Has the Oil Price Bubble Popped?

|

In July, the price of crude oil reached an all time high of over $147 per barrel. Today, the price dipped below $90 per barrel in some markets.

*

http://farm2.static.flickr.com/1305/1353508944_2a26e7bd96.jpg

In March I wrote a column in which I noted that several experts believed that oil markets were in the grip of a speculative bubble. Just one relevant quotation:

So what will happen to oil prices over the next few years? No one is predicting $10 per barrel oil. However, once the current bubble bursts, both Evans and Lynch believe that the price of crude will settle at around $60 to $70 per barrel in the next couple of years. "It's very hard to pinpoint just how long a bubble can expand before it breaks. Getting the timing right is not an easy matter," says Evans. But he adds, "I think that this is the riskiest time to be long in crude oil since 1980."

It turns out that people will buy less when the price rises. Who knew that the laws of supply and demand still work? (The possible advent of a worldwide recession doesn't hurt either.) 

Note: I would like all those who sent me emails in June and July (and you know who are you are) demanding that I publicly admit that I was wrong in my March column to send me emails admitting that they were wrong about the $200 per barrel oil they were predicting was imminent. (wink)

*This looks more like a forest ranger tower than an oil derrick to me, but I liked the image anyway. 

NEXT: Ahoy! It's Google's Computer Navy

Editor's Note: We invite comments and request that they be civil and on-topic. We do not moderate or assume any responsibility for comments, which are owned by the readers who post them. Comments do not represent the views of Reason.com or Reason Foundation. We reserve the right to delete any comment for any reason at any time. Report abuses.

  1. Clearly what is called for is stronger regulation of the energy markets. Like in the housing market evil speculators must be stopped!

  2. Sorry for channeling Alice Pitney for a moment.

  3. So, we’re all in agreement now that speculators can drive up the price of oil, right?

    This was a point of contion recently. It’s now been settled, right?

  4. contention, that is.

  5. You’re just speculating, joe.

  6. I must admit I am not expert, but I did see this analysis — and I wonder what others around here think of it:

    The kneejerk reaction to lowered crude is that its a positive for consumers. Under normal circumstances, that is true. But int he current environment, well, not so much.

    The drop from $147 to $110 or so was demand destruction, as Americans drove less miles, stayed closer to home, consumed less. It is a classic case of high prices being the cure for high prices.

    But the recent acceleration of the price drop in commodities is a reaction to a variety of macro factors. Ike being less bad than expected is certainly part of it, but there’s a lot more to it than that. The collapse of Lehman Brothers, the BA/Merrill merger, and AIG’s crisis are all huge credit negatives.

    They imply further economic dislocation due to a tightening credit availability, and other related problems. In my mind, that’s why Oil is selling off — expectations of further credit dislocation and economic contraction.

    Your mileage may vary . . .

  7. Joe,

    I believe there were a number of factors responsible–speculators didn’t drive it, they just amplified the effect of the growing demand from India and China and whatever other factors were driving up the price.

  8. Sorry about what happened in Kansas City, Bob.

  9. Great. Now we’ll have to bail out the oil speculators.

  10. Smart theory, Matthew.

  11. So, we’re all in agreement now that speculators can drive up the price of oil, right?

    Only short-term.

  12. joe: speculators? actually not everyone agrees. As the NY Times reported 4 days ago:

    But the new 69-page study, by the Commodity Futures Trading Commission, shows that, rather than rising, the stake of index funds in the oil market actually declined in the first half of this year.

    “That certainly doesn’t mesh with the story Mr. Masters is telling,” said Prof. Dwight R. Sanders, an agricultural economist at Southern Illinois University in Carbondale, who has studied both reports.

    The dollar value of those fund positions did rise, to $51 billion from about $39 billion, according to the new study. But the increase reflects only the impact of rising oil prices – not the flow of new money into the market, the report found.

    When counted in terms of separate futures contracts, the funds’ stake fell 11 percent during that period, to 363,000 contracts from 408,000 contracts, according to the study.

