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Theoretical Declines of a Bursting Oil Bubble

by: Bespoke Investment Group September 04, 2008 | about stocks: ITB / OIL / QQQQ / USO / XHB    

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We've compared the rallies of the tech and homebuilder bubbles with the rally in oil plenty of times here.  Below we highlight the returns from trough to peak of the three asset classes during their respective bubbles. 

As shown, the Nasdaq went up 640% during its 1990s bubble, while the homebuilder stocks went up 839% during their 2000s bubble.  From oil's bottom of $16.70 in November 2001 to its recent peak of $145.29 on July 3rd, the commodity rallied 770% -- right in between the rallies of the Nasdaq and homebuilder bubbles.

click to enlarge

Bubblegains

While it's pretty much unfathomable and also unlikely, we charted what the declines in oil would look like if the commodity took the same path as the Nasdaq and homebuilders on the way down.  From peak to trough for the Nasdaq, it went down 77.93% over 647 trading days.  From peak to trough for the homebuilders, the S&P 1500 Homebuilder index went down 78.38% over 750 trading days.  For oil to match the Nasdaq crash, it would get all the way down to $32.06 by February 1st, 2011.  For it to match the homebuilder crash, oil would fall to $31.40 by June 27th, 2011.

Again, odds are that oil has no shot of getting back to the $30s anytime soon, but since the rise in oil was very comparable to the tech and housing bubbles, it's interesting to see what a comparable decline would look like.

Theoretdeclines

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This article has 21 comments:

  •  
    Sep 04 11:09 AM
    It will go the whole way. Lingers a while in the 60-80 range no doubt, so did the other two. These huge prices are pure transfers to the oil producing governments and in no way needed to fund its actual production. At these levels, demand halves every decade. If oil were just to stay at a plateau above $70, it would be economical to make synthetic diesel out of coal (as Germany did in WW II). The only reason companies aren't making such investments is they don't expect prices to stay high long enough, and they fear confiscatory green regulation.

    If the west simply tells green luddites to stuff it, oil will go back to $30.
    Reply
  •  
    Sep 04 12:08 PM
    In the early 1950s I was trading Potato futures and watching Onion Futures. The onions went down to 10CENTS A BAG OF 100 LBS! The bag cost 11 CENTS! I a LONGS SQUEEZE, the Barrell will cost more than the oil!
    Reply
  •  
    Sep 04 12:13 PM
    I tried to finish but the curser wouldn't come up.
    True story. I passed the NYSE test as a salesman in Nov 1949 and worked for F. I. duPont for 21 years. Got out just before they hit the skid!
    Reply
  •  
    Sep 04 12:23 PM
    so that's what systematically abused markets look like. Nice chart.
    Reply
  •  
    Sep 04 12:42 PM
    I think the idea that oil will follow the same path as these other bubbles is a huge mistake. The reason oil will be different... We are running out of the stuff! Planned future oil production projects will not be able to meet expected demand. And the production rates of the world's biggest oil fields are in decline. You might be better off comparing oil to the price of Manhattan real estate - there is only some much of the stuff to go around, and demand far outstrips supply.
    Reply
  •  
    Sep 04 12:55 PM
    Anyone still waiting for your tech stocks to come back? (I am) Waiting for your builder stocks to come back? (no, just bought in now) Anybody long oil now? (not me, I'm short since mid July). When news has not been able to change the oil price direction, why stay in? Clearly oil has not hit bottom yet.
    Reply
  •  
    Sep 04 01:58 PM
    This scientist/businessman/... beautifully explains and illustrates why oil is not a "bubble" in the sense that people like to compare and lump it into things like the tech/housing bubble. It's the best single essay I've read that ties everything together: the economy, population, and energy:
    Exponential Money in a Finite World
    chrismartenson.com/exp...

    His Crash course is also well done and covers everything in more detail.
    Reply
  •  
    Sep 04 04:34 PM
    "While it's pretty much unfathomable and also unlikely" might be more dangerous than "this time its different."
    Reply
  •  
    Sep 04 05:16 PM
    The real question is, why did the Tech Bubble and Real Estate Bubble pop?
    The answer to that is Demand Saturation.

    Now ask yourself this: Is the demand for oil saturated? The answer to that is no, it's not. Had oil not spiked to almost $150, no one would be even saying anything about the fact that it's hanging around $110 now. There'd be no "bubble" talk regarding oil.

    Oil, like water and electricity is a commodity that has extremely high value to an end-user. On the other hand, a $750,000 McMansion really isn't tangibly any better to the person who lives in it than a $350,000 house. Both have A/C, new carpets, a nice garage, etc. etc. What I'm saying is that it's easy to cut your housing usage by 50% or more, but in a lot of ways, you really can't do that with your oil usage.

    And as for tech stocks, after the blizzard of IPOs had churned and churned for a while, it was as if the world population of beautiful people has suddenly jumped by a factor of 10. Like beauty, tech was only exciting because of its newness and rareness.

    I assure you, if everyone in the world were beautiful, supermodels would be unemployed and truck drivers would be in demand. It's hard to drive a truck and it's hard to supply the world with fuel. Right now, only oil can do that and if oil even went back to $80 for three years, that alone would be enough to kill virtually all alternative ideas where they stand.

    Don't be fooled: In a world with a growing population filled with people who want more of everything, substantial amounts of consumable oil is the only viable way for them to head in that direction. Oil demand will not drop substantially without a major USA ramp-up of coal, nat gas, nuclear power and additional drilling.

    And that’s a political problem, which even if solved, would take 10+ years to fully implement. Over those 10 years, the demand for world oil will continue to be very strong. With a real miracle, the USA may cut its net usage over 10 years, but the world will not.

    There will be ups and downs, but the long-term demand trend for oil in the next 10 years is still upward.

