This article provides an overview of Preston and Stig’s interview with the author of the book “Oil 101” Morgan Downey. Get ready to have the nuts and bolts of the oil industry broken down.
This article and podcast answers the following questions:

  • Who is Morgan Downey and what can we learn from his book “Oil 101”?
  • Will oil be replaced in the future?
  • Will the price of oil increase over the long term?
  • Ask The Investors: Should I invest in an inverse S&P500 in an overheated market?

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Who is Morgan Downey and what can we learn from his book “Oil 101”?

Morgan Downey is an oil trader and a top authority in the oil industry. Originally published with 1800 pages, this is the book he said he would like to have read himself. This comprehensive book took Morgan 3 years to edit and filter it to 363 pages it is today. It takes the reader through the fundamentals of the oil industry from the composition of the molecular level, through the fundamental economics, and ends with how to practically trade and manage oil risk.

Will Oil be replaced in the future?

In more than 150 years since the oil industry was established, the consumption of oil has literally gone up every single year with the exception of 1973,1981,1982,1983, and 2009. According to Morgan, the consumption of oil is fairly easy to predict. It’s closely correlated with the growth in population and the economy. The overall consumption of energy is undoubtedly going to increase. You would have a hard time finding anyone who disagrees with that. Rather the battle right now is whether if the rise in energy consumption should be filled by oil, renewable energy, or even a third source.
Oil is really in a bucket for itself. What that means is that oil has properties that you can’t find with other types of energy sources. For instance, you can’t have a container’s ship sail on electricity. Another thing is that the debate about electricity, which is just one form of energy, is completely misplaced. Oil is not a big contributor to electricity – it’s simply too expensive to be used for that. When you hear about electricity being produced increasingly from windmills and solar to replace other energy sources, it doesn’t dilute the need for oil in any way.

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Alternative sources are typically replacing coal or nuclear and not oil. Contrarily, one of the most important features of oil is that you can store a vast amount of energy in a simple barrel and transport that very easily.

Another interesting point that Morgan Downey mentions is that while we have become more efficient with oil, this effect has not been reflected in a decline in consumption historically. He mentions cars as an example. You can now drive longer on a gallon of gasoline in the same type of car, but the cost saving has rather been reflected in more people driving SUVs, which dilutes the efficiency of oil consumption.

Will the price of oil increase over the long term?

The short answer is yes. The long answer is “yes in the very long term because…” The thing to understand about the oil business is actually very basic. There is a demand side that is consistently growing, and a supply side. The demand and supply of oil together determine the price of oil, just as in any other market. Now, where the oil market is very different is the complexity of the supply side. It’s composed of both private and state-owned companies that have huge interests in manipulating the price of oil, and they are not shy to do so. The supply side is therefore not easy to predict.

With the rise in oil demand, it can be predicted is that the overall costs of producing oil in the long run will go up, and as a result of that the price must also increase. No companies will produce at a loss in the long term and the demand will push the price to meet the long term marginal cost. As Morgan puts it, “A company will produce oil at $81 if it can get $82 back.” He also points out that most of the cheap oil has already been extracted. It’s actually quite simple to understand. Producers in aggregate will start by extracting the cheapest oil until there is no more and then move up the cost curve to maximize the profit. The cost curve looks like this.

$15-$25: Onshore oil.