Recent Oil Rally: Another Crowded Trade

We wrote a piece a few months ago in which we argued that the rally in oil from $32 per barrel in March to $73 in late June had characteristics very similar to the mania which took oil up to $147 per barrel in July of 2008. In that piece, we dealt mainly with investment psychology and the idea that we had never seen a bubble burst in the investment markets get put back together in anything less than about five to seven years.

Here we are at $72 per barrel today with the U.S. economy appearing to be on the mend and the same army of energy bulls still out there promoting huge upside in the commodity oil and the energy-related stocks.

My professors in college always criticized me for not providing enough evidence in my writing to back my arguments. Fortunately for me, Michael Lynch, the former director for Asian energy and security at the Center for International Studies at MIT, provided all the evidence we need in an August 25 op-ed in the New York Times. In a piece called “Peak Oil Is a Waste of Energy”, Lynch backs our argument from an energy consultant’s fundamental viewpoint.

Peak Oil is a Malthusian argument which states that geological scarcity will at some point make it impossible for global petroleum production to avoid falling. To the Malthusians this could spell economic disaster.

Like many Malthusian beliefs, peak oil theory has been promoted by a motivated group of scientists and laymen who base their conclusions on poor analyses of data and misinterpretations of technical material. But because the news media and prominent figures like James Schlesinger, a former secretary of energy, and the oilman T. Boone Pickens have taken peak oil seriously, the public is understandably alarmed.

Lynch explained that most arguments about Peak Oil are based on anecdotal information, vague references and ignorance of how the oil industry goes about finding fields and extracting petroleum. As an example, he showed how using pumped water in the Ghawar Field in Saudi Arabia scared Malthusians because the field registered 35% water.

However, they failed to mention that the average field is estimated at as high as 75% water!

But those are just the latest arguments — for the most part the peak-oil crowd rests its case on three major claims: that the world is discovering only one barrel for every three or four produced; that political instability in oil-producing countries puts us at an unprecedented risk of having the spigots turned off; and that we have already used half of the two trillion barrels of oil that the earth contained.

He debunks the discovery argument quickly. He describes the fact that at the beginning of a discovery the energy industry chooses to make a conservative estimate of what is in the field. It is almost always revised upward, because of new pockets or improved technology. Those raised estimates are never counted as new discoveries. He says that you hear that all the easy oil is gone. Read Daniel Yergin’s The Prize, which is a history of the oil business from 1855 to today and you’ll realize that there never has been any easy oil.

Once you conclude that the geological claims don’t stand up, Peak Oil folks jump right into the political instability arguments. We all remember the two oil embargoes in the 1970’s and Jimmy Carter’s wool sweater. The major oil producing companies have diversified themselves around the world and have very much moved away from the Middle East dependence. In the U.S., we currently import more oil and gas from Canada than any other country.

Lynch believes that the most misleading claim of the Peak Oil advocates is that the earth is endowed with two trillion barrels of recoverable oil and we’ve used half of it already. The consensus among geologists is that there are some ten trillion barrels out there and based on technological improvements that as much as 35% may be recoverable.

Here is Lynch’s conclusion:

Oil remains abundant, and the price will likely come down closer to the historical level of $30 a barrel as new supplies come forward in the deep waters off West Africa and Latin America, in East Africa, and perhaps in the Bakken oil shale fields of Montana and North Dakota. But that may not keep the Chicken Littles from convincing policymakers in Washington and elsewhere that oil, being finite, must increase in price.

We argue that the constant enthusiasm displayed for the reflation trade and buying energy based on emerging market economic growth rates is a crowded trade. In our experiences, when investors ignore the law of supply and demand it is at their own peril. Lynch argues that supply is abundant and car buyers are reducing their demand with higher mileage cars.

More supply and less demand could spell lower prices and would be very positive for the U.S. consumer, the U.S. economy, corporate profits and owners of quality companies.

Disclosure: no positions mentioned

Comments

[AndrewBaker:]

Oil is being bought and sold on the futures market like black gold, with little regard to supply and demand. If the dollar is down, the oil price should rise, right, as people selling whose own currency is not the dollar will want parity?

No-one is sure if we are starting an industrial recovery or not, so no-one knows what future demand will be, whether up or down, by a little or a lot: so the oil price bears more relation to the stock market and the dollar than it does to how much is needed to be used. For that reason, I'm only taking a position when a definite trend appears, and there isn't one right now.

Sep 10 07:17 AM

[Quaker:]

I was a petroleum engineer who worked on South Ghawar field for 6 years in the 80's.

You really should stick to posting things you have a capacity to understand. Ghawar's water cut is irrelevant to the concept of peak oil.

The only thing more oversimplified than the concept of peak oil is the moronics involved in debunking it. You could fit all the knowledge of oil on financial blogs in a thimble.

Sep 10 07:41 AM

[unfaire:]

You all may remember that in our high school science class we were taught the earth began with an atmosphere full of carbon dioxide, the green house gas. Over many eons, the vegetation on the earth converted them into hydrocarbons and oxygen and the atmosphere became almost all oxygen and nitrogen and it left only a trace of carbon dioxide. Where did all those carbon or carbon dioxide go? I guess they are all there under our foot in the forms of oil, coal, and other carbon-containing materials.
If what the scientists tell us is true, there is so much oil and coal around us it is almost inexhaustible. In fact it is not there are not enough oil and coal to go around instead we cannot afford to use up all those oil and coal. If we do burn them up, it would put our atmosphere back to its primordial carbon dioxide. However, before we even began to burn up some of them, as we are doing now, there would be enough green house gas to cause significant climate changes to make us human beings extinct like the dinosaurs did some million years ago.
Therefore, as we start to see such catastrophic climate changes coming on, we will have to simply stop burning oil and coal. We have to survive on alternate energy sources. There is no other choice.

