Best of the Week
Most Popular
1. The Trump Stock Market Trap May Be Triggered - Barry_M_Ferguson
2.Why are Central Banks Buying Gold and Dumping Dollars? - Richard_Mills
3.US China War - Thucydides Trap and gold - Richard_Mills
4.Gold Price Trend Forcast to End September 2019 - Nadeem_Walayat
5.Money Saving Kids Gardening Growing Giant Sunflowers Summer Fun - Anika_Walayat
6.US Dollar Breakdown Begins, Gold Price to Bolt Higher - Jim_Willie_CB
7.INTEL (INTC) Stock Investing to Profit From AI Machine Learning Boom - Nadeem_Walayat
8.Will Google AI Kill Us? Man vs Machine Intelligence - N_Walayat
9.US Prepares for Currency War with China - Richard_Mills
10.Gold Price Epochal Breakout Will Not Be Negated by a Correction - Clive Maund
Last 7 days
US Housing Market Real Terms BUY / SELL Indicator - 16th July 19
Could Trump Really Win the 2020 US Presidential Election? - 16th July 19
Gold Stocks Forming Bullish Consolidation - 16th July 19
Will Fed Easing Turn Out Like 1995 or 2007? - 16th July 19
Red Rock Entertainment Investments: Around the world in a day with Supreme Jets - 16th July 19
Silver Has Already Gone from Weak to Strong Hands - 15th July 19
Top Equity Mutual Funds That Offer Best Returns - 15th July 19
Gold’s Breakout And The US Dollar - 15th July 19
Financial Markets, Iran, U.S. Global Hegemony - 15th July 19
U.S Bond Yields Point to a 40% Rise in SPX - 15th July 19
Corporate Earnings may Surprise the Stock Market – Watch Out! - 15th July 19
Stock Market Interest Rate Cut Prevails - 15th July 19
Dow Stock Market Trend Forecast Current State July 2019 Video - 15th July 19
Why Summer is the Best Time to be in the Entertainment Industry - 15th July 19
Mid-August Is A Critical Turning Point For US Stocks - 14th July 19
Fed’s Recessionary Indicators and Gold - 14th July 19
The Problem with Keynesian Economics - 14th July 19
Stocks Market Investors Worried About the Fed? Don't Be -- Here's Why - 13th July 19
Could Gold Launch Into A Parabolic Upside Rally? - 13th July 19
Stock Market SPX and Dow in BREAKOUT but this is the worrying part - 13th July 19
Key Stage 2 SATS Tests Results Grades and Scores GDS, EXS, WTS Explained - 13th July 19
INTEL Stock Investing in Qubits and AI Neural Network Processors - Video - 12th July 19
Gold Price Selloff Risk High - 12th July 19
State of the US Economy as Laffer Gets Laughable - 12th July 19
Dow Stock Market Trend Forecast Current State - 12th July 19
Stock Market Major Index Top In 3 to 5 Weeks? - 11th July 19
Platinum Price vs Gold Price - 11th July 19
What This Centi-Billionaire Fashion Magnate Can Teach You About Investing - 11th July 19
Stock Market Fundamentals are Weakening: 3000 on SPX Means Nothing - 11th July 19
This Tobacco Stock Is a Big Winner from E-Cigarette Bans - 11th July 19
Investing in Life Extending Pharma Stocks - 11th July 19
How to Pay for It All: An Option the Presidential Candidates Missed - 11th July 19
Mining Stocks Flash Powerful Signal for Gold and Silver Markets - 11th July 19
5 Surefire Ways to Get More Viewers for Your Video Series - 11th July 19
Gold Price Gann Angle Update - 10th July 19
Crude Oil Prices and the 2019 Hurricane Season - 10th July 19
Can Gold Recover from Friday’s Strong Payrolls Hit? - 10th July 19
Netflix’s Worst Nightmare Has Come True - 10th July 19
LIMITLESS - Improving Cognitive Function and Fighting Brain Ageing Right Now! - 10th July 19
US Dollar Strength Will Drive Markets Higher - 10th July 19
Government-Pumped Student Loan Bubble Sets Up Next Financial Crisis - 10th July 19
Stock Market SPX 3000 Dream is Pushed Away: Pullback of 5-10% is Coming - 10th July 19
July 2019 GBPUSD Market Update and Outlook - 10th July 19

