What is the Fair Value of Oil?

For much of the past two years, we (meaning most of the world) have been complaining about high oil prices.  As the price per barrel climbed past once unthinkable milestones – $75, $100, $125 and then nearly $150 – the complaints grew louder and louder.

Now that the price of a barrel of crude oil has fallen in excess of 50% from this summer’s record high (after falling as much as 60% before this week’s slight rebound) many of the world’s oil producers – OPEC in particular – are complaining.

In fact, even after recently announcing a 1.5 million barrel per day production cut, OPEC is rumored to be considering another cut of similar size in order to defend an oil price of between $80 and $100 per barrel.

With all of this being said, I think it begs the following question: what exactly is the fair value of oil?

I posed this question to Daily Fuel Economy Tip readers, and here’s how nearly 350 people responded:

  • 46% said the fair value of oil was at $50 or below
  • 29% said the fair value of oil was between $51 and $75
  • 17% said the fair value of oil was between $76 and $100
  • 8% said the fair value of oil was above $100

Unfortunately, I think these responses have been borne of what we’d like to be paying, rather than what we probably should be paying.  Don’t get me wrong, I would certainly love it if oil fell below $50 a barrel, especially if it didn’t deter alternative energy research.

That being said, I think it’s impossible to argue that at this moment, aside from life sustaining resources such as air and water, oil is not the most important and valuable natural resource.  After all, it’s not only the major ingredient of transportation fuels, but it’s also a key component of the following items:

  • Plastics
  • Fertilizer
  • Ink
  • Synthetic rubber
  • Candle wax
  • Make-up
  • Polyester
  • Soapless cleaners

Obviously, this is just the tip of the iceberg in terms of items we wouldn’t have if we did not have readily available oil.

And, unlike air and water, which are both readily available and seemingly infinite, there is a finite amount of oil left in the world; for ever drop of it we use, that’s one less drop we have left.  Theoretically, this should put some sort of “scarcity premium” on the price of oil as well.

So, with all of this in mind, what do you objectively think the true value of oil really is?  Please leave your comments below!

Comments

  1. As much as I hate to say it, mainly because I like cheap, oil prices are too cheap. I would say that $100 per barrel is reasonable today. Why? Mainly because of availability and accessibility. Add to the fact, as mentioned in the article, the many other uses with oil for our daily life and the prevention of usage of our other natural resources like wood, hard to get and process metals, etc. Also, cheap equals waste, we tend to discard “things” when they are cheap.

  2. I didn’t participate in the survey because it’s a meaningless question. The fair value of oil is whatever price a willing seller can get from a willing buyer. That price is reflected in the market. That’s the fair price, no other price has meaning.

    You could say “well, what does it cost to get out of the ground, and then what’s a fair mark up?” Are we talking about oil from Ghawar, the North Sea, Cantarell, where? OK, then use a weighted average of the extraction cost for all oil. Fine. Then what’s a “fair return?” Well, what’s the cost of capital, what’s the risk free rate in today’s environment, what is the risk premium, etc.? Hmmm… maybe the market price reflects all of this analysis.

    Bingo

  3. Based upon work I did back in the ’70’s, which predicted oil prices based upon supply and demand, the answer is between $90 and $150 per barrel.

    Unless a new field is discovered, or a depression hits and kills all the economies, that is a reasonable guess. The pendulum already swung too low.

  4. I think Chinese energy companies are a huge investment opportunity right now; APWR, for example, which builds and installs wind-based energy solutions across China’s mainland.

  5. I have to agree with Rob on this one, what we think the ‘fair price’ is doesn’t really matter. The market will take care of it. If the price is too high, demand will drop. If the price is too low, it will have to come up. So let the market do it’s thing, and that’s the fair price!

  6. Hey… I think americans cannot complain on “high” oil prices. Here in germany we pay 1,5 € ( 2,2 dollar ) for one liter gasoline! How much do you pay? 1 dollar? So i think every american human must pay a ecological friendly car whithout huge uptake rates… Thats the right way.

  7. I actually did work on this question, and a the fair price of a gallon of gas (when environmental impacts, traffic, and other negative externalities are considered) is above $6. Translating into your question’s terms, and considering that we were only at $4 per gallon when oil was $147/barrel, the socially optimal price is almost certainly above $100/barrel. As to the “fair” price, that’s a subjective call.

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