- The Washington Times - Monday, April 4, 2005

Just one day after it appeared that oil prices had finally peaked and were heading lower because of substantial buildups of inventories, Goldman Sachs decided to tell the world that it thought oil prices were not only going to rise further, but would spike at a peak level of $105 per barrel.

It isn’t very difficult to see how Goldman got to that forecast. The accompanying graph shows oil prices adjusted for inflation — which everyone accounts for — and adjusted for both inflation and the value of the dollar, which not everyone does. Given these figures, it only takes a few seconds to calculate that if oil prices were to rise to peak 1981 levels, taking into account both the increase in the overall price and the deterioration of the dollar relative to 1981, the nominal price of oil would be — no peeking allowed here — $105 per barrel. I guess that’s called research.

You didn’t have to stretch very far to find the cynics last week. The general view on the street is that Goldman holds heavy positions in oil stocks, and they needed that uptick on the last day of the quarter to pare their losses on other stocks during the quarter. I won’t get into that. The real question is: Where are oil prices heading?

By that we don’t mean tomorrow, or even next Wednesday, when the newest round of inventory figures are announced. Where will oil prices be a year from now? Do you hedge your bets against further large price increases by locking in contracts at $56 per barrel — or do you wait until prices fall over the next few months? Or, if you are really gutsy, do you go short here?

Peter Lynch said many worthwhile things, but for my money one of the most memorable — and valuable — was his comment that “Wall Street only captures the last 20 percent of any rally.” As we read the press releases (oops, research reports) from major Wall Street firms, it seems that most of them hopped on the bandwagon when oil prices were between $45 and $50 per barrel, up from their equilibrium level of about $25 per barrel three years ago. The Peter Lynch rule would thus suggest that oil prices are very near their peak levels right now.

Of course, that’s not the only weapon in our arsenal. Over the past few months, OPEC production has increased, and worldwide demand has slackened as the economy slows down in the United States, Europe and even China. Of course that would not be reflected instantaneously in oil prices; there are invariably lags of a few months as the channel stuffers and the speculators try to eke out their final gains.

But in our view, the fundamentals clearly favor lower oil prices by mid-year, with a major decline as the summer driving and air-conditioning season winds down. We put the current equilibrium price of oil at $30 per barrel, up from $25 per barrel three years ago because of the U.S. recovery, a modest rise in the overall price level, and the continued weakening of the dollar. It will probably take a year or two to reach this price, but buying oil here on the grounds that it will go substantially higher is a fool’s errand.

Michael K. Evans is chairman of Evans, Carroll & Associates, Inc. and a former consultant to the Senate Finance Committee, the U.S. Treasury and other agencies and corporations.



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