Sunday, December 7, 2008

Mr. Geologist, How Much Speculation Is In That $90 Oil Price?

I had the honor and privledge to sit at the same table as legendary GE CEO Jack Welch at a family wedding in November, 2007. Halfway through the meal without warning, Mr. Welch says "Mr. Geologist, how much speculation is in that $90 oil price?". I quickly responded "I don't know". He said "what do you mean you don't know?". I then realized that he probably wasn't used to that answer. I then quickly changed my answer to "$30". He said "that's what I thought."

Historically, I believe that there has been two factors controlling the price of oil: supply/demand and whatever OPEC wanted it to be. In recent years, I believe that a third factor has arisen and that is fear. The fear factor could include "peak oil", terrorism, and geopolitical conflict in oil prone regions. This factor can explain the rapid rise to $145 per barrel this year. Supply and demand hasn't changed that drastically to explain the rapid rise or rapid fall. Most OPEC companies desire oil to be above $70 per barrel, so some overpowering force has won. Most recently, the "sprint to cash" and deflationary fears could explain the capitulation in the price of oil along with all other commodities.

In the coming years, I believe that these fears, geopolitical events, and market dynamics will drive the price of oil to very high levels. In the meantime, lets hope that low gasoline prices don't encourage us to take our eye off of the ball regarding the long term underlying problem of overconsumption.

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