Do we have an oil bubble?

[Supercilious]

I've been convinced for quite a while there is an bubble. Peak Oil is real but we are not yet there. (Peak oil is the point after which the oil production decreases regardless the number of new drills, new technologies employed and and new fields discovered).

Every umtpteenth attack in Nigeria or Israeli-Iranian exercise in rhetoric escalation is used to scare the market into a permanent $1-5 increase in the oil price.

I'm trying to model the oil bubble starting from the premises of the housing bubble (because bubbles are based on the deception that "this time is different", when, in reality, it is always the same).

My working model is based on the concept of a financial love triangle:
#1 The fed keeps selling treasury paper in order to keep the bad spending habits in fashion and generate profits in #3
#2 The central banks of mercantilist countries (with China the main culprit) gulp quickly all that deluge of T-bonds (in order to maintain their currency pegs) and try to recycle it into higher return investments or hedge against soaring prices of energy and other commodities (price increases which are making manufacturing and basic subsidies painful or unsustainable).
#3 Wall Street investment banks and commodities funds take the influx of recycled T-bonds from #2 and, for nominal fee, they blend it with some of their own excess of bad debt paper and invest it in (oil) futures, basically selling to EM's central banks (from #2) some sort of funny futures based paper (some equivalent of subprime CDO's but the low risk of investment is justified by the premise of never ending increase of commodities/oil prices). Of course, WS banks always make a good profit by selling worthless (but good looking) paper, and besides that, they create another bubble i.e. another money destruction bonfire, which allows the Fed to sell more government securities (as explained in #1) and continue the cycle.

The big problem comes when I'm trying to put numbers into my contraption. I cannot find a realistic set of data that explains the low levels of (physical) oil inventories when oil price is soaring.

Only when the sales of futures structured paper (produced in #3 by Wall Street) has a logarithmic growth, the price of oil can be driven up only by futures contracts without any increase in oil inventories. Such a premise leads to dramatic numbers so I don't think it's realistic ...

Maybe there is another way to explain it, but I couldn't find it ... yet...:mad:

Anyway ... I'm stuck ... so I decided to take a break from models and math, to search for evidence of an oil bubble elsewhere...

In only 10 minutes of Internet search (who needs math when we have Google? ), I found irrefutable evidence that there is indeed an oil bubble.

Judge for yourselves:

1-Oil in reality TV shows (remmeber those RE reality shows?).
http://www.dallasnews.com/sharedcont...1.4db7317.html

The reality-TV formula for the producers of Deadliest Catch and Ice Road Truckers is simple: Chronicle the lives of people who work in extreme conditions for big payoffs. Tonight, the scene moves from the frigid seas and icy plains to the West Texas heat and dust. Black Gold, which debuts at 9 on TruTV, follows the lives of three drilling operations hoping to strike it rich.

If oil becomes the subject of reality TV shows there must be a bubble :p

2-The emergence of the belief that only God can produce a miracle and bring the oil prices down:
http://toledoblade.com/apps/pbcs.dll...WS10/806200333

"We've tried everything and just nothing seems to be working, so we're going to ask God to intervene and help us overcome this terrible crisis," said Rocky Twyman, founder of the Pray at the Pump Movement.
[...]
Mr. Twyman designated today, the day before the official start of summer, as "National Pray Down the High Gas Prices Day." His group is asking prayer warriors of all religious traditions to join hands at their local gas stations to pray at 9 a.m., noon, and 5 p.m. Since Mr. Twyman founded the Pray at the Pumps Movement in April, he has led groups in praying and singing at gas stations in Baltimore, Washington, and San Francisco.

3-Biblical interpretations are now used to create public traded oil exploration companies (read, view and laugh )
http://www.zionoil.com/

4-The strongest of all .. the argument that never fails: The French have already surrendered... to high oil prices ....

http://online.wsj.com/article/SB1215...googlenews_wsj

AIX-EN-PROVENCE, France -- Renault SA Chief Executive Carlos Ghosn said Saturday the company is getting ready to mass produce electric cars to offset rising energy prices.
"We're getting ready for mass production of electric cars," Mr. Ghosn said at an economic conference in the southern French city of Aix-en-Provence. "Energy will remain expensive."

