Is It Time to Buy Oil?

Those bullish on oil point to the inevitability of “peak oil,” arguing that the time will come when we hit the peak of global oil production. From that point on, we’ll be able to pump less and less oil out of the ground. In economic terms, we’ll face decreasing supply.

Meanwhile, bulls argue that demand will increase greatly, as China and other emerging markets fuel their economic growth with oil. On average, each person in the U.S. consumes about 25 barrels of oil a year; each person in China consumes just more than two. That’s a lot of possible future demand.
And all of us amateur economists know what happens when you restrict supply while simultaneously increasing demand: Prices rise.

But then again …
Um, weren’t these the same arguments made when oil was at $147 a barrel? Yup. At that price, all of these favorable supply-and-demand assumptions were baked in, and then some. The subsequent price fall highlights that we’ll only make great returns if we buy at low prices.

With oil prices at less than half of their summer highs, oil plays are certainly tempting now. Getting in at steep discounts to the prices Buffett paid is a wonderful thing. However, when we look back in time, we see that current oil prices are about six times the lows of the late 1990s.

In other words, looking at price movements by themselves just isn’t that helpful. We need to estimate oil’s intrinsic value.

OK, so is oil a buy?
The question boils down once again to supply and demand. If peak oil is a way off, demand slackens, and alternative-energy options evolve quickly, a high oil price isn’t justified. But if our oil supplies become constrained, the world greatly increases its energy lust, and alternative-energy players hit snags, it’s off to the races.

Motley Fool