Peak Oil Is Bullsh**

After the run-up in oil prices last summer, followed by the price collpase, analysts and pundits have called for a return to the summer’s highs. Possibly even higher.

They’re all wrong, writes Ruchir Sharma at Newsweek. The reasons analysts attribute for the coming price spike–growth of the developing world, nationalization of oil fields, peak oil, underinvestment–are all old hat, thus no reason to think the price will rise.

Sharma explains: Yet the fact is that the world has faced all these issues before, and for the past 200 years, commodity prices have been trending downwards, thanks to new technologies, greater efficiency in extraction and the substitution of one commodity for another (which explains the high correlation between commodities prices). Bank Credit Analyst, a research firm based in Montreal, has data showing major industrial commodity prices are 75 per cent below where they were in the year 1800, after adjusting for inflation. Despite all the worries over “peak oil,” the fact is that the major bear markets in oil have been demand, rather than supply led. And when demand eventually picks up, there’s usually some new alternative (nuclear energy, natural gas, green technologies) waiting to pick up some of the slack. The real price of oil today is now at the same level as in 1976 and, before that, in the 1870s, when oil was first put to mass use in the United States. This long-term price decline is due mainly to the constant discovery of new fields and greater energy efficiency, making nonsense of the idea that the world is rapidly running out of oil. The experience of the 1980s is instructive in the current context as well.

Sharma then explains that there are always emerging nations. In the 80’s and 90’s China grew at 9%, but commodities didn’t follow, and oil never broke $40.

The reason oil prices did not spike higher is simple: demand for any commodity is price-elastic, which means that once the price goes too high, consumers stop buying it or make heroic efforts to find a substitute. In the 1960s and ’70s, the revival of manufacturing in Japan and Europe propelled prices for industrial metals like copper and nickel higher, until the buyers couldn’t take it anymore. Total spending on copper peaked at 0.45 per cent of the global economy in the mid-1960s, and on nickel at 0.2 per cent in the 1970s. Once copper prices got too high, aluminium was used as a substitute in many functions. As commodities are inputs in themselves, they can justify only a certain share of the total costs before it becomes prohibitive to consume the end product.

Sharma then points out that as recently as 2005, future contracts traded below spot contracts, as most people believed oil prices would fall.

Now there’s two thoughts on why the price will rise: 1. Consumer demand will return, production will follow and oil will spike. 2. People are buying oil as a hedge against inflation.

Both scenarios ignore history, which shows that only one commodity rises in an inflationary environment: gold. Other commodity prices tend to bloom only during the mature stages of a boom when the global economy overheats and demand briefly exceeds supply. At the moment, supply for nearly all commodities far outweighs demand, and likely will decline for at least the next couple of years.

Read the whole article at Newsweek—->>


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