An Oil Bubble Ready to Burst?

June 14, 2008 · Filed under Energy, Uncategorized

Paul Walker, of GFMS metals and mining consultancy, believes so. He says we are seeing a “last hurrah” in commodity markets – a final surge upwards in prices as the credit crisis lurches towards its conclusion – and that we will see a severe retrenchment of prices as financial markets recover.

The US Commodities Futures Trading Commission suspects so too. It has been probing how agricultural commodities are traded and pondering moves that could curb financial speculation in grains, soy beans and other foodstuffs. It has also launched inquiries into the recent heavy speculative activity in oil futures.

So why hasn’t the bubble burst before now? There are two problems with the ‘bubble’ thesis. One is that there has always been speculative activity in these markets and that warnings of a bust have been around for a long time.

The second is that matters have been exacerbated by the behaviour of central banks. The oil boom, buoyed by recent confident predictions that the price is heading towards $150 a barrel, if not $200 over the next few months, has to a significant degree been driven by a weak dollar for most of this year – a policy tacitly agreed by the US authorities as an antidote to the credit crunch. More recently the oil price rose sharply on warnings from Jean Claude Trichet, head of the European Central Bank, that it may soon raise interest rates – a warning that backfired as it pushed down the dollar and drove up the oil price by almost $10 to $138. The price has now pulled back to $134.60 a barrel, but a sustained fall is needed before we can be sure of a speculative exhaustion.

How long can the oil price stay above $130? The supply-demand fundamentals do not explain the sharpness of the ascent this year – 60% since January. Nor does it make any allowance for the reaction of the end consumer. Stockbrokers Charles Stanley estimate that oil speculators have amassed 1.1 billion barrels of oil, more than eight times the amount added by the US to its strategic reserve, making them the largest single influence on oil-related commodity futures trading. William Enghadi, research associate at the Centre for Research on Globalisation, conservatively estimates that “at least 60% of today’s crude oil price comes from unregulated futures speculation by hedge funds, banks and financial groups”.

It would be wholly wrong to suggest that speculative activity in the futures market is solely or even mainly to blame for the spectacular rise in oil. But it has certainly exaggerated the price trend in recent months. One characteristic of a pending bust is when the price of a share or commodity becomes a national – or supra national – obsession. That is certainly the case now, with riots across Europe and Asia and haulier protests and blockades in the UK.

It doesn’t necessarily follow that prices then automatically behave in the manner that presidents and finance ministers would like. But a growing determination to see a firmer dollar would certainly help drive the oil price down. And the key factor most likely to make speculators switch positions is already evident: an adverse market response to an ever higher price.

There are signs that the commodities bubble may already be bursting in some areas. Prices for wheat and rice have come off the boil. Nickel prices have fallen by 25% since mid March.

The economies of the oil consumers are now slowing and oil demand falling as businesses and households cut back.

At the same time, governments in developing countries that have been operating price subsidies to shield consumers from the full impact of fuel price rises have been forced to lower or withdraw these subsidies in a move that will hit demand hard. Longer term, oil demand will be further hit by the accelerated push towards alternative energy sources.

Source: Scotland on Sunday

I’ve long thought that the speculative oil bubble price was going to burst, and the companies left holding the bag are going to be ruined. The evil part of me that knows that I’m paying an overly inflated price due to speculators when I fill up the tank hopes that all those bastards go out of business. I hope that state pension funds aren’t among the gamblers, but I fear that they are.

I remember the last time this happened, and it wasn’t pretty.