The Oil Price Conundrum

What should be the fair price of oil? The fair price is obviously the market price. But the price oscillation is really too big to be “credible”. From $51 to $147 in 1.5 years, and then from $147 to $36 in 4 to 5 months, do you know anything that you buy everyday that changes price so much (besides oil-related stuffs)?

Market price is always right (for the very second), but from such big oscillation, it is obviously that the market is extremely short-sighted. Rephrasing it in mathematical terms, the best predictor for the near term price is the current market price, but the prediction power of the current market price further out in time is essentially zero. And that is the point that I want to make: the current oil price is probably reflecting very little with the fundamental picture of the coming oil depletion.

If you have some time, you should take a look at Matt Simmons’ presentation slides. It’s an excellent source of information. And for the record, I’m still in the peak oil camp. I’m short-term (3-4 months) and long-term (2+ years) bullish on oil. For the intermediate term however, I think oil prices may stay in the lower range along with the stock markets.

I won’t repeat things in Simmons’ slides, but the title captures it all: The risk of misjudging peak oil: a real physical crisis. In fact, I think the consequence of a real physical crisis in the oil market can easily be the biggest paradigm change in the next decade. Let’s hope that civilization is wise enough NOT to rely on the current market prices of oil to determine what may come in the next 10-20 years. Otherwise, using the zero information content from the current market price will most likely lead us into a bigger crisis down the road.

Comments

[silverwood:]

When I look at the price movement of oil on a three year weekly chart. What stands out is the unsustainable rise in price immediately followed by an equally unsustainable fall in price. In his slide presentation Matt Simmons eludes to a disconnect between the paper oil barrel price and the wet oil barrel price. Prices can be influenced by perceptions real or imagined and are not wholly aligned with the fundamental picture. We see a similiar situation occuring in the precious metals markets. I see oil moving back up in search of the real fundamental price level.

2008 Dec 29 05:04 PM

[User 278665:]

Requisite for "Market Price" to occur is an open and competitive market. Oil is at best an Oligopoly with severe gvernment and internation intervention on supply. As such, "Market Price" as typically defined in an open competiive market does not apply as it does not occur. No pricing model will ever get it right. Applying open market terminolgy, market theory, and capitalistic analysis is no better than a dart board!!!

2008 Dec 29 05:05 PM

[John Polomny:]

I like the oil ETF USO here as I can can write covered calls on the shares. With the price of oil way down it is probably going to base around this level. As the world economy comes back the oil price will move higher and this covered call writing strategy becomes an ATM machine.

2008 Dec 29 05:44 PM

[Timothy Swift:]

Mr. Simmons is using a very short view of the oil market's price actions. Including this year, oil has exceeded $100/bbl on an inflation adjusted basis only three times in the last 150 some odd years. Add to that, oil has averaged around $27 - $28/bbl on an inflation adjusted basis over the same time frame. Its not clear why the market is different today than during other periods of hyper price escalation and collapse.

The area I agree with him most on is the need for sound policy. For much of oil's history the U.S. has been the dominant producer and, as the third largest producer, seems prudent that policy makers need to adjust policy to sufficiently and materially increase U.S. production.

I won't suggest the U.S. can assume the role as the number 1 producer but policy can certainly add spare supply to the system on an as needed basis. The Texas Railroad Commission served a useful purpose once upon a time.

The market mechanisms work fine if there is minimal lead time to market, and if properly applied can smooth the peaks and valleys of price swings instead of being held hostage to the fringe buyers and sellers in a tight market.

