Oil!

Beer drinkers and hell raisers,
Baby won’t you come along with me…
—Z Z Top 

For the second time in the last thirty years, the oil patch is economically beating the socks off the country as a whole. It happened in the seventies when, during a bust in the U.S., OPEC ran the price up from two bucks a barrel up to forty. And again in the last five years, when hedge funds, having bought the “Peak Oil” argument that the globe was running out of the stuff,  dove into oil, driving it from twenty bucks to a hundred forty-two.

Oil men say,”Yeah, boy, the all bidness is purty good.” And, when you get past the fact that they all come from Texas or Oklahoma sounding like they can’t spell their own names right in three tries, you will discern that what these canny dudes really mean is that the bullish sentiment in the oil markets makes it possible for them to get boatloads of suckers to buy into their drilling funds. A look at the long term chart of oil is instructive:

The oil market is no different than any other, in that most of the exploration money comes in near the top. How’d you like to have been an oil investor that bought into a drilling project in ’08? If you didn’t have an infarction during that 74% drop into the ’09 lows, you’d have to be brain dead. And the worst is yet to come. The first drop figures to be an A wave following one of the greatest commodity tops since the tulip mania of 1620. The reflex rally into what has so far been the top of a B wave ended in May 2011. The C wave is where fundamentals catch up to the market. As Prechter recently wrote “…the rally into 2011 rekindled the peak-oil vision, which prompted investors’ hoarding of black gold in tankers all around the world. When the owners see this price fall further, as more supply enters the pipelines, they will give up and sell their inventories, which will depress the price even further.”

I must confess, the Peak Oil argument was pretty convincing to me, despite the obvious speculative look of the chart. So, now we are hearing that the U. S.is proving up scads of new reserves using hydraulic fracturing (“fracking”) to produce oil from previously inaccessible oil sands. Although the technique is controversial, the projection is that the country will soon be out-producing Saudi Arabia.

Deja Vu. Every time the wells are supposed to be running dry, more is found. Given that we are in a deflation during which all asset classes go down, the next decline should parallel the stock market both in time and in magnitude. The overhang of speculative positions in the futures markets, physical surpluses, markedly lower consumption due to better gas mileage and less driving brought about by a bear market in social mood will make the C wave a dilly of a move down to, maybe twenty bucks a barrel or less over the next four years.

Don’t give up on that Hummer you’re driving just yet. By the time the markets hit bottom, you’ll only be plunking down 32 bucks for a fill up, instead of 112.

Cheers,

Rod

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