Are oil markets experiencing a bubble?
Real Estate Investor · Las Vegas, NV · Member since 2008 · 1k+ posts · 447 votes
Here is an interesting article that compares the current climb of oil prices into the stratosphere with the recent housing bubble. The theory is that the oil market is as unsustainable as the housing market was. I hope they’re right:
http://money.cnn.com/2008/06/06/news/economy/tully_oil_bust.fortune/index.htm?postversion=2008060610
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When everyone from the experts to OPEC are out there saying that we're at prices that are close to 50% above what they should be, I become convinced that we're definitely in a bubble. Sadly, players like the investment banks continue to manipulate the traders and everyone else, leading to jumps like we saw on Friday.
Like all bubbles, this one is poised to pop. I just hope that it happens SOON!
Great article. Thanks for the info.
Aside from the info in the article, one other large factor for the increase is the weaker US Dollar. Our dollar has less buying power and thus the price on many goods we import are higher.
When the dollar does improve, I think the burst of the oil bubble will be fast and swift.
I think it is too late to buy oil futures. I think that ship has sailed.
On the other hand, everybody in the oil industry now knows they can charge that kind of price and the consumers will pay it.
The oil industry has a bad habit of raising prices, then backing off, but not to prior levels. Then they raise again and then back off. Next thing you know, we are all saying "thank goodness gas is only $3 a gallon. In spite of the fact that a year earlier we were screaming because gas was $2.25.
They'll charge $5 for awhile and then we will all be grateful when gas goes down to $4.
I've lived though an earlier outrageous oil price hike and it nearly destroyed the economy of the US at that time. That one was worse because in addition to huge price increases, they cut production and there was no gas to be had. There were long lines at any station that had gas, and the stations were rationing, so once you finally got to the pump, you could only have a few gallons.
The fact that the oil market moved $11 yesterday is direct evidence of speculative buying on futures contracts. Under normal market conditions, true consumers of crude (i.e. refiners) buy contracts and ultimately receive and process the oil. Speculators who are buying futures contracts as hedges against inflation have no intention of ever receiving the oil, and artificially remove it from the marketplace for the term of the contract, which results in the appearance of a shortage of crude available to refiners. So yes in my opinion, when the futures market for oil runs cold, and speculators dump their contracts and take their money somewhere else, we will see a relative collapse in oil prices.
Isn't this kind of heavy for a Saturday night. I need to get a life.
Dwayne
Futures exchanges exist to provide vital liquidity to commodities markets. Without futures exchanges, there would be drastic and frequent price fluctuations in our commodities and the goods made from them. Businesses that produce / use these commodities would have to pass those fluctuations through to the consumer immediately (or at least within their credit floats), the net result being that the price of gas (or any other commodity) would fluctuate by very large amounts very often.
Speculators bear all that risk of price fluctuation in the interim between production and delivery and create the liquidity needed for businesses to lock in the sales price of a good they haven't yet produced (or the purchase price of a good they need to use in production). Without futures exchanges, and the speculators that keep them moving, businesses would have no way to plan production.
The futures markets are a zero sum game (less the vig, of course). For every contract that someone is long, someone else has to take the other (short) side. Many, many more (think 100:1 or more) futures contracts for goods exist than actual goods traded.
If as a speculator, I buy a contract to purchase gold, for instance, at $1200/oz. in November, I'm betting that gold will be more than $1200/oz. by November. If it is, I can take delivery of the gold and sell it on the market at the spot (immediate delivery) price. If I'm wrong, and I take delivery, I will either keep it in a vault, or sell it at a loss.
In practice, speculators do not take (or make) delivery. They either liquidate their position before contract expiry or the exchange will settle their accounts against the opposite positions for cash. If you, as a speculator, hold through expiry, there is a chance you will have to take (or make) physical delivery, so in practice all speculators close out their positions prior to this. The only ones left standing, so to speak, are the actual producers and consumers, though they probably never dealt directly with each other.
Futures markets don't really move the market, though they do influence it. The markets are a way for producers and consumers to hedge (i.e. pass their risk on to speculators). The real market is the spot price of a commodity on any given day. Futures markets smooth the fluctuations in the market price out. Supply (OPEC, lack of refineries, regional blends of gasoline) and demand (from China, India, summer driving season, etc.) are what really move the oil and gas markets.