Market Oracle FREE Newsletter

Top AI Stocks Investing to Profit from the Machine Intelligence Mega-trend

When... Not if... Crude Oil Price Drops Below $70

Commodities / Crude Oil Oct 17, 2014 - 02:21 PM GMT

By: Andrew_Butter

Commodities

Since mid 2010 the oil industry was getting used to Brent averaging around $110. From then to mid 2014 share prices of Halliburton (HAL) Schlumberger (SLB), Hercules (HERO), Transocean (RIG) etc, went up by average 250%. By way of a benchmark for the collective enthusiasm in the idea of the irreversibility of Peak Oil, MODU (jack-up drilling rigs) utilization and day rates climbed into the champagne-all-round arena. According to IHS, a consultancy, there are 118 new ones being built so as to complement the current worldwide fleet of 550. About 40% of those are in China thanks in part to the 5% you used to be able to put down grace of the beneficence of the Bank of Chairman Mao...which incidentally has the smell of the dry bulk carrier enthusiasm seven years ago, also largely financed by the Bank of Chairman Mao.


Then the darn “market” threw a wobbly.

Thankfully there are some excellent explanations for why that happened:

  • A cunning terrorist plot to undermine America, Freedom and World Peace
  • Sunshine in Moscow and rain in Riyadh
  • Electric cars
  • Ebola
  • ISIS

Here’s one more. There was a bubble...and it popped.

This isn’t the first time since 2010 that there was a “scare”. In mid 2012 Brent dipped to $90 before bouncing back just after I pronounced it would go under $70 and stay under $90 for a couple of years: http://www.marketoracle.co.uk/Article34980.html. Then in March 2013, same story... http://www.marketoracle.co.uk/Article39075.html

That was my third wrong-call on oil. I’d said pretty much the same thing in 2011. Be that as it may, calling the timing of the collapse of a bubble is almost impossible; it’s all about when the collective consciousness does an about-turn and/or the soon-to-be losers and their banks have irrevocably over-committed, like perhaps the beneficial owners of those 118 MODU’s.  George Soros gets a pain in his back when a bubble is about to pop, well I put my back out in July, perhaps that was a sign, just I didn’t join up the dots?

 So at risk of getting nominated for the Nouriel Roubini Broken Clock Award, I’m still saying that since mid 2011 oil was a bubble and one day Brent will go down below $70 and stay under $90 for as long as it was over $90.

When?

In 2011 and 2012 no one knew how well the new technology for extracting oil from shale would work. In the event it worked very well, also at a price of $100 combined with the memories of the talk of Peak Oil, investment in upgrading old fields and looking for new ones skyrocketed. What’s changed since 2011 is the money that got put on the table can’t be taken back, so now, even if the price goes to $70 or less and the marginal cost of production in a new or re-vitalized well is $75, likely the banks will insist the oil that cost $75 to get is pumped, rather than waiting for the price to bounce. Meanwhile OPEC and other incumbents will keep pumping until anyone mad enough to develop an oil well that produces at a cost more than $75 will be either bankrupt or on intravenous government-funded life-support. When the last of the losers are wheeled away, prices will recover to the correct level, which currently, according to my calculation (below), is about $90 (Brent).

When that process starts is hard to call. The evidence from the share-prices of the oil service companies would seem to suggest that as we speak, there is a collective re-thinking of how much good money to throw after bad.

How can anyone say there is a bubble?