    The study also showed that index funds have a much smaller share of the market than previously estimated – 17 percent of all futures and options involving domestically traded commodities, as of June 30. Their net stake in oil markets was just 13 percent, not the 70 percent or more cited in previous estimates.

  13. joe,

    Really, it was a point of contention? Where? I mean, I saw it some places, but that was only being stated by idiots (usually left-wing, peak-oil idiots). Speculators can speculate on anything.

    Ron,

    Dont be a wuss, publicly call out the people who sent you the eamils. ๐Ÿ™‚

  14. And now that Brazil has uncovered new reserves that are likely to exceed the finds in the North Sea way back when the medium term is looking a bit less grim.

  15. joe | September 16, 2008, 12:58pm | #
    So, we’re all in agreement now that speculators can drive up the price of oil, right?

    This was a point of contion recently. It’s now been settled, right?

    Nooooooooooo. There was never any contention that speculators could drive up the price. The point of contention was whether we should put a stop to it. The speculators are now driving down the price. Should we put a stop to that? No we should let the market function. When oil was at $147 the market was telling us we were on a path of increasing demand and flat supply. Now demand has fallen and supply is expected to increase. All is right with the world. DON’T FUCK WITH IT

  16. What Warren said.

    Watching speculators crash and burn is one of the great joys in life. For that to happen, they first have to have the nice run up. ๐Ÿ™‚

    I wish all the “flip this/that house” shows were still doing new episodes. Flip that House – Miami 2008, condo edition would be some of the awesomest TV ever.

  17. I believe I had a bet with someone on here that by next spring it would be at $80 a barrell. I am not ready to collect but it is getting there.

  18. Of course, naked short (but ultimately taxpayer backed, IMO) silver speculation

    http://www.resourceinvestor.com/pebble.asp?relid=46175

    seems to dwarf long oil speculation. The media and our wonderful regulators are trying, desperately, not to notice what looks to a lot of folks, me included, like a slowly unfolding default in physical silver. The “good” news?? There’s still plenty of the paper variety around if you want to buy something called silver…

  19. This looks more like a forest ranger tower than an oil derrick to me, but I liked the image anyway.

    The context of the picture makes me think it’s the observation tower for a small airport. See: Cargo Cult

  20. All is right with the world

    The Obama Speech Cops will get you for that one, Warren. All is not right. Just yesterday I heard Tailgunner Joe Biden say we are in an actual depression. Real People? are hurting, Warren.

  21. The drop from $147 to $110 or so was demand destruction, as Americans drove less miles, stayed closer to home, consumed less.

    The world price of oil is only affected by what Americans do?

  22. Flip that House – Miami 2008, condo edition would be some of the awesomest TV ever

    No doubt. But be consoled with the rumor that Bravo network is working on a new (and yes, gay) series called “Torch That Unsold House For The Insurance.”

  23. The world price of oil is only affected by what Americans do?

    Leela: This is important, one of these two men will become president of the world!

    Fry: What do we care? We live in the United States.

    Leela: The United States is part of the world.

    Fry: I have been gone a long time!

  24. robc,

    I loved watching flip this/that house. My wife couldn’t figure out why until she saw my complete schaddenfreude at the guy who lost his ass. Problem was, it only happened about once every 6 episodes. And of course with the bust the show is gone.

  25. Why doesn’t Bravo and Logo merge to form Brogo?

  26. Warren,

    Look in the archives from this summer. MP repeatedly stated that there was no supply/demand shif that accounted for the price spike, and he was roundly denounced by people asserting that demand increases and supply restrictions were the effect.

    There were plenty of people, including yours truly, who made the point you raised, but no, that was not the only bone of contention. Heck, Bailey just denied that speculation was at play in this very thread.

  27. John-

    I think you’ll be ready to collect soon enough.

  28. “But be consoled with the rumor that Bravo network is working on a new (and yes, gay) series called “Torch That Unsold House For The Insurance.”

    FTW

  29. Ron Bailey –

    It turns out that the CFTC data was being manipulated.

    WASHINGTON (Reuters) – The U.S. futures market regulator is investigating whether companies are reporting false oil inventory levels to benefit their trading positions, The Wall Street Journal reported on Thursday.

