Is Oil Bubbling Over?

My earlier post about the possible oil bubble seems to have touched a nerve, so here is more. The good people at Factset have out a fascinating new report on the same subject -- how energy markets are becoming awfully bubblish -- and it's worth a read in its entirety.

Here is one quick figure from the report showing how profits are growing so quickly that oil companies can't keep up by raising prices. It creates an interesting box for energy companies and is one sign of a crack in the market.(Click chart to enlarge.)

To be clear, I see no reason why oil prices tumble materially tomorrow. Matter of fact, I'm usually two years too early on these calls -- at least I was in 1998 on dot-coms, and again in 2004 on housing markets -- but it feels, as they say, directionally correct (couldn't resist), and the vehemence of perma-petro-bulls helps (and you can be petro-skeptical and an energy bull at same time).

More seriously, I don't buy the argument that oil is a special case. Yes, oil supply is finite and yes, demand is growing, and yes, energy is the core of our modern life, but oil is also a classic complex system: Small demand perturbations, given the market's current criticality (c.f., Per Bak), could have massive implications for price. Oil is special, but it's not that special.

So, what would it to take oil prices down from here?

• A huge oil find might help, but it wouldn't likely make much difference. Too long to market, too much capital, too much uncertainty about productive size, etc.
• A brilliant technology innovation would do the deed, but you have to be truly a wild-eyed optimistic sort to buy that argument, at least in the short run.

About the only thing I can realistically imagine is a material decrease in demand, or potentially in demand growth. Oil supply and demand are currently delicately balanced at the 85-million barrels-a-day mark, and supply is growing, at least a little. A decrease in demand growth, likely caused by a regional recession in China/India/Europe, or an outright demand decrease, which could only be caused by a global recession, would do the deed.

And how likely are either of the above? At current prices, a lot more likely than they were $30-a-barrel ago.

Comments

[blah-blah]

A huge increase in the margin requirement for trading oil or a denial of leverage would produce amusing results but the bubble will likely end like all others - once everyone's bought, there's no one left to buy anymore.

According to that Bespoke chart on your blog, it looks like we have at least another 30% upside from here and maybe another year.

Unlike the other 2 recent bubbles on the chart, this will produce some fantastic innovations in energy efficiency so the pain is not without gain. The last oil bubbles reduced the US energy per economic unit requirement by 20% each.

[iThinkBig]

The dollar amount of speculation when oil was $112 dollars a barrel in March was $17. Denial of leverage occured for a very brief time and revealed this exact amount. So speculation is 15% of a cost-per-barrel. Is that extreme? I don't know, perhaps another hedge fund expert could fill me in on comparisons of other markets. Agree with the article and forsee a short-term correction on all commodities but long-term this is a very big bull, pending global geopolitical fallout from a global recession (my views).

[JREwing]

Even if it where theoretically possible to eliminate speculation the oil market, it wouldn't do any good. Let's say that takes 25 bucks of a barrel.

Any decrease in price would be met by an increase in demand an therefore offset.

I am shocked by the number of people who seem to be unable to understand the principle of 'supply and demand'.

[VP ofCommon Sense]

How's this for an anology:

speculation to supply and demand is like an amplifier to a guitar.

[TheRealBull]

Peak Oil is here! Peak Oil is here!

And that is about all you really need to know when trying to comprehend the price of oil and where it is going.

[The FItzman]

Regardless of the trend in oil prices, what your chart clearly shows is that energy related stocks are currently great investments.

Long term, the realities of peak oil are clear. Sure we can (and should be) drilling in ANWR and off our coasts, and that will certainly help keep up with worldwide depletion rates. However, what the US government, media, and citizens need to do to prepare and protect the US from its biggest national security threat (peak oil) is to:

1) acknowledge peak oil (no problem can be solved until it is first acknowledged). forget the talking heads on CNBC and elsewhere, peak oil is a fact, and peak oil realities are here NOW.
2) craft a US energy policy to prepare and protect us from peak oil.

Here is a damn good start:
seekingalpha.com/artic...

I posted this on April 4, 2008 and oil was around $100/barrel. It's up nearly 20% since then, and now trades at $124/barrel. Still, no word from the President or Congress on an REAL energy policy.

So, oil will go higher. Stick with ConocoPhillips, nat gas stocks, and inflation hedges. The US simply doesnt have a clue at the crisis it is facing.