I rest my case :cool:

[Guest]

Re: We have an oil bubble : the proof

Quote:

"We've tried everything and just nothing seems to be working, so we're going to ask God to intervene and help us overcome this terrible crisis," said Rocky Twyman, founder of the Pray at the Pump Movement. ... Since Mr. Twyman founded the Pray at the Pumps Movement in April, he has led groups in praying and singing at gas stations in Baltimore, Washington, and San Francisco.

This sort of display must leave the rest of the world sorely tempted to conclude that our entire nation have succumbed in herd like fashion to mad cow disease. God created us to think for ourselves, not to abdicate thought. But "thought abdication" seems an increasingly popular component of American society when distressed by circumstances. We also happen to be the worlds biggest energy hogs, and a correction of that habit could to some extent alleviate this early fuel distress? Altogether a pathetic display of abject regression - seems almost like some form of animistic religion at work here (group prayer at the gas station??). This man needs a few vigorous administrations of the "boot in the derriere" therapy to wake up to the issues overtaking his world.

[Master Shake]

Re: We have an oil bubble : the proof

Quote:

We also happen to be the worlds biggest energy hogs, and a correction of that habit could to some extent alleviate this early fuel distress? Altogether a pathetic display of abject regression - seems almost like some form of animistic religion at work here (group prayer at the gas station??). This man needs a few vigorous administrations of the "boot in the derriere" therapy to wake up to the issues overtaking his world.

What makes you say that we are the world's biggest energy hogs? The irrelevant metric "per capita oil consumption?"

What is pathetic is that we have put ourselves in the situation intentionally: no new nuke plants for about three decades, no new refinieries in the same period, putting exploration and development off limits because of specious or exaggerated environmental concerns, allowing private legal action to hold up the building and development of new power plants, transmission lines, etc, forcing power plants to shift from coal to natural gas or oil. Need I go on?

No doubt the dollar's fall has much to do with rising energy costs, as does the indutrialization of the Third World, specifically China and India. But, we've brought a lot of problems on ourselves by hamstringing our our energy infrastructure. We're not energy hogs so much as energy naifs. The average American thinks his gasoline comes from filling stations and his food from supermarkets. We're waking up from that fantasy land. Maybe we'll do something about it rather than demonize oil company execs. However, if you're looking for a scapegoats, you need look no farther than the environmentalist movement.

[FRED]

Re: We have an oil bubble : the proof

Oil is not a bubble. See: Peak Cheap Oil Diaries: Anatomy of a collapsing government sponsored oil anti-bubble

• Oil is not “too expensive” now, it was “too cheap” before
• Global central banks, by inflating the value of the dollar since 1971, distorted the oil market for decades, exaggerating oil demand, and causing over-consumption and rapid depletion
• Soon after the start of the Iraq War in 2003, markets began to reassert control of oil prices as US political influence waned
• As the housing and other FIRE Economy asset bubbles markets started to deflate in 2006, markets began to wrest control of the dollar's exchange trade value from the weakened dollar cartel we know as global central banks
• Now we have too many dollars and not enough oil
• Ten reasons why oil cannot ever be an asset price bubble

[Supercilious]

Re: We have an oil bubble : the proof

Oil is not a bubble. See: Peak Cheap Oil Diaries: Anatomy of a collapsing government sponsored oil anti-bubble

It's hard to argue with your views since I don't have access at premium content.:p

However I can agree with this part

• Now we have too many dollars and not enough oil

with only minor modifications:

Now we have too many dollars seeking a safe and profitable investment in oil futures and not enough oil to have a price discovery process based on physical supply and physical demand.

