Editore"s Note
Tilting at Windmills

Email Newsletter icon, E-mail Newsletter icon, Email List icon, E-mail List icon Sign up for Free News & Updates

July 26, 2008
By: Kevin Drum

OIL BUBBLE?....Is the recent rise in oil prices a speculative bubble? Via Mark Thoma, economist Jim Hamilton tackles that question here. Shorter Hamilton: if you think it's a bubble, what makes you so sure you know what the price should really be? But read the whole thing for a bit more detail.

UPDATE: Alternate theory: the market is afraid that Obama will win the presidential election and this will send George Bush into a frenzy of military activity. Thus, prices are up.

Kevin Drum 11:29 AM Permalink | Trackbacks | Comments (38)

Bookmark and Share
 
Comments

Aah, Existentialist Philosophy applied to modern economic questions. Now *that's* helpful.

You know, sometimes an economic bubble is just an economic bubble.

Posted by: Harold S on July 26, 2008 at 11:37 AM | PERMALINK

The anti-bubble skeptics don't have a lot to hang it on. First, it just isn't reasonable to think that such a dramatic oil price rise over several months could *all* be due to fundamentals, regardless of the showcased red herring of whether we can pin down exactly how much is from speculation. The trading activity is going to have to affect prices too, not just respond to them as some absolute wanks are stupidly or dishonestly pretending. (Some of the best and most honest minds do give a shot at rough quantification, and say speculative forcing could be as much as $60/bbl during the recent peak off.)

Sure, demand in India and China etc. is inching up, but not enough to near-suddenly spike the prices in the manner they have been. Supply has been flatish but not substantially impacted lately either, and the indirect issues like Iran didn't go through a major whoop. There is a point where the matter of degree makes the alternative simply not credible. Do not believe all those apologists/enablers poo-pooing the speculation angle.

See http://www.csmonitor.com/2008/0624/p01s04-usec.html and http://www.c-span.org/Topics/Energy.aspx for some scoop.

BTW, it isn't in the news much, but before long we will also have a peak helium problem causing big problems for scientific research etc.

Posted by: Neil B. ♪ ♪ ♪ on July 26, 2008 at 11:52 AM | PERMALINK

This typical right wing spin. Oil will spike because Bush will attack Iran if Obama wins, and that's Obama's fault. Uh huh.

Posted by: sal on July 26, 2008 at 11:55 AM | PERMALINK

Let's also not forget the seminal role in the spike of Phil Gramm, McCain's once economic adviser and enabler of the "Enron Loophole" (and a far more important issue than Obama's minister.) McSame wasn't exactly trying to stop this crap himself, either; with some good takedown by Olbermann shown:

http://www.crooksandliars.com/2008/06/19/countdown-mccain-oil-and-the-enron-loophole/

tyrannogenius

Say, you guys and gals that have some interest in physics/deep philosophy, drop by my blog of the same name sometime/s, tx

Posted by: Neil B. ♪ ♪ ♪ on July 26, 2008 at 12:15 PM | PERMALINK
The anti-bubble skeptics don't have a lot to hang it on. First, it just isn't reasonable to think that such a dramatic oil price rise over several months could *all* be due to fundamentals, regardless of the showcased red herring of whether we can pin down exactly how much is from speculation.

It doesn't matter whether its all due to fundamentals are not; if the fundamentals exist for a long-term, fairly rapid, sustained increase, a small speculative bubble on top of that isn't the main problem, and efforts spent to restrain speculation to address it rather than addressing the fundamentals are a waste of resources.

Sure, demand in India and China etc. is inching up, but not enough to near-suddenly spike the prices in the manner they have been.

That makes assumptions about elasticity that I don't think are necessarily justified, but even if true, you ignore the possibility that the prior prices could have been in part the result of the reverse of a speculative bubble; that is, that prices of oil contracts (which are driven by prices of future delivery) could have been artificially surpressed by a misperception that quantity supplied was more capable of responding to demand than it has shown to be.

The assumption that a change in price that is greater than appears justified by the change in fundamentals must reflect a speculative bubble assumes that the price was "right" before rather than built in part on a misperception of future conditions.

