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Here Comes the Oil Price Silliness

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With crude prices having dropped at least 20% from their record highs earlier this year, the first silly predictions about how much more they can fall are beginning to gush forth. You won't be surprised to know that some of the prognosticators have thrown caution -- and reality -- to the wind in arriving at their conclusions.

For instance, I recently read a column in which the author predicted that black gold would fall -- "plummet" is probably a more appropriate verb here -- not to $100 a barrel, nor to $70, but to somewhere in the $30 - $50 range. You won't be surprised to lean that the logic employed to arrive at that target was straight from left field.

Elasticity stretch
For starters, most of the rather absurd forecasts overdo the recent decline in U.S. gasoline usage, the assumption being that the slippage will continue to the point where we'll be using a tiny fraction of prior amounts. Admittedly, Americans are driving less and thereby using less gasoline these days, but before long we'll be bumping up against the economic concept of "elasticity of demand."

It's easy to assume an extension of initial drops in fuel use, which have occurred as drivers have focused on shorter routes to work, working from home more frequently, and otherwise reduced their miles driven. The trouble there is that the declines tend to be wrung out of the system early on, and our reduction in usage will almost certainly plateau before long.

And then there's the issue of geography. Those who look at slipping U.S. gasoline consumption tend to ignore the reality that, while we Americans can "adjust" our gasoline consumption significantly, unless China and India’s growing demand for petroleum follows suit, demand for oil isn’t going anywhere.

Start your engines
And then there's the all important issue of changes in automotive engine technology that has a number of observers in a lather. Let's start with hydrogen. Essentially all the automakers, including Ford (NYSE: F  ) , General Motors (NYSE: GM  ) , and Honda (NYSE: HMC  ) are working feverishly to perfect hydrogen fuel cell cars. The difficulty here is that the widespread proliferation of hydrogen, of the type that'll meaningfully reduce gasoline demand, is years off. Such a dramatic shift in our nation’s infrastructure – (Pop quiz: where is your nearest hydrogen refueling station?) – can’t happen overnight.

So then we move to hybrids. When you say you have a hybrid, the world assumes you're getting all sorts of elevated mileage. Trouble is, all hybrids aren't created equal. For example, while Toyota's (NYSE: TM  ) Prius and Honda's Civic hybrid both are capable of going more than 40 miles on a single gallon of gas, GM's Malibu hybrid nor its Saturn VUE hybrid attains much more fuel efficiency that my standard-engine Toyota.

Plug-in promises
Beyond that, there's the plug-in, to which most of my hopes are pinned for real gas savings. But while we'll probably begin seeing more and more plug-ins coming at us on our nation's roads as the years pass, real progress, as measured in millions of working plug-ins vehicles, is probably a decade or more away.

Finally there are the all-important geological and geophysical considerations that often are completely left out of crude price predictions. In this context, I remain convinced that it's unlikely that we'll be successful in ramping global crude production meaningfully above 85 to 90 million barrels a day. On the geological front, many of the world's biggest fields are becoming tired, and their yields are dropping steadily. We'll need to replace those declines before we can start to raise global production significantly.

Geopolitically, countries like Venezuela, Kazakhstan, and Russia have made life very difficult for Western oil companies like Total (NYSE: TOT  ) and BP (NYSE: BP  ) that have endeavored to work within their boundaries. And looking ahead, the elbows of many oil-producing states are likely to sharpen significantly as time passes.

So, while I believe that further slippage in oil prices is entirely possible, it's difficult to envision those prices far below triple digits before some unpredictable event quickly halts their slide. On that basis, Fools would be well advised to continue to keep close tabs on the energy portions of their investment portfolios.

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Fool contributor David Lee Smith doesn't own any of the companies mentioned above. He does, however, welcome your questions or comments. The Fool has a disclosure policy.

Read/Post Comments (5) | Recommend This Article (3)

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  • Report this Comment On August 20, 2008, at 4:40 PM, Brettze wrote:


    I think that you failed to take into account the quaking groundswell of the driving public against Big Oil. I think it is still largely inertia going on as people are making new decisions with regards on driving habit changes. Old habits die hard, but they will surely die. $4.50 gasoline was a nightmare that had already happened and it is in the past but certainly not in the future for another long period of time to come as inflation will afford cushion against rising gas prices in the future. All car makers are not as quick to supply fuel sipping models to the buyers as expected. We used to buy a SUV or PickUp for every coupe or sedan but it will be reversed. I think that it will be more like one or two for every ten coupes or sedans. Crossovers will be the new gas guzzlers as SUVs and PickUps will gradually disappear into the foggy days of Dusenbergs. This movement toward great fuel efficieny is irreversible and even growing demands coming from emerging markets will not stall the declining gas prices as more oil will be discovered and drilled in the emerging markets as well. No matter how skeptical you feel about falling oil prices, the bottom line is that high oil prices just do nothing but skid our economies to a screeching halt and we all know that. You still dont know that?

  • Report this Comment On August 20, 2008, at 4:43 PM, Brettze wrote:

    It is nothing different than swearing off booze or gasoline all the same!

  • Report this Comment On August 20, 2008, at 10:29 PM, fiveamericans wrote:

    Let's see.... markets lag reality right?

    No wait, they anticipate what's going to happen. So it's reasonable to say that even though hydrogen as an automobile fuel is "years off", oil futures - remember we're talking futures - could very well begin to anticipate this and other developments.

    Markets tend to fall slowly, methodically... without overshooting fair value, right?

    Not in his lifetime! The emotion that drove oil futures - remember we're talking futures - to ridiculously high prices drive oil futures to ridiculously low prices. Alas, if only the pits were full of academcians instead of local speculators.

    Finally, your last paragraph is insulting to the intellect. Despite your reasonably cogent arguments presented above, you rest your conclusion on some "unpredictable event"? And then you follow that comment with sage advice to monitor my energy investment closely. Tell me please, which part of my portfolio should I not be monitoring closely?

  • Report this Comment On August 21, 2008, at 1:00 AM, Metamagnet wrote:

    So where is this hydrogen going to come from? That is, where will the hydrogen stations get their gas? Hydrogen is fine as energy storage, but not as an energy source. Thermodynamics tells us that it will always require more energy to extract the hydrogen than we will get back by burning it (even in a fuel cell).

    We already have a hydrogen economy--the hydrogen is chemically bonded to long chains of carbon and efficiently transported as a liquid to fuel cars, trucks and planes. And for heating and some electrical production, it's transported in pipes on single carbon atoms so that the hydrogen doesn't corrode the works. In other power plants, the carbon chains are much longer, so that it is an actual solid. Pretty amazing actually.

  • Report this Comment On August 21, 2008, at 11:09 AM, PardonMyDust wrote:

    Ahhhhhh Brettze, your "foolish comment" reveals only your age. The global players behind "Big Oil" are not quaking with fear that the proletariat will bring them to their knees.

    $4.50 "a nightmare"? Noo Yawkers have been paying $4.00 roundtrip to ride the subway to work for quite a while now. If $4.50 breaks your budget, you have bigger problems than gas prices.

    First fallacy, NO MORE DUSSENBERGS? Did someone mindswipe your memory? There WAS an earlier "oil crisis" in the 70's and we DID build SUV's and Hummers after that.

    Next Law of Nature: Oil is finite!

    Corollary to that is that once producers can jump on the "increase prices" bandwagon, you will not see them as willing to reduce them no matter what happens.

    Live long and prosper!

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