Betting on a supply squeeze and a spike in the price of oil

ECONOMIC NAVIGATION AND SIGHTSEEING

December 21, 2008|By JAY HANCOCK | JAY HANCOCK,jay.hancock@baltsun.com

The price for a barrel of oil has fallen from $145 in July to less than $40.

So you might think investment banker Matthew Simmons is worried about his wager that oil will be worth five times that amount two years from now. Convinced that oil production can't keep up with global growth, Simmons bet New York Times columnist and blogger John Tierney $10,000 that the average daily crude price in 2010 will be more than $200.

Is he having second thoughts?

"God, no," he said on the phone the other day. "We bet on the average price in 2010. That's an eternity from now."

Simmons argues that the economy isn't as weak as it seems, that low oil prices will shut down production and that the world will soon see a supply squeeze and price spike. Oil price graphs, he says, will look like a "V" - straight down and straight up.

"We're going to create a 'V' that's very dangerous," he said. "We could pierce through the old price high like a hot knife through butter in a very short period of time."

Well, why did oil just crash below $37? Doesn't that indicate evaporation of demand?

"What we're witnessing is probably a massive liquidation of paper contracts," said Simmons, author of Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy.

Tierney, a fan of late University of Maryland business professor Julian Simon, likes his chances. The last time commodity prices soared, in the late 1970s, Simon bet environmental scaremonger Paul Ehrlich that they would fall.

Simon's thinking, based on centuries of economic history: Substitution, technology and new discoveries would keep resources from becoming scarce and expensive.

Simon won the bet. Tierney had him in mind when he bet Simmons in 2005.

"I remain utterly ignorant about the intricacies of the oil market either today or in 2010 - and I remain confident that it's smart to bet against energy or any other resource becoming scarcer and more expensive in the future," Tierney says via e-mail. "So I figure the odds are with me to win this bet, especially now that prices are still so much below $200 a barrel."

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