Oil Price Cycles Up, Then Down

I’ve been having an interesting email discussion with Matt Trivisonno about some energy issues. What started it was our prior discussion on Why is Oil Dropping (and what might its impact be)?

Matt is more bullish than I (to say the least). I found his 20 points as to how and why Oil prices have been all over the place interesting; consider it a bit of counterprogramming.

Here’s Matt’s 20 point chrononlogy:

1) Oil is cheap in 2002, there is no investment, oil infrastructure decays

2) Everybody "knows" oil is an inherently cheap commodity

3) Oil producers fail to forecast robust global growth and oil demand

4) Prices rise as market signals its needs to producers

5) Oil execs still reluctant after being burned in the last bust

6) Prices rise more as global growth continues

7) Oil companies begin to invest, but increasing supply takes years

8) Oil prices rise some more

9) Oil companies are now scrambling to meet demand

10) SUVs still selling as drivers expect gasoline prices to fall after

11) Speculation picks up

12) The new boom induces oil-investing mania

13) Everybody "knows" that oil always goes up

14) Capitalism works after all, and supply finally meets demand in 2006

15) But the speculation-turbo-charged price of oil induces a demand shift

16) Drivers capitulate and switch from Detroit SUVs to Toyotas

17) The demise of the Hummer H1 in June marks the top of oil prices

18) The huge oil inventory built up by speculators cascades onto the market

19) Prices plunge as the economy signals "that’s enough" to producers

20) Lower energy costs feed back into continued global growth

I have 4 primary difference with Matt:

a) Notably missing is the impact of the Fed cutting
rates to half century lows, and how that impacts any dollar denominated
commodity (oil, gold, real estate, etc). I believe that was quite a significant event;

b) What? No terror premium?

c) The switching process from SUVs to more fuel efficient vehicles takes much longer, as drivers are stuck in leases, ownership, etc.

d) Oil only goes up? I thought it was Real Estate that only went up!

Anyway, its a thought provoking scenario regardless . . . 

Thanks, Matt!


Will OPEC Collapse in 2006 Like it Did in 1986?
Matt Trivisonno
Techsono, September 30, 2006

Demise of the Hummer
Phil Erlanger
Minayanvcille, Aug 09, 2006 12:52 pm

Pain From ’80s Factors Into Oil Now
James J. Cramer
RealMoney.com, 3/17/2005 11:21 AM EST

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What's been said:

Discussions found on the web:
  1. bb commented on Oct 2

    Good to see some thought -provoking economic thought here , fully agree

  2. T commented on Oct 2

    The changeover to higher MPG vehicles will take at least 5-7 years or more — necessarily, it’s going to take longer than one replacement cycle of the auto market, since buyer behavior will take 2-3 years at least to roll over (this seems at least to have started.) I’m still seeing lots of brand-new looking SUVs and Pickups on the road — and even if they change owners, most of them will still be in use 10 years from now.

    A lot of this goes back to the saying … “in the long run… we’re all dead.” If you make your timing window wide enough, the market will eventually adjust for excess… but the wait can be painful.

  3. wcw commented on Oct 2

    Iran wants and needs to sell crude. I would relabel it the way our host did, as a ‘terror premium’ which encapsulates a host of more-realistic worries.

    When the market worries, it builds storage, as it has been doing.

  4. M.Z. Forrest commented on Oct 2

    A couple things:
    1) The shift from a typical 20 mpg to 30 mpg is significant, but overplayed. It is a 50% increase in efficiency. The last big shift, from 10 mpg to 20 mpg, involved a 100% increase in efficiency. In short, we are dealing with diminishing returns.
    2) Oil has had a selloff, but supposedly the oil producers were always priced for $40 oil in the oil run up. Oil is around $60 presently. There is a long way to go from $60 to $40 and from $40 to $20. That is a long way from the 90’s when it averaged around $20/bbl. I think a reasonable argument can be made that $40/bbl is the new floor.

  5. Alaskan Pete commented on Oct 2

    The estimated “fleet rollover time” (replacement cycle) for the US is approx 12-14 years. Claims of a substantial shift from gas guzzler SUVS to fuel efficient 4 bangers is really reaching IMO. Maybe other conservation measures were also in play (drive the sedan more and the Suburban less, teenagers can’t afford to cruise as entertainment, etc).