    The paper, quoting people familiar with the probe, said the Commodity Futures Trading Commission is taking testimony on periods when there have been big moves on the oil futures market, including July 2007.

    The commission is concerned that companies may have tried to manipulate short-term pricing on oil markets through physical oil sales and purchases, the Journal reported.

    According to the report, companies could also theoretically push prices higher by under-reporting oil inventory and then sell their oil at a premium.

    Proving it will be difficult. Testimony will include lots of “I don’t recalls” and “No one could have anticipated that”.

  30. ed,
    I was referring solely to the price of oil. The price of other things, such as housing, credit, and equity, are definitely not right with the world. That’s because Uncle Sam keeps fucking with it and not letting the market function.

    We’re running a junkie economy. We keep shooting up more and more whenever we feel bad. The decission not to shoot up Lehman Brothers brought on some withdrawal pains. But now it looks like we’ll keep shooting up with rate cuts, AIG bailout, and FDIC guarantees.

    We need to go through a lot of pain before we get healthy. And I think we’re still on the way down.

    So yeah, we’re definitely in a recession, and well on our way to full on depression. And to tell you the truth, I wouldn’t be at all surprised to see global financial collapse in the next year. The one thing I’m sure of, there will be pain.

  31. So, we’re all in agreement now that speculators can drive up the price of oil, right?

    I don’t know that anyone was saying that speculators could never drive up the price of oil by even a cent for so much as a day.

    I think the argument was over how much of the oil price rise was due to speculation, and how long the speculative bubble would last.

    Its hard, still, to filter out the effect of speculation from supply and demand drivers. Its no coincidence, I suppose, that the price dropped immediately after the OPEC meeting where the Saudis said they would keep pumping as fast as they could.

    Still, if speculators can drive the price up, why can’t they drive it down? How do we know that the speculative premium hasn’t been replaced by a speculative discount?

  32. I suppose, that the price dropped immediately after the OPEC meeting where the Saudis said they would keep pumping as fast as they could.

    Nobody pays attention to what the Saudis say they’ll produce. It’s like depending on the Chinese to enforce intellectual property and put a stop to pirate DVDs and Rolex.

    The speculation bubble burst when the congressional democrats started proposing removing restrictions on domestic drilling.

  33. Oil has always been a boom and bust business. I don’t know why people find this last boom so odd. People also seem to ignore even larger increases in the price of other commodities such as soybeans, up 162% from two years ago.

    I think oil has such cycles of boom and bust because oil is a massive global commodity whose inputs vary day to day (unlike soybeans which are seasonal). It takes roughly 90 days on average for oil pumped out the ground to reach the consumer. Spread over the entire planet, that makes it very hard for producers to predict the value of oil three months down the road. Neither do they know how much oil all the other producers plan to pump. As a result producers over and under pump oil with about a 3 month lag between increased demand and increase supply.

    I do find it interesting that people blame high oil prices on the greed and dishonesty of people in the oil business but they never credit them when oil grows cheap. The same people provide the oil and the same people benefit and suffer with occupations in prices.

  34. Umm, did I miss any discussion of the rising value of the dollar? For a commodity valued in dollars, doesn’t it makes sense that a stronger dollar will buy more on an international market? Dollar up, cost of a barrel (in dollars) down. I’m sure that doesn’t account for the entire reduction, certainly, but it seems as much an issue as reduced consumption and the bursting of a speculative bubble.

  35. People also seem to ignore even larger increases in the price of other commodities such as soybeans, up 162% from two years ago.

    That’s probably because when the average American’s tofu budget went from $0.00 to $0.00 when that happened. As opposed to the $100 people are dropping in their tanks every week.

  36. On the plus side of the high cost of oil, my dad grew up in the one small town in Eastern Montana that’s raking in cash hand over fist because of a recent oil boom, based mostly on new technologies for slant drilling. Most of my cousins are still back there, and there is a shitload of money running through that town. They’re doing very well. 99% of the oil production in Montana is in Richland County. They had to outsource the drive through window at McDonald’s to an out of state call center because they couldn’t get people to work there for $10/hr.

