NYMEX June 2010 Crude Oil Futures now quote at $ 64 per barrel, a one year forward contango of 20%. This is one of the highest spreads available on crude for nearly 6 months and comes on the back of a possible cut of another 1 mn bpd of Crude production by Saudi Arabia in the coming summer. It is widely known in Western circles that a lot of excess crude is now being stored on the high seas in leased out Super Tankers. The increasing rates of contango highlight the confidence of the bulls in carrying forward unhedged physical oil inventories with a year’s view. With the onset of the Summer Driving season in the US, and renewed feeling that Global Stimulus will work with a lag, it seems obvious that Crude could make a dash for 60+ levels in the short term rather than in the next year.

Large cap names like Cairn and Ongc have moved up shortly as Oil has seemingly found a bottom and bounced off. However, small cap Selan Oil is still trying to catch up. At a price of Rs 141.70 investors are unlikely to go wrong on the stock, if near term crude forecasts hold true. The corporate is expected to have ended March 2009 with Crude production at 275000 barrels. This is likely to rise up to 350,000 bbls and 500,000 bbls in 2010-2011. Thus Selan will benefit both on Volumes and Price over the next two years and be considered for investment.

Crude an Enigma

Even Warren Buffett has been puzzled by market trends of oil. He disclosed the same his latest annual report to the shareholders of Berkshire Hathaway, the holding company he runs. In his own words: "I bought a large amount of ConocoPhillips stock when oil and gas prices were near their peak. I in no way anticipated the dramatic fall in energy prices that occurred in the last half of the year." Particularly, he made the bulk of his purchases during the six months ending Sept. 30, 2008, the same time in which oil prices peaked near $150 a barrel. The price of oil is now around $50 a barrel, and ConocoPhillips' stock price has tanked in lockstep with the oil freefall. Buffett undoubtedly bought oil too early. But is it still too early for us to buy up oil stocks now?

Now may be the time

Those bullish on oil point to the inevitability of "peak oil," arguing that the time will come when we hit the peak of global oil production. From that point on, we'll be able to pump less and less oil out of the ground. In economic terms, we'll face decreasing supply. Meanwhile, bulls argue that demand will increase greatly, as China and other emerging markets fuel their economic growth with oil. On average, each person in the U.S. consumes about 25 barrels of oil a year; each person in China consumes just more than two. That's a lot of possible future demand. And all of us amateur economists know what happens when you restrict supply while simultaneously increasing demand: prices rise.

Considering price movements by themselves should not be the sole criterion. We need to estimate oil's intrinsic value.

But then again...

With oil prices declining to a third of their summer highs, oil trends are certainly tempting now. But, if we look back, we see that oil prices at present are four times the lows of the late 1990s. In other words, looking at price movements by themselves just isn't that helpful. We need to estimate oil's intrinsic value before we go ahead with investing.

--Prof. Pradeep Mehta and Mr. Hamed