Tuesday, June 10, 2008

More on oil

I believe we are in the midst of a general commodities bubble and that oil prices specifically will come back down, despite all the doom and gloom you currently hear. Much of that talk sounds very similar to the "it's different this time" talk of the tech boom and the housing boom. Here's an article that pretty much says what I'm thinking. Note that I don't believe we will go back to gas being less than $1 a gallon, only that I doubt we will be staying above $4. However, unlike the stock market, it will take a while for this situation to correct, more similar to the housing market, so it could be a while before things level out. And, as Jeff correctly pointed out in an earlier comment, it is impossible to predict exactly when a bubble will burst, but I believe it is possible to identify that you are in a bubble.

Here's some things that will likely be changing and impacting oil prices (some of this is in the aforementioned article also).
1) Weak dollar. I expect US monetary policy will move towards a more sound dollar, making oil worth less dollars/gallon.
2) In normal free market situations, as profits rise in an industry, new entrants are attracted to those profits and find ways to do things differently and more efficiently or at least source more of the desired item so that they can gain some of the profit. This should be happening in the oil industry. A variety of regulations make this difficult, but eventually these hurdles will be crossed. You probably hear a lot surrounding drilling in ANWR in regards to this topic, but oil shale in the west seems like a bigger story. Some of these options, like shale, require a higher price of oil/barrel than the $40 we used to be at, but settling down around $80/barrel would still make the new investments lucrative and be a significant decrease from where we are now. Also, refinery capacity is going to have to increase. All of these things take time.
3) We are seeing shifts in demand. While small, these trends are actually likely to widen over time. Technological innovation will shift not only to alternate fuels, but also to greater efficiencies with what we have now. As the original article explains, slight adjustments in demand can actually have a large effect on price.

In the end, who knows. Regardless of the price of oil, it doesn't hurt any of us to figure out ways to use less energy, for no other reason than it's nice to save money, even if it ends up being less savings than it is right now. My family was into buying higher mpg cars back when gas was less than a buck a gallon. A good dose of cheapness so often exceeds today's environmental fads.

** Update 7/1/2008 **
A couple more interesting links on the same topic:

Some interesting graphs from the WSJ. I especially like the one at the bottom overlaying the recent oil runup to the stock boom.

Article from Barron's saying oil may be back to $100/barrel by the end of the year!

Equal Opportunity to be Wrong

Obama has come out in favor of a windfall profits tax on oil companies. Number 1, it is idiotic for the government, the least efficient entity in the history of man, to decide how much profit someone should make for doing something. On what basis is such a decision even made? Many tech companies would suffer to have as LOW of a profit margin as Exxon-Mobil's 10.85%. Check out Microsoft's latest number, 28.33%. In fact, of the 529 companies with a market cap greater than or equal to $10B listed on US stock exchanges, there are 247 with profit margins of 11% or more. Apparently 47% of our largest companies should be subjected to a windfall profits tax. I hesitate to even make that remark sarcastically; that will probably be the next plank of the Democratic party platform. Also, for anyone who complains about the fact that Exxon-Mobil has the largest sheer profit of any company in history, that just reveals economic ignorance. They are one of the largest companies in history, so if they make any kind of a decent return, of course they have a very large overall profit number. As you can see from the previous links, plenty of companies get away with taking more from customers on a percentage basis. Number 2, a tax on oil company profits serves only as a disincentive to produce more oil. If the reason oil prices are so high is that current demand outstrips current supply...how are things improved by further inhibiting supply?

Now let's move on to McCain. He proposed, with Hillary no less, a moratorium on the federal gas tax for the summer. We all know I virtually never oppose reducing taxes any way possible, but I have a hard time making sense of this one either. Removing taxes on an item has the obvious effect of lowering prices. Businesses lower prices to stimulate demand. If the reason oil prices are so high is that current demand outstrips current supply...how are things improved by a temporary stimulation of more demand?

*It looks like the numbers I'm feeding into the google stock screener above have reset, so you'll have to re-enter the appropriate date if you want to see the number of companies for yourself. Obviously the number vares slightly over time as companies' valuations change. With the recent losses, we now have 20-some fewer companies with a market cap above $10B.