  6. tjofpa commented on Oct 2

    How about some analysis of the price of oil versus global excess CB reserves floating around out there. I seem to remember that $12/b oil back in 1999 coincided with Cinton’s budget “surplus”. (I’ve still got a receipt from 3/99 at .899/Gal!)

    International reserve assets (excluding gold) – as accumulated by Bloomberg’s Alex Tanzi – were up $549 billion y-t-d (18.1% annualized) and $625 billion (15.8%) in the past year to a record $4.595 Trillion.

    It seems funny how every time we report another record trade defecit everything starts to rally.

  7. Rado commented on Oct 2

    Great points Barry. I don’t know why people fail to see that Oil is going much lower from here ($40-45)
    It’s a cycle and it always will be, until we start to use a different energy source

  8. ilsm commented on Oct 2

    The last bust was caused in part by alternatives, more by recessions.

    It makes no sense to price oil out of the competition and also cause a string of recessions.

    Bring prices down a little now to prevent big drop soon.

    For these reasons and the fact that oil pricing prevents alternatives there should be either a tax on oil to make to encourage alternatives or a better record of DoE research grants to get alternatives moving.

    There are a number of economic reasons for energy diversity and none are supported by the various incarnations of oil cartels.

  9. Brian commented on Oct 2

    Trading in our 2 MPG Canyoneros for something more fuel efficient won’t matter all that much with 3 billion people in India and China buying cars. Or wanting to at least. Even if they’re all Yugos.

    That’s the theory anyway.

    Every shoulder season we get “oil has topped” stories. Every summer it’s reaching for 80.

  10. snook commented on Oct 2

    Hum, I recall saying don’t trust OPEC speak, however, listen to the Saudis…. Looks like Chavez IS giving them a reason NOT to pull back on production. Great… crude just might close below $60 this week. Did anyone pick up on Ford not projecting higher sales of F-100 pick ups….wonder what that means? Building contractors now buying Bentleys?

  11. Steve Goulet commented on Oct 2

    My favorite peak oil alarmist (http://www.kunstler.com/Grunt%20Archive.html) is claiming that world oil production is on track for a 2.5% decline in 2006!

    Also, page 16 of this PDF (warning – long download) on Matthew Simmons’ Website shows production slowing during the first 5 months of 2006:

    This is not gasoline production so you can’t blame it on the refineries. With production falling, refineries slow to come online, and no sign of any relief on the supply side, I see this as a buying opportunity.

  12. S commented on Oct 2

    Richard Branson, Vinod Khosla, Bill Clinton, Al Gore, and others raised over $7 billion for a private equity fund focused on renewable/alternative energy. In a Charlie Rose interview, Vinod claimed we’ve got about 10 years to figure out alternatives to carbon based fuels before the climate is irreparably damaged.

    These guys have the ear of policymakers. If the Dems take the House next month, I wouldn’t be surprised to see new environmental/tax legislation designed to encourage research and investment in alternative energy sources and/or discourage the use of carbon based fuels to try and reduce demand for oil.

    But oil is a global commodity and there’s only so much we can do to reduce demand. The reality is about 60 million people are added to the planet every year creating demand for resources. And countries like China and India are rapidly building out their domestic infrastructures also increasing marginal demand.

  13. GRL commented on Oct 2

    One thing that also ins not discussed is the role of technology in demand-substitution, which in the sequence above, would come somewhere after point 15and look like this:

    15) But the speculation-turbo-charged price of oil induces a demand shift

    16) Drivers capitulate and switch from Detroit SUVs to [hybrid] Toyotas

    16A) Buildings use new technology to increase energy efficiency, thereby further reducing the long-term demand for oil

    16B) Over the longer term, energy producers rely on new techhnology to improve the efficiency of existing and new oil, coal, and natural gas fields, and invest in other forms of energy, such as nuclear, biofuels, solar, and other renewables

    John Mauldin’s “Outside the Box” had an extremely interesting discussion of this whole issue (which Mauldin does not agree with, but I do) from GaveKal:


    Having lived through the last “energy crisis” in the late ’70’s and early ’80’s, I can say that the latest run-up in prices is nothing new (“peak oil” B.S. to the contrary notwithstanding). The only difference is that this time the impact has not been as severe because the market, at least so far, has, for the most part, been allowed to operate, sort of.

