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Dr. Paul Price
Articles  | Author's Website |

The Truth About Oil... Is Not What You Think It Is.

Headlines proclaiming last year's 46% decline in the price of oil are designed to provoke fear while goosing readership and ratings. Professional commodity traders are having a ball and making tons of money as amateurs pay them big bucks to speculate on each day’s fluctuation.

The Wall Street Journal noted that crude was at its lowest level since 2008. That sounded familiar to their headline after the DJIA declined 316 points on December 12, 2014. Buyers that fateful afternoon are feeling richer today than the traders who panic-dumped shares that day.

Those who got long oil contracts, or oil-based equities, in late 2008 experienced similar results. From the final bottom, the price of WTI jumped more than 240% over the next couple of years.

The 10-year chart of WTI (West Texas Intermediate) shows the volatility, or relative stability of crude pricing, over the entire past decade. Based on the wild swings you might think that big changes in global supply and demand for crude were big contributors to the movements.

In fact, worldwide demand increased during nine of the previous ten years.

It took The Great Recession to cut absolute usage, and even then it dropped less than 1.5% year-over-year. Boom times led to 2% - 3% in extra demand. Most years revolved around 1% increases.

Americans believe in the “oil glut” theory because domestic production has surged due to the shale revolution. The U.S. share of global oil output has risen dramatically since the end of 2006.

Headlines announcing that America has become a net exporter of energy have colored perceptions here at home. It is relatively meaningless when evaluated on a worldwide basis.

Over the past five years total supply and demand have moved in parallel directions, albeit with some noticeable near-term variations.

The chart belies the idea that supply is now swamping demand, justifying last year’s huge plunge in crude prices.

After the 2008-09 decline crude pricing went from about $40 to above $140. Price per barrel then dropped to near $35 on the way back to $120. In late December, 2014, WTI dipped into the $52 range.

It is more likely that the present weakness will be temporary, rather than becoming the "new normal."

Do you really believe that $2 per gallon gasoline is right around the corner? If not, you should be buying some oil-related stocks while the quotes are depressed.

Over the long term the price of crude will revert to a number that reflects the average cost of production adjusted for all the traditional variables.

Supply and demand were not responsible for the 46% drop in oil prices. The magnitude of that move reflected a speculative mood change more than a fundamental one.

At their last meeting OPEC did nothing to alter supply. People hoping for production cutbacks were disappointed but supply-demand was not affected one bit from the pre-meeting level.

To get a bargain you need to be willing to buy what others are fearfully selling. Buying during panics always feels uncomfortable while you are doing it. That’s why it will end up being so profitable.

Disclosure: Long an assortment of oil-related shares. Short puts on a number of oil-related stocks.

About the author:

Dr. Paul Price
http://www.RealMoneyPro.com

https://seekingalpha.com/account/research/subscribe?slug=arrow-loop-research

Visit Dr. Paul Price's Website


Rating: 4.8/5 (16 votes)

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Comments

b3nchx
B3nchx - 4 years ago    Report SPAM

Srsly, i enjoy every article from you!

Hpeterscheck
Hpeterscheck premium member - 4 years ago

Love the article. I looked at November cara sales and it was amazing that in just one month of reduced gas prices, sales volumes of hybrids and EVs dropped (http://www.hybridcars.com/november-2014-dashboard/).

The other stat touted a great deal is the reduction in petroleum used per capita in some countries. Of coures, that ignores the fact that the "captia" part of that equasion grows much faster than the drop in the "per."

The problem for me was picking which companies to bet on. I decided to take the ones that had the lowest production cost combined with the strongest balance sheets. It seems like a temporary game of chicken and the highly leveraged higher cost producers will lose in the short run, get snapped up by the companies with staying power and before we know it the price of oil will go back up. That strategy probably won't find the highest returns, but I'm trying to play it safe since I'm not super knowledgable about the industry.

Another fallicy is that people think of oil as a commodity similar to gold and silver. There's a huge difference... when I get done using my gas I can't resell it for close to the same price I bought it for. It's more or less gone forever.

