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Oil explained



May 12, 2008 – Comments (10) | RELATED TICKERS: USO , XOM , BOLT

Oil is way higher than $120/barrel now, and everyone thinks it's over $100 to stay, and perhaps headed for $200. Wowie-zowie! Peak oil, huh?

It's more complicated than that. There are vast oil shale reserves all over the world, as well as "subprime" undersea wells, and we're discovering new oil all the time. Furthermore, people on the cutting edge of petroleum are questioning whether it's a fossil fuel or not. It may be the byproduct of microbes that live miles below the earth's crust, in the extreme heat of the earth's mantle. But that's incidental to my point. My point is that there is still a lot of oil in the world, and it can be extracted and refined for well under $100/barrel.

The fundamental supply and demand, backing out speculation, puts the price of oil in the double digits, in fact below $80, according to most economists.

By now you probably suppose that I'm trying to say that oil should be less than $80. Far from it. Speculation is a valid economic activity, and it is based on (more or less) reasonable expectations of the future, or at least, hedging against a possibility that may have only a 10-20% chance of occurring, but will be the most important thing that could happen if it does. For instance, world war probably won't break out over oil, but if it does, you will want to be the one who paid just $1,250,000 for ten thousand barrels of oil ($125/barrel), because everyone else will be paying $1000/barrel after the OPEC flow ceases and the rationing starts.

Do I think oil will come back below $100? Probably, but I'm not so convinced that I would put money on it, because fundamentals based on sound speculation have a way of catching up with speculation. At some point we may be looking at fundamentals that dictate $120, while speculation raises the actual price to $200. In that case, the people who bought at $120 can sell for > 60% profit.

Silver is another resource where the price seems to have gotten ahead of the fundamentals, if you think of it as merely an inflation hedge, but I think the fundamental case for silver is even better than oil. People underestimate the industrial usefulness of silver, and nobody's trying to find alternatives for it. (We already have alternatives: gold is the high-end alternative, and copper is the low-end alternative.) Silver is much more useful than copper, and much rarer. And we have been depleting our mined and refined supply of silver much more rapidly than that of gold. That's why I own call options for companies like Coeur d'Alene Mines (CDE), and I'm ignoring oil, except for companies like Bolt (BOLT), which profits from the increasing price folks are willing to pay to find undersea oil wells.

So I expect silver to rise, outpacing inflation for the next few years, and silver miners to outpace silver itself, if they refrain from hedging on the way up and can keep their dilutive tendencies under control. Oil could see a serious pullback, meanwhile, especially if someone has a serious breakthrough on an affordable, effective alternative energy, which we don't yet have. (Don't kid yourselves, solar flacks.)

10 Comments – Post Your Own

#1) On May 12, 2008 at 1:32 PM, LordZ wrote:

SU is the oil stock your going to want to get...

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#2) On May 12, 2008 at 1:38 PM, madcowmonkey (< 20) wrote:

what is flacks? Good post and interesting take on silver. CDE comes up a bit here on caps. So are we going to see a significant rise in silver in next year? 

The oil shale and sands projects scare me, because the companies have thrown so much money at them that they can't let them fail or fade away. When big money goes in a certain direction it is certain to happen. The pollution that these plants will be kicking out is enough for me to say forget it and look for another energy, but it will not happen with the mainstream. Unfortunately for us and the future people that will be around after I am turned into a fossil fuel, the big oil companies will have their way in not going green and getting everybody else to just look the other way 

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#3) On May 12, 2008 at 1:46 PM, FourthAxis (< 20) wrote:

WOW.  I love this discussion and I just had it with a friend the other day...though I TOTALLY DISAGREE with most of your points.

1.   "There are vast oil shale reserves all over the world, as well as "subprime" undersea wells" 

True.  However, aren't you ignoring the added expense to get to those reserves and refine them with an offhanded $80/bl estimate?  I mean...if it were cheap wouldn't some enterprising sould have already plundered?

2.  "and we're discovering new oil all the time."

FALSE.  Not in large quantities or easily available.  Sources?

3.   "people on the cutting edge of petroleum are questioning whether it's a fossil fuel or not"

True.  There is a debate, but is there any substance to it? Research?  Anything?

4.   "It may be the byproduct of microbes that live miles below the earth's crust, in the extreme heat of the earth's mantle"

It *MAY* be, but I think the laws of thermodynamics are gonna call BS on that quick. 

5.   "At some point we may be looking at fundamentals that dictate $120"

True.  However, your "discovering new oil all the time." comment tells me your conflicted somehow. New Oil != Expensive Oil

6.   "the fundamental case for silver is even better than oil." 

