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Two years ago, Seahawk Drilling Inc. was plotting to expand its fleet of rigs worldwide. Now the Houston-based company may sell itself after BP Plc’s well explosion in the Gulf of Mexico thrust the industry into regulatory limbo.

“If we can’t be more diversified, I would rather sell the company to somebody else and let them try to do it,” Seahawk Chief Executive Officer Randall Stilley said in an interview, Bloomberg Businesweek reports in its Jan. 24 issue.

Mergers and acquisitions among offshore drillers are likely to accelerate as size becomes a matter of survival in the $125 billion industry. Intensifying government scrutiny and rising customer demands may crank up costs so high only the largest companies can compete, bankers and analysts say. There were $5.3 billion of deals involving drillers last year, more than triple 2009, according to data compiled by Bloomberg.

“What you have to do these days to get a contract if you’re a driller is going to get tougher and tougher,” said Mark Bentley, who advises on energy mergers and acquisitions at Greenhill & Co. in London. “This means the industry will increasingly rely on larger companies.”

Oil giants Exxon Mobil Corp., Chevron Corp. and Royal Dutch Shell Plc are demanding drillers have the highest-quality equipment and the most experienced rig workers to drill in waters that can cost them as much as $1 million a day, said Brian Uhlmer, a Houston-based analyst at Global Hunter Securities.

U.S. Permits

On top of that, regulators have yet to issue the first permit for deep-water drilling in the Gulf since ending a moratorium imposed after the Macondo well disaster, the biggest offshore oil spill in U.S. history. Applications are being returned by the Interior Department for more information on how companies are meeting environmental and equipment standards imposed since the April 20 explosion.

That’s put a squeeze on drillers. “The drillers have to scrap, upgrade and modify because of environmental concerns and to meet new requirements,” said Bjarne Skeie, who last year sold his stake in Skeie Drilling & Production to Rowan Cos. Inc.

“New regulations, stricter permitting/certification procedures and higher insurance costs could push small-caps with limited operating experience into the arms of stronger players,” Robin Shoemaker, an analyst for New York-based Citigroup Inc., wrote in a Jan. 11 report.

Buyers, Sellers

Rowan, Ensco Plc and Pride International Inc. may be attractive targets, according to Shoemaker. Ensco, with a market value of $7.5 billion, trades at 12.64 times earnings, while Rowan has a price-to-earnings ratio of 12.46, lagging the 13.99 average among drillers, according to Bloomberg data.

Other potential takeover targets include the drilling unit of Greece’s Metrostar Management Corp. and Vantage Drilling Co., Global Hunter’s Uhlmer said. Transocean Ltd., Diamond Offshore Drilling Inc. and Seadrill Ltd. may be buyers, he said.

Representatives for Metrostar, Vantage, Diamond Offshore, Transocean and Rowan declined to comment. Seadrill and Ensco representatives didn’t return calls or e-mails seeking comment.

Seadrill, controlled by Norwegian billionaire John Fredriksen, has been the most acquisitive driller since 2006, with 11 announced transactions worth $4.96 billion, according to Bloomberg data. The company, which is based in Bermuda and has a market value of about $14.3 billion, agreed on Jan. 3 to buy two ultra deep-water rigs for $1.2 billion.

Oil Price Rise

Seadrill owns a 9.4 percent stake in Pride International Inc., a Houston competitor with a market value of $5.7 billion. Pride trades at 26.5 times earnings, making it twice as expensive as Rowan and Ensco. Seadrill said Nov. 30 it’s maintaining its position in Pride while “evaluating” options for the shares.

Recovering rates for rigs, higher oil prices and more flexible financing markets may also be an impetus for deals — and also give some small drillers a chance to stay independent.

Oil prices have reached a more than two-year high of $91.86 a barrel and rental rates for the industry’s most expensive rigs, which can drill in deep waters, may be $450,000 a day this year and $475,000 in 2012, according to a Jan. 6 Goldman Sachs Group Inc. report. Rates reached more than $600,000 a day in 2008.

