Energy Markets in Chaos?

Anyone who follows this blog should not be terribly surprised by the recent fall in the energy markets. After all, I've been writing for quite some time that oil prices (in 2007 dollars) should be in the $50-75 range in the long haul. And, despite the wild ride in the short term, I believe the logic still applies. That is, that investment in alternative sources, efficiency improvements and conservation become attractive in this price range and therefore will result in actions that control long term prices.

I will have to admit that I underestimated the short term impact of factors like leverage, speculation and the herd instinct. But, unlike many others, I don't begrudge the effect of these factors. Ultimately, they have little effect on long term trends, but tend to bring about needed adjustments more quickly. Energy markets are much more balanced today as a result of the speculative prices of a few months ago. And, don't be surprised if prices tend to overshoot on the down side in the near future.

In fact, some markets may already be seeing this effect. The investors who bid oil up to $147 are now unwinding their positions, or even shorting oil. And some investments already seem to reflect much lower oil prices.

Take BP ADRs. One year ago, BP stock was at $70, while oil prices were $80/bbl. Today, BP stock is at $54, despite much higher oil prices. Two years ago, BP was at $67, while oil was at $65. In fact, you have to go all the way back to 2004, when oil prices were below $50 to find BP stock below the current price. (Full disclosure: I own BP stock and have recently been buying more). I suspect speculation and the herd instinct are now driving prices down below what can be expected for the long term. There seems, in fact, to be a double effect. Everyone expects oil prices to drop, and they are selling oil stocks based on that expectation. But, in fact, the stock prices never represented even current oil prices, let alone the peak oil prices seen a few months ago.

Just to balance things out, my son says I shouldn't be buying oil stocks, since it is clear prices are headed down. And, I'll admit that BP has had more than their share of screwups in their operation. Maybe it does make more sense to keep investing in energy conservation and efficiency around your house, which offer an almost certain return. Unless you have a house already well insulated, adding some insulation will be a more solid investment, while insulating you from worrying about energy prices as well as heat and cold. And, for other ideas on conservation, you may want to look back through my archives, or at the Energy Boomer link to the right.

Whatever you do, the oil markets make for some interesting thinking these days.