Bill Jamieson says: An oil bubble ready to burst
Published Date: 17 June 2008
By Bill Jamieson
Bill Jamieson looks at whether the end is near for soaring prices.
FOR the past 18 months economies worldwide have been at the mercy of the
biggest ever commodity price boom. The benchmark CRB commodity index rose 15%
in the opening three months of this year, eclipsing moves in the Seventies..
Oil has led the advancADVERTISEMENTe with a doubling of the price in barely a
year.
The boom has combined with a global credit crunch to create a massive policy
crisis for governments and central banks. Little wonder that the commodities
boom, along with record oil prices, inflation and the wavering dollar are
centre stage of the G8 summit this weekend in Japan. This killer combination is
driving the world's most powerful economies towards a painful and extended
slowdown – and with pressure on central banks to raise interest rates, not cut
them. Inflation in America rose 0.8% last month to an annual rate of 4.2%.
The boom, in the eyes of a growing number, has come to resemble a speculative
bubble. And they warn that like all bubbles before it – emerging markets in the
Eighties, technology and internet stocks in the Nineties, house prices in the
US and Britain in the past six years – it will end in bust.
Paul Walker, of GFMS metals and mining consultancy, believes so. He says we are
seeing a "last hurrah" in commodity markets – a final surge upwards in prices
as the credit crisis lurches towards its conclusion – and that we will see a
severe retrenchment of prices as financial markets recover.
The US Commodities Futures Trading Commission suspects so too. It has been
probing how agricultural commodities are traded and pondering moves that could
curb financial speculation in grains, soy beans and other foodstuffs. It has
also launched inquiries into the recent heavy speculative activity in oil
futures.
So why hasn't the bubble burst before now? There are two problems with the
'bubble' thesis. One is that there has always been speculative activity in
these markets and that warnings of a bust have been around for a long time.
How long can the oil price stay above $130? The supply-demand fundamentals do
not explain the sharpness of the ascent this year – 60% since January. Nor does
it make any allowance for the reaction of the end consumer. Stockbrokers
Charles Stanley estimate that oil speculators have amassed 1.1 billion barrels
of oil, more than eight times the amount added by the US to its strategic
reserve, making them the largest single influence on oil-related commodity
futures trading. William Enghadi, research associate at the Centre for Research
on Globalisation, conservatively estimates that "at least 60% of today's crude
oil price comes from unregulated futures speculation by hedge funds, banks and
financial groups".
It would be wholly wrong to suggest that speculative activity in the futures
market is solely or even mainly to blame for the spectacular rise in oil. But
it has certainly exaggerated the price trend in recent months. One
characteristic of a pending bust is when the price of a share or commodity
becomes a national – or supra national – obsession. That is certainly the case
now, with riots across Europe and Asia and haulier protests and blockades in
the UK.
It doesn't necessarily follow that prices then automatically behave in the
manner that presidents and finance ministers would like. But a growing
determination to see a firmer dollar would certainly help drive the oil price
down. And the key factor most likely to make speculators switch positions is
already evident: an adverse market response to an ever higher price.
There are signs that the commodities bubble may already be bursting in some
areas. Prices for wheat and rice have come off the boil. Nickel prices have
fallen by 25% since mid March.
The economies of the oil consumers are now slowing and oil demand falling as
businesses and households cut back.
At the same time, governments in developing countries that have been operating
price subsidies to shield consumers from the full impact of fuel price rises
have been forced to lower or withdraw these subsidies in a move that will hit
demand hard. Longer term, oil demand will be further hit by the accelerated
push towards alternative energy sources.
Falling oil demand is every inch as fundamental a consideration as constraints
on supply. With clear signs of a slowdown in both developed and developing
country economies, the likelihood of oil rising much above current levels looks
ever more stretched. Meanwhile oil companies have a greater incentive to step
up exploration and development that will in time boost supply.
The more these two reactions become evident, the greater the likelihood traders
will turn speculative long positions into short ones – betting on a price fall.
Expressions of concern at G8 summits and regulatory attention by the US
authorities will not in themselves have much effect. But allied with consumer
cutbacks, they could mark the turning of the tide. The bursting of the bubble
will ease matters greatly. But it will mark an epochal shift, from a prosperous
era to one altogether more chastened.