“The level of desperation has been tempered,” said Ian Macpherson, a London-based analyst at Simmons & Co. who estimates the 15 publicly traded drillers that operate about two-thirds of the global offshore rigs have a combined enterprise value of about $125 billion.

The figure — a measure of market value, preferred equity and debt that is used as a proxy for the takeover value of a firm — excludes some larger publicly traded companies with drilling units.

Rigs Increase

The number of active rigs worldwide rose 29 percent during the past year to 3,227, according to data published by Baker Hughes Inc., an oilfield-services provider, as exploration picks up in Brazil and western Africa.

“Today’s environment is one of eager buyers and reluctant sellers, but deals can and will be done,” Citigroup’s Shoemaker wrote.

Seahawk’s Stilley is holding on to hopes that he can avert a sale if banks agree to finance his plan to buy rigs that are already operational and bringing in revenue.

For now, that option hasn’t materialized.

“We didn’t set this company up to be a small Gulf of Mexico driller,” Stilley said. The future of Gulf drilling means the timing for expanding Seahawk “has changed due to the uncertainty.”

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Shareholder groups are pressing Chevron Corp., Exxon Mobil Corp. and Southwestern Energy Co. to disclose the risk the companies face from hydraulic fracturing.

The groups say they want shareholders to know that the companies could face litigation or fines related to their use of rock-fracturing techniques to find natural gas and oil. They plan to introduce resolutions during the annual meetings of nine companies, calling on them to disclose the chemicals used in hydraulic fracturing.

The Investor Environmental Health Network in Falls Church, Va., helped organize groups of investors to file the resolutions, including the New York State Comptroller’s Office, the Sisters of St. Francis of Philadelphia and Ceres, a Boston- based coalition that directs the $9 trillion Investor Network on Climate Risk.

The same groups, working together as the Investor Environmental Health Network, filed similar petitions last year against 12 oil and gas producers. None passed.

More than 20 percent of shareholders voted for the resolutions at some companies, said Richard Liroff, executive director of the Investors Environmental Health Network. “Clearly we’re getting our point across,” he said.

Some landowners have accused gas companies of polluting local water supplies with their fracturing activities.

Cabot Oil & Gas Corp. agreed to provide drinking water and put $4.1 million into escrow for families in Pennsylvania who said their drinking water was polluted by the company’s oil wells, settling a claim by the Pennsylvania Department of Environmental Protection.

New York has imposed a moratorium on fracturing horizontal wells until an environmental review is completed. The U.S. Environmental Protection Agency is also conducting a study of fracturing’s impact.

Few Problems

Morgan Crinklaw, a Chevron spokesman, said the company is reviewing the shareholder proposal. “We believe that hydraulic fracturing is critical to accessing the nation’s natural-gas resources, leading to greater energy security,” Crinklaw wrote in an e-mail.

More than 1 million wells have been hydraulically fractured over the last 60 years with only a few problems, America’s Natural Gas Alliance, an industry trade group, says on its website.

Exxon said it supports the disclosure of hydraulic fracturing chemicals, without commenting on the shareholder proposals. “We believe the concerns of community members can be alleviated by the disclosure of all ingredients used in these fluids,” Karen Matusic, an Exxon spokeswoman, wrote in an e- mail.

Southwestern didn’t return calls seeking comment.

Exxon and Southwestern have looked for ways to reduce the need for chemicals used in hydraulic fracturing.

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By OGJ editors

HOUSTON, Jan. 20 — US regulators approved a permit enabling Apache Corp. to resume plugging and abandonment operations on East Cameron Block 278 Platform B, where workers reported seeing a hydrocarbon sheen on Jan. 16.

The depleted natural gas field is in the Gulf of Mexico in 168 ft of water 95 miles due south of Cameron, La. The platform had been evacuated, and a remotely operated vehicle was used to study the safety of the platform.

The platform, which has not been in production for nearly a decade, was used to process gas and condensate from other facilities. Before Apache shut in the platform for plugging and abandonment operations, EC Block 278 Platform B processed 20 MMcfd from other facilities, the company said (OGJ Online, Jan. 19, 2011).

