Can Governments Pop the Oil Bubble?

How long will the bubble in oil prices last, and how high will oil prices go before they peak? Will it take governmental manipulation to puncture the bubble, and would such manipulation work long term?

No one can predict prices for the next week, month or for years ahead.

But based on the history of the 1980 bubble in oil prices, economists and analysts think that the current oil bubble might last a long time, according to wsj.com.

It takes a long time to increase oil production in response to increasing demand and high prices. Some think that because oil production is controlled by dictatorships, oil production may not increase as it would if the major oil companies owned and managed the world’s oil reserves. And it takes a long time for consumers to reduce consumption significantly.

In most markets such as housing, autos, corn, wheat and other foodstuffs, high prices cause producers to increase supplies and consumers to find alternative products. That causes prices to peak and bubbles to burst relatively quickly.

But, the theory goes, because oil isn’t renewable, and demand from China, India and other emerging markets appears insatiable, it will take consumers a long time to wean themselves from petroleum-based products. So today’s high oil prices may not be the top.

Last week oil futures topped $135 a barrel and closed Friday more than 100% above year ago prices. In the stock markets, there always are a few stocks that are trading two or three times what they were trading at 12 and 18 months earlier and commodity prices frequently double and triple over short periods. So a tripling in oil prices wouldn’t be unprecedented.

In most markets, such a run ends with a major price correction as consumers stop buying and speculators take profits.

The problem with the comments by The Wall Street Journal’s sources is that they aren’t taking into account several new factors that could end or at least slow the surge in oil prices.

Governments can manipulate markets in ways that would put private traders in jail, and they often do. The current boom in corn prices can be blamed in large measure on presidential candidates and members of Congress who forced taxpayers to subsidize the production of ethanol as an alternative fuel. Those promises, which were made years ago, bought votes and power for President Bush and members of Congress, but they have done and will do nothing to make the U.S. less dependent on oil imports.

What can consuming countries’ governments do to dampen demand for oil and oil prices?

Congress probably will be talking about taking institutional speculators out of the futures markets. And other consuming countries such as China and India could end the gasoline subsidies that are making their consumers insensitive to soaring prices, as I’ve written here and here.

In the last few years, pension funds, mutual funds, hedge funds and exchange traded funds have become major speculators in the commodity futures markets. Lacking money-making opportunities in securities and other financial markets, portfolio managers are increasingly speculating in the risky futures markets. And they appear to be mostly buyers, not sellers.

They say they know how to manage their risks.

But the buyers of subprime mortgages said the same thing before their markets and careers crashed.

Congress is not good at policy making, but it sure knows how to demagogue private businesses, and as the election nears and politicians need excuses for soaring food prices, look for the demagoguery against commodity speculators to soar not only in Congress but in legislatures and parliaments around the world.

Demagoguery isn’t doing much to the oil futures prices, yet, but that’s because it’s aimed at big oil companies, not the institutional speculators and foreign governments who are most to blame for soaring prices.

If and when politicians refocus on institutional speculators, the institutional money managers will quickly rethink their missions and strategies and try to get out of the way of the bad publicity that is already beginning to put them in the spotlight.

As speculators increasingly fear new governmental manipulation of the futures markets, they will sell and prices will correct. This will take some major buyers out of the market quicker than economists and many speculators are anticipating. Once prices break, there will be a rush for the exits.

The question then becomes, if institutional speculators, but not individuals nor hedgers, are taken out of the futures markets, will actual supply and demand fundamentals begin to be reflected in the markets?

What prices will more accurately reflect the actual supply and demand fundamentals and expectations for changes in supply and demand?

It’s hard to say. Oil bulls are predicting $150 oil by year's end and $200 oil by 2010. Yet there are plenty of people who think oil currently is vastly overpriced for the near term and the long term. But they’re only guessing. As noted above, no one knows for sure.

Governments can manipulate global money and commodity markets only so much. And it takes awhile to figure out what the next attempt at governmental market manipulation will be and whether political tinkering with the markets will have long-term effects or not.

Even if American politicians try to take U.S.-based institutional speculators out of the futures and commodities markets in the U.S., they can’t control speculation in futures markets that are outside of the U.S. And they have no control over the governments that control most of the world’s oil reserves and have the most control over the supply side of the oil markets.

For governmental manipulation of the oil markets to have any long-term effect, the governments of other oil importing countries will have to conspire with American politicians to dampen speculation and consumption.

And that may happen, because consumers around the world are feeling the effects of institutional speculation in the commodity markets, and they will take it out on politicians unless the politicians take it out on institutional speculators.

The final unknown in the oil markets is whether the governments of oil producing countries that are the most to blame for soaring oil prices will decide that high prices will reduce consumption so much that it will be in their best interest to join consuming countries in manipulating prices in an effort to make them more acceptable to consumers. High oil prices in the early 1980s caused consumption to decline. As a result, oil prices were depressed through most of the 1980s and 1990s.

