Why Oil Prices Won't Stay Down for Long

Oil prices, like stocks, took a few big hits last week.

West Texas Intermediate crude last week dropped below $80 a barrel before bouncing back up to $87 a barrel this week. Meanwhile, Brent crude fell to a six-month low below $100 a barrel before climbing back to $110 a barrel this week.

To hear the mainstream media tell it, much of the drop is based on the assumption that global growth is waning and oil demand is soon to follow.

But that couldn't be more wrong.

Energy is one of the most highly leveraged and most liquid trading vehicles on the planet. A good portion of the decline we've experienced in recent weeks can be explained by nothing more than trading houses raising cash to meet margin calls or redemption requests from hedge funds, pension funds, and other investors.

That's all there is to it. Firms simply need cash and are selling the most easily sellable assets they've got. In the past that's been gold, but lately it's been oil.

Longer-term, demand is still going up and $120 a barrel oil is our next stop, followed by prices of $150 or more in the years ahead.

What's happening now with the markets and energy prices is like being in the eye of a hurricane.

That is, it won't be long before we're once again caught up in the whirlwind growth of emerging markets and energy demand shoots sharply higher.

The Looming Demand Downpour

Global demand is still rising—and it's not going to slow down any time soon. There are huge swaths of the world now adopting gasoline engines.

Let me give you two examples.

Take the farmers in Cambodia. Many put up sheets in their fields at sunset. They then mount small incandescent light bulbs on sticks behind the sheets. The bulbs are powered by small gasoline generators to ensure they stay on all night.

In the morning, those farmers go back and harvest the thousands of crickets that have collided with the sheet after having been drawn to the lights. They wrap up the fallen bugs and head to the markets where they are sold as food.

It's much the same situation in Africa, where small villages require simple engines to pump water.

You may think bugs and small farm pumps are no big deal, but there's an even greater energy revolution going on in the transportation industry.

Auto sales in China, which overtook the United States as the world's largest auto market in 2009, rose 32% last year to a record 18.06 million vehicles.

The majority of China's 300 million middle class citizens don't care about what kind of car they get, just that they get something that helps them climb up the social ladder, move their products to market, or get them to the cities so they can have a better life.

Fatih Birol, chief economist for the International Energy Agency (IEA), says that 700 out of every 1,000 people in the United States and 500 out of every 1,000 in Europe own cars today. But in China, only 30 out of 1,000 own cars. And Birol thinks that figure could jump to 240 out of every 1,000 by 2035.

That's a big reason why oil demand in China is expected to grow 10.4% this year—the fastest rate of any country in the world. China's oil imports are growing at 12% a year. At that pace, China will use as much oil as the United States does, and their daily demand will equal our own by 2018.

You also have to account for India's middle class, which is another 50 million to 150 million people, according to Deutsche Bank. Then factor in Vietnam, Cambodia, Thailand and Latin America, and it's clear we're headed for a global supply squeeze.

Globally, we burn four barrels of oil for every one barrel we discover—and unless you've got a few million years to wait, Mother Nature is tapped out.

In recent years there have been massive new discoveries off the coast of Brazil and a few other places, but these aren't long-term game changers. Nor is oil shale, barring massive investments and dramatic increases in technological efficiency that may still be years away.

That's why China has been buying up resources for the last 10 years. It's why China is building up its refining and storage capacity in South America and other places around the world. And it's why the country just established a commodity futures market in Shanghai despite the fact that exchanges in New York and Chicago already trade all forms of energy.

Beijing knows that when there are 1,000 people trying to buy the last egg at the store, the price will inevitably go up.

And if that still isn't clear, just look at how much money you're paying for gasoline compared to just five years ago.

All the signs are there. - Zacks Investment Research