, according to a leaked report from J.D. Power and Associates, the June seasonally adjusted annual sales rate will plunge to 12.5 million vehicles, down from 16.3 million last June.

Add it all up, and America has the ingredients for a major economic collapse.

And Yet Oil Demand Is
Still Skyrocketing Globally!

Will reducing U.S. demand cause oil prices to plummet? No, because demand in emerging markets is accelerating, and even if the global economy slows, that won't stop them. Much of China's growth is fueled by internal spending now. They may not like it if Americans are out of work, but they'll carry on.

Just think: How bothered were you by the collapse of the Soviet Union? A major superpower hit the skids in 1985 and imploded in 1991. Did that adversely affect your life in any meaningful way? I'm not saying a severe recession in America won't affect China ... just not as much as we might think.

This year, emerging markets are overtaking the U.S. in consumption of oil for the first time, and it won't be long before they consume more than the entire developed world.

At the same time, internal demand is rising in major oil producers and exporters. Over the last three years, oil consumption among OPEC members has grown by more than 5% a year. Hence, their exports go down and prices go up.

So while America's car sales may be hitting the skids, 6.6 million to 10 million new cars, trucks and vans will hit the roads in China this year. India will probably grow at an even faster pace, percentage-wise. Bottom line: They'll use every barrel of oil we don't.

And the Rising Price of Oil Could
Even Lead to Severe Food Shortages

American agriculture directly accounts for 17% of our energy use, or the equivalent of 400 gallons of oil consumed by every man, woman and child per year, according to the most recent statistics I could find.

If the cost of fuel gets too high, farmers won't plant. If truckers run out of fuel, they won't deliver food to supermarkets. If enough of this happens often enough, people won't just sit there and take it. They will lash out.

Now, what would you say the odds are of this happening in a year when we are on the brink of war with Iran ... when meteorologists say this hurricane season should be worse than normal ... and when refineries are keeping historically low levels of inventories? I'd say better than average.

And the sad thing is, I've just barely scratched the surface of what could go wrong this year. I'd say America is in real trouble.

How to Protect Yourself — And Your Family

Laying in a month's supply of food might not be a bad thing to do for the next year. But you can also protect yourself financially.

Take, for example, the United States Oil Fund ETF (USO): This fund is designed to track light sweet crude, plus or minus 10%. It's not perfect, partly due to the fact that the fund has an expense ratio of 0.50. Still, that's pretty good, and it's an easy way to get direct exposure to rising oil prices.

In a recent one-year period, the S&P 500 fell by 12.6%. Crude oil rose 94.7%. And the USO rose by an astounding 110.3%. That's the kind of investment you may want to consider in this market.

Yours for trading profits,

Sean
email: SBrodrick@weissinc.com

About Money and Markets
For more information and archived issues, visit http://www.moneyandmarkets.com

Money and Markets (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Tony Sagami, Nilus Mattive, Sean Brodrick, Larry Edelson, Michael Larson and Jack Crooks. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM, nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical in as much as we do not track the actual prices investors pay or receive. Regular contributors and staff include Kristen Adams, Andrea Baumwald, John Burke, Amber Dakar, Dinesh Kalera, Christina Kern, Mathias Korzan, Red Morgan, Maryellen Murphy, Jennifer Newman-Amos, Adam Shafer, Julie Trudeau and Leslie Underwood.

This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.



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