Oil Price Ten Year Forecast To 2025: Importers Set To Receive $600 Billion Refund

This is an update on a long-term oil price forecasting model developed in early 2008 first posted in April 2009 as "The Impending Mother of All Oil Shocks" which was updated in December 2010 and posted as "Crude Oil Price Ten Year Forecast to 2020".

 

Comments

Reference the current drama, in 2011 the model said:

  1. Brent at $125 was a bubble
  2. Bubbles pop
  3. Whenever the bubble popped the price would halve

In 2011 the model predicted the forthcoming crash would bring Brent down to $67 which was out by 30%...or more - Brent today is $50. That doesn't prove the model is no good, just it needs calibrating, the busting of the 2011-2014 bubble, if that's what it was, provides new data; which is the reason for re-visiting the model.

With regard to semantics, what is called a "bubble" in this analysis is when price departs upwards from what makes sense economically. That encourages what Austrians call, "mal-investment" - i.e. building condos at the height of the housing bubble, or in this case, drilling for expensive oil. A bust is the process of the mal-investors and/or their bankers losing their shirts, or if they are smart persuading governments to bail them out. Figuring out what does, and does not make sense economically (called Other Than Market Value, (OTMV)) is what this analysis is about.

Whether or not $125 Brent in 2011 and $140 Brent in 2008 were bubbles...certainly not many are talking in those terms...the price today is indeed less than half of what it was in 2011, which is pretty much what the analysis in 2010 said would happen. That, along with four other predictions by the model that turned out to have been reasonably correct, and none that were precisely wrong, is offered as evidence the model, or more specifically the valuation opinion of the model driver, Other Than Market Value (OTMV), may in general terms be correct. That said, clearly the model is better at looking long-term, i.e. on average, than for day-trading, i.e. individual data-points.

There could be other explanations for the recent plunge in prices...butterflies flapping wings in Brazil, Black Swans; China doing whatever; "imbalances" between production and consumption...whatever that means - when I went to school that was called "inventory"...and of course there are the conspiracy theories. Yet none of those collective nuggets of wisdom are offered by anyone who said, three years ago, that what did happen just now; was going to happen, which suggests perhaps the idea of bubble/bust may be correct.

By definition, the market does not recognize bubbles; if it did there would not be bubbles. So long as there is a common belief that the market is working efficiently, bubbles persist. The basis of this analysis is first...Big Idea...bubbles actually happen, they really do...remember the housing bubble, the stock-market bubble, and what looks suspiciously like what was a bubble/bust in gold, and perhaps a bubble and one of these days a bust in U.S. Treasuries (watch this space)...and second that markets do work efficiently, in the medium/long term, which is why every bubble must be followed by a bust. The thesis on which this analysis is based is that bubble/bust is zero sum, it creates no long term economic value, therefore in the long-term the Net Present Value (NPV) of cash flow into the marketplace above OTMV (+) plus out, below OTMV (-), must be zero; and that provides a basis for calibrating OTMV.

This analysis says:

2011 to 2014 was a bubble, during that time the world paid about $600 Billion more for oil than what was "fair"... where "fair" is OTMV; which incidentally is about the price H.H. Prince Turki Al Faisal Al Saud, has been saying was fair since 2008. It is not known whether he based his opinion on reading this analysis; probably not, particularly since he has the advantage of being able to talk to his customers. In which case that provides a level of confidence, because if you work out price/value two different ways, and both give a similar answer, that suggests both methods may well be valid.

If that's right, what has to happen next is that at some point in the future the world will pay $600 Billion less for oil than what is "fair", plus the time value of money; because bubble/bust is zero-sum. In effect, the world overpaid for oil between 2011 and 2014, therefore, according to this thesis, at some point in the future they will get their money back on the difference from "fair", with interest. When, is impossible to predict, this analysis says that regardless of "when", how much the refund will be, is not in question; the interest paid on top will depend on when.

Since the bubble (if that's what it was) does appear to have well and truly popped, unless it is re-inflated (always a possibility, but less likely once there has been a good-clean-bust; see below), likely by 2020 all of that $600 Billion, plus interest, will have been "refunded". By that time the "fair" price will be over $100.

Then:

  1. The oil industry will likely have been totally spooked by four-to-five years of $50-$70 oil (Brent), so drilling activity will have fallen through the floor.
  2. Likely investment in new Big Oil projects that take five-to-ten years before you get any oil, if you are lucky, will have been put on hold. [IF] so spare production capacity in 2020 will be minimal; [IF] so it is very likely a bubble will start again in about 2020....[IF] history repeats, oil could go to $150 in 2022 (that would be a bubble...which would at some point bust down to perhaps $70, depending always on when). If...if...if.
  3. Rental/charter rates on drilling and related equipment will be through the floor, which is why there is a good argument to say that now is a good time for Shell to start drilling the Arctic, for the Brazilians to start developing sub-salt, and for the Saudi's to start re-drilling/working-over their aged wells, taking advantage of equipment and people for hire at half-price; but that probably won't happen. The danger of everyone stopping drilling is that once prices get back to "pay-back-values", there is a shortage of equipment and people; which means bubbles are more likely.
  4. There will be a strong downward pressure on interest rates because mispricing of oil alone explains 76% of changes in yield on the U.S. 10-Year since 1970 (P<0.0001*). Run that along with a model with the FED-rate and GDP growth as explanatory variables and you explain 90% with the "oil" component explaining 46%. That, plus the windfall of the refunds helping the current account deficit, may persuade central banks to start the dangerous maneuver of letting steam out of the pressure-cooker to wean their economies from QE-X. It will be tricky to do that without crashing stock-markets or creating a bust in bonds. If they get it wrong they risk serious deflation; printing money to pay budget deficits is inflationary, but printing it to bail-out incompetent bankers is highly deflationary. The successful strategy to save the banks from their collective insanity, over the past seven years, has, with regard to deflation; been countered to some extent by the bubble in oil prices which is/was highly inflationary, evidence the inflation in the 1980's which can be completely explained by oil mispricing (P<0.0001*). This analysis says that "safety-valve" is now removed by the bust in oil prices, [IF] importing inflation is indeed what Martha Stewart calls a "Good Thing", which is debatable.
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Disclosure: 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 and ...

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