[thesession]

I'm fairly certain here that a decrease in price does not increase demand... basic economics...

it increases the quantity demanded... but not demand.

[zenalgorithm]

Apparently, none of us here understand supply and demand. Inventories rise 7 million barrels the last 2 weeks and that's supposed to be bullish...?

A handful of billionaires are pushing oil futures into bubble territory. Throngs of suckers will eventually be left holding the bag - as with all bubbles.

Fuel cell vehicles at potentially $50,000 are starting to look reasonably priced now. Home hydrogen recharging units could make fuel virtually free:
money.cnn.com/magazine...

This is a huge bubble. Like others keep saying: "Where are the shortages; where are the long gas lines?" Once they change the oil future margin requirements within the next week or so, what's going to happen to this bubble?

[BrianPursley]

How is a 10.4 p/e for S&P 500 Energy overvalued?

How do you know oil is finite? Hydrogen is the most common element in the universe and carbon is the fourth most common element in the universe.

A recession in Chindia? Seriously?

"I think the people who are making forecasts don't know what they're talking about. Because we really don't know." -- Peter Bernstein

[GKM]

Let me adds a link to comments I made months ago... seekingalpha.com/artic... (at the top of the comments section).

The Fed is out there handing out money for the I-banks to put into the market and drive the bubble even higher. What the heck to people think the I-banks are doing with the t-bills they get in return for junk? They're using them to leverage up to make more (commodity) investments to bail themselves out and at the same time building in more bubbles - as I predicted back in February. There is only one way this market is going to end and its going to be a doozy.

[poet1]

drilling for oil in anwr will NOT help. there is approx 3seconds worth in there, and then we end up destroying a beautiful place. enough of that. half the earth has already been trashed for a glass of sludge. enough with that groundhog failure. hmmm, how about, try something different! hello, like geo thermal, mass transit, etc etc etc. anyone who suggests drilling in a wildlife refuge should just shut up.

[maher]

Oil is going to $150 on its own, and to $200 with the coming Iran conflict/war.

It's Iran, stupid.

[JREwing]

First to maher:

Dude just get lost! You are nothing but a bum!

Second to the session:

Are you for real??
'it increases the quantity demanded... but not demand.'
That is an increase in demand. When things, people need, are cheaper, they buy more of it.
Go back to economics 101.

[123akennedy]

What's wrong with opening up the oil shale in Colorado and the other two states for drilling and let Shell have at it. There is about a trillion barrowls of oil we wouldn't have to import from the Saudi government. Why did the Bush admin shut it down this time? I know it wouldn't go on line instantly, but, at least Shell knows how to get that oil out of the rock. Let them get started, and it would shure help the US with its oil needs.

[JREwing]

When the pain gets bad enough they're gonna open up everything.

[fxtrader07]

oil is in a bubble here, no doubt. the most silly argument for the price rise this morning cited on bloomberg: fears that supplies in gasoline may not be sufficient!!
HELLOO?? gasoline supplies are higher than in the past 5 years, refiners lose money these days or hardly make any - so every $ increase in oil price serves as a direct disincentive for refiners and crude supplies are very high right now
the long term fundamentals are there to justify even higher prices. but get real: there are many peak-commodities out there that do not command such a rich premium to replacement costs as oil does.
it is all about perception, again. the moment the hoarding stops prices will retreat.
imho "paper oil" (i.e. oil futures) have started to decouple from the real stuff. when they catch up to reality, there will be a short, but very brutal sell-off.
that being said, long-term, 160$-200$ oil are a matter of a few years only

[us oil]

The world has more oil than it knows what to do with. This crisis is another con, a reaction. Sure, demand is going up, but no one is trying to find or "open" production. Oil will be 70 by next summer.

[paulk8756]

Thanks for a generally thoughtful discussion. A few thoughts here:

1. When the price of something gets high enough, markets always correct themselves. No matter how "special" a commodity, oil (...and tulips, for that matter) is not an exception to the rules of economics.

2. Demand for any product is not totally inelastic, people are beginning to curb their energy usage already. High prices are also bringing to market alternate substitutes for gasoline.

3. Living in the oil patch, we've seen these oil bubbles before. Of course, how and when this one will end is anybody's guess... but it will...!

