Even Warren Buffett has been bamboozled by oil.

He admitted it in his latest annual report to the shareholders of Berkshire Hathaway -- the holding company he runs. In his own words: "I bought a large amount of ConocoPhillips stock when oil and gas prices were near their peak. I in no way anticipated the dramatic fall in energy prices that occurred in the last half of the year."

Specifically, he made the bulk of his purchases during the six months ending Sept. 30, 2008 -- you know, the same time in which oil prices peaked near $150 a barrel.

Despite a recent run-up, the price of oil is currently around $60 per barrel, and ConocoPhillips' stock price has tanked in lockstep with the oil free fall. Buffett clearly bought oil too early. But is it still too early for us to buy up oil stocks now?

Now may be the time
Those bullish on oil point to the inevitability of "peak oil," arguing that the time will come when we hit the peak of global oil production. From that point on, we'll be able to pump less and less oil out of the ground. In economic terms, we'll face decreasing supply.

Meanwhile, bulls argue that demand will increase greatly, as China and other emerging markets fuel their economic growth with oil. On average, each person in the U.S. consumes about 25 barrels of oil a year; each person in China consumes just more than two. That's a lot of possible future demand.

And all of us amateur economists know what happens when you restrict supply while simultaneously increasing demand: Prices rise.

But then again ...
Um, weren't these the same arguments made when oil was at $147 a barrel? Yup. At that price, all of these favorable supply-and-demand assumptions were baked in, and then some. The subsequent price fall highlights that we'll only make great returns if we buy at low prices.

With oil prices at less than half of their summer highs, oil plays are certainly tempting now. Getting in at steep discounts to the prices Buffett paid is a wonderful thing. However, when we look back in time, we see that current oil prices are about six times the lows of the late 1990s.

In other words, looking at price movements by themselves just isn't that helpful. We need to estimate oil's intrinsic value.

How do we do that?
Beyond bubbles and busts, oil should sell at its marginal cost of production, plus some profit. Unfortunately, that's not easy to calculate with much precision. Some oil sources are really easy to find and extract (traditional onshore) while others are especially onerous (for example, oil sands and deepwater). Continued...