Thursday, October 23, 2008

Plain Old Scary

Not quite a year ago, during our Friday night dinner, a real estate broker friend and I were talking about energy and peak oil. He said that oil was way over priced and that a big bust was coming. At the time, oil was not even close to 100 a barrel. Knowing that the world has likely hit the peak of oil production, I disagreed strongly. Given that he is a real estate broker, and I'm an energy know it all, we bet on it.

His number was so low, I don't even remember it. (I think it was in the 30s)

As the price of oil almost hit $150.00 during the summer, I remembered our dinner bet thinking I might claim my free dinner in the next year or so, after oil had gone through the $200.00 dollar mark.

But I also remembered my caveat in the bet, and that was of course, "anything can happen", especially if we have a depression that completely disinflates all kinds of commodities, and at the same time destroys demand.

Well, oil is under 70.00 dollars this week and the "anything can happen" caveat is looking breaktakingly possible. Of course, this is the short term trend, and it was just early 2007 when oil was trading at 50.00 a barrel. Except for the bumps from the oil embargo in the early 80s, the long term oil trend has been pretty flat with a strong upward movement since 2000.

If world demand seriously weakens, then we can expect to see even lower prices. However, world demand is still at or near peaks. Still, the oil market is a huge, finely tuned market, and "a glut" is defined in small percents, as is a shortage. And each condition is greatly exacerbated by investors and speculators.

And that brings me to this piece from John Michael Greer who writes about the Tyranny of the Immediate. Here's a small part of it, but it's worth a full read.

"Most people who didn’t live through the opening years of the last Great Depression leave school with the notion that when the stock market crashed in the fall of 1929, the economy reached a full stop by the time investors stopped plummeting from Wall Street windows.

In reality, it took more than three years for the economy to finish contracting, and scenery en route included a dramatic stock market rally in 1930 and some of the best days of rising prices, in percentage terms, that Wall Street has ever seen. At every point along the course of contraction, furthermore, financial pundits drew false conclusions from short-term changes. The resulting headlines have more than a little similarity to the ones that clutter the financial press today.

This habit of reading too much into short-term conditions has shown itself more than once in the recent economic convulsions, and guesses about the future price of oil – a subject of interest to many peak oil researchers – have been particularly affected.

Earlier this year, as the price of oil soared to $143 a barrel, a great many people argued that it would keep on climbing to $200 or $250 a barrel in the near future. Now that the price of oil has slumped below $70 a barrel, the tide of opinion has turned, and some pundits are now predicting a continued slump to $50 or even $35 a barrel.

These predictions seem quite plausible at the moment they’re uttered, but then so did the idea that shares in dot-com startups would keep on climbing in value all through 2000.

The problem with linear projections of oil prices is that several factors unrelated to ordinary issues of supply and demand dominate the price of petroleum just now.

One of the most important comes out of the crucial but rarely remembered fact that, while oil is priced in US dollars, most of the oil in the world these days is produced and used in countries where the US dollar is not the local currency.

Since the value of the US dollar has been anything but stable of late, the price of these transactions in dollars has changed dramatically, while the price in any other terms has remained much more stable. (clip)

Even more dramatic though, has been the effect of commodity speculation on the price of oil.

Those economists who still insist that a completely free market will manage production and price with perfect rationality have apparently done their best to ignore the multiple monkey wrenches speculation throws into the market’s machinery.

The crucial point to realize is that the results of speculation, unlike most other economic phenomena, are radically asymmetric over time." more

I'm probably going to have to buy my friend dinner pretty soon... maybe not because we hit the price he said we would hit just a year ago, but because the general condition of falling prices in the oil market is clearly upon us.

And yes, the world probably did reach the all time peak in oil production last summer.

And yes, the price of oil may go below $50.00 a barrel by Halloween.

And that is just plain old scary.

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Anonymous Anonymous said...

I think in the next year, if you factor inflation into the price of oil, you will have won your bet.

11:30 AM  
Anonymous Anonymous said...

A strong dollar should bring the price down. But how will a reduction of 1.8M barrels of oil per day on the market impact supply and demand - and prices? Will Saudi Arabia try to keep production and supply up over an interim period to keep Venezula (who "screwed" SA in 1973), Iran (Sunni vs Shitte), and Russia (keep them from medeling any further, especially in the Middle East) down? There may be a short term trend down, but over the long run is not the trend up, given the declines in world wide supply?

10:21 AM  

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