Oil: irrational exuberance [updated 11/27/07]

| November 26, 2007

[UPDATED 11/27/07: Here’s an article from the CNN/Money web site that is raising the same issue: given current supply and inventory levels, there’s not much justification for oil approaching $100/bbl.]

No, I’m not talking about whether or not the Peak Oil phenomenon exists, even though the Wall Street Journal seems to have jumped on the Peak Oil bandwagon, or at least is kicking the tires (haven’t they ever read Julian Simon? Wait — they did!).

What I am talking about is this Foreign Policy interview with energy analyst Fadel Gheit (Oppenheimer & Co.), who says in effect that oil has become a complex financial hedge market rather than a straight supply-and-demand market (emphasis mine):

FP: The International Energy Agency is now saying that it’s really growing demand from China and India, not tight supply, that is driving these high oil prices. What do you make of that argument?

FG: Well, that is also true, but does it change the equation so much that we see oil prices up 60 percent in less than six months? Obviously not. I’ve been in this business for 30 years, and I can tell you, I try to justify $60 oil and I can’t find any plausible reason to think that oil prices should be a dollar above $60, let alone above $90 or $100.

FP: So what about derivatives trading—

FG: That’s exactly what I’m focusing on. I truly believe that major investment banks and a large number of very high-risk-taking financial players have seized control of the oil markets, especially in the last six months. During that time, oil prices moved in one direction and market fundamentals really moved sideways or even lowered. Demand has slowed down significantly. We have seen all kinds of indications that we are reaching a breaking point here. We’ve seen what happened to gasoline margins on the West Coast; they’ve dropped to an almost 18-year low. All this is an indication that something is wrong with the system, that supply and demand fundamentals do not justify the current price. But if the current price is based on speculation, there is no limit to how high oil prices can go. Basically, as long as there is somebody willing to bid higher, the price of the commodity will move higher.

Just great. Read the whole thing. ..bruce..

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Category: 2008 Election, China, Economics, Environment, Geopolitics, Main, Recession Watch, US Politics

About the Author ()

Webster is Principal and Founder at Bruce F. Webster & Associates, as well as an Adjunct Professor of Computer Science at Brigham Young University. He works with organizations to help them with troubled or failed information technology (IT) projects. He has also worked in several dozen legal cases as a consultant and as a testifying expert, both in the United States and Japan. He can be reached at bwebster@bfwa.com, or you can follow him on Twitter as @bfwebster.

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