Sep 10 08:12 AM

[NUCLEAR1929:]

Today it's all about SP500, all trading desks are trading the same stuff and everybody gets insight from the major index like SP,Dow,Dax.
But Oil can go higher, even to $90 to squeeze some shorts, but long term I see $10.

Sep 10 08:41 AM

[TurtleTrader72:]

The weekly trading pattern of OIH (Oil service Holders) suggests that oil has more upside potential over the intermediate term. From the current perspective, OIH appears to be breaking a symetrical triangle pattern (on the weekly charts) to the upside which could take it to the $120 mark over the next several weeks. The longer term Fibonnaci retracements studies also suggest that oil prices could hit the $80 per barrel mark before the year is up. It may be a crowded trade but the technicals still suggest higher prices are to come.

Sep 10 09:13 AM

[Ferdinand E...:]

What is this constant quoting of Michael Lynch. Dont you know that he has constantly been wrong about oil, especially the last few years.
Now he has oil coming down to 30 dollars. According to some moron in Forbes or Fortune early last year it was 20 dollars. And dont you and he and the other amateurs understand that when oil can touch $147/b, peak oil is irrelevant.

Sep 10 09:41 AM

[Chris Cook:]

The first point is that Peak Oil is often mischaracterised as "the oil is all gone" when in fact it's an argument about there being a maximum rate of production, and the costs inviolved in maimtaining that production.

The second point is that the motive of profit maximisation by miners and drillers means that they actually have an economic motive to store oil, gas or coal in the ground when they perceive that the financial assets they would receive in return for producing them are likely to be less valuable over time than if the oil etc remained in the ground.

ie the yield curve of financial assets is one of the principal drivers of the price curve.

Sep 10 09:45 AM

[Living4Divi...:]

Quaker is right - "Peak Oil" is a silly term. The ultra deep water, tar sands and oil shale discoveries have shown us we have not peaked in the discovery of oil or oil equivalents. What has reached its peak (long ago) is the discovery of cheap oil. Take the silly term "Peak Oil" and replace it with "Peak Cheap Oil" and it now makes sense.

There is plenty of oil to be found in ultra deep water rigs and also in oil sands. As the price goes higher, more capital will flow and more oil will be found.

Most of the world's oil isn't distributed by truly private enterprise. Most of the world's oil is in public hands. Even the oil in private hands isn't truly and fully privately owned. As Brazil's recent oil legislation shows, oil in many countries is really considered the property of the state, rather than private enterprise. shareholder considerations are secondary.

On Sep 10 07:41 AM Quaker wrote:

>
> The only thing more oversimplified than the concept of peak oil is
> the moronics involved in debunking it. You could fit all the knowledge
> of oil on financial blogs in a thimble.
>
>

Sep 10 11:16 AM

[Mad Hedge F...:]

zxcvb. Crude has been trading like a 3X short dollar ETF. If you look atpure supply/demand considerations, oil should be trading in the $40-$50range, not the $65-$75 range that we have seen. That means that a $25speculative premium can be laid purely at the door of the big hedgefunds. The big oil producing countries, seeing Obama’s policies leadingto a weak dollar for as far as the eye can see, are also ditching theirbucks as fast as they get their hands on them. That is why the Gulfsheikdoms were one of the biggest buyers of crude near last year’s $148peak. This leaves industry insiders clueless about the price directionof their products, not an easy way to run a business. They understandrig counts, tanker deliveries, and depletion rates, not commitment oftraders reports, Bollinger bands, and Fibonaccis. No doubt it was theircarping that brought regulators to pressure Deutsche Bank to shut downits double long oil ETN (DXO). Of course, this all means the consumeris getting shafted, paying $3.39/gallon at the pump, instead of $2.This premium is causing a drag on the economic recovery as well.Europeans and Japanese who are paying up to $10/gallon are wonderingwhat we are bitching about. Bring on a “W” recession and poof!, thatpremium disappears, as it did last year.

Sep 10 02:35 PM

[Tony Daltorio:]

The article was of time. Can the author tell me when was the last time Michael Lynch was right about oil? Let me help you - NEVER!

Face the fact that the era of cheap, easily recoverable is over. It is gone, never to return.

Sep 10 03:24 PM

[geologist:]

"Once you conclude that the geological claims don’t stand up" --- You are a far cry from coming to any geological claims regarding Peak Oil. Your statement regarding 75% water cut is way off base and out of context.

You have not made any geological claims that stand up, period. Your professor was correct. Regards

Sep 10 03:57 PM

[Erick Tippett:]

You think oil and natural gas prices are going lower here and
globally in the future? When China and India begin accelerating
their purchases of automobiles you will see what supply and
demand can do to oil prices in a way you have not yet witnessed!

E. Tippett
Chicago, Illinois

Sep 11 12:03 AM

[William Dav...:]

Reply to NYT: Peak Oil is not a theory; Peak Oil is the reality of past and future oil production.
Submitted by Kjell Aleklett on Wed, 2009-09-09 20:16. Headline news
(On August 24, 2009, New York Times published an Op-Ed contribution by Michael Lynch with the title: ‘Peak Oil’ Is a Waste of Energy. Kjell Aleklett, president of ASPO International, has written an answer that NYT decided not to accept. ASPO International is now publishing this contribution.)
Kjell Aleklett, Professor in global energy systems at Uppsala University, Sweden (fysast.uu.se/ges) and president of ASPO International (peakoil.net).

www.peakoil.net/headli...

Sep 12 06:03 PM