From the February 01, 2008 issue of Futures Magazine • Subscribe!

Can Elliott solve the oil conundrum?

World oil production is near its peak. Global oil depletion is a little more than 30 billion barrels per year, while the finding rate is much less at about 16 billion barrels per year. Peak oil means an inexorable decline is about to begin. It also means that half of the world’s endowment of conventional oil has been used.

High oil prices will undoubtedly spur more oil from deep water drilling, the conversion of heavy oil deposits to replace conventional oil and energy conservation. Those actions will sustain the peak for probably a decade or so. On the demand side, energy conservation has been the cheapest equivalent of finding oil. The United States has avoided energy conservation because it has had the ability to generate enough income to pay for high cost energy. That situation is likely to change as energy prices rise and incomes level out.

Nuclear power is being reconsidered as a clean source of energy. Nevertheless, the first major battle for oil, in recent times, may be already occurring in Iraq and the globe is dotted with geopolitical hotspots that increase the uncertainty as to the long-term price of oil.

The most fearful uncertainty is the collapse of the world credit bubble. The United States is currently in the midst of one of history’s greatest eras of runaway lending, speculation and financial leverage. The Federal Reserve Bank is now making a desperate attempt to keep afloat what may be an unsustainable credit bubble that could burst into an unprecedented deflation. Deflations after a super-credit binge always lead to economic depression. Under those conditions oil prices would plunge. If, however, the Federal Reserve can produce a soft landing by injecting massive amounts of money into the banking system, they will have provided the fuel for inflation. Then the U.S. dollar would plunge, and both gold and oil will soar.

These variables make it difficult to get an accurate oil price forecast. To address these uncertainties, we turn to the principles of the Elliott Wave Theory.

The movement of prices in any market are the product of many people whose emotions are embodied in the price. Ralph N. Elliott, in the 1930s, discovered repetitious patterns from which he developed a theory of price movement for any market in which the public is involved.

Basically, there are impulse waves that are speedy and show the main direction of the market, and corrective waves that allow the impulse wave to reach an equilibrium that allows the generation of the next impulse wave. This system is not perfect, but it is very useful in situations like the current dilemma in oil price forecasting.

The price of WTI (West Texas Intermediate) crude oil rose from $3 per barrel in 1970 in an impulse wave that was kicked off by an Arab oil embargo. WTI reached $38 per barrel in 1980. That rise was a factor of about 13 times. Then corrective A-B-C waves began that lasted from 1980 to 1998 (see “How high?”).

During the correction at A-square in 1986, Saudi Arabia under oil minister Zaki Yamani, increased oil production in an effort to discipline the rest of OPEC. Oil prices plunged. In 1990, Saddam Hussein invaded Kuwait and WTI rallied to $32 at B-square. The defeat of Saddam and the subsequent flood of oil pushed WTI down to $14 at C-square/B-circle in 1998.

We are now in the notorious C -circle impulse wave that ultimately could be larger than the A-circle wave. If it is only as large as A-circle, WTI would be expected to rally 13 times where WTI stood after the correction. That would put WTI at 13 times $14 or about $180. The projection made here is limited to 2012 when WTI is expected to be $160. Implicit in this forecast is the probability of the “printing of money” attempt to avoid the punishment of the bursting credit bubble.

Stanford Field began his career in the oil industry in 1951. He retired in 1993 from Stanford Research Institute in Menlo Park, Calif., where he was director of energy programs.

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