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Make way for the next market mania
Jacqueline Thorpe, Financial Post
Even in the depths of the credit crunch in March, Chen Zhao, global investment strategist at Bank Credit Analyst in Montreal, advised clients oil was a candidate for a classic financial mania.
As oil roared nearly US$5 higher to a new record at US$133.72 a barrel Wednesday, Mr. Zhao said that with global growth slowing and supplies relatively stable, there was no economic reason the price should be setting new highs. However, mania could take it higher still, he said.
“Every day the thing is going up,” Mr. Zhao said in an interview. “We know demand is not exceeding supply on a daily basis, no way. It’s got to be something else. It’s definitely a building mania.”
(21 May 2008)
Oil’s No Bubble
Lionel Laurent and Carl Gutierrez, Forbes
Oil’s astonishing rise is becoming a cliché on Wall Street, but the rise is real and will keep going until supply catches up with demand.
“The story of the past month has been the sudden surge demand in China for diesel fuel,” said Jeff Rubin, Chief Economist and Chief Strategist at CIBC World Markets. P ower plants in some areas in China are running desperately short of coal and certain earthquake-hit regions are relying on diesel generators for power.
Rubin stressed, though, that the spike in demand over the past month is only a footnote to the bigger story: “Even at $133, demand hasn’t been reined in, and without a real raise in supply we think it’s ultimately going to go over $200 a barrel.”
In short, this is no bubble …
(21 May 2008)
Oil trading turns contango on its head
Kevin Cook, Stockhouse
Oil prices spike to record highs; front contract worth more in a “backward” market.
As oil continues its meteoric rise, the markets debate the reality of “peak” oil. Peak oil is the idea that we are reaching the end of natural oil supplies. So, some analysts and traders are convinced that oil prices will only go higher because demand will persist in outstripping supply. But, others have pointed to the market itself and noted that if the long-term fundamentals were predicting continued higher prices, then the back month oil future contracts would reflect this.
Well, a shift is starting to occur that may win the argument for the peak camp. Today, as oil hits another new all-time high, above $129 per barrel, the back month contracts are on the rise too. Normally, futures markets for physical commodities will display a “contango” price relationship, where contracts for further delivery are higher than the near months. This is usually a function of a market where oil for future delivery trades at a premium because producers have fixed costs for storage that must be priced into those contracts. But, the last few months have seen markets driven by the demand spikes in the spot and front month contracts. This forced those near contracts higher, while the back months drifted lower. Now that “backward” market is starting to shift back to the more normal contango pricing.
What’s the reason for this shift?
(21 May 2008)
Oil Is Up Due to Fundamentals, Not Speculation
James Hamilton, Econbrowser
I’ve been offering reasons for believing that the flow of funds into commodity investing has contributed to the recent oil price highs. Although I believe this speculation has gotten ahead of fundamentals in the last few months, there is no question in my mind that market fundamentals are the main reason for the broader 5-year move up in oil prices. Here I review those fundamental factors.
The developed economies consume a disproportionate share of the world’s energy, with North America and Europe accounting for about half of the total oil use in 2006. However, it is the newly industrialized countries and oil producers that account for the recent rapid growth in demand, with Asia and the Middle East accounting for 60% of the increase in petroleum use between 2003 and 2006. North America and Europe contributed only 1/5 of the growth.
Particularly dramatic in this growth has been China, whose petroleum consumption between 1990 and 2006 increased at a 7.2% annual compound rate. It’s always amusing to project these impressive exponential growth rates. If that rate of growth were to continue, China would be using 20 million barrels a day by 2020, about as much as the U.S. is today. By 2030, China would be up to 40 mb/d, twice the current U.S. consumption.
… Are such projections plausible from the point of view of potential supply? Not remotely. I do think there are prospects for a significant boost to world petroleum production … At any point in time, some of the world’s producing fields are well into decline, some are at plateau production, and others are on the way up. It is not clear what average decline rate is appropriate to apply to aggregate global production, but a plausible ballpark number might be 4%. That would mean that in the absence of new projects, global production would decline by 3.4 mb/d each year. To put it another way, a new producing area equivalent to current annual production from Iran (OPEC’s second biggest producer) needs to be brought on line every year just to keep global production from falling. …
To summarize, I think we will see some net production gains this year, and expect this to bring some relief for oil prices. But I cannot imagine that the projected path for China above will ever become a reality. Oil prices have to rise to whatever value it takes to prevent that from happening.
