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Is Oil Cheap?

Penelope Wise
26 October, 2008

Any investment adviser will tell you to buy when something is cheap and sell when it is expensive, whether it's a house, a stock or a commodity. Unless you are Methuselah, for that rule to be useful your target purchase must have a volatile price over reasonably short time frames. How about oil? Or rather, a proxy for oil such as the shares of oil companies.

Per barrel, using inflation-adjusted dollars, the price of oil varied between USD10 and USD20 after WWII until 1970, when it was about USD14. Because of the Yom Kippur War and the Iranian Revolution, the price rose to a high of about USD40 in 1973, dropped back to USD30 and then shot up to USD70 in 1978. Then the price fell sharply to USD20 in 1986, pushed up to USD30 because of the Gulf War, but fell again to USD14 in 1996. With a minor dip in 2001 and 2002, the price then didn't look back, reaching USD150 a barrel in 2008, before falling precipitously to today's USD63.

Much as OPEC would like to think it controls the price of oil, in reality it has been almost completely unsuccessful in changing this roller-coaster ride. Perhaps its actions flatten the trends, but they don't make any real long term difference.

It's easy to make money with hindsight in any market, but with a rule that says, sell when the price you paid has doubled, and buy when it has halved from its most recent peak, here is how my initial USD1,000 in 1950 (I wasn't born yet, but, hey, this is just a game) would have fared:

Stock in 1950, 71 barrels (at USD14)

Sell in 1972 at USD28, giving cash of USD1,988

Then the price peaked at USD70 in 1978, and the next buy, at USD35, would have been in 1984, giving me 57 barrels.

The price fell to USD14 in 1996 (boy, was I sick!) and reached a sell point at USD70 in 2006, giving me USD3,990.

Then I get to be sick again as the price hits USD150, but this week I bought at USD75, giving me 53 barrels.

Now I need USD150 a barrel again before I can sell, and I'll probably still be sitting on my oil when I'm 90. At least I can use it to keep warm when my blood starts to get thin. And soon after that I'll be going to the great kerosene heater in the sky.

Suppose though that I can sell in 2020, netting USD7,950. That's a gain of 700% in seventy years. Sounds good, eh? Not so, I'm afraid - my actuary boy-friend tells me that this is a compound return of 3% almost exactly, so I'd have been better off with Treasuries, and I wouldn't have had all that hassle with the Fire Department over what they claimed was a UXB in my woodshed.

Oh well, back to the drawing board!


About the Author

Penelope Wise

Penny Wise but not Pound Foolish! But remember: I am not offering investment advice. My comments are just for your general information; I do not recommend investments, and you should take professional advice before entering any investment contract.


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