Hypothesis on Why Oil Declined From $78 in August to Low $60s if in Fact Peak Oil is Real

When supply is closely matched to demand little things can cause the price of oil to fluctuate significantly. For example such things as a hurricane in the Gulf of Mexico, a colder than normal winter, oil worker strike in Nigeria, concerns on Iran, sabotage can cause the price of oil to fluctuate significantly higher.

In contrast there are events that can also cause the price of oil to fluctuate significantly lower even though supply is closely matched with demand. Such events include a warmer than normal winter, a lack of hurricane activity in the Gulf of Mexico, lack of concern over Iran, U.S. government decisions, higher than average inventory levels to name a few.

We have been lucky with world events since August of 2006. In this time concerns over Iran have declined. Actually since autumn of 2005 we have been very lucky by virtue of having experienced a warmer than normal winter along with an absence of hurricanes this year in the Gulf of Mexico. Inventories have been built up for a worst case scenario (cold winter, hurricanes, problems with Iran, etc) and we have in fact experienced a best case scenario.

So here we sit with oil inventories at 5 year highs and the price goes down from $78 a barrel in August to the low $60s currently and now Wall Street analysts, the media, traders who are short oil and economist claim that there was never any Hubbert's peak and that peak oil was a myth because, "The price has gone down."

This feeling that low oil prices are here to stay or that they may even go lower will quickly be dispelled as soon as we experience a little bit of bad luck such as a colder than normal winter, Iran becoming an issue again, OPEC announcing significant cuts, a hurricane, natural disaster, terrorism, or quite simply the passage of time. As time passes the gap between supply and demand will become even tighter or worse: demand exceeding that of supply. One can certainly expect demand to continue to climb higher especially with current prices. One can also expect worldwide supply to continue to flatten out as the worlds largest oil fields continue to go into decline by virtue of their old age. Spare capacity will continue to be squeezed out of the system with the passage of time.

In conclusion, expect prices to offer significant fluctuations both to the upside and to the downside due to supply and demand being so close. Having a little bit of good luck as previously described will offer a false sense of security that everything is just fine when in fact it is not. It would not be surprising at all to be back above $70 within 3 months time. Enterprising investors will take advantage of any significant market fears of declining oil prices and subsequent market panic selling to increase or initiate positions in quality oil companies or drillers. It is precisely at this time when the outlook appears the gloomiest when ownership in these equities offers the most promise and profits.