By: Jonathan M. Lamb. Jonathan M. Lamb is an Economist, Consultant, and Entrepreneur that resides in the Research Triangle of North Carolina.
People will do anything to bring attention to their cause. Last week Gary Shilling who writes in such places as Forbes, NY Times, and the Wall Street Journal pumped a story that oil is going to $10. He obviously does not understand how markets and economics work. Back when oil was trading around $150 in the summer of 2008 there were analysts that were forecasting $200 and $300 oil prices, and now that oil took a swan dive these same people are predicting $10 oil prices! Any person with a basic understanding of economics should know that as prices move, supply and demand changes (or better yet as supply and demand changes, prices move), and markets move toward long term equilibrium (ie. break even prices for producers).
The people that pump these headlines typically have a self-promoting motive when they make wild predictions in the equity, bond, or commodity markets (and often it is a Goldman Sachs analyst or some other “expert”). If you are a trader maybe you have heard the expression, “buy the rumor, sell the news,” and those that make crazy predictions like $10 oil are typically after nothing more than to pump their cause.
From 2004 to 2012 I was a commodity trader, and while I was on the trading floor I saw oil prices go from the $40s, to the $140s, to the $20s, back to the $100s, and now in the $50s. While black swan events can cause wild swings in markets, baseline supply and demand end up driving prices towards producer breakeven cost when markets break outside of “typical” trading ranges. Oil baseline breakeven for the bulk of supply is in the $60-$70 range, so from both an economic and trading view we have a band above or below that $60-$70 breakeven equilibrium before mid/long term changes are made (ie before we have shifts of the supply or demand curves).
So I have to strongly disagree with Shilling and others that pump $10 oil, as based on market fundamentals oil bottoms in the $30s and tops in the low $100s even with very, very large black swan events in the global market. A black swan event is not out of the question for world markets in 2015, however even if the Chinese and European economies crap the bed $10 oil will not happen. The sun will still come up in the east and set in the west, and there will still be baseline fundamentals that keep prices in that $30-$110 range. However, with a complete global depression or a new technology (think cold fusion or some crazy discovery) then a change in the long term $60-$70 equilibrium then there could be a rebalance and prices could move out of that range and in theory only then could see $10 oil.
For the rest of us down in reality we are not going to see $10 or $300 oil anytime soon, but we could see oil peak and valley many times over in that $30-$110 range. Anything too far outside of that band of the cost of production and real “old fashioned” economics will kick in and supply and demand will rebalance prices (ie. producers will supply more or less, and consumers will purchase more or less). But for now be prepared for a rollercoaster ride in the oil markets, and when you see $10 oil you should be more concerned about the 4 horsemen of the apocalypse than the price of oil.