Give Me a Gallon and I’ll Give You the World

With oil dropping to the low $60 range, and a number of analysts and pundits calling for $50 oil, there is a growing debate over the future of alternative energy investment.

The argument that green energy investing will come to a grinding halt, however, is no more shortsighted than the argument that $50 oil will be sustainable. Even if McCain were elected and oil subsidies had higher hopes for a continuation, a long shot at this point; the cost of a number of the current extraction technologies combined with strategic hoarding at the national level, and future cuts from OPEC are sure to drive current oil prices higher. And with an Obama victory a strong carbon-call option will begin to price itself into the marketplace.

After having experienced $150 oil, the world will unlikely return to the good old days any time soon.  Consumers, companies and countries have been pinched by the let’s not get there again bug.  The price spikes in oil in the 1970’s impacted worldwide demand for almost a decade, despite global growth. The result was extremely cheap oil in the years that followed.

However today the price of oil has become quite sensitive to a number of factors, not the least of which is the perception of peak oil and the smallest imbalance in supply and demand.  In addition, with the advent of two wars in Afghanistan and Iraq, a potentially unstable Iran, and a major contraction in the Russian economy, not to mention five sigma natural disasters, and the increasing costs of extraction, there are almost too many reasons for oil to go up for it not to have the occasion to do so again, in fairly short order.

Oh yeah, and lets not forget what helped drive oil that high to begin with: another two billion people who would like to live like Americans.  That amounts to about five more USA’s worth of emerging consumers, all of whom would like warm homes, infrastructure and personal transportation.  While economists are screaming “bloody recession”, we need to keep some perspective on what that really means.  Just because nearly every major economy may slow down for a short period does not imply that every economy will grind to a halt.  A country with GDP growth rates in the low double digits who slows to the high single or even middle single digits, is still growing awfully rapidly.

If any of these countries does believe in peak oil, there is still going to be an incentive to hoard reserves, particularly at today’s prices.

Add to all of that that a number of the hot extraction technologies of recent days, including tapping into hard-to-extract tar sands, and other such energy and labor intensive methods require higher oil prices to remain profitable.  Without those technologies, the supply falls anyway, pushing the price back up, again making them attractive.

Lastly one more catalyst for the rapid fall in nominal oil prices has been the quick acceleration in the strength of the dollar, in relative terms.  Oil along with other basic commodities has become the dollar hedge trade du jour.  With interest rates headed as close to zero as the fed can stomach and the massive amount of greenbacks being printed by the Treasury there is little reason to believe that a strong dollar will be maintain for any significant period of time.

At the end of the day, I’d bet the mid and long term price of oil is higher than today.


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