Then there are the people who believe that the oil economy is going away any minute now. They think in 5 years everyone will drive Teslas and Leafs and companies like Exxon and Chevron will be history. Good luck with that. If the oil companies stopped producing for about a week, there would be unbelievable pain in the world. Of course oil supply is limited and of course there are environmental factors... and I hope we work all of those things out. But we're talking about a 4-6 decade time horizon and that's IF we make major steps to replace oil with something else (or lots of other things more likely). As much as I see people fighting against fracing, I don't see too many people protesting against 2$ gas... so... I'm long Exxon, Chevron and the other integrated oil companies. I don't understand the transportation or construction side of the business well enough to pick winners from losers, but I suspect there are really good bargains there as well.

Jackov
Jackov - 4 years ago    Report SPAM

Very slick, lol.

Dcube
Dcube - 4 years ago    Report SPAM
Dr. Price,

Thanks for shedding some data-based light on this matter. Sometimes it is better to step back and revisit the simple things, such as supply and demand trends.

Some heavy hitters like T Boone Pickens (Trades, Portfolio) share your (and my) belief.

Cheers

shaved_head_and_balls
Shaved_head_and_balls - 4 years ago    Report SPAM

The world is spiraling into disinflation. Oil is following the path of other industrial commodities. Yes, gas is going below $2.00 per gallon. Like the speculators since 2011 who've called bottoms in gold, iron ore, nat gas, copper, etc., those who buy oil stocks now will regret that decision. Oil will go into the $20s when China and emerging markets finally go into the forestalled recession.

Praveen Chawla
Praveen Chawla premium member - 4 years ago

Enjoyed the article and your contrarian call. I agree the "real normal" is somewhere between the "new normal" and the "old normal" oiow, the truth is somewhere in the middle.

Dr. Paul Price
Dr. Paul Price - 4 years ago    Report SPAM

Mr. Balls,

Nobody will continue producing, transporting and marketing anything, including oil, at prices that do not more than cover their cost of production.

That can be seen clearly in the numbers of shut down gold mining operations since precious metals peaked back in 2011. Oil rigs are already decreasing in number and more production will be delayed or capped until crude prices head higher.

Oil is much more likely to be well above today's price one year from now rather than "in the $20s" as you predict.

I'll look forward to seeing your comment in January of 2016.

________________________________________________________________

Regarding your other (inaccurate) statement regarding my utilities-related article:

http://mutualfunds.com/expert-analysis/when-will-fed-raise-rates-never-paul-price/

AlbertaSunwapta
AlbertaSunwapta - 4 years ago    Report SPAM

^ Good article and nice counterpoints to the prevailing view. Thanks.

On cost of production though, in bankruptcy protection I believe the definition of "cost of production" changes. Still, it would take a major producer bankruptcy, avoiding significant associated debt costs, to undercut a lot of other production. State oil companies' abilites to produce at uneconomic levels might be another factor.

As this analysis showed (below), OPEC's window of opportunity was closing fast...
(however it was closing for all of OPEC and the other members seem angry at the Saudis)

See Page 5
"...A hypothetical oil price downturn would have a significant impact, albeit short-lived, if it occurred before most of the projects considered in this paper had advanced significantly - that is, before 2015.

Conversely, if an oil price collapse were to occur after 2015,..."

http://belfercenter.ksg.harvard.edu/files/Oil-%20The%20Next%20Revolution.pdf

buhrlakc
Buhrlakc - 4 years ago    Report SPAM

Dr. Price, what is the break even cost of production?

Dr. Paul Price
Dr. Paul Price - 4 years ago    Report SPAM

Buhrlakc,

It is a company's all-in cost of finding, extracting and delivering oil to the market. Every situation is different but each firm knows what their own figure is for any set location.

AlbertaSunwapta
AlbertaSunwapta - 4 years ago    Report SPAM

I haven't looked at any US companies but have picked up Canadian Oil Sands, Freehold Royalty, Prairie Sky Royalty, and some micro caps seemingly unjustifiably caught in the downdraft. Mostly speculation on my part because I can't predict the future and prolonged low oil prices would eventually hurt my positions.

axd07
Axd07 premium member - 4 years ago

What exactly are you trying to say??? this "article" lacks a point, or sense for that matter.

shaved_head_and_balls
Shaved_head_and_balls - 4 years ago    Report SPAM

If mine closures halted the decline in a commodity's price, gold would not have hit its 4-year low just months ago. Very few junior gold miners have cut production substantially in spite of the price of gold declining below all-in sustainable costs for many of them. You're making a classic rookie error of buying commodity stocks at the beginning stage of a cyclical downturn, when trailing earnings give the illusion of value. You have entered the twilight zone of the latest commodity value trap.

shaved_head_and_balls
Shaved_head_and_balls - 3 years ago    Report SPAM

Dentist Price: Six months have passed since your prophecy about higher oil. Except for the usual speculator bounce, the price is flat since then. Yes, oil in the $20s is coming your way after China goes into recession. Unfortunately, an army of bull market genius stock tip peddlers in US markets will also have their comeuppance too. Where China goes, goes the world equity markets.

