The chorus is a lot louder these days. “The oil bubble has popped! The oil bubble has popped!” It would seem so— at first glance. As I write this, MarketWatch is reporting:
Oil futures dropped below $70 per barrel Thursday for the first time in 14 months…
Only three months ago crude futures reached their record high intraday level of $147.27 back on July 11, 2008.
And just look at what headlines across the country have been saying lately:
“The oil bubble has burst” –Kansas City Star
“Analysts backpedal after oil bubble bursts” –Seattle Times
And my personal favorite…
“Markets ‘suckered’ into oil bubble” –The Oregonian
Even the Wall Street Journal has declared the “official” demise of the oil “bubble.” The Journal’s David Gaffen wrote on October 10:
Like a number of other commodities, oil’s move went from a steady ascent to a vertical bounce in the spring of 2008, topping out near $150 a barrel before speculative excess started to drain from the market. And those who believed that the oil price was justified by fundamentals — being, as it is, an actual product, rather than an Internet company’s vague promise of revenue — are smarting. “This is a market that is basically returning to the price level of a year ago which it arguably should never have left,” says Tim Evans, energy analyst at Citigroup. “We pumped up a big bubble, expanded it to an impressive dimension, and now it is popped and we have bubble gum in our hair.”
Black, stinky, oozing bubble gum, perhaps, but the point is taken. The decline in worldwide demand is only the secular story in this rapid decline in oil. The unwinding of large-scale leverage positions in commodities has meant the end of the spring’s most popular trade, one based on going long inflation (that’s commodities) and short everything else.
Despite all this hoopla surrounding oil’s demise, I’m not sure I’d declare the crude oil bull dead just yet. Neither would a seasoned investor such as Jim Rogers, who called the beginning of the latest bull run in commodities back in 1999. The former partner of George Soros in the renowned Quantum Fund pointed out as recently as October 4 in a New Delhi Television Limited (India) interview that:
You always have consolidation and correction. Three times in the last nine years, oil prices have gone down by 50 per cent, and each time it was not the end of the bull market.
FREE VIDEO LESSON: It’s not over till it’s over
Those who believe crude oil prices will rebound and go higher (much, much higher in some cases) make some pretty good points.
According to highlights from the latest “Oil Market Report” produced by the International Energy Agency (IEA):
Oil demand forecasts for 2008 and 2009 were trimmed by 240 kb/d and 440 kb/d, respectively, given weaker OECD deliveries and the IMF’s downward revisions to 2009 global GDP assumptions. World oil demand is expected to average 86.5 mb/d in 2008 (+0.5% or +0.4 mb/d vs. 2007) and 87.2 mb/d in 2009 (+0.8% or +0.7 mb/d).
Global oil supply declined by 1.1 mb/d in September to 85.6 mb/d. Hurricane outages in the Gulf of Mexico and renewed stoppages in Azerbaijan and among OPEC producers offset higher supply from Russia and the North Sea. Non-OPEC net output growth is largely wiped out for 2008, now averaging 150 kb/d, plus an extra 310 kb/d from OPEC gas liquids. Combined 2009 growth is +1.45 mb/d.
I interpret this as meaning overall global crude oil demand is forecast to increase next year. In addition, that tight supply-demand scenario we’ve been seeing is also expected to continue in the near-term.
Just one second. Hasn’t the media been reporting slowing economies around the world will translate into slowing demand for crude oil, resulting in lower prices?
I’ve often heard that when the mainstream media in the United States talks about crude oil and “the world,” they’re referring only to the U.S. and the twenty-nine other members of the Organisation for Economic Co-operation and Development (OECD). I suspect it suffers, quite understandably, from something akin to ethnocentrism, the tendency to look at the world primarily from the perspective of one’s own culture.
And just what exactly is taking place with crude oil demand in the real world? Although yesterday’s OPEC report was misconstrued as being oil bearish, Stevenson Jacobs of the Associated Press noted:
The Organization of the Petroleum Exporting Countries said rich nations in 2009 are expected to need only 400,000 barrels a day more oil than this year, whereas demand from developing countries will increase by an estimated 1.1 million barrels, with most of that growth coming from China, the Middle East and India…
While total oil consumption dropped in developed countries by more than 1 million barrels a day as of September over a 12 month period, demand growth from developing countries increased by a daily 1.2 million barrels over the same time, OPEC said.
Looks to me like the rest of the world (non-OECD nations) still have a thirst for that liquid gold. At least for now. Jacobs added:
OPEC’s report comes about a month before the cartel is scheduled to hold a special meeting to discuss ways to deal with oil’s slide, including the possibility of tightening output. OPEC controls 40 percent of the world’s oil supply, though analysts say a cutback in OPEC production likely would not dramatically alter crude’s downward direction.