Anyway, this is a news post examining public perceptions, and the four Google arguments are hard to disprove :p

[Supercilious]

Re: We have an oil bubble : the proof

http://www.bloomberg.com/apps/news?p...d=aLB5zfASo8NY

Oil Is Steady Near Records as Investors Seek Stocks Alternative

July 4 (Bloomberg) -- Crude oil traded little changed near records above $145 a barrel as investors purchased commodities as an alternative to flagging equities markets.
Oil has set new highs the last three days as money managers bought futures, shunning stocks as global equity indexes fell for a fifth week. Crude may rise further next week, according to analysts surveyed by Bloomberg.

Building up market value based on the self enforcing belief that the value of the product has no other chance than to continuously increase = bubble

Tulips, dotcom stock, houses and oil now, it is always the same. Even the seemly solid argument that "this case is different" is always the same.

[FRED]

http://www.bloomberg.com/apps/news?p...d=aLB5zfASo8NY
Building up market value based on the self enforcing belief that the value of the product has no other chance than to continuously increase = bubble

Tulips, dotcom stock, houses and oil now, it is always the same. Even the seemly solid argument that "this case is different" is always the same.

First of all, welcome to iTulip. You are asking a question we get often: Is oil a bubble?

If you define a "bubble" as a big increase in price, then, yes, you can call oil a bubble. But then you'd miss the whole point. That's like saying Moby-Dick is a book about a whale.

We have been covering asset bubbles here for over ten years. Recommend you read The Next Bubble for a primer.

No question there is speculative activity in the oil market, and of course prices never go up forever, but inflation in oil prices is fundamentally different from inflation in dot com stocks and home prices. As explained in the article linked to before:

1. Oil is not a financial asset backed by a security sold by Wall Street
   
2. Lack of artificial scarcity created via inflation
3. Unlike dot coms and houses, oil is the most essential commodity in a developed economy and is without substitutes
4. Oil price appreciation is not a self-reinforcing price appreciation process, but rather is self-limiting (leads to falling demand)
   
5. No new source of credit has been created to finance oil purchases (No oil CDOs)
   
6. No government deregulation (No change in government regulatory environment fueled the oil bubble; policy has been a constant)
   
7. No new tax incentives (No new tax laws lowering capital gains taxes on oil investing ala 1986 tax relief act)
   
8. Lack of enforcement of securities law or other market regulations (No instances of market regulators looking the other way while laws are broken)
   
9. No bubble psychology (No "I'm going to get rich in oil" psychology. Every year since 2004 it's "The oil bubble will burst soon.")
   
10. Press negativity (The business press has talked down oil prices and investing unlike the dot com and housing bubbles which the business press talked up.

Oil prices have been confounding "bubble" prognosticators for over four years.
Our last example is George Soros who called oil a bubble at $110 March 2008. Oil closed over $144 on Friday.

There is no question a lot of fund money has been flowing into commodities and out of stocks and bonds. That's because the government response to the credit crisis that is following the collapsing property bubble is to reflate; the reflation is wrecking the dollar, and the weak dollar is creating an inflation spiral. Investors are desperately trying to preserve the purchasing power of their wealth.

Bubbles tend to be positive investment phenomena that benefit the government and a small group of insiders. The public goes along for the ride later in the process. Investors thought they were going to get rich in dot coms and houses but every fund dollar that goes into oil is scared of the loss of purchasing power of all other asset classes.

As for Peak Oil, here at the tulip we have the concept of Peak Cheap Oil that predicts that years before global oil output actually begins to decline that oil prices will rise and keep rising as the futures markets begin to price in future increases in spot prices. This appears to be what has been happening since 2004.

Hope that helps.

[jtabeb]

Re: We have an oil bubble : the proof

What makes you say that we are the world's biggest energy hogs? The irrelevant metric "per capita oil consumption?"

What is pathetic is that we have put ourselves in the situation intentionally: no new nuke plants for about three decades, no new refinieries in the same period, putting exploration and development off limits because of specious or exaggerated environmental concerns, allowing private legal action to hold up the building and development of new power plants, transmission lines, etc, forcing power plants to shift from coal to natural gas or oil. Need I go on?