[galewhitaker]

us oil
The earth is awash in oil. We will never run out of oil. The problems is that everything in our civilization has been designed to operate on $30 oil. Now that oil is $130 all that stuff (cars, trucks, buildings, planes) our civilization has built no longer makes sense. How can a person live in a house that has a $40,000 heating bill attached? There were some solutions but the oil companies have made sure that meaningful conservation has not been developed in time to make a difference. I think you better buy yourself a really warm coat and start hoarding some canned goods. Things are going to get really nasty.

[bill d]

I just heard Bilary say: "we are going after OPEC and the oil companies - we are not going to continue to let them sit in their boardrooms and gouge us, rant, rant, rant."

I would like to ask HOW ?

1. If I were OPEC I would let her know who really has the "power". Tomorrow and for one day:
2. I would stop drilling.
3. Oil tankers would not leave port.
4. Pipelines would be turned off.
5. Close all gas stations.
6. Stop all deliveries of any petro chemical related goods to stores, etc.
7. Shut down all refineries
8. All tanker trucks would pull over and take the day off.

Take that - you big mouthed idiot twat.

[richandmer]

I don't know about you, but I am upset at the U.S. automakers for not being prepared for high fuel prices and the demand for high mileage vehicles. If they had a line of high mileage vehicles and cars like the toyota prius, it could be the start to getting us out of this poor economy we are going thru.

They have had years to get ready, but for some reason, they have been focused on SUV, etc, rather than preparing for what people are going to need in the future.

I look at Toyota, Honda, Nissan and they are really getting their act together and we can't even copy what they are doing. I am Mad!

[Mmarrkk]

They built high mileage cars but there were no buyers. So they built what people would buy. Now they have to be ready to react to the changes again. Unfortunately for them that they are very slow in doing so. But, when they built those 35-40 mpg cars, no one wanted to touch them.

[Whisper OnThe Wind]

So, Mmarrkk, if the "(not so) Big 3" built them once, they have the means to do it again, relatively quickly. No designers needed, just a bit of retooling (which my company would gladly help them with), and they could do it. So why aren't they? Because they don't want to admit they were wrong... or maybe because everyone fell for the bigger is better theory. I had a Plymouth Colt, it was okay. I had a little bitty Geo, too. Loved it! But now, I'm aiming for a Mini Cooper because I like getting better than 35 mpg. (My Toyota gets about 34 in the city now, not a hybrid.) I just grin when I see the difference between my gas costs and theirs. I invest the difference in energy stocks for now and collect the dividends.

[user 191485]

Paul Kedrosky has no idea what he is talking about. Dot-com stocks busted because these stocks were being sold left and right in the late 1990s before these tech companies even made a dime. That is why tech stocks went bust. They weren't making any money. Our entire way of life in the United States depends on oil. Oil is not doing to drop to 30 dollars a barrel. Do you see people driving less to work? Do you actually see Americans consuming less? I urge people to read the book titled "The Long Emergency" by James Kunstler.

[paultaut]

Looking through this long list of responses makes me very happy...I started investing in CanRoys when oil was a $25...will hold until they are all bought for Cash by China,Russia,India...

With Oil at $125+, and so much dissension, there is no need to fear a bubble. On the other hand, a coordinated effort by the US and Opec, could drop Oil 10% sometime soon...an end to Nigeria's woes would be the best thing and add maybe 5% to that drop...

that being said, it will be a temporary drop. Psycological...Opec's unused capacity is totally comprised of the heavy/sour grades which most of the world can't refine...US reserves will be tapped temporarily...Nigeria is ify..

Hurricane season is coming boys and girls...the forecasts are grim.

[JREwing]

Paultaut is right. When so many people are convinced that something is a bubble, then it most certainly is not. In the 90s everybody was crazy about techstocks, not just joe public.

The oil price on the other hand, is hated by everybody. There are even NYMEX floor traders, who call it crazy (I guess they went short and got their butts kicked).

That is not a bubbly environment.

The problem is, that people don't understand the oil business. The 30 year long underinvestment, the time it takes to bring new production online. Joe Kernen type folks, who neglect the fact, that in the time new production comes online, existing fields are being depleted. They don't understand refinery runs, that's why most people thought the last inventory data was bearish, when it was exactly the opposite.

By the way, I bet half of that price increase last week was because of all that populist talk of gas tax breaks during the driving season. You lower the price and demand destruction doesn't take place and then the price goes up again. Traders anticipate that.

