The escalating price of oil is throwing the world economy into a spin, a downward spin. The big question is whether recent price levels ($140 to $150 per barrel) are permanent, or just a stop on the way further up, or instead represent a high-water mark driven by speculators who can’t make a killing right now on the stock market or in real estate. As a person with part of my retirement money in a mutual fund that promises long-term performance but for now is doing very poorly, and which is staking its comeback on the notion that the oil markets are currently in a bubble which will soon break, I have some skin in this game. So here’s my 2 cents on what’s going on with oil.
The bottom line is that we’re in a twilight zone; we see through a glass darkly right now. One of the biggest questions is whether classic microeconomic theories regarding market behavior still apply in the oil markets (or to what degree). Economist Paul Krugman and others believe that the lack of supplier hoarding (above ground oil storage increases) indicates that the problem revolves around the demand fundamentals. I.e., current oil prices accurately reflect growing demand relative to the increasing inelasticity of output (i.e., inability to ramp up output significantly due to political and geo-technical factors). The oil that is left is in the worst places with higher and higher marginal production and distribution costs.
On the other side of the coin, there does seem to be a lot of ‘restless capital’ out there, in the hand of investors who drove the stock bubble of the late 90s and the real estate bubble of the 00’s. So I’m leaning towards the bubble theory, despite the dearth of signs regarding above-ground inventory hoarding. The ‘smart money’ and its corresponding panic psychology is focusing on oil futures, not on actual oil barrels from the spot market. So, if there is hoarding (as seen in bubbles of the past, e.g. the tulip mania of 1636), it would logically occur further up the production chain — i.e., in-the-ground hoarding, reflected in lack of effort on the part of the oil owners and producers to ramp up drilling and production. That might – again, MIGHT – be consistent with the surprising lack of production increase over the past few years despite the amazing price run-ups. (Only a year ago, oil was around $70 a barrel; two years takes you down to $45).
The oil markets are pretty wacky; you can’t assume that all producers are fiscal profit maximizers, Venezuela’s Hugo Chavez being a case-in-point. I’m still waiting for the flood of new oil that analyst Daniel Yergen predicted in 2005. Is that new oil just around the corner — admittedly, deep sea and tar sand projects do take a lot longer to bring on-line than the good old Texas gusher from days past. So what if this is a bubble being driven by in-the-ground hoarding, what breaks it? Some combination of reduced demand because of business recession and increased output once long-term oil production projects of a more exotic nature finally come on line MIGHT cool the fever. I hope.
But, the real wild card is in the situation between Israel and Iran. Once Iran tests its bomb, or once Israel finally runs out of patience with negotiations and fires up its jets for a strike against Iran’s nuclear facilities, the oil market will go off the rails. Especially if an Israel strike fails to thoroughly destroy Iran’s nuclear program. Maybe I need to get my $$ out of that overly optimistic mutual fund!
PS, what we clearly DON’T need right now is John McCain trying to be humorous, doing a takeoff on an old Beach Boys song (Barbara Ann), using the refrain: bomb bomb bomb, bomb bomb Iran.
Jim,
Once again, I come at your view from another position.
First of all, I think that all such speculative thinking about what may or may not happen, who may be doing what to cause this or that to happen–all such “if-this-then-that” thinking is a waste of time. I also tend to think that it tends to make people nervous.
In my life’s experience I have learned that what tends to happen is something least expected–the Black Swan. Speculating on the situation simply tends to get one’s stomach upset. As to the Black Swan, from what I hear and read Texas is now heavily invested in wind-making machines to generate energy. Will Texas win on that investment or lose? Are wind-machines the Black Swan? Or is there some still-unknown discovery that will radically change everything “energy” as we know it? I bet on the latter.
Second, I simply refuse to believe that the oil market, for all the talk about supply and demand, blah, blah, blah, is in the end actually controlled by supply and demand. If it were, wouldn’t we see prices bouncing around these last couple of weeks–or more specifically, wouldn’t gas prices be plunging? Rather, my opinion is that oil prices are actually dictated by the big oil companies, etc. All the talk about supply and demand, IMHO, is the ideal; the real is much more likely that the price of oil is controlled by those who own it. And this includes some of the Americans who are “pals” with the Saudis, specifically, the Bush family.
MCS
Comment by MCS — July 19, 2008 @ 6:00 pm
Jim,
Once again, I come at your view from another position.
First of all, I think that all such speculative thinking about what may or may not happen, who may be doing what to cause this or that to happen–all such “if-this-then-that” thinking is a waste of time. I also tend to think that it tends to make people nervous.
In my life’s experience I have learned that what tends to happen is something least expected–the Black Swan. Speculating on the situation simply tends to get one’s stomach upset. As to the Black Swan, from what I hear and read Texas is now heavily invested in wind-making machines to generate energy. Will Texas win on that investment or lose? Are wind-machines the Black Swan? Or is there some still-unknown discovery that will radically change everything “energy” as we know it? I bet on the latter.
Second, I simply refuse to believe that the oil market, for all the talk about supply and demand, blah, blah, blah, is in the end actually controlled by supply and demand. If it were, wouldn’t we see prices bouncing around these last couple of weeks–or more specifically, wouldn’t gas prices be plunging? Rather, my opinion is that oil prices are actually dictated by the big oil companies, etc. All the talk about supply and demand, IMHO, is the ideal; the real is much more likely that the price of oil is controlled by those who own it. And this includes some of the Americans who are “pals” with the Saudis, specifically, the Bush family.
MCS
Comment by MCS — July 19, 2008 @ 6:00 pm