Bye, Bye Oil Bubble?

The latest Barron’s has run a good article against an obvious oil bubble, which is really worth reading. By reaching $135 a barrel from $20ish in 2000, just 8 years ago, the trajectory of oil prices looks very similar to the Nasdaq’s eight-year run to a peak of more than 5,000 in March 2000. Today, Nasdaq sits on ~2,400. Most believe that the hike of oil prices, up 40% simply this year, doesn’t reflects fundamental changes in supply and demand caused by the economy, but by some other factors.

Not surprisingly at all, the biggest hoarders are always the governments across the world.

There are several ways for the governments to keep the oil prices high. One is through the government controlled buffer-stock system, which, ironically, is supposed to help ease fluctuations on the free market. In the US, it is called the strategic petroleum reserve [SPR]. The SPR now holds 705 million barrels of crude, equal to about 35 days of domestic consumption. Thank God that Congress moved in May to stop adding the SPR as it neared capacity.

The second way is called government subsidy. In an ideal free market, higher price will curb demand and eventually push the price down. An unrealistically low price simply pushes the price even higher. China raised prices on retail gasoline and diesel fuel by 18% last Thursday. Guess what had happened? The crude price sank the next day. If all the governments follow suit, we will see the price dropping below $100 per barrel soon.

Last but not least, the governments should stop maintaining an artificially weak currency. Fed Chairman Ben Bernanke and his colleagues need to understand that weakening the dollar purposely to avoid a sharp price dip in the real estate market simply sacrifices the whole economy, further stimulating the speculation against commodity prices, oil in particular. All the other countries who pegs their currencies with dollar in some degrees need to do the same.

The second largest force include endowments, pension funds and other institutional investors. They employed what so called commodity-indexing strategies, which has topped at $260 billion in March from $13 billion in early 2004, which may control 1 billion barrels of crude. There is also a loophole in the system that lets indexers escape commodity-position limits by purchasing over-the-counter swaps and other derivatives. The triple whammy finishes when the sharp price jack-up forces short-covering by independent oil and gas producers.

All in all, unless governments, especially the US government, start to act towards the right direction, we have to live in a world with ridiculous oil prices. It doesn't look like that we have a free market for crude oil since governments and big funds have played dominate roles in the market. Common people like us just want to say: bye, oil bubble!

Disclosure: None

Comments

[chistletoe]

Thank you for using the word "hoarders".

As for ridiculous prices, well, the price of gasoline is still about half of the price of bottled tap water at my local gas station.
But don't worry, realistic prices will be here soon!

[Investor612]

Comparing energy prices to the tech bubble isn't even "apples vs. oranges." It's "apples vs. rocks." One is a necessity, the other a luxury. One sector has stocks selling at mostly under 20 PE's. The other had a majority of stocks with no earnings whatsoever.

Chistletoe makes a good point. The other day I heard a woman complain that she was astounded that a gallon of gas now cost as much as a Grande Latte at Starbucks. Shouldn't she be perplexed that a cup of coffee costs as much as a gallon of gas?

[AlexS]

As you say, the bubble will be here until governments, including the U.S. government, starts acting in the right direction. Based on the make-up of Congress and the expected Presidential winner, I would put that at about 2012 or later.

[dieuwer]

The more "bubble talk" the better. When was the last time we heard talk about the Tech bubble? When is was clear is had bursted.
Usage if the word bubble is a sign of low prices, not a top.
I just LOOOOVE these "bubble heads" here on SA and on "bubble vison" like CNBC, or MarketWatch!

[pachanguero]

What trash from this kid. Please get a real "expert" not some idiot.

Supply and demand fool!

[Georealist]

Perhaps you've been keeping your nose to the Yahoo grindstone too long to really understand the oil market..this certainly puts you in the same general area as the inept David Bui.
Oil prices aren't caused by endowments, oil funds or any other conspiratorial fantasy...it's a function of lack of supply! It's geology..something an internet wonk will never understand. Well..lots of luck to those of you who think this is a bubble!!
I have to say..and people can take this any way they like...there is an incredible oversupply of inept and self pumping articles on this site by ...fill in the blank...

[Still Laughing]

To all the speculators who are sure that we're not in a bubble because oil has a finite supply, thank you for stating the only one half of the obvious. Unfortunately oil is a form of energy with substitutes. Speculative pricing rests on future cash flows. If the price becomes too inflated and invites substitution, oil will crash hard. Oil is OIL because it is the cheapest and most efficient form of energy on the market today. Remove that, invite research on more effective nuclear fission/fusion and renewable energies and more effective batteries and oil becomes irrelevant and worthless except to the chemicals industry. As energy, it is simply a substitute good. That's not wishful thinking, that's the same economics book you are reading for when you trumpet lack of supply as the reason we're not in a bubble.