Have Crude Oil prices peaked out?

Crude oil, which seems to be the bug bear of most world economies and stock markets, has corrected from its high of around US $148 to about US $118.

Many believed that such high crude oil prices were unsustainable and crude was in a bubble. So their faith in their views seems to have been vindicated.

So has crude oil made an eventual top and has its price peaked out?

First some quick fundamentals that are known to everyone:

On the demand side:
-North America and Europe account for about half of the total oil consumption in the world.
-Asia and Middle east account for about 30% of the total oil consumption.
-But Asia and Middle East contribute 60% to the increase in demand for oil while North America and Europe contribute 20%. Clearly, additional demand is coming from Asia and Middle East.
-China consumes about 7.7 million barrels of oil per day, and growing at 7%
-India consumes about 2.75 million barrels of oil per day, and growing at 5%
-Together, the 2 countries consume 10.5 million barrels per day and growing at 6.5% per annum.
-Oil consumption is seeking higher levels, mainly on account of developing countries.

On the supply side:
-World production is declining. Almost all oil fields are in decline. USA, Saudi, Iran, UK, Russia, Mexico, Indonesia, are facing production constraints. Countries like Nigeria are facing security issues. It is estimated that the total production is now going down at the rate of about 3 million barrels/day.
-There has not been a single large oil field that has been discovered in over 30 years.
-World oil production in 2007 was 84.6 million barrels per day, less by 30000 produced in 2005. -Crude oil production is lower than oil consumption.
-Excess 0il demand is being met by reduction in stockpiles.
-And a small amount comes from ethanol.
-Oil produced by current technology is on the wane. Someone will have to find a new oilfield pretty quickly to keep pace with demand.

So demand is high and rising. Supply is falling quite rapidly.

Of course, everyone is aware of this. And prices have already gone sky high moving up from about US $100 at the begining of the year.

Also, shouldn't higher prices drive down demand?

Yes, they would. Some demand destruction will take place on account of higher prices.
But only in countries where oil is freely priced.
In countries like India, where prices are administered, retail prices do not reflect the scarcity value of oil. Hence demand is unlikely to come down.
Across Asia, prices are controlled.
Hence demand from this region will keep rising.

As an example, the US consumes about 20 million barrels of oil per day. A 5% decline in oil consumption is equivalent to less than 2 years' increase in oil demand from China and India alone!

What about alternative sources of energy? Will we not have substitution?

Yes, we will. But it will take time.
It takes time for habits to change.
We change our habits when pain is intense.
And right now, the pain is not intense.
And nothing major seems to be on the horizon currently.

So over the long run, demand is seen outstripping supply significantly.
We do not have an alternative in the pipeline.

But is all of this already discounted in the price? Have we seen the peak for oil prices?

I don't think so.

First, commodity bubbles do not end like this.
There is a lot of buying before the end.
Most people get convinced that high prices are here to stay. Currently there are many skeptics who might think that we are in a bubble.
A lot of investment starts pouring into the sector.
Investors are gung ho about the prospects of the asset under consideration.
Prices stay high for a long period before starting their move down.
There is intense pain for those badly affected by high prices.

We have not seen such signs yet. Prices have come off their highs pretty quickly.

A look at the charts suggests that oil has a long way to go. Sure, in the short term, prices can come down significantly. Which, if they do, will lull everyone into a sense of comfort. And things will keep moving nicely for a while.
But over the long run, prices are very likely to rise.
To what levels is impossible to say.
My sense is that they will be much higher than recent highs.

The world faced a similar oil shock in the decade of the 1970s.
Oil went up from about US $1.5/barrel to US $42/barrel, a rise of 28 times.
And India and China (with their now 2.3+ billion population) were very marginal consumers unlike today where they consume one eight of total consumption.

Oil is in a secular bull market.
It peaked out at UD $42 in 1981.
A secular bear market ensued for oil from 1981 to its low in 1999 at US $11.
Thereafter it started another secular bull phase.

It has gone up 13 times till its peak in its current phase.
Can it go up 19 times to US $200? Sure it can over time.
Can it go higher still? Sure it can.
When a bubble forms, no prices seems too high.
Till the bubble bursts.

So my sense is that we have not yet seen the ultimate highs for crude oil.
Unless someone finds a large oil field quickly, something not achieved for over 30 years.
Unless someone finds out a profitable method of extracting shale oil.
Unless someone finds a quick alternative to oil as energy.
At some stage we could see oil back to US $50.
But that, in my opinion, would be after we have seen it at much higher levels.

So is oil a buy on dips? Or perhaps oil stocks?