Brent To $85 By Christmas?

This is a long summary:

The Short Story:

  • $85 by Christmas 2016 sounds as far-fetched as the notion that when Oil was $100-Plus, it would crash!
  • The Big Idea then, was that was a classic price bubble – and bubbles always bust
  • That was based on a boring valuation for “Other-Than-Market-Value” (OTMV) done in line with very boring International Valuation Standards; nothing radical, no Black Magic, no Black Swans 
  • The “alleged” price-bubble, led “allegedly” to over-investment which led to over-supply
  • That was probably thanks to central banks printing money to stimulate what Ludwig Von Mises called “mal-investment”, which is why you have central banks and “God’s Workers” ordained by Goldman Sachs
  • The over-supply eventually caused a bust, predictably
  • And then “over-investors” (and/or their banks), lost their shirts. That’s normal, it happens all the time; the only question is who pays; the latest idea of the Fed  is the grand-children do.
  • The model says bubble/bust is zero-sum and so the bust is over; because the supervisor of God’s Workers says so
  • OTMV today appears to be about $85, so that’s where the price is headed now
  • Unless shale oil comes back in a big way – that’s the only caveat.

The Long Story:

Last August the former President of Shell told a reporter on CNBC; “no-one saw this (crash) coming.”

He should know, Shell had billions of dollars riding on $100-plus Oil and employed armies of experts to look out for what came. That in the event, they didn’t see coming. But the former President was not 100% correct; one model did see it coming. In May 2012, just after Brent hit $127 that model said:

“The correct price of oil right now valued according to what the world can afford to pay (without suffering unduly), is about $90 (Brent). So at $127 oil is a 40% bubble, bubbles do have a habit of popping once they get to 40% over the “fundamental”.

No one would argue that $28 from $127 (Brent) was not a “pop” or a “bust”. Solving that model for now says the bust/pop is almost over and so the oil price will go to $85 soon...that’s of course if it’s a good model.

So is it a good model?

That’s a silly question – of course it's nuts!! Everyone knows bubbles and busts are driven by Black Magic and invisible Black Swans, which is why most economists and all central bankers could not see the housing bust coming, how could they? Invisible Black Swans are...Err...invisible! Duh!

Although to be fair, once the housing bust started the Black Swan High Priest, Alan Greenspan, did concede, in a roundabout sort of way, as was his wont, that what had happened might...Err...perhaps...have been a bubble, and there might have been a “flaw” in his thinking. Big Flaw!

But taking a step back, let’s be reasonable and logical here, surely, if no-one saw the recent oil bust coming (if that’s what it was), and, now, no one says it was a bubble prior, that PROVES beyond any reasonable doubt that it can’t have been a bubble, that caused the bust...doesn’t it? Nothing complicated there...that’s what Larry Summers teaches in ECON-101 at Harvard University, and who can argue with that?

It’s obvious, it must have been them pesky Black Swans again, the ultimate Weapons of Financial Mass Destruction. MEMO to Bomber Command – “Search and destroy all Black Swans, nuke them if necessary, and water-board all survivors!”

But...Err...perhaps not? Here’s an idea, just before anyone goes out and spends $3-trillion bombing some unfortunate third-world country back to the stone-ages, to teach them to stop harboring Black Swans, let’s say, just for the sake of argument, that perhaps it was a bubble caused primarily by financial stupidity, and then because there was a bubble, there was, inevitably and predictably, a bust/pop. Just an idea!!

So how do you spot a Bubble?

The first complete version of the valuation model was floated in November 2010, the main focus then was to say that price at the time ($80) which had bounced from $35, was not a bubble; and unless there was a war (always possible), or a bubble followed by a bust (less common; and you need more than a brace of Black Swans with a sprinkling of Black Magic for one of those), oil would never go down below $75 Brent. The explanation, or if you like, the excuse, for why in the event it just did go down below $75, five years later, is there was a bubble in between.

Subsequent updates on the 2010 analysis predicted a $67 bottom for this bust, so that was wrong too, but the general direction was right. This post looks at the reasons for why that was “conservative”, and where we are now.

The model to spot the bubble was simply a valuation done using the boring-old principles of International Valuation Standards (IVS), which of course they don’t teach at Harvard University. Nothing particularly radical there, but the valuation does rely on three somewhat unconventional ideas, well “unconventional” if you are a day-trader or a Keynesian-economist.

Unconventional or not, actually the guidelines put out by IVS say the person doing the valuation can use whatever crazy ideas he wants, so long as he explains how he came to his valuation opinion in words his client can understand, and more important from a practical perspective, that the client buys into...otherwise he might not pay the bill. That’s why the valuation approach used for a tribal chief deep in the jungle, might well be different from how the same issue was approached for a Wall Street banker who believes in the existence of invisible Black Swans, and might, for example, include references to chicken bones and entrails.

There are a few other points about valuation worth mentioning, in particular that the purpose of the valuation and conflicts of interest must be clearly declared. For the record the purpose of the 2010 valuation was to give an opinion on whether the then doubling of the oil prices over a few months prior, meant that there was a bubble. My “purpose” then was to provide a basis for evaluating the feasibility/risk of building a jack-up for deployment offshore ARAMCO, that needed a four-year time-span to pay back at an oil price above $75 (my day-job). And the main reason I post is I get comments, like sort of crowd funding except I’m looking for ideas/feedback rather than money.

The purpose of this valuation (this post) is mainly to try and persuade some bankers who have been cowering under a table whimpering in terror and mumbling “$20 next...$20 next”; that it’s safe to come out now; and so please will they pull themselves together and put up money to build another jack-up.  I suppose I should also declare that I have had a little flutter on some futures for October-dated Brent, although sadly, I’m not so important that,  that information will likely have any effect on the market.

Formalities aside – moving on:

Big Idea #1: Oil, like everything else, has what Warren Buffett calls an intrinsic value.

That’s what International Valuation Standards calls “Other Than Market Value” (OTMV). I don’t imagine the armies of analysts employed to see-it-coming by Shell would know what one of those was if it hit them over the head with a stuffed black swan; but for this analysis, that’s a very important concept.

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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 ...

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