On Jan. 20, Apache said the Bureau of Ocean Energy Management, Regulation, and Enforcement approved a permit to resume operations after air-monitoring equipment found no traces of gas emissions on the platform. Power was restored to assure safe operations.

Apache acquired EC 278 in 2006. The development of the wells and installation of the platform occurred in the 1990s by previous owner-operators. Apache holds a 50% working interest; Stone Energy Corp., Lafayette, La., holds the other 50%.

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BISMARCK, N.D. (AP) — Billionaire oilman Harold Hamm told North Dakota bankers on Thursday that government estimates of recoverable oil in the Bakken and Three Forks formations are too conservative.

Hamm, 64, chairman and chief executive officer of Continental Resources Inc., said the formations in North Dakota and Montana hold about 20 billion barrels of recoverable crude, or about five times the amount previously estimated by federal geologists. The formations also hold the natural gas equivalent of 4 billion barrels of oil, he said.

“This is something that is totally incredible,” Hamm told about 200 bankers who had gathered in Bismarck for a conference. “Everywhere you look the Bakken is front and center.”

The U.S. Geological Survey released a study in 2008 that estimated that up to 4.3 billion barrels of oil can be recovered in the Bakken. USGS geologist Rich Pollastro said the agency hasn’t seen enough data to amend its estimate.

“We think our numbers are fine,” Pollastro said Thursday. “We don’t see anything at this point that would radically change them.”

A state study released after the USGS study found a near identical assessment as the federal report. The state has since bumped its estimate to about 11 billion barrels of oil, based on drilling success and current production rates.

Ed Murphy, the state geologist and director of the Geological Survey, said Continental’s new estimate is possible.

“We know the Bakken is going up but we think (Continental’s) estimate might be on the high end of what we would potentially come up with,” Murphy said.

Hamm’s Enid, Okla.-based company is one the oldest and biggest operators in North Dakota’s booming oil patch, which incorporates most of the Bakken and underlying Three Forks formations. Continental did its own assessment of the formations, using company geologists and analysts.

“We feel we are as capable as anyone to do it,” Hamm told The Associated Press.

Hamm’s company is the largest leaseholder in the Bakken shale formation, with more than 864,000 acres in North Dakota and Montana. The company, which has been drilling in North Dakota for 22 years, was among the first to tap a Bakken well in 2004 using horizontal drilling technology. The company was the first to drill a horizontal well in Three Forks formation in 2008.

Hamm told the AP that government assessments done on the Bakken used production numbers when the oil play was in its infancy. The study also based its estimate on technology used at that time, which is now outdated.

“The technology continues to improve,” Hamm said.

Hamm called his company’s assessment “believable” and could mean production at 1 million barrels daily by 2020. He told bankers that would make North Dakota “one of the 13 or 14 largest producing countries — not just state.”

Hamm said his company has operations in 20 states but North Dakota is its most important at present. The company extracted about 15.8 million barrels of oil from the Bakken and Three Forks in 2010, up from 5.1 million barrels in 2007. About 75 percent of the oil came from North Dakota, where the company has 22 rigs drilling at present.

Hamm ranked as the 44th-richest American last year, with a net worth of nearly $6 billion, by Forbes magazine estimates. In 2007, Hamm was listed as No. 108 with $3.2 billion.

Continental plans to invest $955 million in drilling operations in the Bakken and Three Forks this year, adding about 120 wells to the 257 currently producing, the company said.

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By Damian Kahya

In a field near Kirkham, between Preston and Blackpool, they are preparing to drill a well that many say could change our energy outlook.

Up until recently, most economists had forecast gas prices rising sharply as supplies become scarce. Production in the North Sea is already falling fast.

But the recession saw prices fall and now the process of getting gas out of rocks , shale gas as it’s known, could bring huge new supplies.

The International Energy Agency (IEA) predicts that “unconventional” resources such as shale could double our gas supply worldwide.

Gas for 100 years

At the well in Lancashire, they are preparing to see if the right conditions exist in the UK to get gas from shale.