By definition, when a bubble is in play, everyone except a few odd-balls believes in the infallibility of mark-to-market, and that in a free-market, value is simply the price you can sell something for, to someone dumber than you. That philosophy is a common cause of bubbles, as is explained here: http://www.marketoracle.co.uk/Article8177.html

The only way to really know there was a bubble is when it finally collapses and the investor’s that believed otherwise either go broke or get bailed out. That hasn’t happened yet, until then, it’s all theoretical:

The General Theory of the Pebble in the Pond

The theory so far: (A) Everything has a “fundamental” value, including oil (B) a sustained departure in price from the fundamental one way must inevitably be followed by an equal departure the other way, because (C) bubbles are zero-sum, the windfall of the winners is exactly equal to the size of the empty pockets of the losers...like when you throw a pebble in a pond, the peaks of the waves that are created are exactly mirrored in the troughs, the net result is that the average level of the pond is unchanged.

Of course everyone disagrees about what the “fundamental” value is. They even disagree about what you should call it. Warren Buffet talks about “intrinsic”, accountants, economists and central bankers say “Fair Value”. Which is all very well but that opens another can of worms about how the word “fair” should be translated into Russian and Arabic. 

In 2011 as Brent climbed from around $80 all the way up to $110, the Saudi’s pronounced that they had decided to become the Fairy-Godmother-of-Last-Resort and keep pumping oil until the price came down to what they considered “Fair” – which at that time was $70 to $80. Their argument was that the world economy would suffer, if oil was more than $80. Not that they got any thanks for their public spiritedness. Ironically, the headlines these days talk of how the Saudi’s and the rest of OPEC are deliberately pumping too much oil, so as to sabotage the valiant efforts by Freedom-Loving Americans to escape the ignominy of having to buy oil from what are less-than-diplomatically referred to as “aliens” on the signs in the arrivals lounge in Miami Airport.

http://www.reuters.com/article/2014/10/15/us-markets-oil-production-analysis-idUSKCN0I40CP20141015

Odd-ball (alien) valuation geeks (like me) go with the International Valuation Standards which talks about “Other than Market Value”, but for the purpose of this article I’m going to stick with the word “fundamental” which at least communicates intuitively what I’m talking about.

So what is it...for oil?

According to me, the “fundamental” is as easy to calculate as working out where the sun will come up tomorrow, as is explained here: http://www.marketoracle.co.uk/Article24849.html

In summary, expressing the theory in nomenclature familiar to a trained economist:

For those of us who are not trained economists, the acronyms stand for:

FOOT               Fundamental value Of Oil Today ($ per barrel of Brent)

TOAD              Total Of All De World Gee-DEE-Pee ($Trillion per year – current prices)

OIK                  World-wide OIL Konsumption (Trillions of barrels per year)

 

What that says (according to the theory), is the amount of money that get’s spent buying oil world-wide is a pretty constant function of GDP. If oil prices go up, consumption, relatively, goes down. Equally if consumption goes down (that usually happens when it’s hard to get your hands on oil), prices go up. Evidence that theory might be correct is that it exactly explains the bust after the bubble in the 1980’s and the one in 2009. Let’s see if it works for the bust of 2014 or whenever $70 is breached!!?

On re-consideration, I’ve decided that the best constant in the algorithm looks more like 3.7% rather than 3.3%. Also it’s worth remarking that’s a world-wide figure, in China and USA which generate half the economic value added per barrel of oil they use, compared for example with Europe, the number is higher.

Plotting that out:

.

Discussion:

  • The prediction only starts when oil goes down below $70, at that point there will be a bust in progress, all that the price of $85 says today ius that there might be a bout coming.
  •  If that doesn’t happen, all that means is that the time the price will end up below the fundamental (FOOT) will be longer.
  • There is no way to tell if the bust will happen now, just when it does, as it inevitably must (according to the theory), the fall-out will be of an order of four years.
  • The implicit assumption is that by now, there is sufficient capacity to pump enough oil, and of course that there isn’t a war or any other reason for supply to be constrained.
  • And sure – in five years time, electric cars may indeed become a reality, that would affect the constant in the algorithm.

http://www.reuters.com/article/2014/10/15/us-markets-oil-production-analysis-idUSKCN0I40CP20141015

By Andrew Butter

Twenty years doing market analysis and valuations for investors in the Middle East, USA, and Europe. Ex-Toxic-Asset assembly-line worker; lives in Dubai.

© 2013 Copyright Andrew Butter- All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

Andrew Butter Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules