Soaring Oil Prices Underscore Upturn In Commodity Cycle

Soaring Oil Prices Underscore Upturn In Commodity Cycle

Headlines today bannered that crude oil prices soared to record levels. While it is true that the nominal price of oil is at record levels, the real prices or the inflation adjusted prices of oil is still far from what it was in 1980 at over $90 per barrel.

The chart above courtesy of chartoftheday.com shows you the movement of the price of oil since 1970. It can be noted that recessions in the US have almost consistently followed oil price spikes.

I find it real strange to find people still in steep denial about the dynamics of rising oil prices. In fact, alot of commentaries I heard lately attribute the current prices spikes to either geopolitical events or speculation. Like any other financial assets, as I have explained several times since 2003, the oil price dynamics is a function of CYCLES. Simply, as the chart above shows, oil has completed a full cycle in about 30 years and is at the seminal phase of the new cycle, which I think resembles the 1970-1975 period.

However, relative to the price spikes of the 70’s which were primarily ‘event driven’ or OPEC instigated supply shocks, today’s spiraling prices are basically structurally driven; incremental demand arising from the industrialization of China and the rising standards of living around Asia, which equates to more energy usage of consumer durables such as airconditioners, motor vehicles and others.

To quote Dr. Marc Faber, ``In fact, if we look at what happened to per capita oil consumption during phases of industrialization in the US between 1900 and 1970, we see that per capita consumption rose from one barrel per year to around 28 barrels. In the case of Japan's industrialization between 1950 and 1970 and South-Korea's between 1965 and 1990, per capita oil consumption rose from one barrel to 17 barrels.

``In the case of China, oil demand per capita is still only 1.7 barrels per year, and for India it has only reached 0.7 barrels. By comparison Mexico consumes annually about 7 barrels of oil per capita and the entire Latin American continent around 4.5 barrels.

``Therefore, starting from such a low base, oil consumption in Asia will, in my opinion, double in the next ten to 15 years from currently 20 million barrels per day to around 40 million barrels per day.”

Chart above courtesy of CNN.com

More demand than supply= spiraling oil prices

Further, years of underinvestment due to depressed oil prices and nationalization of oil companies led to the miscalculation of global demand and investment misallocation leading to today’s ‘out-of-whack’ imbalances.

For example, no gasoline refineries where built after 1976 in the US, such that with oil refineries operating at 95%, wear and tear has resulted to 14 disruptions in US refineries since July 20^th according to Bloomberg which prompted gasoline prices to shoot past $2, particularly $2.0048 a gallon after hitting an intraday record high of $2.0145.

In addition, there has been no major oil field or ‘elephants’ discovery in 35 years. I recall an anonymous analyst at Bloomberg who cited that for every 5 barrels the world consumes only 1 barrel is found as replacement.

An even grimmer outlook is that of the “Peak Oil” theory, where the celebrated late Shell geologist Dr. M. King Hubbert predicted that US oil supplies reached its zenith in 1970, who was initially dismissed and ridiculed by the public, which turned out to be uncannily accurate.

Chart courtesy of hubbertpeak.com

Today, peak oil advocates forecast, using the same methodology of Dr. Hubbert, that an oil crisis looms as global oil supplies are peaking coincidental to the present time when demand growth for fossil fuel is accelerating!

Matthew R. Simmons, president of Simmons and Company International, a specialized energy investment banking firm, contends that ``Saudi Arabia's oil fields now are in decline, that the country will not be able to satisfy the world's thirst for oil in coming years and that its capacity will not climb much higher than its current capacity of 10mbd. Considering the growth in demand, this could easily spark a global energy crisis.” writes iargs.org. Care for a $182 bbl oil as Mr. Simmons predicts?

In other words, even if the peak oil advocates are only partially right, it means that the AGE of CHEAP oil is finally over.

Because price is a function of demand and supply, prices determine where allocation would be and would affect fundamentally the lifestyle of people. I recall then in the early 70’s where our family’s car was an 8-cylinder Chevrolet Impala which eventually was replaced by a smaller Toyota Corolla in the early 80’s. Looking at the 30 year chart, I understand now WHY my dad’s decision to the shift the make our car then.

Using the same analogy and premise, I have argued that cheap oil prices begot the current fad of SUVs, not to mention the availability of cheap credit. Do you share the view that SUVs will still be a fad if gasoline prices hit $4-5 per gallon in the US? I don’t. Whereas oil and energy prices continue to scale new heights, the likelihood for new modes of vehicles possibly alternative fuel adjustable engines like Brazil’s ‘flexi-cars’ or much fuel efficient less energy consuming vehicles to be in vogue in the future.

Finally, it is interesting to note that for the week not only crude oil and gasoline was in record territory but also heating oil and natural gas at a 4 year high. Copper prices soared to fresh record levels anew with Gold nearing its 16-year high.