AP: Oil was just another bubble

From the Associated Press, via MSNBC:

As oil prices zoomed toward an unheard of $147 a barrel this summer, it seemed every analyst prediction that oil would approach $200 was a self-fulfilling prophecy, until suddenly it was not.

Instead of $200 oil, oil is now $80. Instead of going up, U.S. demand has fallen at the steepest rate since the oil-shocked 1970s. Americans have dramatically cut down on driving over the past year.

Soaring prices for oil and other commodities this summer have turned out to be nothing short of another classic bubble, and the bursting may not be over, one analyst said Monday.

"It's just amazing that the market gets suckered into this," said analyst Stephen Schork of the Schork Report, who called the idea of $150 a barrel oil "an obscene number, a perverted, illogical number." ...

"We clearly underestimated the depth and duration of the global financial crisis and its implications on economic growth and commodity demand," analyst Jeffrey Currie said in a report.

David Fyfe, an analyst with the International Energy Agency in Paris, was a bit less critical, avoiding the word "suckered." "To be fair, there is always a tendency in parts of the analyst community to look at short-turn trends and assume it's something that will continue in perpetuity," he said.

As recently as July the price of oil was rising based on strong global economic growth, especially in China and India. Now that the financial crisis is threatening to push the entire world into a recession, global economic weakness is likely a major cause of the drop in oil prices.

Also, $4 per gallon gasoline seems to have been the tipping point that encouraged many Americans to cut back on driving and stop buying SUVs. Americans consume roughly 25% of all the world's oil, despite the fact that we make up only about 5% of the world's population.

Now let's see when the gold bubble bursts.

Oil Bubble?

As politicians blame rising oil prices on speculators, it's worth reviewing the counterargument made by Princeton University economist Paul Krugman. Krugman says today's high oil prices are based on actual supply and demand, not financial speculation. Krugman correctly recognized both the late-1990s' stock market bubble and the housing bubble, so the fact that he argues that there is no oil bubble is ominous.

Are speculators mainly, or even largely, responsible for high oil prices? And if they aren’t, why have so many commentators insisted, year after year, that there’s an oil bubble?

Now, speculators do sometimes push commodity prices far above the level justified by fundamentals. But when that happens, there are telltale signs that just aren’t there in today’s oil market.

Imagine what would happen if the oil market were humming along, with supply and demand balanced at a price of $25 a barrel, and a bunch of speculators came in and drove the price up to $100.

Even if this were purely a financial play on the part of the speculators, it would have major consequences in the material world. Faced with higher prices, drivers would cut back on their driving; homeowners would turn down their thermostats; owners of marginal oil wells would put them back into production.

As a result, the initial balance between supply and demand would be broken, replaced with a situation in which supply exceeded demand. This excess supply would, in turn, drive prices back down again — unless someone were willing to buy up the excess and take it off the market.

The only way speculation can have a persistent effect on oil prices, then, is if it leads to physical hoarding — an increase in private inventories of black gunk. This actually happened in the late 1970s, when the effects of disrupted Iranian supply were amplified by widespread panic stockpiling.

But it hasn’t happened this time: all through the period of the alleged bubble, inventories have remained at more or less normal levels. This tells us that the rise in oil prices isn’t the result of runaway speculation; it’s the result of fundamental factors, mainly the growing difficulty of finding oil and the rapid growth of emerging economies like China. The rise in oil prices these past few years had to happen to keep demand growth from exceeding supply growth.

Saying that high-priced oil isn’t a bubble doesn’t mean that oil prices will never decline. I wouldn’t be shocked if a pullback in demand, driven by delayed effects of high prices, sends the price of crude back below $100 for a while. But it does mean that speculators aren’t at the heart of the story.

For anyone interested in the whole oil speculation issue, Economist's View has been covering it.

Any thoughts from readers?

A Graph of Gas Prices Since 1919

Remember those really, really high gas prices of the late 1970s and early 1980s? Well, we're past that and still climbing. From the U.S. Energy Information Administration:

To quote Stein's Law, "If something cannot go on forever, it will stop." Of course, when it will stop is the big question.

The really interesting thing in the graph is that until 1998, the long-term trend for real gas prices was down.

Flashback 2000: That Bubblin' Crude

From The New York Times exactly eight years ago today:

Gov. George W. Bush of Texas said today that if he was president, he would bring down gasoline prices through sheer force of personality, by creating enough political good will with oil-producing nations that they would increase their supply of crude.

"I would work with our friends in OPEC to convince them to open up the spigot, to increase the supply," Mr. Bush, the presumptive Republican candidate for president, told reporters here today. "Use the capital that my administration will earn, with the Kuwaitis or the Saudis, and convince them to open up the spigot."

Implicit in his comments was a criticism of the Clinton administration as failing to take advantage of the good will that the United States built with Kuwait and Saudi Arabia during the Persian Gulf war in 1991. Also implicit was that as the son of the president who built the coalition that drove the Iraqis out of Kuwait, Mr. Bush would be able to establish ties on a personal level that would persuade oil-producing nations that they owed the United States something in return.

"Ours is a nation that helped Kuwait and the Saudis, and you'd think we'd have the capital necessary to convince them to increase the crude supplies," he said.

I'm glad to see it worked out so well. Any comments from readers?