BTW, it isn't in the news much, but before long we will also have a peak helium problem causing big problems for scientific research etc.

Its not in the news as much because Helium, while important in many applications, isn't anywhere close to as critical to the underpinnings of the world economy as petroleum (or even minable phosphates, which IIRC are also peaking, with potentially substantial effects on food supplies given existing agriculture methods.)

Posted by: cmdicely on July 26, 2008 at 12:17 PM | PERMALINK

The markets have included the potential for war with Iran into the price of oil. No one knows if there is collusion between the oil producers, US military, Iran and Israel, but when oil prices begin to fall all it takes is an antagonistic bombing test run or a missile test to drive the price of oil back up by introducing a non-economic component to the price of oil.

Posted by: Brojo on July 26, 2008 at 12:17 PM | PERMALINK


Um, hasn't anybody heard world oil production peaked in 2005? This should be the story of the millenium (so far). Obviously the price of oil is going to rise, with run-ups and pull backs, but increasing inevitably to limit demand to the available supply.

Some folks deserve to lose all their money.

Posted by: M. King Hubbert on July 26, 2008 at 12:19 PM | PERMALINK

It's called uncertainty. The market's like a blind man approaching a wall. I'd rather see some hesitation than an attempt at an Olympic vault.

Don't forget about peak oxygen. It's been declining for at least 20 years. I suspect more so in Washington DC.

Posted by: B on July 26, 2008 at 12:29 PM | PERMALINK

Bubble? Maybe, but it's not just an oil bubble. The speculation isn't on what the market for oil is doing or will do. For futures traders, that's fairly well known. Calculating the risk for war creates an opening for speculation to begin to occur, though the powerful traders will probably have inside information on that. But what no one can predict is the dollar. Since oil is mostly traded in dollars, I think the speculation in oil is really speculation on where the dollar is going to be in the future first, war second, and supply and demand third.

If we had more stable dollar, and introduced mild conservation policies in 2001 or 2002 the price of gasoline at the pump would be half of what it is today.

The falling dollar, the massive debt, the unregulated mortgage market, the unnecessary war, and the escalation of the price of gasoline,...

In short, it's all George Bush's fault.

Thanks again, Ralph.

Posted by: Tim Kane on July 26, 2008 at 12:29 PM | PERMALINK

Well, I am one of the speculators...

The graph of West Texas Crude futures in the second article is fairly convincing.

The remaining unanswered questioned in the Bush endgame is if either the Israelis or US will strike Iran. The future of Iraq is more or less a settled question since Maliki endorsed Obama's plan. Benny Morris' recent NYT op-ed was unusually unequivocal and sobering to me.

I think the price of oil is on the high side in the short term but I am most certainly long on oil.

Oh, and another thing, if Israel or the US strikes Iran, one could bet Iranian (and possibly Venezuelan) oil will be re-priced in Euros or sterling as retaliation. I could easily see light sweet crude hitting $200 almost overnight if that happened.

After all, the good boys at Goldman Sachs have at least some inkling we could be talking $200/bbl soon. Not likely but we would deal a body blow to the American economy.

Posted by: Options Trader on July 26, 2008 at 12:32 PM | PERMALINK

Alternate theory: the market is afraid that Obama will win the presidential election and this will send George Bush into a frenzy of military activity.

Is that really realistic? Bush cares about his legacy-- he's not going to just try to squeeze in an action as risky and uncertain as the conquest of some nation.

Posted by: Swan on July 26, 2008 at 12:34 PM | PERMALINK

*Not likely but that would deal a body blow to the American economy.

This typical right wing spin. Oil will spike because Bush will attack Iran if Obama wins, and that's Obama's fault. Uh huh.

?? TFA implied the market is betting oil will fall if Obama wins, it doesn't blame him.

Posted by: Options Trader on July 26, 2008 at 12:37 PM | PERMALINK

Bush cares about his legacy-

Objection, Your Honor, assumes facts not in evidence.

Posted by: Davis X. Machina on July 26, 2008 at 12:37 PM | PERMALINK

First, there is no such thing as the “real” oil price beyond, well, the real oil price. What people claim is the “real” oil price is some Platonic ideal. That doesn’t exist.

