Oil, Oil, Everywhere

By Kevin Drum

May 7, 2008

OIL, OIL, EVERYWHERE....The price of oil closed at $122 today. But where's it going next? According to this AP dispatch, one analyst thinks it's likely headed up to $200 while another thinks it's probably headed down to $80. Yawn. This reaction, however, grabbed my attention:

"It's not that the genie is out of the bottle — it's that 100 genies are out of the bottle," said Daniel Yergin, chairman of Cambridge Energy Research Associates. Normally known for optimistic forecasts of lowering oil prices, Mr. Yergin's firm now says the price could rise to $150 a barrel this year.

The world's diminished spare production capacity remains the strongest single catalyst for high prices, Mr. Yergin says. The world's safety cushion — the amount of readily available oil that could be pumped in a moment of crisis — is now around two million barrels a day, according to most estimates. That's just 2.3% of daily demand, and nearly all of the safety cushion is in one country, Saudi Arabia. Everyone else is pretty much pumping all they can, which makes the world vulnerable to political or other shocks.

Saying Daniel Yergin is an optimist is like saying Chris Matthews is annoying. Yergin basically thinks peak oil is Luddite crankery and that new technology will allow us to continue increasing production for at least the next several decades. He's the Pollyanna of the oil patch.

Now, I'm sure he'd say that his current pessimism is based not on a fundamental reevaluation of recoverable reserves, but instead on "aboveground" issues: political instability, terrorism, lack of investment, and so forth. Still, if even Daniel Yergin thinks oil prices are headed upward, it's a pretty good guess that oil prices are headed upward.

Way interesting. Oil is well over $120/bbl as I write this. The nature of bull markets is that folks who've been bearish all along start throwing in the towel and getting on the bullish bandwagon late in the game. When you can't find a pessimist; it is a sign the bull market is getting old.

But, as a wise friend pointed out; the end of a bull market is where the most spectacular profits can be made. He pointed out some history on this, especially the NASDAQ tech bubble that happened a few years ago. Check out the chart below:














Half the NASDAQ bubble gains were made in the last four months of its bull market, roughly between November 1999 and March 2000. Prior to that; it built fairly steadily at a minor geometric pace since 1995. This shows up a bit more clearly on the log plot below:
















Using the NASDAQ bubble as a basis to quantify estimates, could Yergin throwing in the towel be a sign we are going to have a "superspike" on oil prices that may double current prices? Possibly only lasting months and followed by a crash down to 25% or so of the peak price? The most amazing profits are made in the last legs of a bull. What separates the men from the boys is: who's got the guts to stick in to get to the peak and who's got the brains to time the sell at close to the peak?

Time will tell. If I really knew the answers to such a question I'd be rich! Sure gets my Spidey Sense tingling though.