Even as they do so, environmentalists – backed by a new report – have called for the practice to be stopped. Some economists, meanwhile, have warned it may yet prove costly to do outside the US.

Shale gas is extracted using a process called fracking. It involves small explosions to fracture the rock, followed by as slurry of water, sand and chemicals to free the gas trapped inside.

IHS Cambridge Energy Research Associates estimate the amount of available gas in the US has doubled in recent years and the US Energy Information Administration’s latest figures for 08-09 showed an 11% increase in economically recoverable gas for that one year.

The new supply has driven down the price.

“The recession happened at the same time as all the shale production, demand wasn’t there and supply was just coming out of our ears,” says Mary Barcella from IHS Cambridge Energy Research Associates.

European Boom?

It has also led to interest from the oil majors.

The flare from the gas burnoff from a Marcellus shale well is seen over the Pittsburgh Mills mall in Tarentum, Pa.

Shell recently invested more than £3bn to buy the shale assets of US producer East Resources. By 2012, the company expects half its production to come from gas of one form or another.

Plentiful cheap gas has opened up the prospect of US power companies switching from coal and therefore significantly reducing carbon dioxide emissions.

But the problem with gas is it that it is notoriously difficult to transport.

Following the US lead, shale is being explored in China, South America and Europe – the worlds largest market for gas.

The IEA estimates that at current usage levels, there is enough conventional gas to last the world a limited 60 years – but if one factors in remaining recoverable reserves including shale, that number increases to 250 years.

It is a tempting prospect.

Lancashire drilling

The main focus so far has been on Poland and Germany.

Though Shell, Exxon and ConnocoPhilips are all reportedly involved in early trials on the continent, none of the major firms have yet outlined any plans for extraction.

In the UK, gas prices also fell after 2008, but have slowly risen again, leading energy companies to raise prices for consumers and and prompting calls for shale reserves to be tapped.

Attention is focused on little known Cuadrilla Resources and its well in Lancashire, which plans to drill a test well soon.

“If we were successful and show reserves then there would be interest from bigger companies,” says manager Mark Miller.

‘Not under our backyard’

But Europe has little history of on-shore drilling.

The first shale well was dug in 2008, and there is a public reluctance to engage in new underground projects.

Experiments in carbon capture and storage have run into trouble in the Netherlands and Germany due to widespread public opposition and the shale gas industry has already been criticised.

A new film, Gaslands, includes scenes of a man setting light to water from a tap because – he alleges – methane has seeped into the water supply due to fracking.

A report out this week by the UK’s Tyndall centre cited such worries to call for a moratorium on shale gas drilling in the country.

Economic problems

But the abundance of US shale has had a knock on effect on the rest of the world.

Tankers of gas previously destined for US ports now need to find a new dock.

“There is an excess of gas supply at the moment,” says Edmond George from the Economist Intelligence Unit.

“Companies are over-contracted and there are many LNG cargos which are not being sold.”

Demand has picked up during the winter, but even so shale may not provide an affordable answer, at least in Europe.

A report by Florence Geny, for the Oxford Institute for Energy studies in the UK, suggested drilling costs would bet two to three times higher than in the US, with water costs up to 10 times higher.

That is if you can find anywhere to put the wells.

“The number of wells required is very great,” says Ms Geny.

“The way you can distribute the wells on the surface is very restricted, due to regulation and high levels of urbanisation”.

Anne Sophie Corbeau from the IEA agrees with her assessment.

“It would take at least 10 years to have significant gas production, if any,” she warns.

Chinese consumption?

There is also the question of what the gas would be used for.

The UK recently reformed its energy market to discourage short term investments in gas for electricity.

“For us, a big uncertainty is China,” warns Ms Corbeau.

“In 2010, their demand is estimated to have increased by around 20%, putting them above any European country.”

Higher demand would counter-act higher supply, pushing up the price.

It would also mean even shale reserves look far less generous – something the IEA is working on calculating.

Supply worries, and a stable high price could prompt European countries to accelerate shale gas development – or to turn away from gas as pricey and limited.

