Sunday, August 17, 2008

Will the Bubble Burst?

There is no doubt that the price pressure on a barrel of oil has subsided a bit it the last few weeks. Falling from a high of $147 (U.S.) to around $113 even as the crisis in Georgia was ramping up. We all know - or we should know - that the oil business is not only one of the most important aspects of any economy it is also one of the most complicated.

There has been volumes written on the part the oil speculators have had in all of this. I am one who believes speculation is definitely a large part of the run up in the per barrel price. I have only to cite the fact that New York Times economist Paul Krugman argues that it's not a speculative bubble, because there had been no build-up of inventory. If there is one thing you must know about Krugman is he is very nearly always wrong. The truth is there is excess inventory. Before the Saudi's substantially increased production (this after both the President and Vice President "asked" them to) and having learned Iran has been floating 30 million barrels in tankers there was no inventory crisis. Even after demand in the world's number one oil consumption economy fell for the first time in decades prices remained high. So, simple supply and demand could not have accounted for the huge run up in prices or this mild pull back.

It's safe to say speculation operates on a human emotional level which can't be divorced from the raw logic of economics 101.

There is a fine article in The Australian business section today that speaks about the psychology of the speculators:

Citigroup energy analyst Tim Evans argues inventories are already rising, with Iran storing 30 million barrels in ships offshore, because storage at its Kharg Island oil terminal is full. The International Energy Agency notes that at almost two months supply, OECD oil stocks are also above their five-year average level.

Evans cites the definition of speculative bubbles by Yale economist Robert Shiller, who says they arise when news of price increases spurs the enthusiasm of an ever larger class of investors who, despite doubts about the real value of the investment, "are drawn to it partly through envy of the other's successes and partly through a gambler's excitement".

Peak oil -- the theory that the world's oilfields are in irreversible decline -- was the elixir that got investors going.

But, speculation is not the whole story. The weak U.S. dollar is probably more responsible for this situation than anything else. It's hard to understand the seeming disinterest for so long in the value of the dollar by the Fed and the Bush administration. Sure there are winners and losers in every move by the Federal Reserve and the Treasury department, but as the weak dollar spurs oil prices higher absolutely offsetting any gains exporters might make it makes you wonder what the upside is... Besides huge profits for the oil companies and those hostile regimes that have nationalized their oil businesses. As the dollar has gained strength in the last few weeks the barrel price has fallen - cause and effect.

There was also the announcement by President Bush that he suspended the no-drill ban in continental waters. The Democrats have also hinted that they will loosen their grip on drilling bans. This may have forced speculators to realize that peak oil is not anything more than "political peak oil".

There is one positive to $4.00 a gallon gas. It has quelled some of the public acceptance of Global Warming as a serious and detrimental crisis worth killing the American economy over. If nothing else this was a taste of what is to come if the eco-nut burgers get their way.