  37. It looks like MEND’s newly launched “oil war” isn’t causing too much concern among traders.

  38. Umm, did I miss any discussion of the rising value of the dollar?

    Oil is $55 per barrel priced in pre-Bush dollars.

  39. The speculation bubble burst when the congressional democrats started proposing removing restrictions on domestic drilling.

    Congressional Democrats? You mean the ones who look like Congressional Republicans? I know there is little difference these days, but the handful of politicians who stayed in D.C. during the August break to harangue Idiot Pelosi about drilling policies were most decidedly Republicans.

  40. Speculators aren’t the cause, they are the effect. Speculation follows expectation. No one speculates that prices will be higher in the future if they are expecting them to fall. Blaming speculators for high prices is like blaming bikinis for unseasonably warm weather.

  41. Holy shit! People’s homes oil holdings have dropped 20% 38% in just two years months!

    The government should be protecting these people. We obviously need more and betteer regulations!

  42. joe,

    So, we’re all in agreement now that speculators can drive up the price of oil, right?

    Only if we’re all in agreement that speculators can also drive down the price of oil.

    Speculators i.e. people making guesses about future prices, are simply a market mechanism. If you’re going to blame them for high prices, you must credit them for low prices. The cost of futures markets are just the overhead for the distribution system for commodities like a grocery store’s profits are for food.

    The political argument over speculation centers on whether the price of speculation/futures-trading was significant to require political intervention. No one ever showed that it was. For example, when oil was 140 dollars a barrel, how much would it have been with “speculation”? No one knows. Indeed, we cannot even calculate it because we don’t know the cost of political intervention.

    A lot of people seemed to think some benevolent government agent could goosestep into the commodities exchanges and with a flip of their riding crop say, “you, you’re overcharging and you, are under charging.”

    We don’t actually have the information necessary to make such assessments.

  43. What I want to know is why have pump prices not fallen back down to where they were the last time oil was at $97 a barrel? the pump price is still at $147 a barrel. I am getting sick of these loser Profit Hoe oil companies.

    Jiff
    http://www.datools.net.tc

  44. Seitz-

    God just doesn’t want Big Macs so readily available in Big Sky conutry.

  45. So, we’re all in agreement now that speculators can drive up the price of oil, right?

    This was a point of contion recently. It’s now been settled, right?

    Did anyone deny that speculators could drive up the cost of oil? That wasn’t the issue (as I recall). The issue was whether it was bad, and whether government should stop them… somehow. The other issue was that the term ‘speculator’ was someone elastic. I am an oil speculator, for instance, as are the airlines.

    I hear-tell some speculators are losing their shirts lately. Double-edged sword that oil market.

    I’m hoping the government will bail some of them out.

  46. “someone elastic” -> “somewhat elastic”

    Damn work gettin’ in the way of my postin’. Ain’t right.

  47. Falling oil prices (gasoline prices follow) benefit gas station owners big time. Those hard working guys and gals deserve a break.

  48. That’s probably because when the average American’s tofu budget went from $0.00 to $0.00 when that happened. As opposed to the $100 people are dropping in their tanks every week.

    What’s tofu?

  49. all this easy money has to find a place to go to avoid losing value do to inflation. First equities (2000), then houses, then commodities (wheat, corn, oil), next up?

    without easy money (credit expansion, inflation) we would see a whole lot less of this. With no easy money people would actually keep their savings in a bank instead of trying to beat inflation with risky investments.

  50. Here is the thread where the denial of speculators was in full force, let by chief Reason denier, Matt Welch.

    Here is Paul Krugman, the king of speculator deniers.

    Funny too how when the bubble was inflating, it was all about Chinese and Indian demand, but now that its deflating, it’s about US demand. Why the speculator deniers don’t recognize that obvious inconsistency, I have no idea.

    So again, for the record, yes, I’m fully versed in the theory of supply and demand, and yes, they are obvious factors in the changing price of oil. But the spike and subsequent pullback was only weakly tied to supply/demand. It was far more strongly tied to speculation. Now that the bubble has mostly unwound, we’re priced much more closely to the true supply/demand drivers.