No doubt the dollar's fall has much to do with rising energy costs, as does the indutrialization of the Third World, specifically China and India. But, we've brought a lot of problems on ourselves by hamstringing our our energy infrastructure. We're not energy hogs so much as energy naifs. The average American thinks his gasoline comes from filling stations and his food from supermarkets. We're waking up from that fantasy land. Maybe we'll do something about it rather than demonize oil company execs. However, if you're looking for a scapegoats, you need look no farther than the environmentalist movement.

In this rebuttal we have even more "thought abdication" .

It's like McDonalds, I'm lovin-it!

How bout oil refiners INTENTIONALLY creating a bottle neck in refining since the last oil crises. I'm sure the environmentalists didn't set out to be unwitting pawns of the oil companies. but it sure did turn out that way.

You have a point, and I stress "a" point, but THE point is much bigger and invasive than your single aspect analysis portrays.

Go listen to some Dr. Hudson interviews and educate yourself whydoncha?

[Olduvai]

Re: We have an oil bubble : the proof

http://www.bloomberg.com/apps/news?p...d=aLB5zfASo8NY
Building up market value based on the self enforcing belief that the value of the product has no other chance than to continuously increase = bubble

Tulips, dotcom stock, houses and oil now, it is always the same. Even the seemly solid argument that "this case is different" is always the same.

There will be speculation but far less then with housing, dotcom etc. for the simple reason that for an average person it is not possible to invest easily in future oil deliveries. The bubble, if there is any worth mentioning, is made by the few participants in this trade and not by the public.

Secondly it is a known fact that there are no big oil stocks (just floating oil tankers for example) in the world waiting for the prices to rise.

Thirdly housing, dotcom etc. are all non essential goods (you don't need to buy a house as renting was/is possible) whereas fossil energy is the commodity without which everything comes down. You have to buy, you can't say i'll wait untill prices come down because then your economy stops. There will be a speculation effect but i doubt it's more than 15%.

So i'm afraid the US has to change it's lifestyle as the average US-citizen uses 3 times as much fossil energy as the average European.
I wouldn't gamble on any future oil price decline whether we are at peak oil or just approaching it. Fact is oil prices will rise due to decling oil findings and ever increasing demand until they will kill demand after which a plateau will emerge (my guess inthe range of $250-$300).

The good thing is that the average European already pays the equivalent of $300 (taxes) and still drives around allthough in a smaller car and less mileage. It'll take the US some adapting and sure it will hurt sometimes but it won't be the end of the world if appropiate measurements (public transport, living closer to work, smaller cars, fridges, smaller housing) are taken by the US in time.

What will happen in 50 years without changes to sustainable energy is another problem. Don't bet on uranium as known reserves are just enough to keep current numer of reactors going for this period.

M3, that's the real problem at this moment.
Transferring society to sustainable energy forms will be the next.

[jtabeb]

Re: We have an oil bubble : the proof

No new source of credit has been created to finance oil purchases (No oil CDOs)

Sorry FRED, I'm gonna have to strenuously disagree on this one. Have you noticed that the FED has been taking all this bad colateral lately vs JUNK and providing the firms that mortgage this junk to the fed pristeen treasuries in the their place. What do the firms then DO with those treasuries?

Sit on them for the yield? Nope, gotta pay the fed back w/interest.
Loan people money? Nope, too risky.
Loan other institutions money? Nope, see above.
Use the proceeds to speculated in the oil futures market? That sounds plausible don't you think?

If you haven't noticed, the OIL price has gone ballistic since the FED started the Alphabet soup of lending facilities.

Is this proof positive, no. But I sure as hell know a rotten egg when I smell one.

I think what has made this possible is constrained supply. In the past OPEC could just punish oil speculators by dumping oil onto the market, I think that they have lost this ability (to flood the Market if needed).

So I would argue it is a bubble in the classic sense, great fundamentals get blown way out of proportion.

How will it end? I'm guessing we see a year or 18 months more of this ballistic behavior before there is so much demand destruction that we get a classic crash. (there won't be any MORE daily oil output than we have today, but the excess between supply and demand will be huge and that will be a huge hair cut on the price. The interesting thing is that this crash may well occur as hit peak decline, which would be really, really interesting.


