Economic bubbles don’t widely reveal themselves until they burst. The bubble in technology stocks was apparent to former Federal Reserve Board Chairman Alan Greenspan in December 1996, yet that didn’t stop investors from bidding up tech stocks to stratospheric levels for three more years. They were in bubble denial, having convinced themselves that the tech revolution meant the normal rules of supply and demand just didn’t apply anymore.
You know what happened.
This leads us to wonder whether there is an oil bubble.
Columnist Steve Chapman argues on today’s Commentary page that oil prices are likely to see a significant decline. We’re going to agree with him. This has the look of a bubble.
Oil prices have more than doubled over the last year, from the mid-$60s to last week’s record of $135 a barrel. What accounts for this phenomenal rise? Is it all due to soaring demand amid finite supply?
Rising demand for oil, particularly in fast-expanding China and India, is a factor in higher prices. So are geopolitical jitters that spike whenever supplies are disrupted by pipeline bombings in Nigeria, insurgent explosions in Iraq, populist rumblings in Venezuela, refinery fires and hurricanes in the U.S.
The world may someday run out of oil; nobody knows for sure when that day will arrive. That plays a role. So does the declining value of the dollar because oil is priced in dollars. A falling dollar makes oil cheaper to overseas investors. Those who buy oil as a hedge against inflation bid up the price when the dollar falls.
All of those are real factors in oil’s stupendous rally. But they were economic factors when oil was selling for $65 a barrel a year ago. China’s rise? Check. Falling dollar? Check. Geopolitical jitters? Check. Finite supply fears? Check.
Now consider this: Global demand for oil has dropped slightly over the last year. Thanks to high gas prices, the U.S. is on pace to see its first annual drop in gas consumption in 17 years. The Persian Gulf “remains crammed with supertankers chartered by oil-producing countries to hold the inventories of oil they are pumping but cannot sell.” pointed out columnist Anatole Kaletsky in the Times of London last week. “There are few buyers for physical oil cargoes at today’s prices, but there are plenty of buyers for pieces of paper linked to the price of oil next month and next year.”
That suggests something other than the supply-demand curve is at work.
Is there an oil bubble? Renowned billionaire investor George Soros declared it so last weekend. But doesn’t mean the price rise is over. When investors are gripped by a frenzy, they don’t let the facts get in the way.
Greenspan warned of “irrational exuberance” three years before tech stock prices collapsed. The housing bubble defied reality even as subprime securities started to turn toxic. The news that oil supplies are adequate and demand is dropping won’t send prices down … until it does. Then investors will survey the damage, thump their foreheads and wonder what they were thinking.
That’s bubble theory in a barrel.
