Consumer Energy Report is now Energy Trends Insider -- Read More »

By Robert Rapier on Oct 10, 2008 with no responses

The Demise of the Oil Bubble

When I made my $1,000 bet that oil prices wouldn’t reach $100 in 2007, I felt like that was a pretty safe bet. Up until about the first week of September in 2007, it was looking like I was cruising to an easy win. But then oil prices went on an unprecedented run. Prices climbed almost 50% between September and the end of the year, and twice came within a whisker of reaching $100. Then, on the first trading day of 2008, the $100 mark was breeched, and eventually soared to almost $150/bbl in July of 2008. I won the bet, but a lot of people felt like I had really lost, as the point I was trying to make is that oil hadn’t yet peaked – and the price would reflect that.

It wasn’t that I felt like oil wasn’t going to reach $100. I did. But I didn’t think it would happen until year end 2008 or some time in 2009. (See the 3rd graph in Peak Lite Revisited which shows $100 being breeched right at the end of 2008). The main reason for this is that the economy has to have time to adjust to higher prices. What I foresaw was a rise, followed by demand destruction, bankruptcies in various airlines and auto makers, a price correction, and then another rise.

I foresaw a jagged rise – not the exponential rise that we saw over the past year. I felt like the rapid run-up starting in September of 2007 could not be justified purely on the basis of the fundamentals. I had a lot of arguments with people who think peak oil has passed who suggested that I just hadn’t anticipated how quickly things would fall apart. And it was certainly hard to win those arguments when oil prices continued to set records.

For some of those peakers, the present environment of falling prices means election year price manipulation. It could never mean, after all, that prices had indeed gotten ahead of themselves. But the Wall Street Journal weighed in today on the matter of the ‘oil bubble:’

The Official Demise of the Oil Bubble

Like a number of other commodities, oil’s move went from a steady ascent to a vertical bounce in the spring of 2008, topping out near $150 a barrel before speculative excess started to drain from the market. And those who believed that the oil price was justified by fundamentals — being, as it is, an actual product, rather than an Internet company’s vague promise of revenue — are smarting.

“This is a market that is basically returning to the price level of a year ago which it arguably should never have left,” says Tim Evans, energy analyst at Citigroup. “We pumped up a big bubble, expanded it to an impressive dimension, and now it is popped and we have bubble gum in our hair.”

On the other side are analysts who think this is a brief reprieve before oil prices rocket back up (many feel this will happen right after the elections):

Oil to Reach New Highs by Year-End

When oil moves, it moves the index. The sell-off brought oil down from a high of $147 to roughly $90. It bounced back up to $108 to $110; $108.50 is a good support and resistance level for oil today. The next price up should be $112.50, then $122.50, followed by a couple of more increases. I think the top is going to be $150 to $157. That was our forecast.

Charlie Maxwell, in Barron’s, says $300 oil in about five years—that’s the long view. Inflation adjusted, he’s probably right. I think we’re only about halfway into the commodity bull market. Despite the credit problems in the U.S., Asia is not going to be economically buried to the extent that we are. And that’s a continuous growing market for gas and oil.

I disagree with that assessment in the short term, but think the long-term is probably correct. I do see the long-term as still very bullish on oil. But it isn’t a market for the timid, as the current correction is proving. These corrections can be brutal, but as a long-term investor, what I really care about is whether oil prices are going to be much higher 5 years from now. I still think the answer to that question is “Yes.” (However, I do think that Matt Simmons is going to lose his $10,000 bet that oil prices will average over $200 in 2010).

One other thing I believe is that oil company stocks have oversold. I own ConocoPhillips stock, and the PE is currently trading at just over 4. The yield is up to almost 4%. Those are insane numbers for a company that has oil reserves worth more than 10 times the market cap of the company. If I was Jim Mulva, CEO of ConocoPhillips, I would be buying back stock as fast as I could.

I have always said that investor psychology can really play havoc with a portfolio, but in the long run I have to believe that oil company stocks are worth significantly more than current valuations. They are trading as if oil was at $20/bbl, and it isn’t going there. No way. In fact, I still don’t believe it will go below $50, which is a prediction I first made in 2005 (that oil would never drop below $50 again).