That said, my back of the envelop scrivenering says that oil could (not “should”) be about $85/bbl, with a variety of factors, not just speculators, adding that $40-$5 to the potential price point. Details here

Posted by: SocraticGadfly on July 26, 2008 at 12:41 PM | PERMALINK

Swan: Bush ... not going to just try to squeeze in an action as risky and uncertain as the conquest of some nation.

Is that sarcasm? If so, it's pretty good.

Posted by: thersites on July 26, 2008 at 12:47 PM | PERMALINK

cmdicely, I'm a bit disappointed in you but at least I know (or hope I know - anything to spill here? heh....) it's a honest independent opinion. Just as a general reply, sure the component due to speculation may not be that large, but it's still game to want to find out, to look into it, and to not "blow off" the idea that it's significant, etc. - do you get the framing behind this question? Also, an oddity here:

That makes assumptions about elasticity that I don't think are necessarily justified, but even if true, you ignore the possibility that the prior prices could have been in part the result of the reverse of a speculative bubble; that is, that prices of oil contracts (which are driven by prices of future delivery) could have been artificially surpressed by a misperception that quantity supplied was more capable of responding to demand than it has shown to be.

But if speculative forces are enough to make a big deal with lowering prices, then it could have made them higher now. And like I said, I'm not trying to do econometrics or push specific notions about elasticity, just saying: what seems *more likely* when demand is inching up? IOW, you could be right, but the suspicious folks have a good point to be suspicious and to consider what's *more* likely. Finally, very many of the experts at the Congressional hearings etc. did have specific reasons to pick out speculation, so I'm impressed with that. They weren't just amateur economists going on common sense.

Helium: NBD for the overall economy, but those of us who care about particle physics know that a helium crunch will make such physics more difficult.

Finally, and it's painful to say, but your put-down of speculation reminds me of how AGW skeptics talk about the role of CO2. I can almost imagine your talking points with "increased CO2" replacing "speculation", and phrases like "That makes assumptions about [CO2 forcing sensitivity] that I don't think are necessarily justified, but even if true, you ignore the possibility that the prior [temperature increases] could have been in part the result of [the sun is getting hotter, the measurements aren't good, it's just the natural variation, yadda yadda ...].

Posted by: Neil B. ♪ ♪ ♪ on July 26, 2008 at 12:48 PM | PERMALINK

Harold, screw "Peak Helium." Besides Peak Oil, North America hit Peak Natural Gas earlier this decade. Following on the heels of worldwide Peak Oil, and worries about CO2 and global warming mean that running out of natural gas is a HUGE issue.

That said, you don't here a lot about PNG, either, and we need to. Why do you think BushCo wants to override any local objections to LNG ports?

Posted by: SocraticGadfly on July 26, 2008 at 1:19 PM | PERMALINK

Sorry, that was supposed to be Neil I was telling to screw Peak Helium. Anyway, on oil, eliminating speculation's $10-15 bbl and several other factors, oil could be (not "should be") $85/bbl.

Posted by: SocraticGadfly on July 26, 2008 at 1:26 PM | PERMALINK

Are the big buyers of crude uninformed jerks whose brains are short circuited by the prospect of getting rich quick doing nothing?

If not, how much of this can be speculation?

Posted by: Boronx on July 26, 2008 at 1:32 PM | PERMALINK

A lot hinges on what one means by "speculation". Is an airline executive who buys a future contract for jet fuel a speculator -or just a businessman who is protecting his company from a potentially catastrophic future price increase? Futures prices are the markets best current guess as to the most probably future price. If the market believes there is say a 20% chance of a catastrophic event that will effect the price (say an airstrike against Iran), then the willingness of an oil consumer to pay a price to buy futures will naturally go up. So the price will fluctuate depending upon the current estimate of future events. Bush took some of the fear out of the market by (in principle) agreeing to talk to Iran.

