Why Oil Will Fall

Barry Ritholtz over at The Big Picture reports on a colloquy with Matt Trivisonno about energy.  Matt’s 20-point chronology:

1) Oil is cheap in 2002, there is no investment, oil infrastructure decays
2) Everybody "knows" oil is an inherently cheap commodity
   
3) Oil producers fail to forecast robust global growth and oil demand
   
4) Prices rise as market signals its needs to producers
   
5) Oil execs still reluctant after being burned in the last bust
   
6) Prices rise more as global growth continues
   
7) Oil companies begin to invest, but increasing supply takes years
   
8) Oil prices rise some more
   
9) Oil companies are now scrambling to meet demand
   
10) SUVs still selling as drivers expect gasoline prices to fall after
    Katrina
   
11) Speculation picks up
   
12) The new boom induces oil-investing mania
   
13) Everybody "knows" that oil always goes up
   
14) Capitalism works after all, and supply finally meets demand in 2006
   
15) But the speculation-turbo-charged price of oil induces a demand shift
   
16) Drivers capitulate and switch from Detroit SUVs to Toyotas
   
17) The demise of the Hummer H1 in June marks the top of oil prices
   
18) The huge oil inventory built up by speculators cascades onto the market
   
19) Prices plunge as the economy signals "that’s enough" to producers
   
20) Lower energy costs feed back into continued global growth

This looks decent to me.  Barry adds a few comments:

a) Notably missing is the impact of the Fed cutting rates to half century lows, and how that impacts any dollar denominated commodity (oil, gold, real estate, etc). I believe that was quite a significant event;
   
b) What? No terror premium?
   
c) The switching process from SUVs to more fuel efficient vehicles takes much longer, as drivers are stuck in leases, ownership, etc.
   
d) Oil only goes up? I thought it was Real Estate that only went up!

Roll this all together and it sounds like me in my recent speeches.  Oil will hit $35 a barrel by the end of 2007.

Note to readers: this is not the guaranteed part of the forecast.  Maybe it’s 2008.  But I’m highly confident that we’ll see a significant drop in oil prices in the coming years.

Business Strategy Implication:  Looking for easy ways to save energy costs is good, but be cautious about large capital spending plans that only make sense if oil prices stay high.