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Woody Brock on Oil Price Volatility


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Below is a link to a 2004 a piece by Woody Brock. In it he argues that oil will rise - but so will volatility. He shows why, in circumstances such as a Chinese recession, there will be sharp and exaggerated down moves. This is a consequence of both the supply and demand being price inelastic in the short to medium term.

 

http://www.sedinc.com/good-reads.html

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Very good find, Newbear !

 

EXCERPT:

The problem is that the road from today to this long-run asymptotic limit is not an interstate highway, but a very curvy country lane. The journey to the asymptote of lower very-long-run prices will be punctuated by periods in which prices rise much more than expected (e.g., 1971–1981 and probably 2004–2020), and fall much more than expected (e.g., 1963–1972 and 1985–2000).

. . .

Production Down-Cycle of 1985 to 2000:

As regards the down-cycle of production during the period 1985 to 2000, the International Energy Institute has confirmed that Big Oil went to sleep, and now needs to spend up to $10 trillion to cope with what lies ahead over the next one to two decades. It is telling that no such plans are on the drawing board.

 

Why did Big Oil curtail its level of exploration and development late in the century? Because the real price of oil fell by 65% between 1985 and 2000.

UNQUOTE

 

Just like our current situation! Food for thought, yes?

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Very good find, Newbear !

 

EXCERPT:

The problem is that the road from today to this long-run asymptotic limit is not an interstate highway, but a very curvy country lane. The journey to the asymptote of lower very-long-run prices will be punctuated by periods in which prices rise much more than expected (e.g., 1971–1981 and probably 2004–2020), and fall much more than expected (e.g., 1963–1972 and 1985–2000).

. . .

Production Down-Cycle of 1985 to 2000:

As regards the down-cycle of production during the period 1985 to 2000, the International Energy Institute has confirmed that Big Oil went to sleep, and now needs to spend up to $10 trillion to cope with what lies ahead over the next one to two decades. It is telling that no such plans are on the drawing board.

 

Why did Big Oil curtail its level of exploration and development late in the century? Because the real price of oil fell by 65% between 1985 and 2000.

UNQUOTE

 

Just like our current situation! Food for thought, yes?

 

Exactly so.

 

I actually posted the article months back when bullishness on oil ruled the day but few wanted to acknowledge the degree of volatility that might be possible. I like Woody Brock's approach because it doesn't require invoking factors extraneous to demand/supply to explain the oil plummet. There's quite a lot of talk about a possible derivatives problem at Glencoe, for example. Of course there might be that as well but Woody's point is that we should expect high volatility even without such extraneous events.

 

My working assumption (without having any detailed evidence) would be that his analysis also applies to other parts of the commodity complex. Aren't the supply/demand/elasticity dynamics true of many other commodities?

 

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