Monthly
Discussion
The Price of
Oil Revisited
The
October 11, 1999 issue of the Newsletter was devoted to "Who Is Pulling
the Strings on the Price of Oil?" We saw in there that OPEC decisions on
production levels, political rhetoric, sanctions lifting, and diminishing
reserves are not among the prime movers that determine the long-term price of
the world's primary energy. On the contrary, oil seems to have its own way and
means to keep its price rather stable with only rare and well-defined
exceptions.
I reproduce below the main exhibit
from that discussion now updated with monthly data from the year 2000. We see
the striking periodic flare-ups of the price of oil resonating with the
Kontratief cycle. As discussed in Predictions
the price of society's primary energy source increases manifold toward the end
of an economic boom. This increase is very localized in time, however. For more
than two hundred years such increases have recurred in intervals of 55-56 years
and have lasted for at most several years. At the same time, such price
increases become invisible in the graph of Exhibit 3 if they last less than one
year (example the price flare-up during the Gulf war).
Exhibit 3. Annual averages for the price of society's primary
energy (see Predictions for an
extensive discussion of this graph). The last nine data points (open circles)
are monthly data for year 2000. The red point is year 1999, still conforming to
the "canonical" price range.
Year 2000 has so far seen high oil prices giving
rise to such rumors as the possibility that oil price eventually stabilizes at
around $50. If this were to happen, the level of the graph in Exhibit 3 in 1996
dollars (following a correction for inflation) would reach around $56, and the
regularity of the pattern would be completely destroyed. In fact the pattern is
all ready destroyed when we include the monthly data points reflecting the
price progression during the last nine months. The only way that the general
pattern of Exhibit 3 can be preserved is if the price of oil goes back to the
$22 - $25 range the latest in several months from now.
There is nothing magic about patterns on price
charts and I can assure you I am not superstitious! But I am convinced that the
level of the natural price of oil has
its roots deep in the works of our society. Energy is the ultimate food for
life, and that makes its price something next to being sacred. Even though
natural gas is slowly replacing oil (and will continue doing so to overtake it around
2010), today oil still constitutes the world's major energy source providing 40%
of the world's energy needs. Taking the bread out of people's mouth could
result in a popular uprising, or trigger a revolution. We came very close to
that in the European Union during the last couple of weeks when popular
uprising of truckers and taxi drivers protesting against high oil prices
managed to grind the French and British economies to a halt.
No one can dictate or force the price of oil too far
from its "equilibrium" position. This position—the range $10 - $24 of
1996 dollars—is what we find to be the case in Exhibit 3 for all times except
the handful of years at regular intervals, when spikes occur. All fluctuations
on the day-to-day or month-to-month price movements must be confined within
this price range when averaged over a
year or so. Consequently whenever you see price excursions of factors of 2
or 3 (a factor of 2 occurs all ready at a spot price of $36) well before the
2030s, it is time for you to buy your puts on the price of oil.
If you are conservative, like me, and want the extra
insurance, make sure your puts cover a period of several months.