Wednesday, April 30, 2014

Oil: The Greatest Bubble Of Them All

(Drivebycuriosity) - Bubble, bubble, bubble. The media - and the pundits - see bubbles everywhere. But the greatest bubble of them all is overlooked: Oil.

Today oil costs around 4-times of the late 1990! (wikipedia) Since the end of 1999 the price of oil jumped from around $25 to around $100 - plus 300%, while the US stock market (S&P 500) gained anemic 30%. It seems that the oil market ignores the sluggish global economy since the begin of this century. It also ignores the rise of the US as a major oil producer which is lifting the global oil production thanks to new technologies like fracking & deep sea exploration.

The discrepancy between high oil prices and the economy signals that the oil market ignores the economical fundamentals - neither the supply of oil nor the demand for this commodity explain the oil price explosion in this century. Instead the price of oil has been ruled by geopolitics.

Oil is traded on financial markets like stocks and bonds. Many hedge funds and other speculators are buying oil futures, which represent the energy prices. Since the early years of this century they have been pumping many billions of dollars into the oil market in the hope of further price gains. Hence the oil price reflects expectations rather than the real supply and demand.

Today the speculators focus on the Ukraine conflict. Russia is one of the world`s biggest oil producers. Speculation that sanctions against Russia - and the worst case scenario of a war in this region - will interrupt the global supply of oil are keeping the price of oil north of $100. Today the future for Brent Crude - the type of oil which is used globally - costs $108, WTI (West Texas Intermediate), the future for US oil, fluctuates around $100.

The Ukraine conflict is just the newest of the political issues which are keeping oil expensive. Since the year 2004 oil prices have been agitated by continuous speculation about conflicts in the Middle East, the so-called Middle East tensions. Wars and unrest in Iraq, Libya, Syria, Egypt and other countries of this fragile region plus the ongoing conflict with the Iran about its nuclear facilities all induced speculation that the global oil supply could be endangered. Hence the price of oil has a geopolitical risk premium.

The high price of oil is a huge incentive to produce more of this precious commodity as you can see in the US. Other countries like China also are beginning with fracking to reduce the dependence from imported energy. Expensive oil also curbs the demand: People drive less, use fuel-saving cars and other energy-efficient machines (demand destruction). They also switch to alternative energy sources like natural gas, wind & solar energy. Both trends lead to an over supply which you can see in the US where the stockpiles reached a record high.

But the price of oil is still floating around $100.  It seems that the oil market is functioning like a hot air balloon. A steady flow of geopolitical news (Ukraine, Middle East) has been heating the speculation on upcoming supply problems and is keeping the price of oil high like a balloon in the air.

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