Even Cuadrilla’s Mr Miller admits it will be “several years at least” until shale gas comes on-stream in the UK.

By then the situation my look very different.

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By David Vitter

1776 was quite a year for American ideas — and not just because of the political philosophy embodied in the Declaration of Independence. Just as importantly, 1776 also saw the publication of Scottish economist Adam Smith’s The Wealth of Nations, the first textbook, if you will, on free-market economics.

As with the Declaration, The Wealth of Nations is a treasure trove of principles that are at the heart of America’s exceptionalism and unparalleled economic success. Adam Smith realized something revolutionary for his time: The wealth of nations is not dependent on finite factors like the precious metals nations possess. Rather, it is determined by the labor of their citizenry and how productively that labor is employed. This led Smith to additional modern economic concepts such as the opportunity for almost limitless economic growth through division of labor and employment of capital, and perhaps most famously, the “invisible hand” of the free market, which organizes economic activity with astounding efficiency.

Sound compelling? Don’t worry — 235 years and indescribable economic success later — the Obama crowd isn’t buying a bit of it. This is perhaps most evident in Obama’s approach to energy and the environment, particularly in the Gulf of Mexico and in my home state of Louisiana.

At the heart of America’s recipe for remarkable economic growth since World War II has been cheap energy. As mentioned, Adam Smith wrote about division of labor, employment of capital, and how those factors could increase productivity, economic output, and wealth. He gave eighteenth-century examples of how that works. But he couldn’t possibly have imagined just how powerful such an engine could become — or what cheap energy could do for American economic growth.

The Obama approach to cheap energy? Cheap energy is a key part of the problem. This attitude is perhaps even more worrisome than the president’s actual environmental goals like taxing and regulating away purported “man-made” climate change. His primary means of getting there is, pure and simple, dramatically raising the price of energy — not increasing productivity and innovation.

This impulse is so strong that it seems to be part of an emotional reaction against our very economic prosperity — as if that end in itself is outdated and suspect — stemming from the belief that it can only have been gained to the detriment of the less-developed world. In this way, the president would be right at home with most thinkers before Adam Smith, who considered economics a zero-sum game.

Before President Obama tapped Carol Browner to be his climate-change czar, she was listed as a leader of the Commission for a Sustainable World, which argued that developed countries actually must shrink their economies and consumption to address climate change. Similarly, White House science advisor John Holdren had advocated “de-industrializing” America. That means we all need to “face up to . . . zero net physical growth” in which we all need to consume far less. As a candidate, Barack Obama himself admitted that his cap-and-trade plan would necessarily create “skyrocketing” utility costs. And even in office, Obama’s energy secretary Steven Chu has baldly stated that he hoped the U.S. would “boost the price of gasoline to the levels in Europe,” currently about $7 per gallon.

Small wonder that President Obama still has the Gulf of Mexico virtually shut down to oil and gas activity nine months after the Deepwater Horizon disaster. The formal moratorium is lifted, and promises to resume drilling abound, but the reality remains — a virtual shutdown. And offshore may be the good news. Onshore, federal permitting for domestic energy resources has been reduced by a whopping 79 percent since Obama took office.

According to the International Energy Agency, these Obama trend-lines mean that we’ll need to import 300,000 barrels of oil more per day in 2015. Even at today’s oil prices (which are likely to look low in 2015), that’s $27 million more per day, $9.855 billion more per year flowing out of our national economy.

To me, this sure doesn’t add up to a renewal of American prosperity. Rather, it seems to be giving up on that very goal. It’s as if President Obama is saying: “Well, yes, our time has passed.” And that’s probably because the President never understood The Wealth of  Nations and how America became so exceptional to begin with.

— David Vitter is a U.S. senator from Louisiana.

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Congress isn’t the only entity that knows how to pick winners and losers for energy sources and technologies. The Environmental Protection Agency (EPA) is doing its best to follow suit by imposing new rules on the natural gas industry and providing exemptions to the biomass industry.

