A Memorable Flashback

While doing research on my next paper, which is supposed to identify trends worthy of a contrarian investigation, I stumbled on a gem, courtesy of Google and the Policy Review (Summer 1986). It is an extract of an article by Werner Meyer that simply lists “authoritative” quotes from around the time of the second oil shock, in 1979. Here is a selection of these quotes:

"Even with decontrol of oil prices, we can see a 30 percent to 40 percent decline in domestic oil production." Daniel Yergin – Sierra July/August 1979

"An already serious energy problem has now become an energy emergency, an emergency that will persist throughout the entire 1980s." - Robert Strobaugh and Daniel Yergin - Foreign Affairs vol.58, no.3, 1979

"World oil prices have only one way to go in the next decade--up, and probably sharply so." - John Mattill - Editor, Technology Review -December/January 1980

"During 1980 and 1981, for each barrel of oil newly produced as a result of decontrol, the cost to the U.S. economy could range from at least $56 per barrel under the most optimistic assumptions, to about $870 per barrel under assumptions which many experts believe are realistic...Thus even if decontrol does in fact stimulate a few extra barrels of oil, the total cost to the economy of those few barrels is so high as to make decontrol the most nonsensical, irresponsible, and expensive energy supply strategy imaginable." Energy Action - March 24, 1979

"Ronald Reagan brushed aside energy issues during the campaign, insisting the shortages could be overcome by unleashing private enterprise. But not even his most fervent supporters in the energy business share that optimism. Virtually all private forecasts predict declining domestic oil production and liquid fuel shortages in the next decade." New York Times - November 14, 1980

"There is a dwindling supply of energy sources. The prices are going to rise in the future no matter who is President, no matter which party occupies the administration in Washington, no matter what we do." - President Jimmy Carter - March 31, 1979

"At present rates of exploitation, the United States will exhaust its own petroleum reserves in about 10 years..." - Alan Madian - Foreign Policy - Summer 1979

"Any surplus production capacity that individual OPEC countries may have developed in recent years will almost certainly vanish by the mid-1980s, perhaps sooner... In 1990 prices, adjusted for future inflation, oil could be selling for $42 to $55 a barrel." - U.S. Department of Energy - National Energy Plan II - May 1979

"The present oil shortage looks like the start of a long siege. While the demand for oil keeps growing as world population and economies expand, supply slows and it is difficult to see where large amounts of additional oil will come from in the next several years." Leonard Silk - New York Times - June 29.1979

"We're heading into a world of considerably higher prices. There will be a major impact on housing by 1983, and I'd be surprised if gasoline is less than $2 per gallon plus whatever inflation adds." Kenneth Arrow, Professor of Economics, Stanford University - Forbes - February 4, 1980

"It's obvious that gasoline could reach at least $2 a gallon after decontrol." Representative John Dingell (D-MI)Chairman, Subcommittee on Energy and Power – Forbes December 10, 1979

"Estimating $1.50 [per gallon of gas] is totally, totally optimistic." Dan Lundberg, Gasoline price specialist - New York Times - February 27, 1980

"Without rationing, gasoline will soon go to $3 a gallon." Senator Dale Bumpers (D-AR) - U.S. News and World Report - July 9, 1979

àspan> Note: gasoline prices did not reach $2.00 until 2004

"One thing is for certain: prices will continue to rise. We're dealing with a scarce, finite commodity, one that will be running out in a couple of decades. Traditional criteria of supply and demand don't apply." Charles W. Duncan, Secretary of Energy - U.S. News and World Report - February 25, 1980

"We're going to be on the ragged edge for years." Clifton C. Garvin, Jr. - Chairman, Exxon Corp. - Business Week - December 24, 1979

"With oil, surprises or changes can only go one way: against us." Paul Frankel - Petroleum Economics, Ltd. - Dun's Review - April 1980

"The price of oil now seems firmly locked into a steep upward spiral for the foreseeable future." Business Week - December 31, 1979

"At present rates of consumption, America's oil and gas will be gone within a decade." Newsweek - July 16, 1979

"In moving towards 1990, the industrialized countries will be walking an `oil tightrope.' " International Energy Agency - Energy Conservation 1981

"Most industry observers, however, believe that this time OPEC will be successful in keeping oil prices from falling." Business Week - December 31, 1979

"Responses that might have been sufficient between 1974 and 1979 no longer suffice; today the United States and all the world's importers are caught in an acute and lasting energy emergency." Robert Stobaugh and Daniel Yergin - Foreign Affairs - vol. 58, no. 3 1979

"We must adopt a system of gasoline rationing without delay...in a way that demands a fair sacrifice from all Americans." Senator Edward Kennedy (D-Mass.) - New York Times - January 28, 1980

"I think it [OPEC] has now become such an institutionalized structure that it would be very doubtful that anyone could break it down." President Jimmy Carter - New York Times - February 11, 1979

* * *

I have indicated by an arrow on the graph below the time when these statements were made.

Average Annual Oil Prices (*)

_{(*) Refiners’ average acquisition cost. Source: Economy.com}

As can be seen, the price of oil (as measured by refiners’ average acquisition cost per barrel) was close to a six-year peak of just over $35 per barrel

This peak price was to be followed by an eighteen-year decline (to $13) and would not be surpassed for nearly a quarter of a century!

The parallel with today’s widespread forecast of an inexorable rise in the price of oil, going forward, is striking. The cherry on the cake is the recent warning by Goldman Sachs economists that oil prices could soon “spike” to $100 per barrel from the current price of about $55. They were followed in short order by several other forecasts of $100 oil and two French economists (Patrick Arthus and Moncef Kaabi), not to be upstaged, have just estimated that the price of oil could reach $380 per barrel by 2015, when the world could be short of 8 million barrels per day.

The following chart compares the stock market performances of the Dow Jones Index of Integrated Oil companies with that of the Standard & Poor’s 500 stock market index, over the last five years.

Oil stocks held up much better than “the market” in the post-bubble decline and then, after a year or so of hesitation, they strongly outperformed the market on the way up. After five years of beating the market, we can assume that the high price of oil is now at least partly reflected in the price investors are willing to pay for oil shares.

Finally, I wasn’t able to retrieve the price-earnings ratios of oil stocks around 1980, in the wake of the second oil shock. What I remember, however, is that commodities-related companies, which tend to be highly cyclical, usually sell at low multiples of peak earnings (typically in the single-digit range). To take just one example, Exxon Mobil is presently selling at 13.3 times 2005 estimated earnings, after seeing its earnings more than double in about three years. While this may not seem high, a reversion of the price-earnings ratio to the single-digit range could offset much of the earnings progress projected for the next few years.

As a team, Tocqueville managers tend to be fond of the oil industry, which has been good to us as investors. By and large, we also subscribe to the long term arguments in favor of the industry. This includes the explosive growth in demand from China and other emerging economies, which not only grow faster than mature ones, but also consume more energy per unit of Gross Domestic Product.

Nevertheless, as Lord Keynes used to say: “In the long term, we are all dead”.

Any significant, negative surprise on either the supply or demand side of the oil equation, over the next few years, could well cause a major correction in the price of oil shares.

François Sicart

April 27, 2005

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