    R C Dean said:

    Still, if speculators can drive the price up, why can’t they drive it down?

    ’cause you can’t short Futures.

  51. How much of this has to do with the fluctuation of the dollar? The price hasn’t been nearly as volatile in terms of Euros.

  52. No one speculates that prices will be higher in the future if they are expecting them to fall.

    Right, but remember: they’re betting on the price of oil futures to rise, not oil itself. Think of the dot-com bubble, when people bought, knowing that they’d sell to someone who was buying not to hold onto Pets.com for their retirement, but to turn around and sell it again to another short-term investor.

    As for denying that speculation caused the increase in prices, the archives are up and to the right. MP was ferociously ridiculed for pointing out that there weren’t actually demand increases or supply shortages during and before this spike.

  53. Here on this thread, and on the one MP linked to, we see a recurring theme on Reason comment threads.

    A: “Hey, X is happening. That’s bad.”

    B: Hmm, A wants to put a regulation in place. “Nuh uh, X is not happening, you have no proof X is happening, you socialist!”

    Six months later…

    B: “See, the X problem solved itself without any regulation. As a matter of fact, X is a good thing. Yay X! I hope that X thing just keeps happening even more.”

    I believe you people when you say that your real concern was with people trying to regulate things. Really, I do. But a whole lot of you didn’t limit yourselves to talking about that, but decided it was uber-important to go on the offenseive against the idea that speculation was increasing the cost of oil, or even that it could possibly do so even in theory.

  54. cause you can’t short Futures.

    Umm, you can, actually. You can always buy futures contracts at a price lower than the current price, just like you can always buy them at a price higher than the current price. That’s kind of what futures are all about.

  55. Still, if speculators can drive the price up, why can’t they drive it down?
    ’cause you can’t short Futures.

    Is that right?

    Anyway, can’t you buy dervatives (e.g. a put option on a ETF) which amount to the same thing?

  56. RC Dean,

    You can always buy futures contracts at a price lower than the current price, just like you can always buy them at a price higher than the current price.

    Puts v Calls too.

  57. Also, there’s a graph that the Bloomberg site normally shows it on its homepage, but I can’t see it now, which shows a serial bubble inflation and popping over thte last year first in wheat, then in corn and now in oil (and possibly gold)

  58. Nice, short, ‘n’ easy explanation of how futures trading works, here.

    Note the explanation of how to short a commodity on the futures market.

  59. I knew I should have bet my S&P 500 shorting oil in June. Especially considering how many experts were predicting $90/barral by fall.

  60. I knew I should have bet my S&P 500 shorting oil in June.

    Now, for the New Car, the trip to Hawaii, the living room set, and the cash:

    Did James Ard know this because he knew there would soon be some big increase in oil supplies and/or drop in global demand, or did he know this because he understood that prices were artificially jacked up by speculation not justified by underlying market conditions on the commodity in question?

  61. joe, everybody here knew speculation was part of the equation. We just didn’t think Democratic tinkering was going to do any good. Now we get to watch the foolish bastards get what’s coming to them.

  62. So the Evil Speculators (doubtless stroking their long curly mustaches) who went long oil at $135 are now losing their shirts because demand is falling relative to supply and (surprise!) inflexibility works both ways: when supply is tight on an item with inflexible demand, small decreases in demand (say, from a faltering global economy) make the price fall quickly.

    It’s almost like some sort of invisible hand is at work, or something.

  63. joe,

    I was suggesting a short oil, long gold strategy back then. I even mentioned it on H&R. It wasnt because of supply/demand or speculation, just that the two were out of historical balance. Since gold has been falling too, Im not sure if my strategy would have worked.

  64. Hopefully some of the biggest losers are government union pension funds.

  65. ’cause you can’t short Futures.

    Oh dear God the ignorance.

  66. joe, everybody here knew speculation was part of the equation.

    Read MP’s link. No, they did not.

  67. I was suggesting a short oil, long gold strategy back then.

    Its never a good idea to go long on a commodity that is at or above its five year high.

    Its never a good idea to go short on a commodity unless you have a lot of cash you don’t mind losing. The markets can stay irrational longer than you can stay solvent.

