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Oil: Could Have Been $200 In 2008; Might Reach $20 In 2016

Summary

In 2008, both Goldman Sachs and John Kilduff saw $200 oil as a distinct possibility.

For 2016, these same luminaries see $20 (or even $18).

There has to be a better way to analyze the price of oil: certainly projecting extremes based on momentum is not working, except as an attention getting ploy.

The headlines are scary: For 2016 oil may bottom at some mythic level, either $20 or $18, depending on which oracle you consult. Of course, back in 2008 these same gurus were calling for a stratospheric high of $200. Here are some links:

1) Goldman calls for $200

2) Goldman calls for $20

3) Kilduff calls for $200

4) Kilduff calls for $18

On a simplistic level, one could simply average the four calls, arriving at a target of $109.50. Instead, I chose to locate some data, and perform a relatively straightforward analysis of the same. Here’s a chart:

The only sophistication involved here is the use of a logarithmic scale. I feel as if it makes the data more intuitively and visually accessible. I sketched in a couple of lines, to form a channel, and circled some salient low points. Unless there has been a paradigm shift of some magnitude, oil should recover to something in the $90 area, and well before 2020.

My best guess, oil wanders around in the neighborhood above the lower red line and below the blue regression line. The thinking would be, the commodity spent a lot of time above trend, and drew in more capital than was required to maintain stable pricing. So there will be a period of capital destruction.

It’s Possible to Project Balanced Production and Consumption

Using the EIA STEO International Petroleum and Other Liquids Production, Consumption and Inventory data monthly from January 2011 to the present, I used the spreadsheet trend function to project forward.

For production, I started with August 2015, the most recent high, and made the heroic assumption that reported results through November were a trend, which I extended through 2016.

For consumption, I used January 2011 to November 2015 to develop the trend, and extended it through 2016.

For inventory, I applied any excess or deficiency of consumption as developed above to the starting value. To get perspective, I divided inventory by consumption to get days supply outstanding. By the end of 2016, supply by this measure was similar to what prevailed in September 2014.

There are numerous players whose future actions are unpredictable, and whose motivations and intentions are subject to debate. The point is, it’s possible to project stabilization by making a favorable interpretation of existing data.

Fracking’s Moment of Truth

Further investments will be made with considerable caution. SEC rules require that oil companies evaluate their reserves according to what is economically recoverable at the average price for the preceding twelve months. Similar to FAS 157 during the financial/MBS crisis, this accounting rule will force the industry involved to confront some unpleasant truths.

I believe it will demonstrate that many tight oil producers were not making money, and never will make money. Fortunately, the excess capacity created by the fracking bubble isn’t very durable. The wells involved deplete rapidly.

OPEC’s Moment of Truth

Saudi Arabia, Iran, Russia and the USA are involved in economic warfare. It’s a game of beggar thy neighbor, winner take all. It’s a bizarre type of progressive poker, where the participants keep anteing up but the pot gets smaller with every round.

Conventional oil fields also deplete, though not as rapidly as shale. Once reserve capacity is exhausted, production increases cannot be maintained. Most of the countries involved are theocracies, or plutocracies, or dictatorships of some sort. Economic efficiency is not a hallmark of such systems of governance. The capitalist system that prevails in the US makes the country incapable of participating in a cartel, should OPEC again become functional.

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