For natural gas, the EPA evasively posted a new rule on hydraulic fracturing, requiring a company to obtain permits if the company uses diesel when fracking. Hydraulic fracturing, a long-proven process by which pressurized water and other substances are injected into wells to extract natural gas, has been the subject of much debate between environmentalists and industry because of those “other substances.”

An exemption in the 2005 Safe Drinking Water Act protects natural gas companies from disclosing proprietary information regarding the chemicals they use to when fracking. Environmentalists are pushing for full disclosure because of the concern that hydraulic fracturing is a threat to America’s drinking water. But in this instance, with the EPA’s new rule on diesel disclosure, perhaps more unsettling than the new rule is the way in which the EPA issued the rule. Mike Soraghan of Greenwire reports:

Federal agencies usually change policies with a multistep process that begins with the Federal Register and does not end for a year or more. But the fracturing permit change happened without so much as a press release. It was quietly posted amid an increasingly noisy debate about fracturing, a process in which chemical-laced water is injected underground at high pressure to crack rock formations and release oil or gas.

EPA has launched a multiyear study of the safety of fracturing. Hundreds of people showed up last summer at EPA hearings about the practice in New York and Pennsylvania. It has been the subject of a piece on “60 Minutes,” an HBO documentary called “Gasland” and even an episode of “CSI: Crime Scene Investigation.”

The casual nature of the posting, and the lack of any date, left oil and gas industry attorneys puzzling over what the change applied to and whether it applied only for the future, or retroactively. Of particular concern was that companies had been ordered to give documentation to Congress about their fracturing practices, and EPA was ordering disclosure, as well.

If they had disclosed that they had used diesel—legally—but did not get a specific permit, could they be penalized? Was there any way to get such a permit? What should states, who administer the program, do about regulating fracturing?

The story gets more complicated from there, mostly because of a series of loopholes with regards to the EPA regulating the use of diesel for fracking. Having the EPA close the loophole and create a clear definition with regards to diesel use isn’t necessarily bad, but it sets a dangerous precedent for the EPA quickly changing the rules of the game for industry with no consideration for debate and public comment.

Reining in the EPA’s regulatory overreach and unilateral decision making should be a priority for the 112th Congress. Congress should thoroughly evaluate and question the EPA’s newly implemented rules and have EPA Administrator Lisa Jackson justify her agency’s decision not just when it comes to hydraulic fracturing but other rules as well, most notably the regulation of carbon dioxide (CO2) and other greenhouse gases under the Clean Air Act.

Speaking of which, Congress should ask Jackson why the EPA exempted biofuel refineries from obtaining permit requirements for CO2 emissions. This year the EPA will start regulating emissions from new power plants and major expansions of large greenhouse-gas-emitting plants (more than 25,000 tons of CO2 per year) and will finalize regulations for existing refineries and fossil fuel electric utilities by November 2012. But not biofuel plants. The reason given is that the science clearly shows that biofuel production is net neutral when it comes to CO2 emissions.

Right. Just like the science clearly shows increased CO2 emissions will result in sea level rises, stressed water resources, increased size and quantity of wildfires, insect outbreaks, threats to ecosystems and national security, and other catastrophic events.

New studies, however, are showing that biofuel production is not carbon-neutral. A report from Rice University notes that when you account for land use conversion, the use of fertilizers, insecticides, and pesticides (which emit much more potent methane and nitrous oxide), as well as the fossil fuels used for production and distribution, biofuel production becomes quite carbon-intensive. For an industry that built its business model around subsidies, tariffs, and federal protection, it’s no surprise that the EPA threw the biofuel industry another bone. Now it’s time for Congress to put the EPA on the stand and ask why.

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A barrel of oil is not a piece of paper (like a stock certificate) or a bunch of ones and zeros in a computer somewhere (like money). It takes up space. It is real. It’s a commodity.

The price of stocks and bonds is determined, just like the price of everything else, by supply and demand. Financial assets differ from commodities, however, in several significant respects. For one, financial assets can simply be created out of thin air. Companies can issue almost limitless shares of stock, as we saw in the Internet IPO craze. The creation of vast new supply with almost no effort dramatically alters the supply-demand balance. We all know what happened to almost all of those Internet stocks. Kaboom!

