Name Age Citizenship State Location Education Trading Experience Word Count
Curtis 21 Canadian Saskatchewan University of Saskatchewan Beginner 1,290
Oil will trade at $5 per barrel before it trades at $250 per barrel by the year 2050. Discuss. Maximum word count = 2,000 words. Answers over 2,000 words will be automatically disqualified from the competition.
It wasn’t that long after I started brainstorming ideas and angles to research that I found myself in the middle of something that could’ve been endless and make the 2,000-word limit impossible. I initially thought that I might have to consider OPEC countries, oil corporates, Saudi Arabia and emirates to see what kind of influence they may have on the future of oil prices. I considered the development of the electric vehicle and its costs and how that would have an effect on future oil demand. I even went so far as to take a regression of DXY & WTI with monthly data going as far back to the 80’s to find a 77% negative correlation. Needless to say, I spent a lot of time combing through a lot of data and reports put out by various sources trying to find an answer. I then remembered that this essay was going to be for a trading institution, and recalled what I heard Anton say once. Your point as a trader is to seek out the 5% of information that’s relevant, making sense of it, and turning it into real hard dollars. I wanted to work smart, not hard. The following is what I was able to come up with. At this point I took a step back for a moment and thought about the $5 oil price. I guess I was drawn to it because in my lifetime it has always been a double or triple digit number. I asked myself ‘what exactly does $5 for a barrel of crude oil mean’? It means that in exchange for a $5 bill, you can purchase 159 liters of a liquid resource pumped from the ground. I tried making some comparisons in prices to other products like, ‘what would the equivalent cost be in gravel/sand’? Since gravel was something that doesn’t exactly trade on the CME, I started looking into the prices of gravel from a small distributor of gravel and mulch-like products out of the state of Maine, United States. From this particular business, I picked three products, ¾’ round stone, stone dust, & wood chips, all priced at $35, $12, & $15/cubic yard respectively. I can appreciate that it’s not going to give a fully accurate measure of what the true market price of it would be but I anticipated it’d give some general idea. I went and did all the necessary conversions from cubic yards to cubic meters to volume in a barrel, and came to the conclusion that the same products in a barrel volume would equate $7.25, $2.5, & $3.12 / barrel. $5 gets you in between a barrel of woodchips, and a barrel of rounded stones (Also note that I talked to someone I used to work with when I helped build roads using gravel and they told me that gravel and similar products very rarely deviate in price and usually just increase on par with inflation). I’m sure you could agree with me that a barrel of crude oil has substantially more uses and utility than the equivalent in gravel or wood chips, even if we consider renewable energy, not to mention that there’s essentially an unlimited supply of sand and rock on earth in comparison to physical oil reserves. Let’s try another product. $5 of today’s money will probably get you a specialty coffee at Starbucks. If we go to the extreme and assume 2% inflation rate up until 2050 (which I know is questionable considering in that time the Fed could be broken up), we now deal with a price of $9.80 for a cup of coffee. What we have now is essentially a range of where a cup of coffee could theoretically be selling for in the next 30 years. Try thinking about that and the trade-off between the two products. I realize that this argument does have flaws however as oil is a part of the entire commodity universe, arguably a leading indicator, and can create inflation/disinflation itself. I then set out to find how much oil there was on earth. According to the CIA fact book, in 2016 there is a total of 1.688 trillion barrels of oil reserves across the globe. An oil reserve simply means that there is at least a 90% certainty that the oil is recoverable. If we probability adjust and consider numbers put out by other sources we can reasonably say that there is around 1.5 – 1.7 trillion barrels of oil reserves (An interesting thing to point out is that since the 1980’s the oil reserve growth spikes up on average every 10 years and have less peaks as time goes on [figure 1]). For the sake of this argument let’s assume that with today’s technology they have discovered every last drop of oil. Depending on where you get your estimates from, today’s consumption of oil will range around 95 mb/d, Million barrels per day. Now OPEC has stated that by 2040, they anticipate that world consumption of oil will be around 109 mb/d. IEA has also said that oil consumption will continue to grow until 2040, with an average growth of 1.2mb/d until 2021. Obviously, you may be weary of oil agencies essentially ‘talking their book’ in reporting, but it makes sense when you consider how much the influence developing & emerging economies has grown over time. In fact, if you look
at the chart you can see a mirror image of the percentage of crude consumed between OECD & developing countries since 1997. [figure 2] I took a look at the similar sort of numbers in the coal market to make a comparison. It’s estimated that there is around 892 billion tonnes of coal reserves in the world. 2013 consumption was around 7.9. That equates to 110-115 years keeping the numbers constant. It’s not precise but should give some sort of idea. If you convert both commodities into the total amount of energy available, it means that there are about 8.9 Gigajoules of crude oil in reserve, and 26.1 in coal. That means that there’s close to 3 times more available energy in coal reserves than there is crude. This amount of supply makes sense when you consider that the midpoint of coal is around $40 a tonne. If you convert that into the weight of a barrel of crude (138 kg), that comes to $6 for 138kg of coal. If we take everything into consideration, where we have a theoretical supply of 1.6 trillion barrels left of oil, and a minimum of 95 mb/d consumption, if you do the math that means we’re limited to a maximum of 40-50 years of consumption. When accounted for consumption growth, were looking at around 35-40 years. This helps the case for the potential of $250 oil considering a shortage by 2050 is not completely farfetched. So even if Electric vehicles and renewable energy become a lot more prevalent in western/developed society, you still have to consider how much that will have an influence on the rest of the world that generally has a lag in adopting such technology given cost barriers, less environmental restrictions, and is growing at a rate multiple times faster on average than the west currently. From this what I’ve been able to determine is that the demand for crude oil likely won’t be disappearing, and even if it does, the supply characteristics simply doesn’t make $5 a barrel make sense, and may even run the possibility of a shortage in the future. On top of this when you factor the relative value $5 has for other products, I can confidently say that by 2050 oil has a more likely chance of trading at $250 than at $5.
ITPM Response and Comments. Curtis. I was very pleased to read this response. After reading through so many one-dimensional thought processes and cases put forward it was refreshing to read a totally different perspective on this. I really like the way you think about the world and especially in trying to get your head around this statement. You very obviously understood the proposition which is always a good start and began thinking of comparable products / commodities. This clearly led you into the coal analysis and the conversion metrics you used were really interesting in getting coal to â€œ$6 a Barrel.â€? I did love the big picture thinking and the math behind that! Really original and well thought out. Where you seemed to slip up slightly is that you essentially made a really strong case for Oil potentially going to $5 with the coal argument then you seemed to do a 180 away from that based purely on capacity of known reserves and a brief mention of renewables. Did you consider that known reserves could dramatically increase for any reason(s)? The possibility of energy substitution into renewables could be much further qualified with more research and out of the box thinking as displayed earlier with coal. Thus, cancelling / lowering the importance of known reserves / constrained energy supply as a factor by making a really strong argument. You had a lot of word count left and could have really nailed it. In Summary, you basically, made a really strong case for it going to $5 before it goes to $250 by 2050, then concluded it is more likely to go to $250 first and perhaps never go to $5 â€Ś, and the only argument to support this is known reserves and a brief mention of renewables. However, overall it is very evident you have a strong analytical mind and you made a really genuine attempt at thinking outside the box here. That coal discussion blew me away. I loved it. With a bit of help, instruction, Mentoring and guidance I think you have really good potential to be a strong analyst / portfolio manager. I love how your mind works! Which is why we will be happy to give you a big chance in developing you further in Florida with the help of Raj and Ben. Anton Kreil Managing Partner Institute of Trading and Portfolio Management