That's the title of my latest research paper. Here's the summary from the paper's introduction.
How would one go about explaining what oil prices have been doing and predicting where they might be headed next? This paper explores three broad ways one might approach this. The first is a statistical investigation of the basic correlations in the historical data. The second is to look at the predictions of economic theory as to how oil prices should behave over time. The third is to examine in detail the fundamental determinants and prospects for demand and supply. Reconciling the conclusions drawn from these different perspectives is an interesting intellectual challenge, and necessary if we are to claim to understand what is going on.
In terms of statistical regularities, the paper notes that changes in the real price of oil have historically tended to be (1) permanent, (2) difficult to predict, and (3) governed by very different regimes at different points in time.
From the perspective of economic theory, we review three separate restrictions on the time path of crude oil prices that should all hold in equilibrium. The first of these arises from storage arbitrage, the second from financial futures contracts, and the third from the fact that oil is a depletable resource. We also discuss whether commodity futures speculation by investors with no direct role in the supply or demand for oil itself could be regarded as a separate force influencing oil prices.
In terms of the determinants of demand, we note that the price elasticity of demand is challenging to measure but appears to be quite low and to have decreased in the most recent data. Income elasticity is easier to estimate, and is near unity for countries in an early stage of development but substantially less than one in recent U.S. data. On the supply side, we note problems with interpreting OPEC as a traditional cartel and with cataloging intermediate-term supply prospects despite the very long development lead times in the industry. We also relate the challenge of depletion to the past and possible future geographic distribution of production.
Our overall conclusion is that the low price-elasticity of short-run demand and supply, the vulnerability of supplies to disruptions, and the peak in U.S. oil production account for the broad behavior of oil prices over 1970-1997. Although the traditional economic theory of exhaustible resources does not fit in an obvious way into this historical account, the profound change in demand coming from the newly industrialized countries and recognition of the finiteness of this resource offers a plausible explanation for more recent developments. In other words, the scarcity rent may have been negligible for previous generations but is now becoming significant.
You can read the entire paper here. Comments welcome from all.
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This article has 10 comments:
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ship shape and bristol fashion
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59 Comments
May 25 10:23 AM-
ARTCOL
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2 Comments
May 25 11:15 AMup by around 10% since 1989 whilst the number of rigs
has gone up by 800% in the same period? Surely, the
canny Saudis would not continue to pay for these expensive rigs if there was no prospect of finding oil? Or is it having struck oil in increasing quantities they have deliberately chosen to leave it in the ground for future generations and the future security of the Saudi Royal family?
Either way, this paper should be required reading for oil analysts .
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Dr. No
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27 Comments
May 25 11:49 AMIn fact, since 2000 the global assets under management have increased by 50%, all looking for superior returns, all chasing the same opportunities creating demand without increases in the underlying assets, or did the world economy expand by 50% from 2000 to 2006?
The sad part is that once oil drops back to 50-70, corn to 2.00 alternative energy may not look that attractive anynmore, so the cleantech bubble will pop too.
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ship shape and bristol fashion
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59 Comments
May 25 11:53 AMThey need these rigs to drill additional wells in existing fields in order to make up for the decline. When the natural pressure drops you need to apply artificial pressure by drilling new wells and injecting seawater for example.
This is one reason oil is getting more expensive. The costs are simply going up.
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Jack Yetiv
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442 Comments
May 25 01:07 PMIn contrast, multiple OPEC chiefs have made it clear that they are happy with $120, and indeed, remarks by OPEC chiefs made recently while oil was at $130 might suggest that OPEC will be happy with $130. I'm not as sure they will be happy with $150 (demand destruction risk) but some people believe OPEC does not have much spare capacity to limit upside moves in oil.
Although many people doubt how much OPEC can RAISE production, nobody can have a doubt that OPEC can LOWER production, and few should have a doubt that OPEC will do EXACTLY that if oil threatens to go below $100. OPEC countries have tasted the sweet fruit of $135 oil and will not go back to the (now) sour taste of $100 oil.
For the above reason, this world will never see 2-digit oil prices on a per-quarter-average basis.
Jack
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gigem77
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99 Comments
May 25 03:48 PMThe oil market is a multi trillion dollar annual market, there just isn't enough money out there to manipulate it for anything but a very short time frame, likely days. In fact index funds buy futures contracts and sell the near month, so this should actually put downward pressure on the the near month.
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OilDaddy
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6 Comments
May 25 06:06 PMTake it from one who lived through the past fifty years' destruction of the world's oil producing capability and knows it will take another ten years to train the technicians and rebuild the equipment manufacturing facilities required to restore the oil industry to some resemblance of its former self!
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lntwo
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13 Comments
May 26 02:02 AM-
ship shape and bristol fashion
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59 Comments
May 26 04:48 AM-
ArtfulDodger
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133 Comments
May 26 03:09 PMGreat article. But you are leaving out one important point that every well-seasoned investor must understand: what I call "the scam factor."
You have to be a child and not have lived through the oodles of pump and dump acts that the NY crowd scams the public with to go for this one.
How can so many people believe that, all of a sudden, China and India are grabbing up all the oil in the world, causing prices per barrel to rise 50% over a few months?
China doesn't even report how much oil it buys, uses, or stores. The best we can guesstimate is that over the last five years China has gone from 4.9 million bpd to a little over 6.8 million bpd. The US uses about 20 million bpd.
How can so many people believe that, all of a sudden, there is a shortage of oil? That refiners can't refine enough oil? That there are break downs in the infrastructure lines?
Does no one remember the 1970s?
It's the same old slop warmed over, and the investing public is going for it again—big time!
Known reserves (fairly easily retrievable oil) in 1970 were about 560 billion barrels. By 2000 they were over 1 trillion. Eight years later they are about 1.6 trillion. (see PS below)
The world uses somewhere between 75 million bpd and 86 million bpd. (Nobody is exactly sure, though; these are estimates.)
What's the problem? Where's the shortage?
The telling sign that the first major downturn is about to come is that after Goldman Sachs and T. Boone and nearly everyone else you can imagine came on the tube pumping the ppb at $150 & $200, the price has not moved even 5% since then (from $127).
Pickens has been an oil bull since the 70s, and GS always piles on late to get the public in after the momentum players are fully invested.
If the ppb continues to stall in the low to mid-130s, the momentum players will know the public is finally fully invested. There will then be no more money to go in.
So when they've depleted the public's pockets, they'll start dumping and the public (suckers that WSt. uses them as), which is now buying oil and energy stocks as never before, will get killed—per usual.
That's a view from someone who bought his first stock in 1967 and has been watching the NY crowd run these scams on the public for the last 35 years. They use the same method of operation over and over. And why shouldn't they? The Congress doesn't understand what they're doing, and quite frankly, few other people do.
Jim Cramer has admitted to doing this back when he ran a hedge fund; the people running these operations aren't smarter than the average bear. They're simply more crooked and devious.
They're greedy and heartless, too. They won't stop. Soon after the "we're running out of oil" and "China and India are using up all the world's oil" and "refineries can't refine enough oil" scam is over, they'll move to another sector and within a few months the financial media and the Big NY Houses will begin pumping it. And, guess what? The public will go for it again.
Rebeldog
PS: Iraq has just announced that its latest survey shows that they have another 225 billion barrels in reserve. Thus, add another 225 billion barrels to the World's reserves.