So yes, I do believe that speculation has played a role in the oil price increases, particularly what we’ve observed the last few months. But it’s a big mistake to conclude that speculation is the most important part of the longer run trend we’ve been seeing.
(21 May 2008)
Also posted at Seeking Alpha. From the bio on that site:
James Hamilton received his Ph.D. in Economics from the University of California at Berkeley in 1983. He has been a professor at the University of California, San Diego since 1990 and served as Chair of the Economics Department from 1999 to 2002. He is the author of Time Series Analysis, the leading text on forecasting and statistical analysis of dynamic economic relationships. He has done extensive research on business cycles, monetary policy, and oil shocks, and has been a research adviser and visiting scholar with the Federal Reserve System for 20 years.
Previous post: Oil bubble (May 17)
Oil – Is There a Bubble?
Charles Engel, RGE Monitor
… Economics is an inexact enough science that we can’t know whether $125, or $60, or $200 is the right price based on fundamentals. I don’t know one way or the other what the right price of oil is, but what I don’t understand is the steady increase in the price of oil. How can an asset such as oil consistently pay such a high return?
Adding to the puzzle is the fact that the futures price has consistently underpredicted the rise in the price of oil over the past several years. If the futures price reflects mostly the market’s anticipation of the future spot price, how is it that the market has been fooled over and over for so many years?
One possible explanation is that the market has kept learning about the strength of demand and the weakness of supply over the years. It is consistently being surprised, in other words. That may be right, but it is a shaky argument: why is the market always being surprised in the same direction – that excess demand is greater than we thought?
Another story that I think makes some sense is the one that Jeffrey Frankel and Jim Hamilton have promoted – that Fed monetary policy has played a role. As I noted at the outset, a drop in real interest rates should cause commodity prices to rise. But here again, the decline would also have to be unanticipated to explain the continual increase in the price.
I think there is a lot of truth to the view that markets keep getting surprised in the direction that makes oil prices higher. We have been surprised at the growth in emerging markets, the shortfall in supply from some countries (such as Iraq), and the continuing low real interest rates. On the other hand, it seems to me that rising prices are also typical of frothy markets (like the housing market of late.) In fact, the steep rate of increase could even be a “rational bubble”. The rate of increase of the price is so high, perhaps, because the market is incorporating a probability of the bubble popping and prices falling back down to earth.
… The problem for economists is that the market for oil is so complicated that we cannot very accurately calculate what the price of oil “should be” if there is no bubble. We have to read the entrails to figure out whether the price is really reflecting market fundamentals – demand, supply, real interest rates – or has a bubble component. As I look at the rising price, I wonder which story is most plausible: (1) the markets have been surprised over and over about demand by end users and production capabilities; (2) markets have been surprised over and over about how low real interest rates are; (3) there is a bubble. These stories may go together, in fact. Indeed, it is hard to see how a bubble could get started all by itself, or how it could go on for a long time before it popped. In the previous asset price bubbles I mentioned above, it seems as though fundamental economic causes set off the rise in asset prices. But it looks like the bubble traders were inspired by the price increases to bet on further increases in prices, even when there was little evidence that the price needed to rise more based on fundamentals. It’s as if the fundamental traders normally keep the bubble traders at bay. But a series of shocks to the fundamentals in the same direction seem to undermine the confidence of the fundamental traders and give the bubble traders the upper hand. In any case, if either (2) or (3) are true, we might see oil prices coming down in the future, as real interest rates return to more historic levels, or as the bubble bursts.
(19 May 2008)
Recommended by James Hamilton at Econbrowser.
Bio (“Charles Engel is Professor of Economics at University of Wisconsin. He is also a Research Associate at the National Bureau of Economic Research and a Senior Fellow of the Globalization and Monetary Policy Institute at the Federal Reserve Bank of Dallas. …”)
