Wednesday, November 12, 2008

Digging into oil price trends

Oil is the "lifeblood" of our economy and it is important to understand how the price is likely to develop in the future if we are to manage the economic turmoil ahead. Currently the price is in a serious nosedive. This might help spark an economic recovery. But if the price begins to sharply rise, it could nip any recovery in the bud. Understanding the price trend is important if Canada is going to provide employment and services for its citizens.

A lot of Peak Oil bloggers (such as Jerome a' Paris in this post) have been pointing out that, notwithstanding the current slump, oil prices have been increasing, on average at 30% a year. Such a graph form Jerome's post is shown below.
This correlation has been referred to so often that it is almost taken as a statement of fact when discussing oil prices. This is an easy rule of thumb to use since it fits the data quite well for the most part. The relationship falls apart around August 2006. At that point, the oil price goes into one of the troughs that are endemic to commodities. When it begins to climb again the rate is much higher than before. And with each successive run up since then the slope of the price curve has been higher than the one before.

To really understand oil prices it is important to look beyond the long term averages and into the individual trends. I have plotted the Weekly World Oil Price data (available here) against time from January 1997 (when it is first available) to the end of October 2008.
Oil prices since 1999 have tended to follow a pattern of long term oil price increase (Peaks) followed by relatively short and sharp corrections (Troughs). These have been selected and presented as an overlay on the graph below. The annualized percent increase (red) or decrease (blue) are shown below the trends.
Or without the actual oil price displayed:
Or in a tabular format:
This data points to the need to plan for rapid and significant fluctuations in oil prices with the long term trend towards much higher energy prices. Any steps to recovery and restructuring of the economy will need to keep this in mind. Even if the current downturn in oil prices is sustained for a longer than normal period of time, the price is likely to rise even higher than the last peak. All the current downturn is doing is causing the delay in projects which would help offset the decline in heritage production. This will feed a stronger price increase.

We live in interesting times.Recommend this Post


MrvnMouse said...

Oil has always seemed to disobey the Hotelling model. It's a non-renewable resource, but the price just seemed to stagnate for most of the last 100 years, and only in the last 2 years did it look like it was catching.

However, now, it almost looks like oil is retracting in response to the fact that people are willing to switch sources or, at very least, conserve oil significantly.

However, the oil drop may also be a result of the Baltic Dry Index dropping 98% in the last few months. (IE. not as many people are shipping goods, so a major oil user is going to cut it's use heavily.)

We'll just have to see.

Constant Vigilance said...

Good comments. Thanks for making them.

If I remember an article I read years ago properly, in real terms oil and most other commodities have been dropping in value. I expect that as we go further on the downslope of supply, there will be more switching energy sources. Whether this can be done fast enough to compensate for the drop in energy supply is the concern.

What really interested me was the increasing slope of the price up-tick. Events such as the Baltic Dry Index you mention will end up being evidence that the credit crunch really stopped everything cold or that we are in a lot of trouble. If it is credit problems for the shippers that will resume after a fashion once credit flows again. People have to eat so I expect that will likely resume at some level.