  68. You should get rid of all the speculators, and let the government dictate the price of everything. We did this in my country, and things are GREAT!

    On an unrelated matter, could I borrow a slice of bread to feed my family this week?

  69. So the Evil Speculators (doubtless stroking their long curly mustaches) who went long oil at $135 are now losing their shirts

    If your concern is Da Bad Guyz gettin’ wot’s comin to them, this is sufficient.

    If your concern is not seeing serious economic harm done to individuals and the economy as a whole by an energy-price spike, not so much.

  70. Risten to Robert. He velly smart man.

    Sigh. So ronery.

  71. I love the “buy gold” ads on daytime TV.

    Gold is at a historic high! It’s risen 30% per year for a few years in a row!

    So, buy now! Here, I’ll sell you some.

  72. Why have high gas prices when you can have gas shortages instead?

    Malaise Forever!

  73. Yeah, R C, I probably would have shorted at $120, with the option coming due at $147. But that still may turn out better than the index fund.

  74. I looked at the thread linked by MP. Most of the “denial” in that thread was more in the nature of skepticism that (a) the speculative premium was very large or (b) that any speculative bubble could be maintained for any length of time.

    I would say that the skeptics were at least half right.

  75. I love the “buy gold” ads on daytime TV.

    Me, too. “Gold is at an historic high! Buy now!” seems like not the best strategy for Buffet-style “buy low, sell high” wealth accumulation.

  76. The amusing thing about the stop-the-speculators movement is that it seeks to destroy the very price imbalance that both incentivizes producers to rectify the supply weakness and causes consumers to curtail demand.

  77. Hmm. I guess the word “amusing” used to mean something different. ;-P

  78. That’s a photo of “Crude Awakening” from last year’s Burning Man, fyi. http://flickr.com/search/?q=crudeawakening&w=all

  79. Hey Kim Jong Il, get back to bed! You need your rest, O Dear Leader!

  80. No rest until evely specurator is stopped!

  81. R C Dean,

    Its never a good idea to go long on a commodity that is at or above its five year high.

    Its never a good idea to go short on a commodity unless you have a lot of cash you don’t mind losing. The markets can stay irrational longer than you can stay solvent.

    I agree with both statements. But when combined…then it cant go wrong. ๐Ÿ™‚

    The idea was that gold was low vs the historic gold:oil ratio. So, either gold was going to shoot up (unlikely, unless P3AK O1L!!! was real) or oil was going to crash (bubble).

    I was right, but gold came down too. Im not sure what the ratio is right now though, I guess I should look.

    Hmmmm….780.50 and 91.15, for a ratio of…going to calculator… 8.56. I think that is higher than it was earlier in the year. So, my strategy would have worked if I had had the patience/money to wait it out. In fact, a 10 ratio was my suggested sell point, I think, so I would still be holding.

  82. I don’t see the Dollar holding up it’s recent gains. Everything we’re doing should cut the legs out from under it. I think gold below $800/oz at this point is a buy. Oil can still slide but I think gold turns around before the end of the year.

  83. Silly me, I bought some gold. Too many anarcho-austrians and Paulites telling me the price was going to go up forever. Silly Austrians, they don’t even know their own economics. Gold is not special, does not act differently from other commodities. Pretending that it is a store of value is stupid.

  84. I don’t see the Dollar holding up it’s recent gains. Everything we’re doing should cut the legs out from under it.

    Potential countervailing forces:

    1) Commodity bubble popping which was the source of AUS/CAN $ outsized strength

    2) Projected Eurozone weakness which may make them cut rates even before the US does (which the fed to its credit, did not do today)

    3) Yen returning to it decade-long metastable 110 +/- 5 to the $ as Japan growth stays extremely mellow as ROTW growth mellows for the rest of the decade.

    Naturally, I have no idea if you or I are right. (and as I said on a previously thread, I was spectacularly wrong about yesterday; I thought what happened today would have happened yesterday)

  85. Hey Ron, did Doherty tip you to that photo, or did you slip into Burning Man on your own?

Please to post comments

Comments are closed.