    The demand for oil can’t be diminished or satiated by a “bubble”, because unlike housing or tech stocks, oil is consumed and after that, needs to be replaced if the end-user is to keep using it.

    Trying to equate oil with the chimera of tech or the swindle of overpriced real estate is a mistake.

    Reply
  •  
    Sep 04 08:02 PM
    When oil was a 145 and people where talking 200 dollar oil it was time to sell. Now the opposite is starting to happen, and it may be a good time to get back in.
    Reply
  •  
    Sep 04 08:31 PM
    sr9web - Nice little write up. And to add to that, I'd like to add a recent quote from Jim Rogers:
    "the commodities market can frequently correct 40% to 50% even during a bull market.”
    Citing the crude oil bull market in 1999, he said the commodity prices had gone down 40% to 50% during that period.
    “Even if the world economy is going to collapse with everything coming down, I will opt to own wheat and cotton rather than Google or IBM shares!” Rogers said.

    When you have a plateau in production and increasing global consumption pressures, then prices become more volatile. The easy, high-yield oil has been extracted. Rapidly rising price and flat production (since 2004) = peak produciton.


    Reply
  •  
    Sep 05 08:08 AM
    pure speculation.
    > jack
    Reply
  •  
    Sep 05 11:39 AM
    Declension; I invest, you speculate, he gambles.
    Reply
  •  
    Sep 05 01:23 PM
    Declension. Very nice word, haven't seen its use in quite a while. Oil is finite regardless of price. Worldwide supply declines will be exacerbated by lower prices, ditto inventories of derivative products. If we are in a Global recession, I can safely assume a Global expansion eventually.

    The current oil "bubble" and correction will be seen, in hindsight, as a commodity climbing a "wall of worry". This time is no different from any other time, when the supply does not meet demand. Drawing down inventories does not equate to increased supply.
    Reply
  •  
    Sep 05 01:42 PM
    The charts compare apples to screws (saying "oranges" gives them too much credit). Oil is a world market. Housing is mainly US-UK-Aus. Nasdaq is mainly US. Oil involves geopolitical and mercantile factors that are almost totally missing from housing and stocks (nations do play with their currencies).

    Re housing, there are millions of empty homes in the US and almost a year's supply being actively marketed for sale (not to mention that the builders continue to build).

    Now consider oil. At the margins, folks are being priced out of the market - - kero buyers in Africa, power plants in Pak, and jet fuel buyers all over the world. I see no oil salesmen knocking on doors trying to sell all their surplus oil no one wants. . .
    Reply
  •  
    Sep 05 03:07 PM
    "a major USA ramp-up of coal, nat gas, nuclear power and additional drilling" will never replace the lighter oil-based things we survive on. Cars weigh less now than 20 years ago, toys and housing materials and furniture and clothing all use oil. We don't have anything (yet) to replace those things and the majority of us do not want to go back to the way it was. Ethanol is not the be-all, end-all of oil replacement, nor is electricity or hydrogen. A combination of those three may be, but the cost will be way too high for the common man/woman to accept instantly. Until costs are reduced, there will be a tremendous need for oil and oil-based products. Since the population of the world is constantly increasing, the need will also increase.
    Reply
  •  
    Sep 05 05:02 PM
    realsit: thanks for the link. I agree with you, truly outstanding stuff!
    Reply
  •  
    Sep 06 01:55 AM
    Bespoke....

    finally an article from your group that is interesting. i do not think even you believed the data but you put it out ..... and that is what seeking alpha is all about.

    oil should have never run up to $147 which lacks logic. its fall could be equally illogical. bubbles do not have logic.
    Reply
  •  
    Sep 06 05:34 AM
    Countries that produce oil will ramp up production under the table to keep the same dollars coming in that they were getting when crude was priced higher. The lower the price goes, the more they will cheat. Saudi cost is a couple of dollars per barrel, that gives them lots of room to still make a buck. Knowing that times are changing also gives them incentive to sell as much inventory while the selling is good. next week we could have some scientist figure out how to harness fusion. The oil cos are in no hurry to find more product, thats why it looks like we are running out. Same situation has existed for the last 60 years, yet they always find more when they need to. They are just not sure this time if they are going to need to.


    The invasion of Iraq, besides obviously being fought to make as much money as possible for defense contractors, was also a war to keep Iraq from pumping their oil in order to get the price of oil as high as possible while the selling was good. MISSION ACCOMPLISHED!


    Every action the Bush Adm has taken has been designed to hike the price of oil and keep it up as long as possible. That`s what Dick Cheney was telling his secret energy commission team ``Heres comes the big profits we promised you guys!``


    I`ve been saying ``$20 before $200`` since mid-July. Now I know when we will get to $20. In Nov.of 2012. Thanks.
    Reply
  •  
    Sep 06 05:38 AM
    as I point out in my comment above, the price rise of oil was totally logical and totally contrived.

    here how to fix it.

    If we are serious about wanting to get the USA to kick its `crude (oil) habit`, we need to have Congress add on a 10% surcharge at the gas pump (bumping it up another 10% every six months) and rebate the surcharge revenue in monthly equi-dollar amounts to every registered car OWNER, regardless of how much or little they drive. That causes the biggest oil consumers to subsidize everyone else with no BOTTOMLINE cost to taxpayers or consumers. The surcharge will incentivize cheaper alternatives to rapidly become apparent and we will soon thereafter implement and use them, no government mandate required.
    Reply
  •  
    Sep 07 11:02 PM
    "Declension; I invest, you speculate, he gambles."

    Just keep in mind that the root word is 'decline', as in, 'Decline the verb to invest.'

    The happy solution to the oil problem would be an unpredictable breakthrough like fusion power.
    Reply
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