Oil market bears think and hope that will happen again. Bulls pray and say that a crash in oil prices is unlikely.

Comments

[set:]

Governments tried to manupulate currency rates back in the 1960's and 70's . It was a disaster. I do not expect any better results for oil.
Americans have it in their power to be self sufficient if they would get over the exploint offshore resources which would give us breathing room to develop alternative energy sources. As it remains now, we are transferring the wealth of future generations overseas to buy energy that can be obtained closer to home.

2008 May 27 03:23 PM

[Brian Pursley:]

The US government is manipulating oil prices as we speak with dollar inflation and the ban on domestic drilling. Big Government is the reason why oil prices are where they are now so of course they can pop the so-called "bubble" by allowing oil companies to drill offshore in the US and increase supply.

2008 May 27 04:10 PM

[Vette:]

I find it unbelieveable that in the midst of this crisis our political parties have not been able to agree on a domestic energy policy. So, worry not about government taking any steps to reduce speculation as described in this article. If agreement on an energy policy can't be reached, the ability to agree on a more complex global policy that will truly "curb" Big Money speculation in oil is well beyond the capability of our political system. Manipulation of our commodity markets by Hedge Funds, Middle East oil money (maybe the same as Hedge Funds), and others will remain alive and well... for a variety of reasons.

2008 May 27 04:58 PM

[barnburner:]

drilling off-shore OR in ANWR would give the US "breathing room to develop alternative energy sources." The problem with that idea is that if the US were given "breathing room" they would piss off the chance just like they did after the oil crisis in the 70s. The only thing that drilling off-shore and in ANWR would do is drop gas prices to $2.00 a gallon for a couple of years and then "off to a new energy crisis" yo ho, yo ho

2008 May 27 06:12 PM

[Brian Pursley:]

barnburner - Sounds to me like you don't want to drill, don't want to increase supply, and don't want to see $2.00 gasoline. Since I'm long frankly neither do I.

2008 May 27 07:09 PM

[sivere:]

At this juncture in history, we are getting hit with multiple punches simultaneously. We have a speculative bubble unlike anything we have ever seen (i.e., tulip bubble, etc.). This bubble CREATED the housing crisis. We have a serious energy problem, caused at least by a combination of US foreign policy (Iraq invasion), middle east geopolitics (related to the first point- Iran vs. US and Israel, Israel vs.the rest of the middle east, US support for Israel, Europe vs. US, etc.). Add to that the dynamic growth in China, India, and Asia in general, vying for the same oil, with no easy way to crank up production, plus an at least temporary food shortage, and we are potentially in a heap of trouble.

Now the peak oil folks are saying, 'see, we told you so' (high gas prices, political turmoil), and the environmentalists are saying ,' see, we told you so ' (food shartage, storms, bad weather).

We need to keep cool heads at this point. First, there is evidence enough that the various political situations, including relative falling petroleum supply (i.e., we cannot just crank up oil supply to meet demand) coupled with a panicked rush to commodities due to the financial collapse and various derivative contracts, shorting, etc. are big factors in the energy issues.

Now, peak oil eventually may be real, and with half the world waking up and developing, we need to take the underlyiong theory seriously. I think $120+ barrel oil may end up saving us IF we act NOW to start developing alternatives. We need tax incentives, government sponsorship, as well as good old American ingenuity to kick in NOW.The $120/barrel oil creates the economic framework to make alternatives possible.

This is not the time to give up as some of the more liberal peak oil advocates imply we should. A wise Catholic Saint once said something like 'Know that God can do anything, but act as though He will do nothing'. Let's not forget there is a God, and He could be testing us, He could be punishing us. We do not know for sure. But do not give up. Turn back to some of our basic Christian values (and natural law in general), think about what we are doing and why, and let's roll up our sleeves to solve this issue- not just prepare for the end, and hide in the wilderness. It is not all criticism for the more liberal peak oilers- some of their ideas about reviving urban living are not all bad, and make sense certainly in the short to medium timeframe. Much of their criticisms of suburbia deserve some consideration.

Let's also not get all tied up with Gore gloom and doom over highly speculative theories about disasterous human induced CO2 warming of the planet. In fact we may be headed for a little ice age! Let's develop any energy source we can, and not let the environmentalists tell us (especially the U.S., China and India which have extensie coal reserves) that coal is out because of the CO2 problem. This is pure insanity at this juncture. If the peak oil problem is allowed to play out because of our inaction, you will see an environmental disaster of unimagineable proportions. Even the anti-Christian Malthusian Darwinists could not create a scenario so hororible (though God knows they keep trying).

Turn back to basic values, including. God, country and family, roll up your sleeves, do not give up, and let's work together (with the rest of the world) to solve the problems ahead of us.

siv0.com
TakeBackTheFed.com

2008 May 28 12:38 PM