Editor's note: You might think that demand is the primary driver of oil prices. But the truth is more complicated. In this essay – excerpted from the October issue of Stansberry's Investment Advisory – our colleague Whitney Tilson explains what's really driving oil prices... and why understanding this industry's cycles can help us take advantage of a bullish setup today.

If the Permian Basin were its own state, it would be the 13th largest in the nation...

It takes more than five hours to drive across the entire Permian, located in West Texas.

Today, it's the epicenter of the U.S. oil and gas industry. But that wasn't always the case...

More than 15 years ago, U.S. wells were pumping out fewer than 5.5 million barrels per day. Back then, most folks believed the world was running out of oil.

Our company's founder, Porter Stansberry, was one of the first to predict the U.S. shale boom. In an April 2010 issue of Stansberry's Investment Advisory, Porter explained why new technologies would change the entire industry.

The first innovation was hydraulic fracturing ("fracking"). This means forcing colossal amounts of pressurized water down wells, allowing trapped oil to flow freely. As a result, operators could start drilling smaller-scale wells... unlocking massive amounts of oil and gas in areas like the Permian.

As Porter predicted, fracking hit its stride in the 2010s. And U.S. production began to soar. Industry insiders call this period Shale 1.0.

To make a killing in the oil and gas industry today, you need to understand its cycles – just like back then.

That's because right now, we're setting up for a new boom in this sector...

With access to low-cost loans following the 2008 housing crash, oil and gas companies were able to "drill, baby, drill."

Thanks to cheap capital, production mattered more than profits. Companies not only happily spent all of their cash flows but also took on debt to grow.

The explosion in supply had a predictable economic result...

The price of oil collapsed from $100 per barrel in 2014 to less than $40 per barrel just two years later. We saw a wave of bankruptcies in the oil patch. This period is called Shale 2.0.

The companies that survived had to learn how to live within their means. That meant harvesting returns from existing wells to both fund new growth and, if all went well, return cash to shareholders.

This new era of capital discipline in the oil patch – which we're still in today – is called Shale 3.0.

And it's in this era that we're once again bullish on oil and gas.

You see, when trying to predict oil prices, most folks focus on demand. They think demand is easy to predict because it grows in line with GDP over time.

But the economy is a complex animal, and even the best economists get this wrong all the time. The good news is, they tend not to be wrong by too much... because even seemingly large economic changes have a limited impact on oil demand.

Even in a recession, people still drive their cars, trucks still deliver packages, and planes still fly – just a tiny bit less.

That's why the real driver of oil prices is almost always supply. Today, we're bullish on oil because of a lack of it.

Happily, supply is easy to forecast. The simplest tool to use is capital...

Oil takes money to produce. And we can measure the amount of capital expenditures ("capex") going into the space. This gives us a reliable leading indicator.

Let's look at the past 20 years. The light blue columns show U.S. crude-oil production, and the dark blue columns represent production in the rest of the world...

As you can see, global oil production has held steady in recent years and has barely budged over the past two decades. This is despite substantial energy capex around the globe. In short, the industry is reinvesting heavily to generate very modest growth.

More important, even as global oil production remains nearly flat, we're seeing the trend shift in where the world's supply is coming from.

Look closely, and you'll see that U.S. oil production is where the growth is taking place. It's up more than 170% since 2005...

This means the U.S. has been supplying the majority of the world's growth in oil supply.

Why could the U.S. grow when the rest of the world couldn't? The answer is simple: It's the world's low-cost producer.

But even as oil demand continues to rise, don't count on U.S. output to continue its rapid growth. This is because of Shale 3.0...

Shale 3.0 demands both capex investment and returns to shareholders. The money that has been diverted to shareholder returns is no longer creating additional supply, so shale production is going to grow at a slower pace.

The global population is continuing to grow, so demand remains a constant force. And the world's low-cost producer isn't keeping up.

The only way to balance that dynamic is for prices to rise.

The beauty of Shale 3.0 is this: Not only are companies acting in their shareholders' best interests by directly returning capital, but in doing so, the companies are reducing global supply and therefore improving their future cash flows.

For shareholders, that's a win-win. And it means that right now is a great time to be bullish on oil and gas.

Good investing,

Whitney Tilson

Editor's note: We're seeing a historically attractive entry point into one sector that has only been this cheap two other times in the past half-century. Today, Whitney is teaming up with Brett Eversole to reveal why a "secret bull market" is likely to explode soon in this sector... And it could last not just years, but decades. Get the full details here.