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What About $67 Oil?

June 8th, 2012
in contributors

by Andrew Butter

The story so far:

1: There was a bubble in oil prices in 2008. The evidence for that is it popped which is a pretty good clue; although so far no one has figured out what drove the bubble. Yes it was probably speculators with access to easy money, but sadly no smoking gun has been found, although one gets the impression no one looked very hard.


2: The bubble popped, like bubbles tend to do, and collapsed - then the price drifted back to what appears to have been the “equilibrium” at the time of $80 to $90 a barrel if you are talking Brent. Although by that time too Brent and WTI de-coupled so there is a bit of uncertainty about which line you should be following– if either…using your genius model which was based on a history when WTI used to sell at a premium to Brent.

Follow up:

2:  (Continued) Regardless, the dynamic of the bubble…Blow-Pop-Recover…looks about as perfect an example of the “theory” of BubbleomiX as you will find anywhere; in that the equilibrium [E] looks like it pretty much equals the square-root of the minimum [M] multiplied by the crest [C]:

E = √MC

That is reminiscent of that other General Theory, and I’m not talking about Keynes’ one, by the way, and of course that doesn’t mean it’s right.

3: What followed looked suspiciously like another bubble, with causes still as mysterious as the cause of the first bubble.


4: But after a bit of a wobble, it looks suspiciously like that one is popping too.


This is a chart I put out in March 2012 which I have updated and annotated, which summarizes the action so far:

Click on graph for larger image.

So in March 2011 your Humble Guru was predicting a big fall to roundabout $70 for Brent by November 2011, so therefore either the guru is an idiot or the theory is wrong…or both.


Editor's note: Read the author's articles describing his attempts to define the course of a bubble scenario, in reverse chronological order:  Here, here, here, and here.


Well this wannabe has been exposed as a blithering idiot many times before, so that’s not something worth debating.

The interesting question is whether the theory is any good, and specifically is it any use in making predictions?


There was a caveat of course…all self-respecting gurus have caveats….and that was that [IF] there wasn’t a pop [THEN] that would mean Peak Oil was starting to be a reality, in which case the price of oil would start to be dictated not by what the customers can afford to pay which many people agree is about 3.3% of nominal GDP (so divide that by production and you get to price – that’s called Parasite Economics).


Instead, if the game changes, then the price will be driven by the expected cost to discover and then develop and then transport, oil that hasn’t been discovered yet….i.e. the cost to replace the stuff that has been discovered so far. So, if there isn’t a pop soon, that means Peak Oil has started to be a reality.

So if the theory is right, then the mini-bust mid-2011 might actually get properly expressed in …mid 2012? Or maybe not…looks like the timing of the reversals correlates pretty well with summer blues; that could be what’s happening this time. But if Brent goes down through $90 then this time…it might just keep going.

That will be good news for the spluttering Western economies, particularly U.S.A. which hugely subsidizes the real cost of consuming oil, and pays for that by selling it’s birthright either in U.S. Treasuries, or (previously) AAA rated collateralized debt obligations which had the advantage of being non-recourse, but sadly the supply of dumb aliens willing to buy those seems to have dried up in recent years.


The subsidies in the Land-of-the-Free-Lunch (for the 2% with connections) were a crony capitalist hangover from the days when U.S.A. was more or less self-sufficient in oil. The good news there is apparently, these days, fuel consumption is the major thing new car-buyers are looking at, and finally, with shale-gas so abundant the smarter people are starting to talk about using that to replace oil in trucks, and perhaps some cars.


A pop will also be good news for oil exploration companies too, yes really!! That’s because if the pop is cleanly expressed this time, that will demonstrate pretty conclusively that $70 Brent is the bottom line, and that $90 to $100 is where the equilibrium is….as opposed to the possibility oil will go to $40 and stay there which would kill large-scale investments that have five to ten-year pay-backs.


Of course if there isn’t a real-nice pop, then that will be a sign Peak Oil really is coming to town, which is really good news for anyone who has the capability to find new stuff.


Interesting times!!!

 

More by Andrew Butter

analysis blog opinion blog investing blog

 


About the Author

Andrew Butter started off in construction in UAE and Saudi Arabia; after the invasion of Kuwait opened Dryland Consultants in partnership with an economist doing primary and secondary research and building econometric models, clients included Bechtel, Unilever, BP, Honda, Emirates Airlines, and Dubai Government.

Split up with partner in 1995 and re-started the firm as ABMC mainly doing strategy, business plans, and valuations of businesses and commercial real estate, initially as a subcontractor for Cushman & Wakefield and later for Moore Stephens. Set up a capability to manage real estate development in Dubai and Abu Dhabi in 2000, typically advised / directed from bare-land to tendering the main construction contract.

Put the unit on ice in 2007 in anticipation of the popping of the Dubai bubble,defensive investment strategies relating to the credit crunch; spent most of 2008 trying to figure out how bubbles work, writing a book called BubbleOmics. Andrew has an MA Cambridge University (Natural Science), and Diploma (Fine Art) Leeds Art College.










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1 comment

  1. erdento says :
    ****-

    I've been following the model of oil prices mentioned here and developed in previous articles. And, now, it seems we have an opportunity to see how well it conforms to the recent past and current conditions. Let's assume the model is correct, what amount of time should elapse between the recent peak and a slowdown in GDP? Is there a way of using the model to anticipate the amount of decrease in GDP from the preceding level of oil prices? One other question: with the recent fall in oil price, how will that feedback into the rate of GDP growth and will it remove enough of the previous loss of GDP from high oil prices to prevent a dip into recession?

    The governing effect of oil on GDP that this model predicts seems like a feedback loop, in this case a negative feedback, on GDP growth. But, when GDP drops, and oil consumption decreases, the price of oil falls and this acts like a stimulus or less of a retardant on GDP growth. It seems that the feedback loop will induce an oscillation of alternating GDP growth and contraction phases mediated by the negative feedback of the price of oil. A decrease in the price, when treated as a negative feedback component becomes a positive input to GDP (negative of a negative = positive). The question is the delay time between GDP changes and oil price changes. Taking the idea of a feedback loop further, it also seems that the phase angle matters. By this I mean where in the business cycle the increases and decreases occur. If the oil price increases occur in the early stages of the business cycle they probably would not be as detrimental as if they occurred in the late or declining stages. Similarly, where in the business cycle the price decrease occur may have a differing impact as well. If they occur at the peak and headed down, it seems like the effect would be more beneficial than if they occur at the bottom.

    As the article mentions, now we get to see just where the new floor price is for oil if a global slowdown pushes total oil consumption to a minimum for the current state of the global economy.

    The potential volatility of oil prices and GDP growth and contraction phases suggested by this model would appear to conform to the regimes of oil price stability and volatility that Kenneth Rogoff found in his recent research paper on oil price epochs. This traced oil prices back to the nineteenth century and found several distinct epochs of stable and unstable price regimes. These regimes may (I have not checked this) coincide to the epochs of alternating stable and rising commodity prices that Martin Pring has shown, also going back to the nineteenth century.





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