The price of crude oil dropped again today to rest at a 13-month low of $74, and this represents a 50% fall from the peak price of just under $148 only three months ago. The declining price has been mostly attributed to slumping demand from a stumbling global marketplace. Let’s think back to 3 months ago and you will surely remember that the price of oil and more specifically the price at the pump was the number one topic of conversation. The reason being that as everyone now realizes, oil is the lifeblood of our economy and when it gets expensive the effects are felt by everyone. Granted a lot has happened in the last three months and financial markets are extremely volatile, but often times volatility can create opportunity.

Many investors surely noticed that the energy and basic materials sectors were down more than 14% Wednesday, and the question that must be asked is “what is the true price of oil?”. That is a tremendously complex question with factors both economic and geopolitical, but it’s in our DNA at Ockham to try to break it down to what is important and actionable. Remember when crude first crossed over $100 per barrel, we wrote (Relief at the Pump: Don’t Hold Your Breath) that it would be a while before consumers and the economy would get a break from expensive oil. Well, now eight months later after substantial price appreciation, the oil bubble has burst, which is a blessing because I shudder to think what this credit crisis mess would be with the added impact of record high oil, can you say stagflation?

We invite you to look at a great article from The Wall Street Journal (Crude Counting: How Much Should Oil Really Cost?), in it the author inserts some valuable metrics by which to judge the current oil futures market. From the WSJ, “For the last 40 years, oil has represented more or less 2.5% of global GDP, Deutsche Bank says. That should peg oil today at about $59 a barrel.” This is a reasonable assumption that oil would tend to revert to its historical average price. However, as the article later points out, oil that is cheap to produce is become more and more scarce, and that some oil these days costs as much as $80 per barrel to produce. Clearly, oil producers will not produce oil that will not make them money, and the laws of supply and demand will take over from there.