The case for $40/barrel Oil

Today oil dropped to a 5 ½ year low, closing below $63/barrel.  How low can it go?  I have no idea but I do like to consider correlations.

The energy equivalent of natural gas (per 1 million BTUs) to a barrel of oil is roughly 6 times.  So natural gas at $10 per million BTUs would conceptually construct an oil price of $60.

But oil is much more convenient and less expensive to transport and use- for example a gasoline can versus a propane bottle.   For these reasons, the price multiple has traditionally ranged around 6-12 times.  That was until recent years when the price of natural gas plummeted because of the shale oil and gas revolution- the multiple often exceeded 30 times.

With oil prices collapsing, the ratio currently is down to about 17.  I believe oil has further to drop and the multiple will continue to fall.

Assume $4 natural gas at a 10 times multiplier, that puts oil at $40/barrel.

Seems extreme, but time will tell.  Oil has already fallen 45% in six months.

PS- the implication for Gold could be $600/oz…for a related article on Gold’s price correlated to Oil see:  http://www.investablewealth.com/900oz-goldmaybe/

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