The only reason WTI oil is not in the $30s today is because of the lingering support of speculators fueled by ZIRP. That will melt away by the end of the year, if not sooner.

LwC
LwC - 3 years ago    Report SPAM

Yes, Price like to fill his "articles" with eye catching images and fancy graphs to support his recommendations, but strangely he never follows up to explain how his predictions have gone wrong. However, he almost never fails to post a selfie pat on the back if he's lucky enough to turn out right once in a while.

I especially like this quote from the article:

"Do you really believe that $2 per gallon gasoline is right around the corner?"

Well, gas prices actually did go below $2 in many parts of the country not too long after he posted that un-prescient remark. In my area gas sold for as little as about $1.70 for a while.

Anyway, as a long time observer and participant in oil investment, I'm not so sure that we will see $20 oil, at least for anything other than a fairly short time, and even if we see $30 oil, it probably won't stay that low for long simply because the cost of oil E&P is too high for a significant proportion of the potential supply. It's probably more informative to focus on what the average oil price might be over a period of time. That's the parameter that informs the investment commitment decisions.

The speculators can influence the price over short time periods, but ultimately oil price is a function of supply and demand of the physical product, not the derivatives market

shaved_head_and_balls
Shaved_head_and_balls - 3 years ago    Report SPAM

In the long run petroleum oil is the equivalent of whale oil, bound for a slow decline to obsolescence.

In the near future, global supply/demand will be unfavorable. 1998 is coming back full speed ahead for oil. The real price of oil lurked in the $20s & $30s for most of history, punctuated by periods of elevated prices. No matter how many commodities have been crushed in recent years, people still speculate that "oil is different." There will be 100s of bankrupticies in the next few years in the industry. Oil could easily see $15 at the trough, then stagger along in the $20s for the next decade.

The price of production will come down dramatically as newer extraction technologies become widespread. Oil is the new coal, iron ore, copper, gold, etc. etc.

LwC
LwC - 3 years ago    Report SPAM

Next you be saying that oil is the new orange.

You may very well be right about the long term price of oil. But on the other hand, you may be wrong. IMO it's difficult to discern what you actually know about the industry, and what you just think you know but don't really know at all. I think I'll continue to rely on my own experience to inform me rather than your selected recitation of stuff you've read in the media.

On your other point however, that the "price" of production will come down "dramatically", it's just not supported by any evidence that I've seen. Maybe you'd be so kind as to provide support for that assertion? My view is that production costs could in theory be lower, if the high cost operations such as shale and deep water were curtailed, but of course that would result in a significantly less supply which undoubtedly would push the oil price up. The exact opposite of what you are arguing.

You could of course counter that that won't happen because demand will shrink as fast or faster than the fall in supply, thereby maintaining a long term low oil price, but that would just be speculation on your part. Based on what you've written so far, I have no insight into just how well informed you are about the subject; only that you have strong opinions about it.

Good luck.

shaved_head_and_balls
Shaved_head_and_balls - 3 years ago    Report SPAM

You're caught on the wrong side of the commodity cycle. You'll have to learn the hard way. He who believes that any commodity will stay elevated far above historical norms is the speculator. Commodities do not rise substantially above the rate of inflation in the long run.

Slowly the speculators are exiting the oil trade. It might take another couple of years to wring out the retail "investors"; they're last to get the memo because of their lust for high dividends.

shaved_head_and_balls
Shaved_head_and_balls - 3 years ago    Report SPAM

"Do you really believe that $2 per gallon gasoline is right around the corner? If not, you should be buying some oil-related stocks while the quotes are depressed." -Paul Price, January 2, 2015

"The average price of gasoline at the pump has dropped below $2 a gallon for the first time in more than six years as global oil supply continues to surge." Bloomberg, December 19, 2015

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