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Fuel Prices: Headed for a Bull Market
The price cycle is turning skyward for gas, coal, and crude oil.
These days you don't have to do much searching to find different fuel price forecasts and approaches used in developing them. These different approaches and methods-forward curves, econometric, mean reversion, and random walk models-make it difficult to decide which forecast is likely to be the best. Many of the current long-term fuel price forecasts are constrained by the short-term perspective of the forecaster. After more than 25 years of observing and studying the energy markets, it is highly likely that fuel prices will increase dramatically over the next 10 years. This belief is not based on complex algorithms, but on market fundamentals.
What We Learn from History
When facing an uncertain future, the past can often serve as a guide. Those who look back before they look ahead are often better prepared. Beginning with the last energy crisis in the mid-1970s, Black & Veatch has spent considerable effort in trying to understand and evaluate the underlying factors that influence energy prices. 1 This has included an examination of the numerous crude oil and coal price cycles that have occurred since the mid-1800s.
The current consensus is that the rise in fuel prices which occurred during 1999-2000 for crude oil and natural gas, and 2000-01 for coal, was an aberration, and after returning to lower levels, prices will remain relatively level in inflation-adjusted terms through the year 2020 and beyond. However, historical price cycles suggest that this scenario is unlikely.
Figure 1 shows the price of crude oil, natural gas, and coal in real, or constant dollar 2 prices since 1860. This graph uses a logarithmic scale; therefore, distances that are equal in the vertical direction represent the same percent change. The illustration in the lower right hand corner of Figure 1 shows the rate of change for the various slopes of lines shown on the graph.
Fuel prices, when expressed in real or constant dollars, exhibit "cyclical" behavior with significant volatility. The low prices for each "price cycle," since the first low in 1861, have been remarkably similar. During the past 140 years, advancements in exploration, drilling, and production technologies appear to have counteracted the effects of increased scarcity (depletion 3), as cycle low prices have increased at only a minimal rate since 1861. However, the changes that occur in the cost and price structure during these 15- to 25-year cycles are dramatic.
At price cycle lows it is difficult to attract investment capital. When a new energy price cycle begins from a cycle low, a significant amount of time is required to "recapitalize" the crude oil, natural gas, and coal producing industries. This is also true for the associated suppliers of equipment and services that are required for exploration, development, and production. It then requires an infusion of capital and time to explore for, and develop, new reserve areas. The result is a rapid increase in real energy prices that is sustained for several years, until excess capacity leads to lower prices.
In 1998, crude oil and