With Oil Down 25%, Is The Bull Market Over?

After seeing the price of crude oil start the year around $100 per barrel, peak at nearly $150, and come nearly all of the way back, where does the oil market go from here? It is interesting to see how many people no longer think we see a range of $150 to $200 anymore. The Goldman Sachs year-end target of $149 is now considered overly bullish by most pundits. Is the bull market in oil over?

The sharpness of the recent decline lends some credence to the belief that much of the 2008 price spike was related to speculative trading activity. After all, the move from the 120’s to the 140’s came with nearly no new information that would lead one to think the supply/demand balance had changed materially. Daily price swings of $5+ became commonplace without significant events accompanying them. Now with oil down about 25% from its high, calls for $70 or $80 oil are easy to find.

Personally, I think it is important to note that the fundamentals of the oil bull market remain intact. Global demand is growing faster than global supply. It is true that we began to see demand destruction once crude passed $140 per barrel, but since that level was merely temporary, a price of $110 or $115 all of the sudden looks reasonable again. Should we expect gasoline demand to continue to drop at the same pace when gas drops from over $4.00 to under $3,50 per gallon? Probably not.

Even if demand growth drops in the United States and China and India see lower GDP growth levels, oil demand should still rise in coming years. Consider 2008 worldwide demand. Despite the price spike we saw this year, daily global consumption is estiamted to rise 1% to 86.3 million barrels per day. That comes on the heals of a 1% increase last year and another 1% increase forecasted for 2009.

In any bull market there are periods of sharp spikes higher and even sharper declines. Looking at the global economy, it is hard to argue that oil demand will not continue to grow. Sure, alternative energy sources can cut that growth rate noticeably, but with each and every price correction brings less pressure to really promote alternatives in a meaningful way.

A price correction moving toward $100 per barrel, without significant fundamental changes in the outlook for crude oil demand and supply and demand, makes me think triple digit oil prices are not going to become a thing of the past any time soon, for an extended period of time anyway.

From an investment perspective, leading oil producers have seen serious price per share declines, which now imply long term oil prices of far less than $100 per barrel (most are between $70 and $80 per barrel). If you think the next three to five years will see triple digit oil, as I do, then the stocks are going to prove to be excellent investments from here.

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5 Thoughts on “With Oil Down 25%, Is The Bull Market Over?

  1. Anonymous on August 21, 2008 at 8:11 AM said:

    A comment from Vince Farrell on realmoney.com…points to a mispricing in oil and gas.

    I have been on this kick for a bit, but the normal price spread between oil and natural gas is around 8:1. My colleague here at Soleil, Paul Leming of Soleil/Princeton Tech Research, figures it actually has been 7.08:1 for at least the last dozen years. So one of the current prices is wrong. Oil at $116 and natural gas at $8.11 is a 14:1 ratio. Sooner or later, things revert to the mean, and I believe this case will be no different. Typically when you get out of whack to this degree, oil will come down in price and gas will go up.

  2. shepherd on August 21, 2008 at 11:30 AM said:

    Chad,

    You mention the demand growing at 1%, do you know if supply is projected to remain flat or decline?

  3. Chad Brand on August 21, 2008 at 11:54 AM said:

    As long as I have seen forward supply projections, they always show supply rising to meet demand. The EIA numbers I quoted are no different, they project increased supply in both 2008 and 2009. The thing is, production was supposed to increase in 2006 and 2007 as well, but actually fell both years.

    Peak oil theorists think it will be difficult to produce more than 85-86 million barrels per day globally. Current projections are 86+ for 2008 and 87+ for 2009, so we’ll just have to see.

    Here are the EIA numbers for 2005-2009 (produced/consumed):

    2005- 84.59p, 83.65c (act)
    2006- 84.55p, 84.70c (act)
    2007- 84.48p, 85.53c (act)
    2008- 86.39p, 86.31c (est)
    2009- 87.58p, 87.30c (est)

  4. Chad,

    Your comment that the fundamentals of the oil bull market are still intact leaves out one very important factor. In any bull market, there needs to be a sense of greed that persuades everyone down to the shoeshine boy to buy in. I believe most of the rise in oil past $100 was due to hedge funds, speculators and everyone else jumping on the bandwagon. Once this fades (which is definitely happening) we return to normal price appreciation and perhaps underperformance because the allure is gone. (Witness the drop in real estate even though land is a dwindling commodity) Couple that with all the new drilling projects, alternative energies and general push to find more oil (because it’s sooo profitable at $150/bb) plus a slowing economy worldwide and you have a commodity market with serious headwinds.

    The much longer term picture is probably still bullish but I would consider that to be years out.

    Cheers,
    Marc

  5. Chad Brand on September 11, 2008 at 8:57 AM said:

    Marc,

    Thanks for the comments. I agree with you. I even wrote the following in the post:

    “The sharpness of the recent decline lends some credence to the belief that much of the 2008 price spike was related to speculative trading activity. After all, the move from the 120’s to the 140’s came with nearly no new information that would lead one to think the supply/demand balance had changed materially. Daily price swings of $5+ became commonplace without significant events accompanying them.”

    The real question is, since we agree $148 was not based on fundamentals, what is the oil price going to be based solely on supply and demand? I believe the bullish backdrop is intact (demand growing faster than supply) so I think oil in the $100-$150 range is not unreasonable, whereas $50 oil is unlikely.

    Of course, that can change if the world truly weens itself off of oil and adopts alternatives en masse, but i don’t see that happening, at least anytime soon anyway.

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