Now, regarding supply/demand, we are at an interesting point. We see some demand response to the recent price increases, but we also have a rapid increase in car ownership in the developing world which shows signs of accelerating. A bit of more supply is becoming available, but this must be balanced against depletion of existing fields, and demand changes. Then I think that OPEC is probably debating what price they want to defend (by cutting supplies). My guess, is that they will not let it go under $100, as the world economy can probably live with that number.

Posted by: bigTom on July 26, 2008 at 1:56 PM | PERMALINK
And like I said, I'm not trying to do econometrics or push specific notions about elasticity, just saying: what seems *more likely* when demand is inching up?

First, what is usually referred to as inching up is not "demand" but "consumption". But consumption is constrained by production and drawdown of stockpiles. Proxies for oil demand (which is a function, not a simple value, and not amenable to direct measurement) —such as overall energy use—aren't merely inching up.

Second, while perhaps the million-barrel-per-day-per-year-and-increasing growth of the last couple years in consumption is fairly described "inching up", one must also consider that against the falling global production.

Third, one needs to consider that the cost to extract oil is itself increasing, as more of the oil produced is from places where it takes more to extract it.

Fourth, one needs to consider the increasing awareness in the marketplace of all those factors, and consider the increasing perception that the 2005 production peak is likely to have been a global peak and not merely a local (temporally) peak in production. And then one needs to consider the evidence that that perception is accurate. (If it is inaccurate, arguably the results would be a kind of "speculation", while if it is accurate, they would be really a kind of reversal of a prior "anti-speculative" factor artificially depressing oil prices.)

Finally, and it's painful to say, but your put-down of speculation

I haven't made a "put-down" of speculation, I've made a response to your put down of those who are skeptical of the claim that essentially the entire $60/bbl price difference between today and the price in ~2004 (before the 2005 production peak!) can be explained by speculation rather than fundamentals.

Frankly, its seems more logical, looking at the price history, that the major part of that price increase is a direct result of the peak in production with continued rising demand, and that the extraordinary uncertainty resulting from that peak and the lack of a clear energy future is the source of the extraordinary volatility and the continued escalation in the average and peak prices in oil since 2005. There is probably some sense in saying that some of the price difference between the troughs and the peaks in that volatile period are due to "speculation" (at least, insofar as that term is equivalent to misperception in the market of the fundamentals that overestimates demand or underestimates supply) driving the peaks and that, on the other hand, some part of that gap is "anti-speculative" forces (that is, misperception in the opposite direction) driving the troughs. But there is little reason to think that is driving the longer-term trend that is evident in price levels as well as the short-term volatility, and there is little reason to think that the kind of "speculation" at work is bad behavior that can be corrected with policy targeted as "speculators". What needs to be done to smooth volatility in the markets, if that is the goal, is to provide energy policy with some direction and certainty, rather than a series of overtly "psychological" propaganda measures whose effects instantly wear off and are reversed. As for bringing oil prices down any more than you get by reducing the peaks by calming volatility, that takes policy that reduces demand (to do that without crushing economic growth means increasing the supply of alternatives.)

Posted by: cmdicely on July 26, 2008 at 1:59 PM | PERMALINK

Economics in general isn't advanced enough for prediction, so if it bursts, it's a bubble, in hindsight, subject to partisan cherrypicking of statistics.

Posted by: Luther on July 26, 2008 at 2:00 PM | PERMALINK

Luther, good point. Plus, most conventional neoclassical economists, or variations thereof, still refuse to let behavioral economics in their tent.

And, once you throw gasoline of the often-irrational psychology of human emotions on an economic blaze, making predictions becomes harder by a degree of magnitude.

Speaking of that, if anybody is still looking for summer reading, I recommend "Predictably Irrational" by Dan Arely. Good into to behavioral economics and some of its findings, like the power of the word "free" on "buy one, get one free" specials.

Posted by: SocraticGadfly on July 26, 2008 at 2:19 PM | PERMALINK

What needs to be done to smooth volatility in the markets, if that is the goal, is to provide energy policy with some direction and certainty, rather than a series of overtly "psychological" propaganda measures whose effects instantly wear off and are reversed.