Futures markets exist almost entirely to provide hedging opportunities to producers and consumers, and to do this the markets need speculators. Lots of them.
This notion that speculators are bad for commodities markets and should be removed or reined in, is the polar opposite of the truth. "Speculators" are a convenient scapegoat for the media and politicians, and this finger pointing works because of the criminal negligence that exists in our education system that refuses to teach anyone anything not related to learning how to be a wage slave.
As far as oil as a bubble market at the moment, I don't know but I would say we are probably above the true value curve. I don't believe this enough to put my money where my mouth is, however.
I am certain that the trend in oil is up and is going to remain up due to increasing demand from the 2nd world and the general resistance toward alternative energy solutions such as nuclear power, wind, hydroelectric, domestic drilling, etc. professed by the NIMBY and Green crowds.
The oil industry can charge whatever they want and the consumer will pay it!!! I asked this question of my brother a year ago, and at that time he was dead set against any regulations..... What other product that is produced can have as big affect on the economy, other than oil?
Plutopia, Your points are all well and good, but speculation is at the root of market bubbles. When a gross excess of speculators come to the market bidding up contracts, it inflates the price of the commodity pure and simple. I'm sure you've read about the classic market bubble that developed with Dutch tulips. Growers and their agents regularly sold contracts for bulbs, which were then bought and sold as a hedge against poor harvest etc. When an excess of speculators moved into the market, the price moved ever higher. Marketers created investor pools to bring even more small investors into the frenzy (sounds like hedge funds to me). In the end the smart guys sold their contracts and took their money elsewhere leaving the market hollow and ready to collapse.
Currently the gross finding and development costs for the oil industry is somewhere around $50 per barrel. That includes the cost of the whole enterprise including cost of acquisitions, expensive deep water development, premiums paid to governments for the concessions to develop their resources, frivolous lawsuits, G5's to take execs to Washington to testify etc. At the moment short-term supply is keeping up with refiner demand. Last time I looked, worldwide crude supply was a few million barrels per day ahead of true refiner demand. Yes, China and India are increasing demand and a number of governments subsidize petroleum products,which distorts the market. And of course the folks in the Middle East and Africa keep sharpening their knives hoping to score a blow on some infidel or lackey that is robbing them of their birth right.
The facts are that best estimates for true worldwide demand will raise oil and gas needs by 2-4% per year. You also have to factor the declining value of the dollar which adds maybe another $20 to the cost relative to 2003. All of the above make oil a great place to place your bets Vegas style.
When it's all totaled up you are somewhere near $70-$80 as the true cost of a barrel of oil today.
So what brings it down? One factor not well advertised is the cycle time on new oil development. All the oil companies have large developments in the queue and many will be coming on stream over the next five years in response to the high prices. Saudi Arabia has 200 rigs running in the Kingdom, as we speak to build up supply capacity. So I expect 2-5 years out to see the leading edge of the excess supply that will cause the smarter speculators to sell and ultimately collapse the price.
Dwayne
Commodities speculation has broken the oil market. I know I'll get flamed for stating this, but I can't see it any other way. It is no coincidence that the drop in oil started almost to the day that the CFTC announced it would be investigating possible manipulation in the market. Then you have Henry Paulson and mainstream media market analysts say that futures speculation has nothing to do with oil prices, and up they go again.
It almost amounts to hoarding, which is why India banned agricultural futures because people were starving. Can the US do this? Perhaps a temporary moratorium or maybe some limits on trading are needed. If companies are involved in the production and distribution of oil then of course they should be allowed to trade as a hedge.
The solutions aren't easy but I am pretty sure that regulations on commodities speculation would drop oil prices by at least 15 percent within a week.
I agree with you. There is a supply/demand component to a market and there is a speculative component. (There are others as well, such as regulatory, monetary, via collusion, etc.) Oil prices are being driven higher by supply and demand, regulation and monetary imbalances (as you pointed out). I don't really think there's any question that this is the case. The trend line is up.