2008 Dec 29 08:50 PM

[Greg Pinelli:]

Some of the posters above obviously haven't read much of Simmons or the Peak Oil perspective...Simmons take has always been that we are facing a geological..not a market... issue. There is NO..I repeat NO ...conundrum about oil. The market price is "fair.." Whatever that might mean..However, the market price may not be reasonable or reflective of real conditions in the supply world. My bet..it's not even close.
The "reasonable" price must ALWAYS be what producers need to make a profit given the risk they take..for oil that's around $70-75...ANYTHING LESS AND THEY MAKE A VERY SOUND CHOICE..WHY PRODUCE???..IT'S MORE REASONABLE TO LEAVE PRODUCT IN THE GROUND AND COME BACK AT A LATER DATE......
Morons like Phil Flynn are always looking thru the rear view mirror..the forward thinker wins the day....oil (and nat gas) are depleting...it's a race against the stagnant or falling economy and oil..a burst in one will lead to a very large burst in the other.

2008 Dec 29 09:02 PM

[John Lounsbury:]

John Polomny, be careful with covered calls if oil starts an up-move. Covered calls can bite back and get your stock called away that you would rather not lose, and give you a big instanaeous opportunity loss. To prevent that you must buy back the calls before they get too expensive. Another strategy is to buy additional shares if the price rise hits your prselected point and allow the original shares to be called away. You probably know all this, but I offer my two cents for our other readers.

Siverwood, good perspective. We had a price spike much above any reasonable equilibrium level. Overshoots are frequently followed by an over-correction. Greg Pinelli has as good an equilibrium price as any, because $70-$75 is close to the production cost of new oil (oil not from established wells still in production).

TRS, it is not likely that the U.S. can increase production enough to do much more than replace old wells as they decline, unless oil goes well over $100 and stays there. In that event, other sources, such as shale oil recovery or coal liquification may be able to push us ahead. But at those cost levels, other energy sources, such as nuclear and new technologies may be more cost effective. Ultimately, our energy independence will be pursued by following the most cost effective path and that path is not yet clear.

2008 Dec 30 12:41 AM

[NOWHEREMAN:]

There is plenty of oil, hundreds of years of it. Coal gasification, Coal to liquids, Shale, Tar Sands, whatever you want to call it, still untaped waiting to be used.

Peak Oil just referred to the easily found and extracted variety. That epoch has come and gone. Peak Oil has come and gone but no one paid any attention to it because high prices saw the use of extreme but expensive technologies which would have obviated the effects.

Low oil prices have stopped the use of these new techniques, hopefully they will be revived in the US via Government mandate. If Not then we will be back to square one and the price rise will be greater but not really that much faster since Opec will have a much greater level of Spare Capacity.

Peak Oil should not be confused with Refinable Oil. State of the Art Refineries are quite capable of handling the heavy and sour grades that are in abundance. The fact that there aren't enough of them doesn't mean that there isn't enough oil.

At least 50% of all of the oil pumped out of the ground in the US over the last 200 years still rests underground in those same locations. The technology to eke out another 10-20% out of them did not exist when they were capped, it does now.

Its a matter of extraction costs vs price levels. If the price is right, there will be plenty of oil. If Refineries capable of handling the heavy/sour grades are built, there will be an ample supply of product. The Technology is here and available.

Peak Oil referred to the WTI, Brent, Louisiana Light grade oil fields which are as scarce as hen's teeth.

IMO

2008 Dec 30 12:58 AM

[NOWHEREMAN:]

Oil needs overlapping demand increases from around the world. Increased demand from China and the US combined will not raise the price significantly above $70 even if it gets to those levels in 2009. Opec has the spare capacity to keep those levels intact. Those floating oil storage containers give additional spare capacity.

The demand has to accelerate and stay in an accelerated mode Globally for oil to go above $100.

Caveat, war premium has not been factored into my expectations nor what happens if the Dollar weakens significantly over the same time frame.

Apparently Pinelli is " looking tru the rear view mirror " when talking about Peak Oil which has always been defined as the depeletion of the "low cost and high availability" type of oil. He says " Morons like Phil Flynn look through a rear view mirror". Its the same mirror. IMO

2008 Dec 30 01:27 AM

[Greg Pinelli:]

Government mandate?? It's important if one is going to be in the game to understand at least the rudiments of Peak Oil..there are not "hundreds" of years of oil...Where??? This nonsense sounds like a CERA press conference....
How does a..whatever KNOW tht Saudi Arabia has the kind of spare capacity he claims??? Simmons doesn't think so...Campbell doesn't think so..and now the IEA doesn't think so! So share these brilliant insights with us Mr. anonymous....HOW DO YOU KNOW SO????


