$150 Oil? Don’t Go Malthusian (geopolitical premium at issue)

“The misinterpretation of high oil prices as driven by geological scarcity instead of transient problems exactly mirrors the mistakes of the 1970s, suggesting that some, at least, never learn from history.”

Suggestions that the oil price will soon reach $150 or more need to be considered carefully, coming from respectable sources (in some cases), and given that the market has seen those elevated levels a mere decade ago, with the price of Brent crude reaching $144 per barrel July 03, 2008.

Too many recall that the price collapsed shortly thereafter and attribute the change to the financial crisis.  It regained three-digit levels for a couple of years before shale oil production soared and sent prices tumbling in 2014.

Except that the financial crisis really became apparent two-to-three months after the oil price peak and began dropping, and shale oil did not begin its rapid growth until 2012.  It seems impossible not to conclude that the 2008 oil price spike was a bubble, reflecting momentum trading spurred on, in part, by belief in the peak oil theory.

The fundamentals of the oil market in 2008 were not significantly different from preceding years.  Inventories dropped in the second part of 2007, but remained high on a historical level.  Demand had been very strong in recent years, while OPEC producers like Iraq, Nigeria and Venezuela struggled with unrest that kept supply depressed, and spare crude capacity outside Saudi Arabia was all but non-existent.  Still, the increase in the Brent price from $53 in mid-2007 to $130 in mid-2008 was the sharpest ever seen and can hardly be explained by the relatively minor changes in supply and demand.

The Last Price Exaggeration (2007/2008)

Forgotten now was the response of many in the industry to those high prices, which were described as only the beginning of a new era.  Partly, some believed that a permanent peak in oil production had been reached, with T. Boone Pickens proclaiming in an interview published in the January 2007 Playboy that world production could not possibly grow:  “We’re currently getting 85 million barrels of oil a day worldwide and using it all. We won’t be getting more.”  (Production is now approaching 100 mb/d.)

Matthew Simmons, who frequently appeared on cable networks like CNBC, had proclaimed at a Department of Energy conference on April 7, 2008, that oil production had actually peaked in May of 2005–but only by looking at crude and condensate production, as opposed to petroleum liquids.

Against this background, extreme price predictions became if not the norm, at least acceptable.  When, in 2005, Goldman Sachs had suggested that a supply disruption could see oil reach a “superspike” price of $105, many scoffed, even arguing that the bank was trying to promote its commodity index fund.  Yet three years later, when prices passed $140, predictions that they would continue rising were treated seriously.  Among them:

• In May 2008, Goldman Sachs suggested surging demand would send prices to $200 in six months to two years;[1]
• In August, 2008, T. Boone Pickens insisted that the price would reach $200 or $300 in two or three years, after prices had begun to retreat;[2]
• A month later, in a Fortune magazine article titled “Here Comes $500 Oil,” peakest and Pickens friend Matthew Simmons was profiled arguing that oil production had peaked and would decline sharply, “that from here on out, oil supplies can’t meet demand, and if we don’t act soon to solve this crisis, World War III could be looming?”[3]
• Probably the most amusing case was The Economist magazine, which had in 1998 published its famous “Drowning in Oil” cover, referencing an article which foresaw an extended period of prices in the $12/barrel range, and possibly lower.  With the price at $140, they attempted to make amends by publishing an interview with Matthew Simmons titled, “The high priest of “peak oil” thinks world oil output can now only decline.”[4] The reference, of course, to world oil production, of which Simmons’ book was said “others held it up as convincing proof of the notion that the world’s oil production would soon reach a pinnacle, never to be exceeded.”

A Bubble It Was

Relatively few analysts seemed to treat seriously the idea that momentum trading was creating a bubble, although Phil Flynn certainly bucked the trend.[5]   Indeed, when I published two pieces on marketwatch.com titled “Investing for the Oil Price Crash,” six weeks before the price peaked in 2008, the overwhelming response online was derisive.[6]  (Posters were anonymous, and sadly, the website no longer shows the comments.)

Sadly, most observers (and especially the media) treat this as a race, with winners and losers, rather than an analytical question, wherein the issue of why someone was right or wrong is of preeminent importance.  My predictions in 2003/2004 of a rapid decline in oil prices proved wrong as Iraqi oil production was much slower to recovery than I expected, and new problems, like Hurricane Katrina and the Arab Spring, kept removing supply from the market.

But the neo-Malthusian argument that resource scarcity was to blame for high prices, not transient production disruptions, was clearly wrong, and it was simply happenstance that so many supply problems occurred during the 2000s a few years after the peak oil arguments received renewed attention.  The misinterpretation of high oil prices as driven by geological scarcity instead of transient problems exactly mirrors the mistakes of the 1970s, suggesting that some, at least, never learn from history.

Conclusion

The “superbulls” have largely adopted an age old defense, insisting that their work was scientific but they had misjudged the date.  This same approach was used by London astrologers, who had predicted that the Thames would flood London in early 1524, and faced public anger when such did not occur.

Luckily for them, they thought of an expedient which allayed the popular fury. They asserted that an error (a very slight one) of a little figure, they had fixed the date of this awful inundation a full century too early.  The stars were right after all and they, erring mortals, were wrong.[7]

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[1]  http://news.bbc.co.uk/2/hi/business/7387203.stm

[2]  http://www.cbsnews.com/blogs/2008/08/27/politics/horserace/entry4390453.shtml

[3]  http://archive.fortune.com/2008/09/15/news/economy/500dollaroil_okeefe.fortune/index.htm

[4]  http://www.economist.com/node/11702995

[5]  https://www.independent.co.uk/news/business/news/crude-oil-price-passes-120-a-barrel-mark-for-the-first-time-821691.html

[6]  https://www.marketwatch.com/story/investing-for-the-oil-price-collapse-part-1 and https://www.marketwatch.com/story/investing-for-the-oil-price-collapse-part-2.

[7]  Charles Mackay, Extraordinary Delusions and the Madness of Crowds.”