This weekend, we are in Chicago for a family event. After dinner (over Kir Royals), we discuss the economy, tax cuts and Oil. The subject of whether Oil is a bubble comes up. What’s become a now standard argument — that Oil, inflation adjusted, is relatively cheap (see chart at left) — gets made.
My B-in-L Bob, a very senior BP exec (now retired), is the one who initiates the "Oil is a bubble" discussion. All the inflation adjusted charts seem to only go back to include the 1970s — and that’s not far enough to show the true price trend of oil. Bob argues that Oil has been in a very long downtrend, and the 1970s price spike was an aberration. So too, the 2003-05 run up. A longer, inflation adjusted chart would reveal that the present spike is aberrational, and unlikely to be sustainable. I am somewhat incredulous of this claim.
His point however, is well taken. While he is expecting an eventual mean reversion, simply base dupon price, I have a similar expectation based upon market cycles. The next recession (there’s always a next recession, just as there’s always a next recovery) will see reduced demand for Oil, and that will allow prices to fall.
By coincidence, an article in the NYTimes the next day has this chart in it of the real price of Gasoline for the past century. Surprisingly, it supports Bob’s position pretty well:
Graphic courtesy of the NYT
Let’s look at this technically: This chart is of a very long downtrend. There was a minor spike in the 1930s, which eventually reverted back to trend. There was a major spike in the 1970’s; It subsequently collapsed in price some 50%, from $3 / gal to $1.50, over the 1980 to ’84 timeframe. It would not be outrageous to call that price action bubble-like.
This certainly supports the argument that Gasoline/Oil prices are unsustainably high at present, and will eventually revert back to trend. However, as the prior two spikes make clear, the key is the word eventually. It typically takes about a half of a decade or longer for this mean price reversion to occur. With Oil prices still in an unptrend at present (i.e., no reversals indicated yet), this implies that $30 a barrel (real) oil may be a phenomenon no sooner than 2010. Work that data into your econometric models — high oil persisting at least another few years — and the 2006-2008 period is an even more pronounced recession than I have previously suggested.
Incidentally, consistent with our views on multi variant analysis — a single factor should not get all the credit or blame for major economic or market events — the significant strength of the 1980’s can be as easily traced to the plummeting cost of real gasoline as it could to tax cuts, interest rates, or the stock market. Looking at this helps to explain to some small degree why the 1980s were such a powerful economic period.
At the Pumps and on the Web, Drivers Check for Lowest Prices
NYTimes, August 13, 2005
The Plot Thickens
UP AND DOWN WALL STREET
Barron’s MONDAY, AUGUST 15, 2005