Monthly Discussion



The Price of Oil Revisited



The October 11, 1999 issue of the Newsletter was devoted to "Who Is Pulling the Strings on the Price of Oil?" We saw in there that OPEC decisions on production levels, political rhetoric, sanctions lifting, and diminishing reserves are not among the prime movers that determine the long-term price of the world's primary energy. On the contrary, oil seems to have its own way and means to keep its price rather stable with only rare and well-defined exceptions.

          I reproduce below the main exhibit from that discussion now updated with monthly data from the year 2000. We see the striking periodic flare-ups of the price of oil resonating with the Kontratief cycle. As discussed in Predictions the price of society's primary energy source increases manifold toward the end of an economic boom. This increase is very localized in time, however. For more than two hundred years such increases have recurred in intervals of 55-56 years and have lasted for at most several years. At the same time, such price increases become invisible in the graph of Exhibit 3 if they last less than one year (example the price flare-up during the Gulf war).



Exhibit 3. Annual averages for the price of society's primary energy (see Predictions for an extensive discussion of this graph). The last nine data points (open circles) are monthly data for year 2000. The red point is year 1999, still conforming to the "canonical" price range.


Year 2000 has so far seen high oil prices giving rise to such rumors as the possibility that oil price eventually stabilizes at around $50. If this were to happen, the level of the graph in Exhibit 3 in 1996 dollars (following a correction for inflation) would reach around $56, and the regularity of the pattern would be completely destroyed. In fact the pattern is all ready destroyed when we include the monthly data points reflecting the price progression during the last nine months. The only way that the general pattern of Exhibit 3 can be preserved is if the price of oil goes back to the $22 - $25 range the latest in several months from now.

There is nothing magic about patterns on price charts and I can assure you I am not superstitious! But I am convinced that the level of the natural price of oil has its roots deep in the works of our society. Energy is the ultimate food for life, and that makes its price something next to being sacred. Even though natural gas is slowly replacing oil (and will continue doing so to overtake it around 2010), today oil still constitutes the world's major energy source providing 40% of the world's energy needs. Taking the bread out of people's mouth could result in a popular uprising, or trigger a revolution. We came very close to that in the European Union during the last couple of weeks when popular uprising of truckers and taxi drivers protesting against high oil prices managed to grind the French and British economies to a halt.

No one can dictate or force the price of oil too far from its "equilibrium" position. This position—the range $10 - $24 of 1996 dollars—is what we find to be the case in Exhibit 3 for all times except the handful of years at regular intervals, when spikes occur. All fluctuations on the day-to-day or month-to-month price movements must be confined within this price range when averaged over a year or so. Consequently whenever you see price excursions of factors of 2 or 3 (a factor of 2 occurs all ready at a spot price of $36) well before the 2030s, it is time for you to buy your puts on the price of oil.

If you are conservative, like me, and want the extra insurance, make sure your puts cover a period of several months.