Friday, August 04, 2006

An Oil Bubble?

I have a hard time believing oil and gasoline prices are high (and profits large) due to oil company price gouging. Oil is a world wide commodity that is traded on a market. Regardless, it seems to be a popular opinion and both those on the left (Maria Cantwell) and right (Bill O'Reilly) are taking advantage of it politically.

But, given that it is a market, what we might be seeing is an oil bubble created by speculators. Instead of looking into price gouging, I wish congress would look into this.

Robert Samuelson of the Washington Post writes this:

"Speculation" has a bad image. It suggests financial sharpies plundering everyone else. The reality is often the opposite: financial innocents following the latest fad to ruin. That happened with tech stocks. The oil picture is murkier. The big "speculators" are institutional investors -- pension funds, hedge funds (pools of loosely regulated funds) and investment banks. They have purchased oil futures contracts and, in effect, bet that prices six months or a year out will exceed present prices. Since 2002, investment in futures contracts may have quintupled to more than $100 billion, estimates energy economist Philip Verleger Jr.

Oil inventories for industrial countries "are at a 20-year high." Spot prices rise because there's less oil on the market.

It's unclear how much this sort of speculation has increased prices, if at all. The report mentions estimates ranging from $7 to $30 a barrel.
We have oil inventories at a 20-yr high, $100 billion in speculation and increased prices of anywhere from $7-$30 a barrel. That looks like evidence that there is speculation and it might be a major cause of the price increase in oil.

He also wonders why the large outrage at prices (which I have also wondered):
Even at $3 a gallon, it costs Americans only about 4 percent of their disposable income, reports economist Nigel Gault of Global Insight. The same is true globally. At $70 a barrel, global crude sales would total about $2.2 trillion annually; that's still a tiny share of the $50 trillion world economy.
The Economist also took a look at the issue:
Some analysts believe that investors have inflated a speculative bubble in commodities. Hedge funds' investments in energy markets rose from $3 billion in 2000 to about $90 billion last year, according to the International Energy Agency, a think-tank.

It is hard, concedes Frédéric Lasserre, the author of Société Générale's report, to translate nebulous fears about future supply into prices. In the long run, the price of any given commodity should revert to the cost of producing an incremental unit of supply. By that measure, Mr Lasserre calculates, oil is overvalued by 50%, and zinc and copper by almost 40%. In the short term, the level of stocks plays an important part. But again, relative to the historical relationship between stocks and prices, Mr Lasserre reckons copper is 148% too dear; zinc, 122%; nickel, 70%; and oil, 49%.
They come to a similar conclusion and see oil being 49% overvalued compared to the marginal cost of production.

In general bubbles are neither good for customers or investors in the long run. Half of me wants the government to get involved and try and reduce the amount of speculation. The other half thinks getting the government involved will only make the situation worse. But if politically we need to blame someone, I wish we would go after the speculators rather than the oil companies.

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