Why oil could fall to $20 a barrel

Published Tue, Apr 28 20154:19 PM EDT

A new report from an economic research firm makes a surprising case for crude oil to eventually fall to $20 a barrel over the coming years as technology makes the process of extracting oil from the ground and getting it to the pump as easy as stocking a shelf at Wal-Mart. The theory is probably not a concern for short-term traders snatching up WTI crude at its current price of about $57—a rise of more than 30 percent from a six-year low—but should be a concern for long-term investors in oil and the related stocks. The report comes from Donald Luskin's Trend Macrolytics , a firm he founded after long successful stints at Barclays and Wells Fargo Investment Advisors. The note was co-authored by Trend Macrolytics' energy strategist, Michael Warren. They bottom line their report this way: "Oil is now subject to 'just-in-time production' and kaizen, a productivity revolution reminiscent of the Japanese manufacturing productivity surge of the 1970s and 1980s. This productivity, coupled with competition from alternative fuels for transportation borne by ever more efficient batteries, onboard lighter all-electric vehicles, means oil prices will eventually revert to their historical norm of $15-$40 in today's dollars. This doesn't mean that less oil will be consumed in the future, nor that oil producers can't grow and prosper. But the old model of mega-projects has passed, and the future belongs to the nimble." They make the case that horizontal drilling and fracking innovation, along with increases in battery technology, will be far more disruptive than anyone realizes, placing it on par with Wal-Mart's global supply chain innovation and the "Moore's law" description of rapid improvements in semiconductor technology. "Today's surge in production is coming predominantly from wells that are horizontally drilled and hydraulically fractured from pads. Because such wells exhaust quickly, exponentially more of them must be drilled. On the face of it, that is an inefficiency. But the exponential increase in the number of wells means a similar increase in learning—about the multitude of processes that can be tweaked, combined and recombined to increase production and reduce well costs. Some of these are still quite new, so there's still a long way left to travel down lots of learning curves where cost savings wait to be captured." The firm sees oil trading between a range of $50 and $65 a barrel this year. But over the course of the next several years they say crude will trend toward $20 or lower as technology to extract oil becomes cheaper and cheaper, making global supply feel "limitless." Take that "peak oil" enthusiasts. Read More With S & P 500 at record, is it still undervalued? The money play: This thesis isn't the death knell for the whole energy sector. The companies that are quickest to adjust to this less capital-intensive oil production environment will thrive, the report states. One such beneficiary mentioned in the Trend Macro report is EOG Resources , which the research firm says is the "stand out at the wave-front of progress." It's worth listening to Luskin and his firm. They made prescient oil top calls in May 2011 and June of last year. And the firm said a short-term bottom was in for crude in January.

Andrew Cullen | Reuters

The theory is probably not a concern for short-term traders snatching up WTI crude at its current price of about $57—a rise of more than 30 percent from a six-year low—but should be a concern for long-term investors in oil and the related stocks.