Just to ensure my position is not misstated by others, here is my exact take.

Oil Bubble? Yes!
Peak Oil? Yes!
Hyperinflation? Yes!
New US currency sometime soon? Yes!

FREAKING BUTT UGLY PROCESS? You BET!

If it's all fun and games till someone looses an eye, well, you are about to see a bunch of pissed off one-eyed folks looking for vengance in the near future. (BTW most of these folks are armed to the teeth)

It's gonna be crowds with torches and pitchforks when this is all said and done.

Should be interesting times.

[GRG55]

Re: We have an oil bubble : the proof

In this rebuttal we have even more "thought abdication" .

It's like McDonalds, I'm lovin-it!

How bout oil refiners INTENTIONALLY creating a bottle neck in refining since the last oil crises. I'm sure the environmentalists didn't set out to be unwitting pawns of the oil companies. but it sure did turn out that way.

You have a point, and I stress "a" point, but THE point is much bigger and invasive than your single aspect analysis portrays.

Go listen to some Dr. Hudson interviews and educate yourself whydoncha?

When Hudson publicly states he has some of his own money on the line in a refinery investment I'll start to take his ranting about that industry seriously. Until then be assured that, although I have learned a great deal from his writings, and iTulip's analysis of same, he doesn't know shzt about the business of refining.

[FRED]

Re: We have an oil bubble : the proof

EJ writes in:

If one learns nothing else from their 10 years at iTulip it is this: all asset bubbles are mean reverting.

We said that about the NASDAQ in 1999 and we said that about housing in 2005. Now we are saying this principle does not apply to oil.

Will oil prices "revert to the mean"? What is the "mean" oil price?

It is an absurd question.

There can be no "bubble" in a non-renewable commodity, one that is consumed and especially one that is the heart of the global economy. You can have a gold bubble as occurred in 1980 because gold is not consumed.

There is no mean oil price to revert to.

Oil price problems are money value problems.

Since 1971 the oil price is the flip side of dollar purchasing power.

We warned in 1999 that the paper dollar standard was going to end within the next ten years. Time's up.

The dollar peaked in 2001 just before the start of the Iraq War.

Bottom line iTulip position on oil:

We are not witnessing a "bubble" in oil but rather the end of the dollar bubble that started in 1971 and peaked during the tech stock bubble in 2000. Barring some unforeseen political arrangement, the positive distortion of dollar value created via the cooperation of global central banks since 1980 to inflate the value of the currency in which oil is priced, if you want cheap oil in the future you will need to either live in a country that produces more oil than it consumes or one that is able, politically and militarily, to extort oil in exchange for another irredeemable national "reserve" currency. Maybe the Europeans can do it with the euro, but we doubt it.

[GRG55]

Re: We have an oil bubble : the proof

EJ writes in:

If one learns nothing else from their 10 years at iTulip it is this: all asset bubbles are mean reverting.

We said that about the NASDAQ in 1999 and we said that about housing in 2005. Now we are saying this principle does not apply to oil.

Will oil prices "revert to the mean"? What is the "mean" oil price?

It is an absurd question.

There can be no "bubble" in a non-renewable commodity, one that is consumed and especially one that is the heart of the global economy. You can have a gold bubble as occurred in 1980 because gold is not consumed.

There is no mean oil price to revert to.

Oil price problems are money value problems.

Since 1971 the oil price is the flip side of dollar purchasing power.

We warned in 1999 that the paper dollar standard was going to end within the next ten years. Time's up.

The dollar peaked in 2001 just before the start of the Iraq War.

Bottom line iTulip position on oil:

We are not witnessing a "bubble" in oil but rather the end of the dollar bubble that started in 1971 and peaked during the tech stock bubble in 2000. Barring some unforeseen political arrangement, the positive distortion of dollar value created via the cooperation of global central banks since 1980 to inflate the value of the currency in which oil is priced, if you want cheap oil in the future you will need to either live in a country that produces more oil than it consumes or one that is able, politically and militarily, to extort oil in exchange for another irredeemable national "reserve" currency. Maybe the Europeans can do it with the euro, but we doubt it.