Good information from OPEC and industry would be great too, but they tend to hold that stuff close to their chests.

to do that without crushing economic growth means increasing the supply of alternatives,/i>

Is conservation an alternative?

Posted by: B on July 26, 2008 at 2:20 PM | PERMALINK

Alternate theory: the market is afraid that Obama will win the presidential election and this will send George Bush into a frenzy of military activity. Thus, prices are up.

Horsepucky. We saw similar futures price behavior in early '06, among other times, and contango has more pedestrian and rational explanations than fear of a "frenzy of military activity".

Moreover, look closely at the chart: the peak-to-trough is about $3/bbl. That seems very low if war is a serious consideration. (NYMEX light sweet crude shows about the same, with peak-to-trough about $5/bbl.)

Posted by: has407 on July 26, 2008 at 3:30 PM | PERMALINK

Economics in general isn't advanced enough for prediction, so if it bursts, it's a bubble, in hindsight

I disagree. A bubble is like a pyramid scheme where a significant fraction of investors are banking on attracting other suckers into the bubble before the whole thing goes up.

If some unforeseen event causes the price of oil to crash, that does not imply it was a bubble.

Posted by: Boronx on July 26, 2008 at 3:33 PM | PERMALINK

I've made a response to your put down of those who are skeptical of the claim that essentially the entire $60/bbl price difference between today and the price in ~2004 (before the 2005 production peak!) can be explained by speculation rather than fundamentals.
No, I made it rather clear that the claim, or the question of whether, essentially the "entire" $60/bbl difference can be explained by speculation rather than fundamentals, is a straw man. It's a matter of how much and then we can at least do something about that, not to be thought of as disdain for other issues. So maybe the spec-premium is e.g. about $20, and even then there's ambiguity due to dollar value issues etc. But that's still $20 more than I want to pay. Yanking the Enron Loophole etc. would be worth doing for that, and doesn't use up valuable effort for other things. That not even as credible as saying we can't so any social programs etc. because we are so up against the wall from fighting terrorism etc. Regulation isn't all that costly, is it?

Posted by: on July 26, 2008 at 3:40 PM | PERMALINK

BTW I don't want my hit against speculation to take heat off conservation etc. I just say *both* matter.
Look at the idiocy of what John McSame is saying:

http://mccainnow.com/index.php


Obama and his Walk to Work and Wear a Sweater Energy Policy
Barack Obama with his "Walk to Work and Wear a Sweater" energy policy is bad enough. Imagine the state of this nation, which still drives the global economy with a President Obama working with the Democratically controlled Congress.
$4.00 a gallon gas will seem like the good old days.

How massively fraudulent. Conserving energy by walking etc. is exactly the best way to quickly reduce demand and thus oil prices. McCain and his Yahoos are willfully deceitful or stupid.

Posted by: Neil B. ☼ on July 26, 2008 at 4:02 PM | PERMALINK

I have a methane well in my front yard, so I know I'll not run short in my lifetime. IF YOU want to lower prices at the PUMP, then use less.

Posted by: Mike Meyer on July 26, 2008 at 4:14 PM | PERMALINK

....send George Bush into a frenzy of military activity.

Ah, I bet George walks out the door like kid leaving school and going on summer vacation and even Dick Cheney will feel it's retirement time.

A Shorter Forbes Mag: "Bush will bomb Iran if people don't vote Repug".

This is akin to saying Bush will start another war but with what army - with a military draft? It is a hollow threat.

Bombing Iran isn't advantageous Western oil contracts or any other American business interest in the region. See as how Bush has lied so much that nobody believes anything he says, and the whole world knows it's about oil with McCain's need to stay for 100 years.

The empire crumbles or not, because it seems to me that Obama will certainly trying and get those contracts where Bushie failed, just not at the same greedy rate, which wasn't going to happen anyway.

Posted by: Me_again on July 26, 2008 at 8:28 PM | PERMALINK

The price of a fixed depletable resource increases at a rate equal to the risk-free rate. Sorry. I know how bad everybody wants this to be the economic equivalent of that noise kids make their straw when their slurpee is almost done, but this is (1) cyclical capacity constraints + (2) commodity market momentum + (3) blowing up the middle east. It will all get better, so very soon the shitheads will again be running you off the road in their giant cars.

