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Yi-Chang (Leo) Wang
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Yi-Chang (Leo) Wang is a Taiwan-based independent investor. He holds an undergraduate degree in economics from Brown University, has observed and invested in US and Taiwanese stock markets for more than ten years.
• ##### 4. \$100,000 per Barrel Oil 7 comments
Jul 17, 2009 10:38 PM

\$100,000 per Barrel Oil

Please note that this is only an interesting thought experiment to illustrate the huge potential for oil’s price escalation.

Assumptions:

1.     Every percentage change of supply (while holding demand constant) or demand (while holding supply constant) results in roughly a 10 to 30 percent change in price. I heard that this tends to be the experience of long time commodities traders. Citation welcomed. But given that both the price elasticity of demand and supply for oil is very inelastic, this assumption sounds reasonable.
2.     Post-Hubbert peak global oil production decreases at the Cantarell Field-like rate of 13.1% annual decline. While large, due to geographical proximity of Mexico, I think this Mexican oil field should have the highest production transparency, unlike Saudi Arabia. Therefore, actually a good proxy for post-peak oil global petroleum production.
3.     In order to get an approximation for long-term oil price, we will take the average of the highest and lowest oil price over the past 18 months or so as a proxy for the current oil price.

Calculation:

1.     Taking the mid-point of 10 and 30 percent gives us 20% for every percentage change in supply or demand while holding the other factor unchanged.
2.     The 13.1% annual production decline rate, holding global oil demand constant, would result a price increase of 10. 896 times! Equation: 1.2 (20% price increase) raised to the 13.1th power = 10.896
3.     Three years into the future, oil price goes up 1293.6 times, if price goes up 10.896x every year. Equation: 10.896 raised to the 3rd power = 1293.6
4.     Taking the highest and lowest oil price from the beginning of 2008 to now (147.9 and 35.13 respectively), and average them, we get \$91.515 per barrel. Equation: (147.9 + 35.13) / 2 = 91.515
5.     Multiply 1293.6 by \$91.515, we get \$118,383.8 per barrel!!

Is it possible? On March 10, 2000, according to one estimate, Nasdaq’s p/e ratio reached an incredible 264. At the market close of Friday July 17th, 2009; the Nasdaq 100 index ETF, PowerShares QQQ Trust I (or “cubes”), trades at the p/e ratio of 22.8. On March 10, 2000, the Nasdaq composite closes at 5048.62. The composite closes at 1886.61 on 7/17/09. Nasdaq’s p/e at the 2000’s tech bubble peak is more than 10 times today’s p/e ratio! Yet the composite still trades at less than half of its millennial peak value today, almost ten years after…

Looks like the p/e ratio at the tech stock’s market top in March of 2000 reflects future expectation more than two decades, from the time of market top, into the future. My opinion: it’s easier for oil to trade at price level reflecting fundamentals only three years into the future.

Again, this is only a thought experiment…

Saturday July 18, 2009 10:40 AM Kaohsiung City, Republic of Taiwan

DISCLOSURE: The information contained in this article should not be misconstrued as an offer to buy or sell securities. Always consult a professional advisor before making an investment. The author holds no positions in any commodities futures. But I am 100% long in oil and energy stocks.

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### This post has 7 comments:

•

You can buy or trade in both domestic and foreign vehicles so not just the US made cars.

henry
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18 Jul 2009, 07:15 AM Reply Like
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It is absurd to talk about supply and demand driving oil prices higher and higher without considering the effect very high oil prices have on the economy. The price of oil will go no higher than people's ability to pay. If half the nation is out of work then we will be in the deepest depression the world has ever seen. The question then will be: "How low can oil prices go?"

Ron P.
18 Jul 2009, 08:30 AM Reply Like
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Ron is correct. It is likely we've seen the highest price per barrel, ever; that is, \$147/barrel will never be surpassed--BECAUSE of the effect it has on the economy and on demand.

There may even come a time when we can't afford \$14.70/barrel oil.

At \$35/barrel, oil companies can't afford to extract it.

At \$147/barrel, consumers can't afford to buy it.

Get ready for the rollercoaster ride of our lives.
18 Jul 2009, 10:04 AM Reply Like
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This maybe like a game of musical chairs. Each time the music starts the world breaths a sigh and then oil starts to go back up. Towards the end of the music oil goes to the highest possible price for that cycle. Then the music stops, we have a recession or slow down. The price falls right back. But similar to the game of musical chairs, some chairs (read oil production) are removed to never come back.
18 Jul 2009, 12:33 PM Reply Like
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This is insanity.
18 Jul 2009, 02:56 PM Reply Like
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We know the sector is averaging 3.2-mbd/yr in new capacity additions. Due to known reserves and resource, we know they can keep this pace for almost four more decades.

We know underlying decline has averaged only 2-mbd annually since 1970; and is only 2.6-mbd in 2009.

We know the 6-mbd of world spare capacity guarantees several years of new monthly/quarterly/annual production records.

Our monthly tracking of price components via the Barrel Meter over the years has been insightful. These are the real assumptions of fundamentals to consider and the reason oil is probable to be less than \$100/barrel five years out: www.trendlines.ca/mont...

19 Jul 2009, 02:53 PM Reply Like
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Hold a minute: Think about this: at US\$600/barrel oil trade would consume 100% of global GDP! Hence really \$600/barrel is the (absurd) limit at todays consumption. At \$150/barrel we would have used 25% of global GDP to purchase our oil. This perhaps is a more realistic wall for the price. Beyond this, drastic market contractions would curb demand to keep the price about there I think, just as happened in 2008.
21 Jul 2009, 10:37 PM Reply Like