Commodities are different. Commodities have to be looked for, mined, farmed, drilled, grown, harvested, or pumped out of the ground and then they have to be shipped to distant locales where they are eaten, burned, hoarded, or otherwise disposed of. In the short run, additional supplies of commodities are very difficult to come by, absent significant stockpiles or a lot of excess capacity waiting to come on line.

Most importantly, to influence the spot price of a commodity, except in the very short term, a speculator or investor has to take physical delivery. Virtually all serious academic studies of speculation in commodities markets, and there aren’t many, have concluded that speculators have limited or no long-term effect on prices and that speculation actually reduces price volatility. Speculators are like market-makers. They provide liquidity to the market and maybe take a position here or there, to little net effect.

Some commodities, of course, are more easily accumulated than others. Gold, for example is easy to purchase and store safely, albeit with some carrying cost. Individuals and institutions who take physical delivery of gold, or who buy gold in allocated storage, ultimately do affect the price of the commodity.

Other commodities, and oil is a very good example, are difficult to store in quantities that are at all significant relative to global daily consumption. Total US stockpiles of crude oil (excluding the Strategic Petroleum Reserve) are about 350,000,000 barrels. But this is only 17 days worth of consumption. A very large increase of current stockpiles is impossible without the construction of vast new storage facilities. With US crude oil consumption already down around 10% due to the economic downturn, who would build such facilities? Hedge funds? Right.

The price of crude oil is determined in two places. Demand is determined at the pump. Supply is determined at the wellhead. That should seem obvious, but it isn’t to investors who have cut their teeth trading purely financial instruments. Granted, futures contracts are financial instruments, i.e. pieces of paper with nearly infinite supply and with significant demand coming not from refiners desiring crude oil for delivery at Cushing, OK, but from institutions looking to profit from the increase in the price of oil. But institutional investors, including hedge funds, don’t want, don’t need, and can’t store crude oil (apart from the occasional tanker here or there). So, they have to close out their positions. Their demand is transitory and always comes back as supply in the front month or earlier. Ultimately, financial institutions just don’t matter to the long-term price of oil, no matter what the self-styled “Masters of the Universe” want you to believe.

What does this mean for investors interested in energy plays? It’s simple. Look at the fundamentals. Global crude oil production has been unable to break the 74 million barrel per day barrier since 2005, even with the significant price appreciation in oil that has occurred since that time (in 2005, oil was “expensive” at $40 a barrel, remember that?)

There is little reason to believe global production will break the 74 million bpd level now, almost seven years later. Where will it come from, Saudi Arabia? Where were they in 2008? Uh, no answer. Will Saudi Arabia ever produce 9.5 million bpd again. Who knows? They didn’t produce more than that in 2005 or in 2008. Why now? There just isn’t any acceptable, rational answer to that question.

Meanwhile, demand in China was up an astonishing 19% year over year in December according to the IEA. OECD demand is up as well with the nascent recovery. Overall, global demand increased 2.4 million bpd in 2010 according to the IEA. If demand increases another 2.4 million barrels per day in 2011 (which seems likely) and there is no or little additional supply (also very likely), we will have another massive price spike in 2011.

The key point is this: don’t worry that hedge funds and other institutions will suddenly get cold feet and bail on the oil trade like they did with Internet stocks and sub-prime mortgages. Oil prices will fall again, but only after the wheels come off the global recovery, likely in 2012. And we aren’t there yet.

My recommendation: buy the crude oil and refined product ETF’s: USO, OIL, USL, BNO (Brent Crude), and UGA (wholesale gasoline), and the oil-service stocks (OIH) and exploration and production stocks (XOP). Close to the money options on all these ETFs with enough time to allow the price spike to happen, like say sometime next year, will very likely produce significant positive returns.

Most of all, don’t worry about being an “evil speculator.” If you want to affect the price of oil, buy a Suburban, or better yet, just blow up the Ras Tanura processing facility in Saudi Arabia, which handles five million barrels a day of the stuff (just kidding, of course.) Now, that would be evil.

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