Friday, February 17, 2017

Oil: The Perpetual Bubble

(Drivebycuriosity) - It looks like oil is in a perpetual bubble. A bubble is defined by an asset price which is inflated by speculation and is not justified by the fundamental data. I suppose that the current oil prices follow this definition.

Today oil costs about 100% more than at begin 2016 even that the world has still an oversupply of oil (oilprice). The oil market ignores the fundamental data which show that the oil price rally was overdone. In the US, the world´s larges market for oil, the oil inventories are climbing to record heights again - a sign that supply exceeds demand (Inventories). It seems that the recovering US oil production (chart below shale ) is overcompensating the pursued Opec production curbs (and it is still unclear how many Opec members participate and how much). The break even point for producing oil, which has been falling since the 19th century thanks to the technological progress, is continuing its long-term downwards trend. As a  result American producers, who have temporarily suspended oil pumping at prices below $40, are coming back, as the climbing oil rig count shows (businessinsider).

 Why doe the oil prices ignore the fundamentals? Bloomberg reports that hedge funds and other money managers are "frenziedly betting" on rising prices (bloomberg). "At the start of February, speculators were betting a net 865 million barrels of oil that prices would rise - a record". This is not a new phenomena - quite contrary. In the recent years speculators have been holding constantly a net long position on oil, meaning bets on rising prices (long) have been exceeding bets on falling prices (short) continuously.

For instance Reuters reported in May 2015:  "Investors have moved heavily into oil over the last few weeks ..... hedge funds and money managers raised bets on rising oil prices to another record, data showed on Monday, pushing net long positions to their highest since official exchange records began in 2011" (cnbc). I don´t recall any media reports about net short positions in the recent years.

It seems that the majority of hedge funds and commodity focused money managers have a bias for higher oil prices. They are notoriously expecting rising oil prices. This lead to a sharp oil price spike in the years 2007-2008, fueled by massive speculation on alleged supply disruptions,  and climbing & high oil prices in the years 2009 through 2014. The result is a perpetual bubble in oil - with short breaks in the years 2008 and in 2014/15.

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