Oil: What Goes Down Must Go Up?

By Richard Stuebi

As posted to Huffington Post

About 60 miles west of Cleveland, Cedar Point is world-renowned for its scary roller-coasters. However, Cedar Point has nothing on the oil markets.

At the turn of 2007 / 2008, oil was at the cusp of $100/ barrel -- a price that was considered a kind of mythical barrier, due to its three-digit numerology. Well, it took just a day or two into 2008 to broach that level, and by July, oil was approaching $150/barrel -- an increase of 50% in 6 months, and fully 6 times the levels that prevailed just 5 years previously in 2003.

Then, the bubble burst, violently: in just the six months since the summer, oil prices have collapsed, falling by about 75%, to below $40/barrel.

I am reminded of the classic Vince Lombardi film clip, in which he yells out incredulously from the sideline, "What the hell's going on out here?" People ask me, as if I should know, because I've been involved in the energy industry for over two decades, but alas: I can't figure it out. And, I'm not alone.

For instance, consider the December 10 presentation given by Matt Simmons in Houston. Simmons has impeccable credentials, having served as an analyst of the oil industry for nearly 40 years -- and it seems as though he's incredulous as to what he's seeing.

Simmons laments (like many others of us) that the recent collapse in oil prices -- as inexplicable as it's been -- is not a good thing. For Simmons and others in the oil industry, low oil prices have caused major investment projects to be deferred. For those of us more on the cleantech side of things, low oil prices cause the alternatives to oil to become less economically or financially attractive.

To Simmons, it is especially frustrating that the decline in oil prices have nothing to do with fundamental realities. Simmons notes that plummeting prices haven't been driven by any material declines in global demand, backing this with the comment that "all signs still say [the oil market is] 'very tight'" -- admittedly cryptic, but Simmons has access to all sorts of data from innumerable sources in the oil industry worldwide.

After asking plaintively "why do we know so little about an issue so critical to our well-being?", he pulls no punches with his stark conclusions: "Crude oil has peaked" and "Its future decline could be swift," giving credence to his warning that "What goes down can come right back!"

The logic of his analysis suggests that oil prices cannot sustain for long at $40/ barrel. Simmons has often said that oil at even $150/ barrel is still incredibly cheap -- 22 cents/ cup -- and that Americans really need to get a grip on how valuable the stuff is, and thus how expensive by all rights it really ought to be.

In an October 2008 report entitled "Ratcheting Down: Oil and the Global Credit Crisis", Cambridge Energy Research Associates recently developed an estimated supply curve for the various sources of oil worldwide, and to achieve production rates at current levels of about 85 million barrels per day, CERA's work indicates that prices of at least $100/ barrel are eminently justifiable.

For you investors out there, all of this is good justification for making a bet on oil prices going up from current levels. Maybe you can make a killing.

At the societal level, though, the implications of peaking oil production are troubling. A really negative take on the prospects is offered by an open letter written by Nate Hagens to President Obama, posted on The Oil Drum, one of the most comprehensive resources concerning peak oil issues on the Web.

As for Simmons, he's less hyperbolic than Mr. Hagens, but not a whole lot more optimistic. He invokes the perspectives of the new leadership at the International Energy Agency -- "Current energy supply trends are patently unsustainable," "Future of human prosperity depends on how we tackle our energy issues", Consequences of policy / investment inaction are shocking", "Massive investment required", and "Time is running out and time to act is NOW!" -- and closes his presentation by declaring that "'Yes We Can' solve this bleak energy future, but we now need to sprint into hasty retreat from our addiction to oil and gas."

How comfortable are you in ignoring such well-substantiated warnings from an oil patch veteran like Simmons?

So, for those of you clamoring for low oil prices, at current levels or even lower, don't bet on it. $40/ barrel is likely to be an aberration.

Disclosure: No position

Comments

[Maxe Paul:]

I cannot see oil at at $150 being "incredibly cheap" as your source claims, this is just not sustainable, and the market strongly disagrees. Until China stops contracting, the oil price will stay unsder pressure.

I also strongly disagree with the claim that supply and demand is largely unchanged. people are buying short term contracts and selling a year out, storing it on super tankers and anywhere else they can find. This supports lower prices for longer.

I do not even believe we have seen the bottom of oil yet. There is simply no evidence to support a sharp demand and price reversal from current levels. The exception to the rule would be a massive blowout in the US dollar. The old adadge was "stronger for longer" it is now ""lower for longer".