"Europeans" and "militarily" would seem nearly mutually exclusive, based on recent history...

[metalman]

Re: We have an oil bubble : the proof

"Europeans" and "militarily" would seem nearly mutually exclusive, based on recent history...

30 yrs after 1971 were fun, except for the vietnam war and a few other inconveniences. choppy these past 8. the next 10 will be at least as ugly for the usa as the 1970s were for uk when the imf had to bail 'em out. oh, and they did find north sea oil.

[Supercilious]

Re: We have an oil bubble : the proof

First of all, welcome to iTulip.

Thank you for welcome. I found this place after I've read "The Next Bubble"

I appreciate you took time to provide me with a detailed answer.
As a skeptic I have though few remarks to make

Oil is not a financial asset backed by a security sold by Wall Street

Houses are not a financial asset backed by a security sold by Wall Street either. I agree though that the term of oil bubble may be incorrect. Maybe we should call it a commodities futures bubble.

Lack of artificial scarcity created via inflation

For a skeptic this argument can go both ways.

Unlike dot coms and houses, oil is the most essential commodity in a developed economy and is without substitutes

This is an exceptionalism argument. In every bubble there is a widespread belief that "this time is different", but it is always the same.

Oil price appreciation is not a self-reinforcing price appreciation process, but rather is self-limiting (leads to falling demand)

In countries with no subsidies for energy there is already a fall in demand, but that is valid for physical oil: the value of paper oil is the perfect candidate for a self-reinforcing appreciation process.

No new source of credit has been created to finance oil purchases (No oil CDOs)

As a skeptic on this one I would rather agree with jtabeb.

No government deregulation (No change in government regulatory environment fueled the oil bubble; policy has been a constant)

I think that what is called in popular culture the Enron Loophole was introduced in 2000 and the Swaps Loophole came in 2006.

No new tax incentives (No new tax laws lowering capital gains taxes on oil investing ala 1986 tax relief act)

Where there any tax incentives playing an important role in the housing bubble?

Lack of enforcement of securities law or other market regulations (No instances of market regulators looking the other way while laws are broken)

Again the voice of skepticism: Enron and Swaps loopholes

No bubble psychology (No "I'm going to get rich in oil" psychology. Every year since 2004 it's "The oil bubble will burst soon.")

I'm skeptic about that too:
http://www.sfgate.com/cgi-bin/articl...BU5U11GF75.DTL

The retirement savings of workers across the country, entrusted to pension fund managers, are being plowed into one of the few investments that has delivered phenomenal returns in recent years. For decades, futures contracts were mostly traded by commodity producers [...]

The only investment offering phenomenal returns are oil futures ... this sound like bubble talk to me, but maybe I'm too skeptic.

Press negativity (The business press has talked down oil prices and investing unlike the dot com and housing bubbles which the business press talked up.

I'm skeptic about that too with respect to direct application of the press role. The press has been a bullhorn for catastrophic and peak-oil scenarios reinforcing the idea that the days of cheap oil are over and the permanent huge increase in oil process is inevitable. Scare tactics are used in bubbles too.

As for Peak Oil, here at the tulip we have the concept of Peak Cheap Oil [...]

I completely agree with the concept of Peak Cheap Oil. But I am a skeptic and I like numbers. The most expensive method for large scale production of oil uses tar sands. It's almost a marvel of engineering and technology: mining the tarsands, separating the bitumen from sand and upgrading the bitumen to high quality synthetic crude.

My problem with the application of Peak Cheap Oil to the current prices of $140+ is that the cost of making one barrel of synthetic high quality oil is somewhere in between $18 and $35 (depending on who you ask )

If the cost of producing one barrel of the most expensive kind of oil is, let's say, around $27, how can one could justify prices of $140+ as being a result of Cheap Peak Oil?