Oil: are we in a bubble?

Posted on July 10, 2008
Filed Under Uncategorized |

Two things caught my attention as I watched crude oil prices fall again… the Iranians shooting off a bunch of missiles and talking tough did not scare the market, and demand for gasoline fell in Asia and the U.S., which during peak summer months is pretty significant.

In Asia governments can no longer afford to subsidize gasoline pump prices so as those consumers start to pay market rates, or close to it, they pull back their consumption. Mexico can’t afford it much longer either, Pemex will ultimately have to raise pump prices. In the U.S. drivers are pulling back in the face of rising energy costs that not only get them at the pump but also at the grocery store. Pump price subsidies distort marktetplace driven demand and if the price of gasoline and diesel stay where they are, it is impossible for governments like Mexico, Indonesia, India and even perhaps China to continue the subsidies.

One interesting thing to consider is that the marketplace for commentary has pretty much accepted that oil prices will not collapse because the supply is finite, global demand will continue to grow and exceed supply, and geopolitical instability will present the opportunity for market disruptions.

The best estimate of the future price is therefore the current price. For it to move upward, rationally, you need new information–i.e., information that none of us knows now. The basic logic behind the predictions I hear of ever-rising prices–the supply is fixed, oil is neat stuff that helps grow economies, there are a lot of economies that want to consume more of the stuff–is all well known to everyone. You should assume that the price is roughly as likely to fall as to rise.

[From Megan McArdle (July 09, 2008) - Oil: are we in a bubble?]

If anything the price of oil today seems driven not by geopolitical issues but rather the valuation of the dollar and uncertainty about what actual demand and inventory levels are, specifically in India and China which don’t put out data on either, unlike the U.S. and Europe.

The assertion that we are running out of oil is technically accurate, after all it is a finite resource that when used is converted into other non-reclaimable forms (unlike iron ore which can be recycled till the end of time). Having said that, over a hundred years of supply in the ground in known reserves even when taking into account growth in demand. Estimates for oil in shale and tar sands alone are around 2 trillion barrels. Current known reserves of crude oil are 1.3 trillion barrels, according to Oil and Gas Journal (this estimate includes 174b barrels of Canadian oil sands), but it’s important to note that OPEC producers are generally believed to underestimate their reserves in order to manufacture scarcity which benefits them in the market.

There are another 6.3 trillion cubic feet of natural gas in known reserves. Include coal, which can be liquified, and there are 200 years of supply there alone. Simply put, there’s a hell of a lot of hydrocarbons in the ground… think about the span of technical and industrial achievement of the entire 20th century… that is what is in front of us.

While I’m tempted to say that there is a bubble in oil prices, what is more likely to occur, if not already, is an investment bubble in clean tech, which to date has produced little that can scale and outside of corn farmers in the midwest, hasn’t generated much in the way of returns. Oil will fall and while I am not qualified to make this projection (just being honest) I would say that $80-90 feels like a right settling point for crude once the speculators decide that the Greater Fool theory no longer applies.

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