Tuesday, May 20, 2008

Oil bubble? Economists wonder

James Hamilton at Econbrowser:
I do not believe that speculation is the reason oil went from $60 to $120 a barrel. The biggest part of that longer term trend is due to fundamentals, not speculation. Notwithstanding, it does appear that speculation has gotten ahead of those fundamentals in the most recent developments.

For the bubble to continue, we would need to see ever-increasing volumes of investment money pouring into the futures markets, and continuing stagnation in global production to ratify them. Even if the former occurs, my best guess is that the latter will not.

Charles Engel at RGE:
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.

Paul Krugman:
If the price is above the level at which the demand from end-users is equal to production, there’s an excess supply — and that supply has to be going into inventories. End of story. If oil isn’t building up in inventories, there can’t be a bubble in the spot price. ... So my challenge to people who say there’s an oil bubble is this: let’s get physical. Tell me where you think the excess supply of crude is going.

Arnold Kling at EconLog
I do not believe that the oil price today reflects a bubble. So in that respect, Krugman and I are not on opposite sides. Nonetheless, I do think that his model of the oil market has some strange properties.

Krugman ignores two elements of the oil market. Explictly, he ignores forward prices. Implicitly, he ignores the decision by producers either to pump oil or keep it in the ground.

UPDATE: More from James Hamilton.



Anonymous Dubai Entrepreneur said...

And Arnold Kling is ignoring refinery capacities. When GW Bush went to Saudi and asked them increase their oil supply, the Saudis responded by increasing production by 350,000 barrels/day. In the grand scheme of things, this increase is symbolic more than anything. It's not that the Saudis don't want to help the Americans (that is irrelevant here). The matter of the fact is, production capacity is just not there!

So I would have to say that I would agree with Krugman. I don't think forward prices alone can be responsible for a bubble (or sustaining one).

2:49 PM  
Anonymous Anonymous said...

great posts lately on commodities, etc.



7:30 PM  
Anonymous speculator said...

When everybody is saying the fundamentals of a situation have changed, we have reached bubble territory. Fundamentals don't change in the course of a few years, they change over time, and im talking decades of moderate change. Oil didnt evaporate and demand didnt peak in the course of a couple of years. There are oceans of untapped oil reserves in the ground in a variety of different countries, but who cares about exploring extraction if there is no economic reason to do so.

China and India will begin to moderate oil intake because it is in their best interest to do so; they are already in the process of building reactors and the majority of the oil they use goes to energy production. China and India are also looking down the nose of a population shortfalls because of past decisions they have made in regard to childbirth regulation, as well as the fallout of their current "industrial revolution" society (use Europe and the U.S. as your paradigmatic reference for that). Oil will bust as demand starts to wane, mainly due to the beginning of a short global recession. Demand will definitely wane over the long term as third world countries approach first world status and populations decrease. That doesnt even take into account shifting to nuclear power in the United States and alternative energies that have finally come to a tipping point in most of the industrialized world.

Believe it or not there is a bubble right now, wait till demand actually adjusts and we end up with huge surpluses like there were in the late 1970's. This time there might not be people to buy up the excess at "normal" prices on the other end of it.

8:11 PM  

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