But it could halt the decline. The Wall Street Journal’s Keith Johnson wrote in the “Environmental Capital” blog Wednesday:
So what’s a cartel to do? Cut production, of course. That’s the plan for the November summit in Vienna. The smart money says OPEC will probably cut production by 1 million barrels per day—on top of the 500,000 barrels it took off the market earlier this fall. Will that be enough?
“At the very least, that should serve to stabilize oil prices,” Paul Tosseti, director of oil market analysis at PFC Energy, a Washington-based consultancy, told us.
Still on the topic of supply, is it just me, or have we forgotten that oil output from existing reserves is dwindling rapidly? It’s not like this fact is a state secret. Consider this:
Worldwide, output from existing fields is falling by as much as 8 percent a year, which means that oil companies must develop up to seven million barrels a day in additional capacity simply to keep current output steady—plus many more millions of barrels to meet the growth in demand of about 1.5 percent a year. And yet, with declining field sizes, rising costs, and political barriers, finding those new barrels is getting harder and harder. Many of the biggest oil companies, including Shell and Mexico’s state-owned Pemex, are actually finding less oil each year than they sell.
As more and more existing fields mature, and as global oil demand continues to grow, the deficit will widen substantially. By 2010, according to James Mulva, CEO of ConocoPhillips, nearly 40 percent of the world’s daily oil output will have to come from fields that have not been tapped—or even discovered. By 2030 nearly all our oil will come from fields not currently in operation. Mulva, for one, isn’t sure enough new oil can be pumped. At a conference in New York last fall, he predicted output would stall at 100 million barrels a day—the same figure Total’s chief had projected. “And the reason,” Mulva said, “is, where is all that going to come from?”
FYI. The above excerpt came from the June 2008 issue of National Geographic Magazine.
This leads us to a very important question:
If crude oil is, or was, in a “bubble,” then where is all the excess supply?
Excess supply seems to be one notoriously-common characteristic of an asset bubble. Think of the housing glut during the U.S. housing bubble, and the dot com bubble of the nineties, where the supply of technology stocks could be expanded infinitely and new stock issues helped push down prices. Back on June 6 on our sister blog Investorazzi.com, I talked about a Bloomberg interview from the preceding day in which Jim Rogers discussed the topic of oil. Here’s what the commodities guru had to say:
I submit to you that most of the people and – I don’t know about most of the people, I shouldn’t say that, but we know that the IEA, the definitive authority on oil has said that the world has an oil problem. The Saudis have told Bush that we have an oil problem. Betty, if there is lot of oil, please, would somebody tell us where it is, so we can all invest in it? The world has a serious oil problem. Now, Betty, that does not mean that oil cannot go down 50 percent. During this bull market since 1999, oil has gone down twice by 50 percent, going down by 50 percent in 2001 and again, in 2000 whatever it was, ‘05 or ‘06. So sure, you can have big reaction in any bull market. But that’s not the end of the bull market. There is no supply of oil unless you – somebody can tell us where the oil is, the bull market in oil has years to go despite new corrections which may or may not come.
Hey, I hate high oil prices as much as the next person. But it appears to me that the over-emphasis on demand in predominantly the United States and OECD countries distorts the big picture for crude oil, which becomes somewhat clearer when supply side issues are factored into the overall equation.
So is the oil “bubble” dead? I’d say, what bubble? I, for one, wouldn’t be surprised if crude oil prices start rising again, and soon.
(Note: The author disclaims any personal liability, loss, or risk incurred as a consequence of the use and application, either directly or indirectly, of any information presented herein.)
Sources:
“Oil below $70 on economic fears, rising U.S. supply”
Polya Lesova
MarketWatch, October 16, 2008
“The Official Demise of the Oil Bubble”
David Gaffen
Wall Street Journal (MarketBeat Blog), October 10, 2008
“Commodity bull run not over yet: Jim Rogers”
New Delhi Television Limited (India), October 4, 2008
“Highlights of the latest OMR”
International Energy Agency (IEA), October 10, 2008
“Oil dips below $75 as OPEC cuts demand forecast”
Stevenson Jacobs
Associated Press, October 15, 2008
“Oil Slide: What Can OPEC Do About Falling Oil Price?”
Keith Johnson
Wall Street Journal (Environmental Capital), October 15, 2008
“World Oil”
Paul Roberts
National Geographic Magazine, June 2008
Sphere: Related Content
