Best of the Week
Most Popular
1. Gold vs Cash in a Financial Crisis - Richard_Mills
2.Current Stock Market Rally Similarities To 1999 - Chris_Vermeulen
3.America See You On The Dark Side Of The Moon - Part2 - James_Quinn
4.Stock Market Trend Forecast Outlook for 2020 - Nadeem_Walayat
5.Who Said Stock Market Traders and Investor are Emotional Right Now? - Chris_Vermeulen
6.Gold Upswing and Lessons from Gold Tops - P_Radomski_CFA
7.Economic Tribulation is Coming, and Here is Why - Michael_Pento
8.What to Expect in Our Next Recession/Depression? - Raymond_Matison
9.The Fed Celebrates While Americans Drown in Financial Despair - John_Mauldin
10.Hi-yo Silver Away! - Richard_Mills
Last 7 days
Dow Long-term Trend Analysis - Coronavirus Triggering a Stocks Bear Market? - 27th Feb 20
Trump or Sanders? Both will pile up the Debt - 27th Feb 20
Oil Price Is Now More Volatile Than Bitcoin - 27th Feb 20
A Digital “Fedcoin” May Be Coming… And It Would Be Terrifying - 27th Feb 20
India's Nifty 50 Stocks: Does the Bad Jobs Outlook Spell Trouble for Stocks? - 27th Feb 20
How Crypto Currencies Are Helping Players Go Private - 27th Feb 20 -
Gold and Silver The Die Is Cast - 27th Feb 20
US Economy Permanently Addicted to Zero Interest Rates - 27th Feb 20
Has the Stock Market Waterfall Event Started Or A Buying Opportunity? - 27th Feb 20
Advantages of Enrolling in a Retirement Plan - 27th Feb 20 - LS
South Korea Coronavirus Outbreak Data Analysis Warning Rate of Infection is Exponential! - 26th Feb 20
Gold Price Long-term Trend Analysis Forecast 2020 - 26th Feb 20
Fake Markets Are on Collision Course with Reality - 26th Feb 20
Microsoft is Crushing the S&P 500, Secret Trait Of Stocks That Soar 1,000%+ - 26th Feb 20
Europe's Best Ski Resorts For The Ultimate Adventure - 26th Feb 20
Samsung Galaxy S20+ vs Galaxy S10+ Which One to Buy? - 26th Feb 20
Gold Is Taking on $1,700 amid Rising Coronavirus Fears - 26th Feb 20
Is This What Falling Through the Floor Looks Like in Stocks? - 26th Feb 20
Gold Minsky Moment Coming - 26th Feb 20
Why Every Student Should Study Economics - 26th Feb 20
Stock Market Correction Over? - 26th Feb 20
US Bond Market Yield Curve Patterns – What To Expect In 2020 - 25th Feb 20
Has Stock Market Waterfall Event Started Or A Buying Opportunity? - 25th Feb 20
Coronavirus IN Sheffield! Royal Hallamshire Hospital treating 2 infected Patients, UK - 25th Feb 20
Dow Short-term Trend Analysis - Coronavirus Trigger a Stocks Bear Market? - 24th Feb 20
Sustained Silver Rally Coming? - 24th Feb 20
Should Investors Worry about Repo Market and Buy Gold? - 24th Feb 20
Are FANG Technology Stocks Setting Up For A Market Crash? - 24th Feb 20
Gold Above $1,600 Amid FOMC Minutes and Coronavirus Impact - 24th Feb 20
CoronaVirus Pandemic Day 76 Trend Forecast Update - Infected 540k, Minus China 1715, Deaths 4920 - 23rd Feb 20 -
Ways to Find Startup Capital - 23rd Feb 20
Stock Market Deviation from Overall Outlook for 2020 - 22nd Feb 20
The Shanghai Composite and Coronavirus: A Revealing Perspective - 22nd Feb 20
Baltic Dry, Copper, Oil, Tech and China Continue Call for Stock Market Crash Soon - 22nd Feb 20
Gold Warning – This is Not a Buying Opportunity - 22nd Feb 20
Is The Technology Sector FANG Stocks Setting Up For A Market Crash? - 22nd Feb 20
Coronavirus China Infection Statistics Analysis, Probability Forecasts 1/2 Million Infected - 21st Feb 20
Is Crude Oil Firmly on the Upswing Now? - 20th Feb 20
What Can Stop the Stocks Bull – Or At Least, Make It Pause? - 20th Feb 20
Trump and Economic News That Drive Gold, Not Just Coronavirus - 20th Feb 20
Coronavirus COVID19 UK Infection Prevention, Boosting Immune Systems, Birmingham, Sheffield - 20th Feb 20
Silver’s Valuable Insights Into the Upcoming PMs Rally - 20th Feb 20
Coronavirus Coming Storm Act Now to Protect Yourselves and Family to Survive COVID-19 Pandemic - 19th Feb 20
Future Silver Prices Will Shock People, and They’ll Kick Themselves for Not Buying Under $20… - 19th Feb 20
What Alexis Kennedy Learned from Launching Cultist Simulator - 19th Feb 20
Stock Market Potential Short-term top - 18th Feb 20
Coronavirus Fourth Turning - No One Gets Out Of Here Alive! - 18th Feb 20
The Stocks Hit Worst From the Coronavirus - 18th Feb 20
Tips on Pest Control: How to Prevent Pests and Rodents - 18th Feb 20
Buying a Custom Built Gaming PC From Overclockers.co.uk - 1. Delivery and Unboxing - 17th Feb 20
BAIDU (BIDU) Illustrates Why You Should NOT Invest in Chinese Stocks - 17th Feb 20
Financial Markets News Report: February 17, 2020 - February 21, 2020 - 17th Feb 20
NVIDIA (NVDA) GPU King For AI Mega-trend Tech Stocks Investing 2020 - 17th Feb 20
Stock Market Bubble - No One Gets Out Of Here Alive! - 17th Feb 20
British Pound GBP Trend Forecast 2020 - 16th Feb 20
SAMSUNG AI Mega-trend Tech Stocks Investing 2020 - 16th Feb 20
Ignore the Polls, the Markets Have Already Told You Who Wins in 2020 - 16th Feb 20
UK Coronavirus COVID-19 Pandemic WARNING! Sheffield, Manchester, Birmingham Outbreaks Probable - 16th Feb 20
iShares Nasdaq Biotechnology ETF IBB AI Mega-trend Tech Stocks Investing 2020 - 15th Feb 20
Gold Stocks Still Stalled - 15th Feb 20
Is The Technology Stocks Sector Setting Up For A Crash? - 15th Feb 20
UK Calm Before Corona Virus Storm - Infections Forecast into End March 2020 - 15th Feb 20

Market Oracle FREE Newsletter

Coronavirus-bear-market-2020-analysis

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