Monday, March 16, 2009

How Low Oil Price Is Setting The Stage For Higher Future Oil Price

Like other commodities, price movements in oil and natural gas work with a significant time lag. Because it takes a lot of time to find new wells, not to mention how long it takes to extract them, supply only responds with a significant time lag. Similarly, demand also responds largely with a time lag, as it takes some time for people to for example switch the kind of vehicles they use. This means that the short-term price elasticity (responsiveness to price changes) is very low, but it is a lot higher in the medium to long-term.

The flip side to low price elasticity is that a large change in prices is required to accommodate even small changes in demand or supply. A good example is the big drop in the price of oil between June and November 2008 in response to the drop in demand caused by the big drop in global economic activity (or for that matter. the big run-up in prices before June 2008).

Right now, we are seeing the first signs of a response to that big drop in demand, as gasoline demand is rising and drilling activity is collapsing. This has so far only resulted in energy prices being stable for the last few months, and not rising, as the continuing deterioration in economic activity in the U.S. and Europe is reducing demand. But once the global economy recovers, so will the price of oil, and likely very fast.


Blogger Ke said...

Here comes the hard part: When will the global economy recover?

11:53 AM  
Blogger jeppen said...

I agree. Also, it's not unlikely that the last three to four years were the global oil peak. Interesting times ahead, anyhow.

12:56 PM  
Blogger Wille said...

I've said several times that right now is probably one of the best times in history to invest with a medium- to long term horizon based on future macro trends.

In my view, it hasn't been easier at any point in recent history to see with a high level of probability how things will play out than it is right now.

7:55 PM  
Blogger Per said...

I suppose that I'm not as bullish on the oil price as you are. I don't think we will see prices anywhere near $140 again in the near future. Here's why: even though the current economic slump causes lower production, the recovery will take a long time. Could the price peak last summer be the result of an (Fed induced) artificial demand? In the range between $40-$140, there ought to be a substantial amount of oil supply that is profitable for drilling. But perhaps I should be careful about betting all my money on this - I'm no geologist after all. :)

10:07 PM  
Blogger Wille said...

I'm pretty sure we'll see $140 dollar oil again within the next 3-4 years.
Although I also think there is some likelihood we'll see $25 dollar oil before then.

12:53 AM  

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