Paul Jackson and András Vig of Source Research say its possible we’re nowhere near a bottom in oil, and offer an historical analogy by which crude oil prices could drop all the way down to $20 per barrel.

In the overview of the December 14th weekly report, Jackson and Vig ask rhetorically: “For 80% of the time since 1870, the oil price has been in the $20-$60 range (in today’s prices). What is to stop it returning to the lower end of that range, as it usually does once a price spike is over?”

Historical lesson on oil prices

Oil Price

The Source Research analysts highlight data from 1870, when the Pennsylvania Oil Rush was in full swing (taking US production from 2000 barrels in 1859 to 10 million in 1873). U.S. oil prices are shown in both nominal and real terms (adjusted with US CPI and rebased to 2014 prices). The recent decline in WTI to $57 has actually only brought it back to the top-end of the $20-$60 range in which real prices have been for 80% of the time since 1870. Measured in today’s prices, the post-1870 average is $43, with a median of $36. Of more concern, after every spike in prices above the $20-$60 range, the real price came back not just to the average or the median, but to the lower bound of the range, and often stayed there for years.

Source Research says historical analogy flawed, oil back to $80 in five years

Oil Price

Jackson and Vig point out that this historical price data is based on a much lower cost of oil production. Given the much higher cost of producing oil today compared to 1870, it’s only reasonable to expect current and future oil prices to be higher.

They also highlight that it would be unwise to be “overly bearish” because it really doesn’t take much to change  market momentum. For example, a 4 million barrel a day cut in supply in 1973 (around 7% of free world production) led to a quadrupling of prices.” The analysts note: “A market that does not seem to be in massive oversupply can easily change tone, especially since the fall in the oil price will itself boost demand for the product.

The report goes on to make the case that the current slump in crude oil prices may be relatively short-lived. Although OPEC’s official $110 forecast for the rest of this decade seem fanciful, the increasing cost of oil production means the historical $20-$60 range will eventually be exceeded, and OPEC’s 2035 forecast of $100 at 2013 prices seems not too farfetched.

In concluding the report, Jackson and Vig note: “We stick to our $80 five year forecast but think it is too early to call the bottom.”‘
As always, we remind readers that not only is it impossible to predict the future, but that the consensus is usually wrong.