Don't get me wrong. I guess they're gonna take 5 or 10 bucks of the barrel after every rally, BUT THE OILBOOM WILL ONLY COME TO END WHEN EITHER THE WORLD ECONOMY IS IN THE TOILET OR WHEN OIL IS NO LONGER THE PRIMARY TRANSPORTATION FUEL.

People in the west are used to, that only they take advantage of all the valuable commodities our planet has to offer. That is over, because 2 billion people want a piece of the pie and they don't care, if we here want commodities to be dirt cheap. They can pay for it and they are gonna buy the stuff.

GET USED TO IT!

[bearfund]

User 191485, yes, actually I do see Americans using less oil, much less in fact. The Americans of the Age of Excess are getting on in years and they and their culture are dying out. The pendulum has already begun swinging back toward urbanism, which will dramatically reduce the amount of fuel used for transportation. Energy efficiency is the order of the day everywhere - high prices are seeing to that, as is concern about carbon and other pollution. At the end of the day, whether it be oil or food or anything else, the Americans simply don't have the money to buy it any longer. They've been borrowing for decades already, deeper in debt every year and saving nothing, paying down nothing. Their credit is at an end and even if longwave demographics weren't favourable, they'll have little choice but to decrease consumption in years ahead.

But I don't see oil at $30 in my lifetime. There's plenty of global demand and although supply seems adequate for the moment, the long-term picture there isn't pretty. Especially in dollar terms, I see nowhere for oil to go but up. And pullbacks will be of short duration, a few years long at most, and modest at that. But in any terms you like, even gold, the long-run standard of real value, oil's headed only higher. Nothing short of revolutionary technological advances can change that. Either those advances will come before the remaining oil becomes prohibitively expensive to extract and consume or they won't. If there's an afterlife (hah!) have your grandchildren let me know, will you? Meanwhile, oil at $100 is a screaming buy, and at $75 I'd happily bet my life on it.

[tclwrap]

amazing the various point of views on the same subject. I think the conception is 2 billion people are going to consume more oil. The US and the world is already complaining about global warming. If the prediction does happen, the concern is not oil, it would be the planet. Therefore the same drivers that motivate higher consumption are the ones that will cause it to decelerate. I think the future looks more urban than an 8-lane highway. For the rest, alternatives will become viable as oil goes up. In the end, stability is reached with oil occupying a much smaller piece of pie.

In the short term, oil most likely would decline due to global economic slowdown. This slowdown should include india and china. I agree with the prediction oil will be back at 70 by next summer. I don't know if the summer is going to be a prosperous time though, I doubt it.

[tclwrap]

like to add some supporting material

news.nationalgeographi...

oil carries a cost.

[Calvin C.]

This may sound immature, but a history ch. special on our addiction to oil really expanded my horizons on the stark reality of oil. The fact that our entire civilization owes its exponential growth for the past century to the burning of this sweet black tar reminds me of an infant sucking on a mother's milk bottle. If we are to advance a energy independent society then 1st we need to feel the pain of having that bottle snatched away.

[user 191485]

bearfund, Americans aren't using less fossil fuels. Go to any major US city (NYC, LA, Chicago, Houston, etc.) and drive in rush hour traffic. How many people do you see in each car? Usually only 1 or maybe 2 people. We aren't carpooling. We aren't using mass transit on a nation-wide basis (do you see people taking a subway in LA? it doesn't exist!). Al Gore clearly shows that the US uses a lot more oil per capata than China or India in his documentary "An inconvenient truth." But the American way is to blame it on other countries. Americans may cut back on car trips for vacation, but major lifestyle changes aren't really taking place (such as buying less bottled water, carpooling, using less napkins, recycling, turning off lights at the office at work, etc.). Also, local governments cannot develop mass transit because American suburbia is so spread out (due to our gas-dependent way of life) that it would take years to develop, which is an unpopular proposal if you are trying to get elected to office on a short-term basis.

Oil is going to go up, up, up for another 10-15 years before the middle class consumer is REALLY going to be pinched, where gasoline/heating/elect... bills will be around 50% of the monthly bills of a typical American household. Then you might actually see some real changes. I don't have the answers to this mess (I wish I did), but that is not what this debate is about. The debate is whether or not you should buy more oil and natural gas stocks, and my answer is YES. Buy as much as you can now and sell them in 25 years, because these stocks will be worthless in 30-40 years when we run out of oil and natural gas.