I also find it likely that speculation has created a bubble as well. If I felt I knew this with any certainty, I'd be shorting oil futures, buying puts, etc. I just don't understand the oil markets well enough to act. You have a much better handle on the oil markets than I do and your posts on the subject are interesting.
(I'm barely able to make sense of the real estate market and I put a lot of effort into that. I'm still convinced that this uptick we're seeing here in CO is just a dead cat bounce. I have good reasons to think that but it's hard to stick to my guns and stay out of the market.)
I'm primarily taking exception to your characterization about how bubbles operate in futures markets. They are very different beasts than stock markets. It's entirely possible to have a negative bubble (artificial price depression) due to speculation in the futures markets. This isn't really true of stocks, which is what people are familiar with. Shorting in the stock market is a very small portion of the volume. In the futures markets, shorting is always half the market, by definition. For every long contract position that someone bought, there exists a short contract position that someone sold.
You can't characterize the speculation in the futures markets by saying that "a gross excess of speculators [came] to the market bidding up contracts" because for every speculator that bought a contract, another speculator had to sell them that contract. Sentiment, based in reality or a bubble mentality, is moving prices, not the presence of speculators.
Speculators, as a general class, are not getting rich in the oil market (or any other commodities market for that matter) because for every dollar made by one speculator, a dollar is lost by another speculator. More enthusiasm by many, or even just a few, individuals on the long side is probably creating a bubble, and those speculators will make out well, but all of their gains will be paid by other speculators who were wrong. Blaming "speculators" for the bubble may be true in a sense, but calling for their removal from the markets (not that you have done this, but some have) makes absolutely no sense.
Isohunter, with all due respect, I think you need to thoroughly understand the futures markets before you start believing in conspiracy or collusion, not that those things don't happen. If after you thoroughly understand the markets, you still see a deus ex machina, then your theory of non-market based price manipulation might have legs. And I certainly don't think we should be modeling our actions after India.
From an AP news report June11th:
Light, sweet crude rose $5.07 to settle at $136.38 a barrel on the New York Mercantile Exchange after earlier trading as high as $138.30. Oil shot up more than $16 over the course of last Thursday and Friday, reaching a trading record of $139.12 before pulling back this week.
OUCH!
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Richard, there's been some interesting discussion of oil related issues by some smart (and some not so smart) guys and gals over on several of the Wall Street Journal online blogs - the Real Time Economics blog in particular. They're pretty well written and offer some perspectives from the big boys and girls now and then.
Yesterday, I was talking to a guy who owns and operates a tanker truck and he brought up the issue of speculators causing a bubble in oil prices.
So the guys in the oil industry think there is an oil price bubble.
When word is out on the street, it's probably time to liquidate your investments. Any of you with oil futures, it looks like it's time to bail out.
Oil closed down over $6 after being down as much as $10 today. That is the biggest one-day drop in 17 years.
http://biz.yahoo.com/ap/080715/oil_prices.html
When markets are experiencing a bubble there is usually a speculative blow-off just before the bubble bursts. It is usually accompanied by extreme volatility, such as we are seeing now.
We can only hope!
Oil down $6.44 Tuesday
Oil down $4.14 Wed
Oil down $5.31Thursday
3-day hat trick = down $15.85
Probably get an upward bounce on Friday, but hopefully the trend is changing.
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Oil closed Friday at just over $123 per barrel. That’s a drop of 16% from the high of $147 just a couple of weeks ago. Looks great, but gas prices here have only dropped about 3%. I know it takes a while for lower prices to work their way into the market, but why is it that when oil prices rise gas goes up instantaneously?
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In this article, I found the comments on speculators to be correct, as well as the explanation of supply and demand factors... Dwayne
http://finance.yahoo.com/expert/article/yourlife/98378
crude oil down 1.27 today closing @ 114.
Anybody know any oil buyers or brokers? I am not really a oil guy but one of my investors has got direct contact with a supplier of d2 refined oil and ran the oppurtunity across to me.He will pay for the lead if they get a contract with him. Some nice change if you know anybody. Just wanted to throw that out if anyone is interested. I know nothing about oil