Hi Stephen, Nice simulation; but human greed and stupidity, which are impossible to over-estimate, are not factored in. The current oil price bubble, which closely resembles the classic Dutch tulipmania, will probably go they way of all bubbles, since they depend on the 'greater fool' principle. At some point fear trumps greed, and the players lose their nerve; then a run starts.
Of course, the bubble will continue if the U. S. takes out the Iranian oil fields. I just read that another Nigerian pipeline was blown up. Mayber Bush told Putin that Bush was going to hit Iran no matter what, and that Putin better stay out of the way, shades of Dr. Strangelove. This may explain the recent Iranian announcement that they are willing to be questioned about their nuclear program. Jack Smith Stephen A. Lawrence wrote: > > There's so much outright garbage on the Internet about the price of > oil, I decided to do a little crude modeling of my own to try to get a > handle on this. My conclusion is that, using a trivial model and > some simple historical values, it appears that oil may not get past > $150 in the next year. Note that at $150/bbl, it's still not going to > be soaking up more of "world GNP" than it was back in 1980, so > this is interesting; it suggests near-term dislocations in the United > States, Europe, and Canada may be a lot smaller than I, for one, > expected. > > Herewith some numbers and stuff. > > ======================================================= > > To start with, I dug around and found a claim that the price of > gasoline has an elasticity of -0.2. OK, that's 1 significant digit, > maybe it's kind of close. I didn't find the elasticity of crude oil > anywhere, but for the time being I'll go with -0.2. That's certainly > very low. (In a monopoly market, prices are "naturally" set at the > point where elasticity = -1.0, for whatever that's worth; -0.2 really > is 'way low according to theory and implies prices are far, far below > the point at which producer income is maximized.) > > Elasticity = (dQ/dP) * (P/Q) where Q = quantity sold and P = total > revenue. It's normally negative, at least if we use this definition, > as the quantity sold normally drops when the price goes up. > > The next piece of information we need is the "natural" rate of > increase of oil consumption. (There is enormous amounts of garbage > spewed about this one!) I found a table of world oil consumption, > going from 1900 to 2005. It's located here: > > http://www.eia.doe.gov/aer/txt/ptb1110.html > > Assuming it's accurate, we get our first surprise: The compound growth > rate in oil consumption from 1900 through 2005 was 3.08%. The growth > rate from 1995 to 2005 was 1.79%. This is far, far lower than I > expected! > > Next we need to make some assumptions about supply. If we assume > there are 100 bbl/day available now, we can scale that up or down to > get supply in one year; call the first "Q" and the second "Q2". > Initially, assuming we're /at/ the peak, I assumed flat supply. > > Finally we need some formulas. Define > > Q = total starting supply = 100 bbl/day > P/Q = starting price = 100 dollars/bbl > P = total starting revenue = (P/Q) * Q = 10,000 dollars > > E = elasticity = dQ/dP * P/Q > > Now, we're going to have a "natural" final value for Q, which is the > amount demanded if the price remains flat. We define that as Q1: > > Q1 = final "natural" demand = 102 barrels, if we assume the "natural" > demand increase rate is 2% per year. > > P1 = final "natural" price = starting price = 100 dollars/bbl > > But we're not going to allow consumption to rise at the "natural" > rate; we're going to pin it to the available supply. This gives us: > > Q2 = "forced" final consumption value = 100 bbl/day > > Now we want to find P2, the final "forced" price. To do that we go > back to the formula for elasticity, which we're assuming is constant: > > (Q2 - Q1)/(P2 - P1) * P2/Q2 = E > > For convenience, we'll define > > delta-Q = Q2-Q1 = difference between "forced" level and "natural" > level of consumption > > Fiddling around a bit we get > > P2 = P1 * (1/(1 - delta-Q/(E * Q2))) > > I plugged that that into a spreadsheet, and found the following, for a > number of values of elasticity and demand growth, but assuming flat > supply in each case (unit width font, please): > ---------------------------------------- > > Demand > Elasticity Growth Final Price > > -0.2 2 111 *** Based on recent oil use > -0.2 3 118 > -0.2 5 133 > -0.1 2 125 *** Based on recent oil use > -0.1 3 143 > -0.1 5 200 > -0.05 2 167 *** Based on recent oil use > -0.05 3 250 > -0.05 4 500 > -0.05 5 Floating point overflow > > ---------------------------------------- > > Since elasticity is a big unknown I've shown it with -0.2 (value > claimed on the Internet), -0.1, and -0.05. I would guess that the > last value -- 0.05 -- is unrealistically small. > > Note that an actual /drop/ in supply has almost the same effect as an > additional increase in the "natural" demand. So, if supply actually > drops by 3% while demand "naturally" would increase by 2% the result > is about the same as an increase in demand of 5%. In fact my very > simple model says that combo results in a final price of about > $139/bbl. > > So, the overall conclusion from this trivial exercise is that, unless > the elasticity is really, really, REALLY small, or demand goes up a > lot faster than it has in the past, we're probably not going to see > prices much over $150 within the next year. > > I was surprised -- I thought we were heading for the cliff a lot > faster than this, and $200/bbl oil next year was a no-brainer. But, > apparently not. > > Steven Vincent Johnson wrote on 4-24-08: > > Several weeks ago the Kiplinger Letter claimed that current commodity > prices are significantly above what supply and demand factors would > historically dictate. > > See: > http://www.kiplinger.com/businessresource/forecast/archive/commodity_prices_near_turning_point_080409.html > > http://tinyurl.com/46a6as > > What's behind it? > > Investors chasing high returns...pouring cash into commodity futures > because other choices seem less attractive. Herd behavior. > > What could burst the bubble? Sez Kiplinger: > > "A number of factors could burst the commodity balloon: A cut in > worldwide commodity demand, big stock market gains, a more stable > dollar or tame inflation signals. Prices will drop by about 30% if all > these factors come into play at once, but declines will be smaller and > gradual if signals are mixed. Oil will slide to $85 a barrel, with a > smaller reduction at the pump, because risk is still a factor." > > Just to be clear on this point, Kiplinger doesn't expect the bottom to fall > out. > > Unfortunately, Natural Gas won't come down. Sez Kiplinger: > > "Demand for natural gas for industrial, heating and other uses is sure > to remain strong, and prices, currently around $9 per million British > thermal units, may top $10 per million British thermal units next > winter. Natural gas supplies are roughly adequate for normal weather, > but harsh conditions are likely to cause real stress. Fading quickly: > hopes that liquefied natural gas will increase supplies. LNG is going > to Asian and European buyers, who are outbidding U.S. purchasers." > > Personal reflections: > > I hope they're right. Not sure that I do. > > Regards > Steven Vincent Johnson > www.OrionWorks.com > www.zazzle.com/orionworks
