http://jeffhirsch.tumblr.com/post/104440107838/the-math-to-40-a-barrel-oil
The math to $40 a barrel oil
On Wednesday, I jumped into the “where oil is headed next” forecast game and set a target of $40.75 a barrel. The chart that was included highlighted a series of lower highs and the recent sudden sharp drop. The line drawn at $40.75 drew criticism for appearing rather arbitrarily placed on the chart. Contrary to this opinion, the target was not simply draw on the chart. But before getting into the math behind this price let’s have a look at a few recent news stories.
ExxonMobil OK with oil at $40: CEO – When the CEO of ExxonMobil specifically says his company is “ok” with oil at $40 when it is trading in the $60s, this may deserve a second thought.
Sub-$50 Oil Surfaces in North Dakota Amid Regional Discounts – Bakken oil has sold in the $40s already.
Why Elon Musk’s Batteries Scare the Hell Out of the Electric Company – This one targets utilities, but it also hits oil demand. It is not that far of a stretch to envision most U.S. households with an off-the-grid solar-powered charging station for their plug-in hybrids and/or all electric vehicles. Once purchased, this combo would make it possible to never visit a gas station again. And for households that already own multiple autos this makes even more sense, one electric auto for the daily commute and local errands and a second fossil fuel burner for those long summer and holiday road trips.
To get to $40.75 per barrel I considered the following: world oil supply and consumption data since 1990, inflation since 1990, crude oil price and the U.S. dollar index. Oil supply, consumption and price data was retrieved from www.eia.gov and is in an average annual format. The CPI was used to represent inflation and is also an average annual value. All four are graphed as cumulative percent change in the chart above beginning with 1990 equal to zero. Crude’s price is on the left axis while the rest are on the right.
In 24 years through 2013, global oil supplies have risen a cumulative 35.6 % while demand has risen 35.8%. In twelve years supplies exceeded consumption while crude’s price rose nearly 300%. A gap of 0.2% between supply and demand suggests that actual oil production has done an excellent job of meeting real demand. Global spare production capacity is more than sufficient to cover any supply shortfalls in 2014. So supply and demand is considered to be in balance, but price is clearly bloated in the new hi-tech era of oil exploration, drilling and production.
Inflation plays a role in the price of crude oil. Using CPI as the metric, inflation has risen 78.3% since 1990 through the end of 2013. Adjusting crude oil’s annual average price in 1990 of $24.53 a barrel for inflation would be $43.66. Since a barrel of oil is priced in U.S. dollars, the U.S. dollar index must also be considered. Due to recent strength, the U.S. dollar index is actually 7.5% higher today than it was at the end of 1990. Factor this into the inflation adjusted crude price of $43.66 and the net result is $40.40 per barrel. This is slightly less today than my initial calculation of $40.75 because the dollar has further strengthened since Wednesday.
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