On Dec 30 12:58 AM aitvaras wrote:

> There is plenty of oil, hundreds of years of it. Coal gasification,
> Coal to liquids, Shale, Tar Sands, whatever you want to call it,
> still untaped waiting to be used.
>
> Peak Oil just referred to the easily found and extracted variety.
> That epoch has come and gone. Peak Oil has come and gone but no one
> paid any attention to it because high prices saw the use of extreme
> but expensive technologies which would have obviated the effects.
>
>
> Low oil prices have stopped the use of these new techniques, hopefully
> they will be revived in the US via Government mandate. If Not then
> we will be back to square one and the price rise will be greater
> but not really that much faster since Opec will have a much greater
> level of Spare Capacity.
>
> Peak Oil should not be confused with Refinable Oil. State of the
> Art Refineries are quite capable of handling the heavy and sour grades
> that are in abundance. The fact that there aren't enough of them
> doesn't mean that there isn't enough oil.
>
> At least 50% of all of the oil pumped out of the ground in the US
> over the last 200 years still rests underground in those same locations.
> The technology to eke out another 10-20% out of them did not exist
> when they were capped, it does now.
>
> Its a matter of extraction costs vs price levels. If the price is
> right, there will be plenty of oil. If Refineries capable of handling
> the heavy/sour grades are built, there will be an ample supply of
> product. The Technology is here and available.
>
> Peak Oil referred to the WTI, Brent, Louisiana Light grade oil fields
> which are as scarce as hen's teeth.
>
> IMO
>
>
>
>
>
>
>

2008 Dec 30 08:47 PM

[stimulated:]

Oil will be one of the best investments of the next 2 years---might not be a day trade, however. Pls quote me on this. USO and DXO.

2008 Dec 30 09:12 PM

[NOWHEREMAN:]

Pinelli, Wiki the definition of Peak Oil. Do some reading.

Low cost, easily found in a nutshell, Peak Oil.

I said that oil in those grades Peaked some time ago, was hard to find, etc.

Canada's Tar Sands, Our Coal reserves provide all everyone will ever need, Shale Oil etc. . The Tech is here the cost of oil has to rise to make employment of the Tech viable.

You are totally clueless. There are hundreds of capped wells which were capped when enhanced extraction techniques were unavailable, usually in the 50% extracted range.

Everyone knows what the Canadian and Shale oil plays are and how much oil they are estimated to have or at least I thought so until your current rant.

Go ahead, blow more smoke.

2008 Dec 31 12:05 AM

[NOWHEREMAN:]

I subscribe to a Newsletter called Outstanding Investments. The Executive Publisher is Addison Wiggin. It is an Agora Financial Publication.

The Newsletter quotes Matt Simmons regularly.

In Re Bitumen Alone, Alberta has the equivalent of 200 Billion Barrels of Oil. But, PetroCanada has postponed the development of the previously estimated $20 Billion Dollar Fort Hills project because of Low oil prices.

Matt Simmons predicts "the Mother of all Energy Crises" because the exploitation of this asset and other assets has ground to a halt.

Meanwhile on Nat Gas, and I am paraphrasing here: There is an abundance of Nat. Gas liquids, because as oil wells are depleted, Nat. gas liquid volumes increase. Short term, NG will have excess production.

Oil up, Nat Gas down for who knows how long.

Since I usually don't understand how things work in every Investment Sector, I tend to Subscribe to Newsletters published by people who do understand.

There are a plethora of quotes taken out of context and posted on Seeking Alpha, Mobius, Faber, Rodgers, Ruff, etc.

You can believe those quotes blindly or you can Subscribe to their respective Newsletters.

I prefer reading the full text and then posting an opinion.

Jan 01 05:30 AM