Natural resources continue to play a key role in fueling Asia’s economic development, while increased demand for energy and other commodities has raised prices for Western consumers. Rising commodity prices also strengthen economic growth and development in resource-rich nations.

Because Asia’s largest economies are big importers of natural resources, higher prices tend to slow economic growth. At the same time, strong growth in emerging markets has brought natural resources to the forefront of the investment world over the past ten years.

In particular, oil prices serve as a barometer of economic growth because increased consumption in emerging markets goes hand in hand with economic expansion. It’s essential that global investors understand oil price movements.

The Silk Road Investor’s model portfolio has exposure to one of the most promising Asian oil companies, and I remain bullish on oil’s long-term prospects.

But short-term gyrations in oil prices can affect markets dramatically. For the latest take on oil, I turn once again to energy expert Elliott H. Gue, editor of The Energy Strategist.

A Few Words about Oil

By Elliottt H. Gue

Over the past six months, I’ve spilled considerable ink discussing the outlook for oil prices and my view that prices will generally rally through 2009 and top USD80 a barrel by year-end.

Although I recognize the potential for another pullback such as the ones we saw in June and early July, investors should regard any hiccup as a buying opportunity. Predicting oil prices is far from an exact science, but this outlook has proven correct thus far–at least directionally.

Of course, there are still plenty of pundits who point to the weekly inventory reports released by the Energy Information Administration (EIA) and note that crude oil supplies are more than ample and prices should be falling, not rising. For the most part, these pundits appear to be frustrated that crude continues to rally, doubling off its lows, even as inventory figures continue to get worse.

Looking at oil inventories, they have declined significantly from the record levels set earlier this year and there remains more oil in storage than is normal for this time of year. This glut will have to decline considerably over the next few months to bring the US oil market back into balance.

Motor gasoline inventories are also above average for this time of year, albeit not to the extent of crude oil inventories. And stocks of distillates–heating oil and diesel–are also above average. The traditional interpretation of these data points is that high inventories are bearish for oil prices because they represent an excess of supply.

I would agree with the bears that the current oil supply picture for crude appears bloated. Some commentators have also observed that global oil demand remains extremely weak and shows no sign of a change or stabilization. This, I believe, is an inaccurate statement. In its most recent report, the EIA released data showing that US demand for oil and related products fell 3 percent from a year ago. This is a far cry from earlier this year and late 2008, when demand was down 10 percent compared to 12 months earlier.

Meanwhile, demand for the most important refined product, motor gasoline, has actually been running flat to higher in recent weeks on a year-over-year basis. Not a great showing, but hardly as bad as some of the bears would have you believe.

And, as I’ve noted over the past month, demand appears to be recovering in some emerging markets more quickly than in the US. Nonetheless, a supply overhang and a tepid recovery in demand is hardly a reason for oil prices to rally 100 percent off their late 2008 lows.

I believe there are four fundamental explanations for the current price of oil:

   1. The elimination of extreme contango that occurred earlier this year;

   2. The improvements in global credit markets;

   3. Continued expectations for a recovery of demand into 2010; and

   4. Legitimate intermediate-term supply concerns that necessitate oil prices near their marginal cost of supply.

Here I would like to expand only on a few of the above factor, starting with the effect of the credit markets.

The ongoing credit crunch simply caused widespread panic in stock and commodity markets and pushed prices to unsustainably low levels. After all, at the time the onset of the next Great Depression seemed a palpable threat.

Although it’s impossible to pinpoint an exact cause, it’s interesting that crude oil prices have tracked improving US credit conditions closely since the beginning of 2009. As credit conditions have improved, the rally in oil prices has gained strength.

Another reason for stronger oil prices is that a price near USD70 a barrel roughly corresponds to the marginal cost of supply–the level needed to prevent a significant decline in oil supplies over the coming years.

As I’ve noted before, there is a potential for a production shortfall in 2010 due to the big slowdown in spending on oil exploration and development in late 2008 and thus far in 2009. The delay and cancellation of major projects will weigh on future supplies. If this remains an issue, expect a price squeeze in 2010–the only question is one of magnitude.

 If demand improves and exploration and production activity stabilizes and picks up into early 2010, we should see USD100 oil next year. If E&P activity continues to sink and there’s another leg down in activity, the eventual spike would be much higher. In that case, it would soon become clear that oil prices at USD150 a barrel wasn’t just a one-off aberration.