THINKING OUT LOUD ABOUT OIL….Is oil in a speculative bubble? There are a couple of memes making the rounds on this score: First, that the “real” fair market price of oil ought to be around $70/barrel or so, and second, that the speculative bubble sending the price up to $130/barrel has been fueled by the “Enron loophole,” a measure passed in 2000 that exempted online energy commodity trading from federal regulation.
On the first issue, I’m confused: I have no idea how you’d figure out the “real” price of oil even in theory. I suppose you could make historical arguments about oil prices, or perhaps compare the prices of different forward contracts and look for inconsistencies, but those strike me as the kinds of strategies that can be used to prove whatever you set out to prove. So count me as skeptical that they can tell us very much. At the very least, claiming that $70 is the right price because that’s how much it costs to pump a marginal barrel of oil is silly. If demand increases but nobody has any more oil to pump, then the price will get bid up regardless of the cost of production.
Now, that doesn’t mean there isn’t a bubble. Maybe the global savings glut, which powered the housing bubble, is now being redirected to oil. But unlike housing, where there are analytical tools and historical trends you can use to get at least a sense of whether prices are way above their fundamentals, oil bobs up and down all the time. And since there’s no truly reliable data on how much production capacity the world has (hell, there’s not even any truly reliable data on how much oil is actually produced on a monthly basis), there’s no way of setting any kind of baseline. So who knows?
On the second issue, I’m also confused, though a little less so. But here’s the thing: the Enron loophole has been closed. I can’t quite figure out if it got closed last month or last week (there was a technical glitch with the farm bill it was attached to), but in any case, it’s been closed. It will be several months before the CFTC can actually implement regulation and oversight of online trading, but if this is really a factor in driving up oil prices then even the prospect of near-term regulation ought to have a dramatic effect on speculative buying. But in fact, nothing much has happened lately. Oil prices are down today based on news out of China, but for the most part prices have just jumped around sort of randomly in the $130-140 range over the past couple of weeks. There’s been nothing dramatic at all. So my initial feeling is that the Enron loophole theory doesn’t hold water.
In any case, this is mostly a long-winded way of shrugging my shoulders and saying, “eh.” I just felt like noodling over this stuff in public. Based on my general knowledge of the oil industry and its constraints, I’ve long believed that the steady rise in oil prices since 2003 has been basically driven by supply and demand. But I have to admit that the huge increase over the past five months has had a bit of a bubbly feel to it. Aside from a few interesting tidbits, though, I haven’t really come across much solid evidence to back that up. But I’ll keep looking into it.