Jan 27 04:01 AM

[Perry1961:]

We were in recession before oil hit $100,and we'll stay in recession until it drops below $20. There's no immutable law that states the world must have a $50 trillion GDP. It could just as easily be 40 or 45 trillion. When will OPEC realize higher prices is no way to stem falling demand? When they produce no oil at all?

Oil has been getting increasingly harder to find since cavemen slicked their hair back with it. The world will have to adjust to what can be found and produced. But,what OPEC is doing now has nothing to do with peak oil. Peak greed is what it is.

Jan 27 04:56 AM

[Amvet:]

US Government data says that demand fell 50K bpd in 2008 and predicts an additional fall of 450K bpd in 2009. With a base of 85 million bpd, this decrease is trivial. With a decline rate on producing field production of 5% per year, over 4 million bpd of new production is needed to stay even.

Don´t forget that oil prices are set by speculators and not by oil users, which is a totally stupid system (unless you are a speculator!!).

Jan 27 07:25 AM

[blinkmnt:]

News cites are being to short term again in this crude things and bloogers to long term, personally im inclined to read the charts and they say 45 oil is a correction and we are continuing up cause oil demand destruction have not being created. What we experienced was leveraging down. Earnings are showing an economy in a plateau, so oil is back to the center stage.

Jan 27 07:33 AM

[Ferdinand E...:]

You can call it greed if you like, Perry, but at Harvard and Stanford it's called business. I also doubt if the OPEC bosses spend a lot of time reading SA, but if they do the first paragraph in Amvet's post is undoubtedly interesting for them, and it should be for everybody. The second paragraph though is completely wrong.

..

Jan 27 08:33 AM

[Timothy Swift:]

This is awesome... "all signs still say [the oil market is] 'very tight.'" EXCEPT price!

The historical inflation adjusted price of oil going back to the mid 1800's is roughly $30/bbl. Prior to '08 the price approached or exceeded $100/bbl on an annual basis only twice. Why is today's market any different?

The price will gyrate around the incremental barrel as it has in the past. When the incremental barrel is scarce the price will go up when its in abundance the price will go down. Econ 101.

The rationing mechanism of price is truly a powerful force. There is nothing new here.

Jan 27 08:55 AM

[toobad41:]

At this point in time the world demand has fallen just 2%. The demand in the US has fallen just 5%. Although there is a current overage on the supply side that amount can be used up in less than two weeks. The recent collapse of oil pricing does not bode well for future supply. When supply is used up, which it will, speculation will jump in again and prices will go up again.

Jan 27 09:41 AM

[alphadominance:]

The $150/barrel oil never had anything to do with supply and demand. It was part of a speculative commodities bubble that blew up as a result of cheap credit and vastly overleveraged investment groups like hedge funds. We are experiencing a correction in all asset prices that was overdue. While I agree that it has unfortunate impacts in driving investment in alternatives, hopefully we were shaken enough by it as a country to keep the political will together to pursue alternatives now while the pressure is not so great. It would be a tragedy for us to again become complacent only to be blindsided when supply constraint becomes a real issue. This is a wake up call and we will probably one get one. Heed it people.

Jan 27 11:49 AM

[oilsands:]

Richard, thanks for the article. Based on continual reading, I believe the central factors in the price of oil are:

1. the increasing worldwide demand for energy, China and India, especially
(many Americans fail to see we are not the only major player anymore)
2. the sharply increasing cost of producing new oil fields whether onshore or off
3. attempts by producers to control price
4. lack of capital to fund the E & P for future production
5. ramping up of alternative energy sources
(China is going to spend 70 Billion on wind energy alone in the next few years.)

The bottom line is that we are bankrupting ourselves buying foreign oil and as Simmons states, we need to break our addiction to oil.

Jan 27 11:50 AM

[M33:]

We have worldwide all major and small automotive manufacturers close to bankruptcy does this not reduce demand?? not to mention energy efficiency vehicles in the pipelines, what other reason do we need to reduce demand, finally when it comes to oil price it is all up to supply and demand, once they play it out, we will be able to determine the new oil price.

Jan 27 09:22 PM

[User 410503:]

when oil goes up , jobs go up,we need the price to be around $80 A barrel, the oilfields crate lots of jobs !!!

May 08 09:24 PM