Peak Oil or a Flaw in the Bubble Theory?

on Jun 8, 2012

On 6 June 2012, the website for financial analysis and stock market news, Seeking Alpha, published the analysis of Mr Andrew Butter, a Dubai licensed venture capital adviser and project manager, providing insight into what might or might not be a 2012 oil bubble.

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In short, the supporters of the bubble theory believe that the price of a given asset can temporarily rise far above its true value. This occurrence is referred to as a “bubble”, with these overvaluations or bubbles being relatively easy to identify. At some point, the bubble is bound to “pop”, causing a significant price decline, before the price is restored to a more reasonable level.

In his analysis, Mr Butter makes a reference to the oil bubble observed in 2008, noting that the reason which caused the bubble was not found at the time. And yet, the oil price dynamics defined the 2008 instance as a bubble.
In 2008, at one point the price of the Brent crude oil per barrel reached over $140, and then fell to under $40. Subsequently, Brent oil climbed to $80-$90 a barrel, following the classic blow-pop-recover price model of the bubble theory.

!m[](/uploads/story/113/thumbs/pic1_inline.png)The present scenario has seen the price per barrel hove between $100 and $130 for the past year and a half, sparking fears of a pop that has yet to materialise with no drop below $90-$100 forthcoming. Traditional patterns would dictate that highs such as the $130 per barrel recently witnessed should be followed by a drop to around $67, followed by a recovery to equilibrium around $90. This could still happen in 2012, but if it does not, Butler believes that this would be indicative of either a significant flaw in the bubble equation, or that peak oil might now be a reality.

Mr Butter points out that the price of oil did indeed go down, but not as much as the predicted $67 breaking point, so as to establish an easily identifiable pop. In the absence of an actual pop, Mr Butter explores the peak oil scenario. In the case of peak oil, the oil price would be determined not by what customers can afford to pay, as has been the case until now but rather, by the costs associated with the discovery, development and transportation of oil to market. Oil will behave and be priced much more like

a basic consumable than a traded commodity.
If, however, the theory is right after all, there is a chance that a pop might be properly expressed in mid-2012. In the case of a pop and oil prices going down again, there will be some relief for Western economies and the United States in particular. The analysis notes that the U.S. has been hugely subsidising the real cost of consuming oil, a consequence from the time when the country was more or less self-sufficient in oil.
As pointed out in the analysis, a pop behaving according to theoretical dictates as to how it should will also benefit oil exploration companies, since it will demonstrate that $70 for Brent oil is about the bottom line, whereas the equilibrium stands at $90 to $100. This will make raising finance for exploration and development easier. This, in turn, is much preferable for oil companies than the possibility of oil going as low as $40 and staying there, which would kill large-scale investments with five to ten-year pay-backs.
On 8 June 2012, Bloomberg reported that oil was heading for the longest weekly losing streak in more than 13 years, yet it remains to be seen how long this downtrend would continue and whether the price decline would be sufficient so as to signify an actual bubble popping.


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