Really? I see it as both are available in finite quantities, but oil is consumed and silver is redistributed.

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#4) On May 12, 2008 at 2:38 PM, Tastylunch (29.54) wrote:

Peak Oil? no. Peak Easy Cheap Oil? yes.

you also forget to mention the effect of the US dollar has on oil prices which is almost all imported... That is one the three key drivers of the price increase (increased demand, decreased easy/cheap supply and loss of purchasing power due to the dollar)

Oil could go below 100 again but it isn't going to stay there long barring major unforseen events.

While I agree with your last point to some degree, I sincerely doubt any tech breakthroughs in the next three yeras or so could be mass adopted rapidly enough to take a significant dent out of oil prices....

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#5) On May 12, 2008 at 5:01 PM, mandrake66 (96.39) wrote:

Peak Oil? no. Peak Easy Cheap Oil? yes.

I'm finding it hard to see the difference. Peak oil means that maximum supply is hit one year, and gradually tails off thereafter, because what is left is harder and more expensive to extract. The first is an event, the second is the effects that derive from it.

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#6) On May 12, 2008 at 5:27 PM, FleaBagger (29.37) wrote:

Axis -

Thanks for your comment. However, you say you "totally disagree with most of [my] points" and yet you go on to agree with at least part of four of the six points you enumerate. And in fact, where you say "FALSE" I think we agree and you miss my point. I'm saying we're discovering small and difficult to extract sources of oil all the time. That's why we agree on what you call point #5. So it seems you partly disagree with most of my points.

I think inflation is also a big part of the coming $150-200 oil range, and I'm not a true believer of peak oil. It may be peak oil, but I think that extraction will continue to advance and become cheaper (in relation to other things in the economy), keeping the world from running entirely out of oil. I think we are likely to see rising prices, rising demand for alternatives, rising funding rates for speculative attempts at alternatives, numerous failed attempts at alternatives, and, finally, an alternative that is practical, effective, and affordable enough to make the combustion engine itself an antique. That will drive the price of oil down and gasoline up, as the oil becomes practically worthless, and the wealthy have to pay a high premium to an inefficient process in order to have the oil refined into gasoline for their antique 2007 Maybach or whatever. Meanwhile the rest of us will be running on rain energy (or whatever wins the economic contest).

That may sound like contradictions in "what I believe," but that's because economics isn't one thing controlling everything else. Economics is supply and demand pushing against each other with human innovation sparking off into things we couldn't imagine ten months before.

By the way, why is the law of thermodynamics against microbial petroleogenesis? (Is petroleogenesis even a word? If not, it should be, and I just coined it.) As I remember it, the law of thermodynamics has something to do with entropy. Well, if you think it's no big deal that microbes live in the earth's mantle, in temperatures that are > 1000 degrees Fahrenheit, why does it seem farfetched to you that these microbes produce crude oil waste? So whatever it is they do to live produces hydrocarbon waste: is that so wild? Is that any more farfetched than oil being dead dinosaurs?

Also, you seem to be one of the many who vastly underestimate silver's industrial usefulness. Over half of the world's demand for silver in 2006 was for industrial fabrication, according to the 2007 World Silver Survey (the 2008 World Silver Survey is too recent for a cheapskate like me to get for free). It is hardly a stretch to think that 2007 saw a similar industrial demand. These are uses from which silver is not easily recovered. You can melt down the jewelry you bought yourself when you thought you were a player, and your ex-girlfriend can melt down the jewelry you bought her when you thought you were a player, but you are not going to dismantle your computer or your camera to reclaim the silver from it. This silver is consumed for good, at least until we see $200/oz. Think $200/oz is impossible? You're probably right, but that just means that I'm right about this silver being unreclaimable. And that kind of industrial use accounts for > 400M oz annually.

Have you ever heard of solar silver? No? Neither have I. Have you heard of government subsidies for corn-based silver substitutes? Have you heard the one about the copper wire that walked into a bar...

Anyway, it was fun talking to you, but I've been at this for over an hour (but a lot of that was me being distracted by someone talking about The Ring), and I can't spend my whole life pretending to be a silver bug (I'm not - at least, I won't be in 2010 or 2011, whenever its price surpasses its true value).

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#7) On May 12, 2008 at 5:40 PM, FleaBagger (29.37) wrote:

madcow -

A flack is a press agent, or in this case, someone who rants wildly about a particular industry without paying any attention to the weaknesses and risks.

I don't need silver to go up in the next 12 mos, because my call options don't expire for more than 18 mos. Despite that, they were surprisingly affordable. Pretty sweet, huh?

I agree that oil shale is scary, but not in the sense that oil companies rule the world. Their lobby is weaker than you think. The corn lobby is much scarier, considering that ethanol is as bad for the environment as oil, and doesn't actually yield anything beyond what it takes to produce, and we nonetheless had massive ethanol subsidies on top of huge farm subsidies.

TL -

I thought I tied oil prices to inflation in the last couple of paragraphs, but after further review, the connection was vague at best. Sorry. That was what reminded me of silver, though, and not my ugsome need to flack my call options in every post I write. Okay, so it was probably a little of both.

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#8) On May 12, 2008 at 7:38 PM, abitare (58.10) wrote:

The oil run up is about the war. The supply/demand has NOT changed that much in a year. But the WAR is getting hotter and HOTTER. 140k US troops in a country of 30 million cannot keep the peace. Sadr has 2 million
followers, who speak the language, know the terrain and have the will and energy to wear down American resolve and help to bankrupt the US.
The current price of oil is about the war and the declining dollar.

The Economist predicts low oil prices for foreseeable future From: Harriet Griffin Subject: The Economist predicts low oil prices for foreseeable futureDate: Mon, 8 Mar 1999 15:35:19 -0000


"The world is awash with the stuff, and it is likely to remain so.

That is good news, is it not? For consumers, certainly, especially those
in poor countries whose lives will be improved by the warmth, light and
mobility that cheaper energy brings. It would be progress, too, to get
away from the notion that oil is scarce-an assumption that led to two
decades of energy-policy mistakes, such as subsidising coal and nuclear

But do not imagine that the bad dream is over. It is worse than ever for
some of the world's most populous and poorest countries that make their
living from oil. Petroleum provides over half the government's income in
such places as Iran and Nigeria. OPEC's oil revenues last year were, in
real terms, only a fifth of their peak in 1980, so most oil producers
are beset by huge budget and current-account deficits. If cash-strapped
producers cut expenditure faster than consumers spend their windfall,
the effect of lower oil prices might even be to slow world economic

Cheap oil could cause instability as well as poverty. As a result of
last year's low prices, the Mexican government has revised its budget
three times and increased borrowing. Mexico is hardly a paragon of good
government, but, thanks to the diversification of its economy since the
1980s, it at least has an alternative to oil. Many other oil-producing
countries are ill-placed to cope with low prices. Cheap oil might merely
aggravate the twin evils of corruption and bad government. " Report this comment
#9) On May 12, 2008 at 8:26 PM, AnomaLee (28.88) wrote:

""It may be the byproduct of microbes that live miles below the earth's crust, in the extreme heat of the earth's mantle"

It *MAY* be, but I think the laws of thermodynamics are gonna call BS on that quick. "

The name fossil fuel is a slight misnomer, but there is no debate over what they are - hydrocarbons. They typically do come from "tiny little microbes". More specifically oil is typically found in places where large amounts of plankton once existed. As geologist increase their knowledge and understanding they have been able to refine and find pockets of oil in places where those "tiny little microbes" existed and Veolia! you have shale rock, oil or natural gas in their crude and various forms.

People forget that phytoplankton produce more oxygen than all the trees on the planet. That isn't hard to do considering the earths surface is 70% water and phytoplankton are the most abundant life forms in them. We know today that when many species of phytoplankton die that they cary large amounts of carbon with them to the ocean floor. There are many researchers trying to alter these "tiny little microbes" to produce higher amounts of hydrocarbons.

Also, you need to squint very hard to see the Great Wall of China from space, but you can easily see miles and miles of phytoplankton from space. It's all that green stuff floating in the ocean, and no it's not just sewage..

Personally, I think it would be ridiculous if we were still burning hydrocarbons as our main source of energy a 100 years from now. Future generations will eventually look at our generation burning oil as being as silly and inefficient as when people burned wood for steam engines. 

Even cavemen had the basic knowledge of burning stuff as an energy source. To our credit, we've just moved beyond that level within the past 150 years, so we are still in the infancy stages of understanding the powers within the atom - the electron and the strong force of nucleus(nuclear energy).

I'd agree with Flea given the technology available today. I'd bet we're powering more things through electricity from nuclear power plants, wind farms, and solar panels before we find a way to produce silver.

I've been following energy for a long time now. Someone said it best in a reply to one of my blogs. "It's funny to see how everything is about energy these days."

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#10) On May 12, 2008 at 11:38 PM, dwot (97.03) wrote:

Interesting discussion...  I'm still thinking $80 oil is in the mix somewhere....


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