Posted by: zzz on July 26, 2008 at 9:02 PM | PERMALINK

The ultimate bubble is people. Just like soylent green.I think oil will decline in price just like it did before the the elections of 2006 only to begin rising the day after the elections.

Posted by: a greenscam on July 26, 2008 at 11:05 PM | PERMALINK

Maybe that "peak oil" theory isn't baloney.

Posted by: FS on July 27, 2008 at 12:24 AM | PERMALINK

If the economy shows signs of having hit bottom, Wall St. will start to push up stock prices. Money that was fuelling the oil bubble will go instead into stocks. If oil prices decline in the next bull market, then we will know it was all speculation.

Posted by: bob h on July 27, 2008 at 7:38 AM | PERMALINK

You can't have a bubble in a physical commodity without one of:

- increased inventories, reflecting hoarding by speculators

- decreased production, reflecting hoarding by producers

There's no evidence of 1 in official inventories. In commodities that are not traded by financial speculators, there have been equally (or more) violent price swings of late.

It's hard to argue the world's oil producers are holding back production.

Contrast to the Hunts in silver. They wound up owning something like 30% of the world's freely traded silver supply, physically. Or Enron, when they physically withheld power supply from the California market, to drive up the spot price.

In a commodity market, without those 2 phenomena, a pure arbitrage is open (buy the spot, and hold it to futures delivery at a higher price, keep rolling that position).

Therefore it is unlikely that financial speculation is what is driving the oil price. This is the difficulty of supply and demand finding each other at a stable equilibrium.

Conservatives are supposed to understand free markets, so they should understand this-- unless they can point to withheld hidden inventories, there is no smoking gun for financial speculation.

Posted by: Valuethinker on July 27, 2008 at 9:02 AM | PERMALINK

"Now, how could it be that China is burning 860,000 b/d more than it used to, but no more is being produced? Well, it could be that there are errors in the consumption or production numbers, and both will likely be revised. Or it could be that we're drawing down global inventories. But the most natural inference is that somebody else in the world must have been persuaded to reduce their consumption of oil between 2005 and 2007 to free the barrels now being used in China. And indeed, according to preliminary EIA estimates, petroleum consumption in the U.S., Japan, and those countries in Europe for which data are now available fell by 760,000 b/d between 2005 and 2007."
- James Hamilton


Excellent work by Mr. Hamilton and I completely agree with his analysis. Obviously, the next question that should be posed is: How long can China and other emerging economies afford to subsidize consumption? When the developed economies slow because of high oil prices it will reduce demand for emerging economies exports, which would make it even more difficult for them to subsidize domestic consumption. So, the emerging economies are not going to be able to "win" the duel for the oil any more than we could. Everybody will simply be forced by the market to switch to alternatives.

Posted by: Doc at the Radar Station on July 27, 2008 at 10:24 AM | PERMALINK

Maybe some of the spec-skeptics know more than me, I realize that. But even if something isn't "physically held" the trading around of the right to it should have some self-reinforcing momentum effect. Like I keep saying, it just isn't credible for it not to matter. And why did most Dems vote for the speculation reform bill, and most Repubs vote against it? It has to matter or they wouldn't be doing that.

Posted by: Neil B. ☼ on July 27, 2008 at 3:32 PM | PERMALINK
Is conservation an alternative?

That depends. Insofar as it means "producing the same useful output with less input" (i.e., efficiency), conservation is an alternative. Inasmuch as it means "making do with less useful output" its just reducing standards of living. "Conservation" has been used in both senses. Conservation in the second sense is sometimes necessary, in regard to a particular resource, to avoid even graver consequences with an acute crisis, but isn't a long-term solution to anything.

Posted by: cmdicely on July 28, 2008 at 2:01 PM | PERMALINK




 

 

Read Jonathan Rowe remembrance and articles
Email Newsletter icon, E-mail Newsletter icon, Email List icon, E-mail List icon Sign up for Free News & Updates

Advertise in WM



buy from Amazon and
support the Monthly