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July 03, 2005

The Oil Bubble.

I realise that this is going out on a limb a little but I now declare the oil market to be a bubble. $60 a barrel and rising? Going to go over $100? Perhaps it might, in the short term. But as sure as eggs is eggs and kittens are cute it will tumble.

All the signs are there, hysterics screaming that the world will end, that demand will outstrip supply (as all good little economists know this is impossible. Demand can outstrip supply only at a particular price level.) and we now have the Chinese Govt, in the guise of CNOOC, buying Unocal.

That purchase is used as evidence that the oil price can only rise further...see, they’re splashing out $18 billion so it must be true. Since when did we look to Communists for information on how markets work?

The clincher is that Will Hutton is now on board.

Occasionally, there are tipping-point moments and we are witnessing one at the moment. Seismic change is afoot. As oil prices breach $60 a barrel and pessimists warn that the world could be as little as 10 years away from a first-order resources crisis, China's largest oil company, CNOOC, has launched a £10 billion bid for one of the US's juiciest medium-sized oil companies, Unocal.

When our Billy starts taking such things seriously one should obviously be selling oil futures.

Oh, and as for the contention that there might be a war over oil in the future. Does no one look at the world around them? The US has just spent a few years invading the country with the second largest oil reserves, has spent $400 billion doing so and what are they doing with the oil? Paying the same damn price for it as everyone else from every other producer in the world. For $400 billion you could buy Exxon. War over "resources" in a globally fungible market is insane, as recent events have shown us. It ain’t gonna happen folks.

July 3, 2005 in Economics | Permalink


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» Putting Things In Perspective from Below The Beltway
Just like every day this week, today brings another story of record oil prices this time topping $ 67.00 per barrel. [Read More]

Tracked on Aug 12, 2005 6:57:37 PM


Since when did we look to Communists for information on how markets work?

Bear in mind that the Communists in question have one of the best economic growth records of any country in history. I think they know what they are doing.

Posted by: Phil Hunt | Jul 3, 2005 2:52:12 PM

Well, it's you and Andy Xie of Morgan Stanley who have called the top on oil so far. I see yer point,but an oil futures Source says that Morgans lost millions on going short oil last month

Tim adds: well, aye, but I’m not actually stupid enough to put my money where my mouth is. A three-five year option on oil at $20 a barrel? Yes, I think I would put $500 on that.

Posted by: Alex | Jul 3, 2005 10:57:03 PM

"War over "resources" in a globally fungible market is insane, as recent events have shown us. It ain’t gonna happen folks."

And people argued just like that in the early years of the 20th century. Before August 1914, I mean.

Tim adds: Quite. And it was insane. Have we learnt the lesson?

Posted by: dearieme | Jul 4, 2005 9:45:46 AM

But...what about all the following arguments I've read about:

1 ) Lack of spare refining capacity, with no major investement in new refineries in the U.S. in the last 30 years.

2 ) Supposed "acceptance" of the high gasoline prices by Americans, as some of the latest demand numbers seem to show (and their supposed unwilligness to change their energy usage habits).

3 ) Global oil production at or near its peak, with many existing reserves dwindling, and very few (if any) major new oil field discoveries.

...and, what many people seem to either ignore or are not aware of or don't seem to mention very often:

4 ) OPEC countries supposed inability to supply enough of the desired light sweet crude, and instead oversupplying the heavier sour crude, which they say most refineries cannot accept and/or is too expensive to refine.

Could one or more of these above factors/fears be the reason behind the insane rise in the prices of the energy commodities over the last year and half? Or all of them?

I agree that prices have most likely "bubbled up" way beyond justification from basic supply/demand fundamentals, and are sorely in need of a correction, but how valid are any of the above arguments?

History has shown over and over again that speculators do create bubbles in financial markets, but could this be a rare case of a bubble that may never pop (esp. because of points 3 and 4 above)?

Posted by: Steve | Jul 13, 2005 11:24:25 PM

1. 'lack of spare refining capacity':
a) A more correct way to look at refining 'capacity' is throughput, changes in refining tech which permit the same refinery to create more from the same barrel of crude.
b) There is a global market in refined products; thinking national distorts an understanding of this.
c) How much 'spare' or not is also related to end products' prices and ability to meet these.
All the above are variables, not fixed.

2. Demand in the U.S. began to fall prior to your 7/13/05 post - so also demand growth in China that over first 1/2 dropped dramatically, and remains down as coal substitution has been taking place.
OECD stocks began their build prior to the post date.

3 & 4. One should not assume that peak oil advocates are accurate, particularly when they have been so wrong so often, and when there are very solid critiques of these beliefs. See Lynch for example.
M. Simmons, in an emagazine interview, stated clearly that the production data required to arrive at a peak oil understanding is NA.

5. Even a cursory analysis of CFTC and/or Platts data over the last 2 years made/makes the bubble aspect pretty clear -- still moreso when fundamentals have clearly turned against spec prices.

It never ceases to amaze that normally rational people will fall for spiels such as those of T Bone or Rogers or any of the other commodity fund promoters. Due diligence is required, and - in this field - that should include some understanding of oil industry history, which is also then to see that 'free marked' does not apply.

For anyone to argue that this is not the case in the futures and options markets is fine but, again, a closer look at the largest traders is helpful.
There really is such thing as concentration and asymmetry.

Posted by: juan de la O | Nov 15, 2005 4:38:06 AM