Oil and other commodity U. S.

Oil price bottomed out?

WTI crude oil futures fell to as low $47.25 per barrel last Friday, extending losses to a seventh week in a row. The crude price was closed at slightly above $48 for the first full trading week of the new year.

The latest peak of crude price happened in the middle of June 2014 and at the time the prices was about $101 a barrel. As of last week, the oil price has dropped for seven months almost monotonically.

The last oil price slump was in 2008. At that cycle, the oil price peaked at $140 a barrel in July 2008, and the price experienced a free fall to just above $40 in February 2009, and the down trend had taken seven months!

Will history repeat? i.e., has crude oil price bottomed out after seven months’ slump this time?

The drop of oil price in 2008 was because of low demand of energy due to the financial crisis and the economic recession world wide that was followed. This time, the drop of price is primarily because of abundant supplies of oil thanks to the boom of the shale oil in the U. S. and sand oil in Canada, as well as the return of oil production in Iraq after years of war.

However, in aggregate, the change in oil price is mainly because of the mismatch between supply and demand. If the oil price is taken as a dynamic process, it can be modeled by some characteristics, one of them being time constant. It appears to me that the duration of free fall of oil price is a constant, although the time constant could change over a very long period of time; and it also appears to me that there is no definitive duration when the oil price increases.

The time constant for the downward trend may be determined by the time it takes for the market force to rebalance supply and demand. In a not very long term, such market force is relative stable; however in a very long term, the market force profile could be varied over time, therefore the time constant for the downward trend is different.

I think the oil price at this moment likely has bottomed out or is close to bottom out. The production cost of U. S. shale oil is about $70 and Canadian sand oil is over $80. With $48 oil price, it is clearly not economically viable for these productions to stay in business and the market force will work its way to regain its equilibrium.

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