What Goes Down, Must Go Up?

by Richard T. Stuebi

as posted to Huffington Post

About 60 miles west of Cleveland, Cedar Point is world-renowned for its scary roller-coasters. However, Cedar Point has nothing on the oil markets.

At the turn of 2007/2008, oil was at the cusp of $100/barrel — a price that was considered a kind of mythical barrier, due to its three-digit numerology. Well, it took just a day or two into 2008 to broach that level, and by July, oil was approaching $150/barrrel — an increase of 50% in 6 months, and fully 6 times the levels that prevailed just 5 years previously in 2003.

Then, the bubble burst, violently: in just the six months since the summer, oil prices have collapsed, falling by about 75%, to below $40/barrel.

I am reminded of the classic Vince Lombardi film clip, in which he yells out incredulously from the sideline, “What the hell’s going on out here?” People ask me, as if I should know, because I’ve been involved in the energy industry for over two decades, but alas: I can’t figure it out. And, I’m not alone.

For instance, consider the December 10 presentation given by Matt Simmons in Houston. Simmons has impeccable credentials, having served as an analyst of the oil industry for nearly 40 years — and it seems as though he’s incredulous as to what he’s seeing.

Simmons laments (like many others of us) that the recent collapse in oil prices — as inexplicable as it’s been — is not a good thing. For Simmons and others in the oil industry, low oil prices have caused major investment projects to be deferred. For those of us more on the cleantech side of things, low oil prices cause the alternatives to oil to become less economically or financially attractive.

To Simmons, it is especially frustrating that the decline in oil prices have nothing to do with fundamental realities. Simmons notes that plummeting prices haven’t been driven by any material declines in global demand, backing this with the comment that “all signs still say [the oil market is] ‘very tight'” — admittedly cryptic, but Simmons has access to all sorts of data from innumerable sources in the oil industry worldwide.

After asking plaintively “why do we know so little about an issue so critical to our well-being?”, he pulls no punches with his stark conclusions: “Crude oil has peaked” and “Its future decline could be swift,” giving credence to his warning that “What goes down can come right back!”

The logic of his analysis suggests that oil prices cannot sustain for long at $40/barrel. Simmons has often said that oil at even $150/barrel is still incredibly cheap — 22 cents/cup — and that Americans really need to get a grip on how valuable the stuff is, and thus how expensive by all rights it really ought to be.

In an October 2008 report entitled “Ratcheting Down: Oil and the Global Credit Crisis”, Cambridge Energy Research Associates recently developed an estimated supply curve for the various sources of oil worldwide, and to achieve production rates at current levels of about 85 million barrels per day, CERA’s work indicates that prices of at least $100/barrel are eminently justifiable.

For you investors out there, all of this is good justification for making a bet on oil prices going up from current levels. Maybe you can make a killing.

At the societal level, though, the implications of peaking oil production are troubling. A really negative take on the prospects is offered by an open letter written by Nate Hagens to President Obama, posted on The Oil Drum, one of the most comprehensive resources concerning peak oil issues on the Web.

As for Simmons, he’s less hyperbolic than Mr. Hagens, but not a whole lot more optimistic. He invokes the perspectives of the new leadership at the International Energy Agency — “Current energy supply trends are patently unsustainable,” “Future of human prosperity depends on how we tackle our energy issues”, Consequences of policy/investment inaction are shocking”, “Massive investment required”, and “Time is running out and time to act is NOW!” — and closes his presentation by declaring that “‘Yes We Can’ solve this bleak energy future, but we now need to sprint into hasty retreat from our addiction to oil and gas.”

How comfortable are you in ignoring such well-substantiated warnings from an oil patch veteran like Simmons?

So, for those of you clamoring for low oil prices, at current levels or even lower, don’t bet on it. $40/barrel is likely to be an aberration.

Richard T. Stuebi is the BP Fellow for Energy and Environmental Advancement at The Cleveland Foundation, and is also the Founder and President of NextWave Energy, Inc. Later in 2009, he will also become a Managing Director at Early Stage Partners.

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