  14. spencer commented on Oct 2

    I generally agree with the bulk of the analysis, but have some problems. One, we have only seen a very marginal easing of demand growth– as June 2006 gasoline demand was right on its post-1993 growth trend. The real thing we are seeing is dishoarding as
    oil was no longer a one-way bet.

    The dishoarding, etc has caused oil to fall from $78 to $60 and it has flucuated around this level for some time.

    So is the $60 level simply a matter of squeezing the speculative excess out of the market, or it simply a temporary stop on the way to lower prices?

    While Matts analysis is good, does it really provide any information that answers that question?

  15. spencer commented on Oct 2

    Second question. In current dollars the real peak in oil prices was around $100 in 1980.

    If we really are at peak world oil production why is the real price of oil still rougly 25% lower then it was 25 years ago?

  16. Rich commented on Oct 2

    4A : When the dollar declines 20% versus the Euro and other currencies, the price of oil rises by 20%.

  17. Athol commented on Oct 2

    “Bobby, the price of oil is never comin’ down.” – J.R. Ewing, Dallas 1979-80

  18. wunsacon commented on Oct 2

    Can you name the truck with four wheel drive,
    Smells like a steak, and seats thirty five?
    Canyonero! Canyonero!

    Well, it goes real slow with the hammer down
    It’s the country-fried truck endorsed by a clown
    Canyonero! Canyonero!

    Hey, hey!
    Twelve yards long, two lanes wide,
    Sixty five tons of American pride!
    Canyonero! Canyonero!

    Top of the line in utility sports,
    Unexplained fires are a matter for the courts!
    Canyonero! Canyonero!

    She blinds everybody with her super high beams
    She’s a squirrel-squashin’, deer-smackin’ drivin’ machine
    Canyonero! Canyonero! Canyonero!
    Whoa, Canyonero! Whoa!

  19. whipsaw commented on Oct 2

    So let me get this straight- some of you think that it is perfectly natural for oil to arch up to extreme levels over four years, then fall 20% in a little over a month and gas prices go down before Labor Day? No monkey business to see here, move along?

    So how are you going to explain it when during the post-erection period beginning about November 15, there begins a series of “crisis events” that result in an “unexpected and unsettling” spike? You can call that “the market” if you want to, but I’d call being cockslapped by the Oil Government again, this time to the point of scars rather than deep bruising.

    Ruat coelum, fiat regis voluntas! Too bad none of you kids understands Latin, actually a very useful source of pointed barbs.

  20. S commented on Oct 2

    A man who can work Latin words AND “cockslapped” in the same post. You da man.

  21. whipsaw commented on Oct 2

    per S:
    “A man who can work Latin words AND “cockslapped” in the same post. You da man.”

    Like Huey Long, I know how to make a point in plain English and then justify it in words the crowd does not understand, but appreciates nonetheless. :P

  22. Brian commented on Oct 2

    Energy Dept. to Delay Oil Purchases
    By Associated Press
    6:10 PM PDT, October 2, 2006

    WASHINGTON — The Energy Department will hold off purchases of oil for the government’s emergency reserve through the upcoming winter, the department said Monday.

    The department said it will not try to recover 1.7 million barrels of crude oil that it loaned refineries a year ago after Hurricane Katrina, nor would it seek to purchase additional oil for the reserve until next spring so as not to take oil off the market during the heating season.

  23. whipsaw commented on Oct 3

    per Brian:
    “the department said it will not try to recover 1.7 million barrels of crude oil that it loaned refineries a year ago after Hurricane Katrina, nor would it seek to purchase additional oil for the reserve until next spring so as not to take oil off the market during the heating season.”

    All of you dope smoking libertarians get in line for the cockslapping, they’ve already told you that they can control the markets, you just don’t want to accept it. heheheh. I am selling futures in “facial wipes” if any of you care to hedge.

  24. tjofpa commented on Oct 3

    u git my vote for post of the year!
    Had me LOL at 8 am.

  25. dwarfdawg commented on Oct 7

    I’ll second that, tjofpa. I just read the post a couple of minutes ago and it had me LMAO. I don’t know what tune (if any) it is supposed to go with, but it would be great material for one of those hoedads with the fake redneck accents on the country music circuit to take to No. 1 on the Billboard chart.

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