The Times: Oil price bubble will burst, but fear of shortage remains
By Graham Searjeant
May 29, 2004
ON WEDNESDAY, the markets paused in suspended animation, waiting for that crucial figure. It was not the rate of interest, output, employment or the election result. It was the routine weekly totting-up of petrol and oil stockpiles in America. On this occasion, the statistic was worth traders waiting for.
Instead of rising, as predicted, stocks fell on the week, which had been set up symbolically in advance as the start of America’s summer driving season. This time, at least, the oil bulls were proved right. When routine reports become staged occasions, however, you can be sure that you are in the middle of a speculative bubble.
Share prices have been retreating globally for the past eight weeks. The initial correction stemmed from Americans realising that their short-term interest rates are going up as well as Britain’s. That is a brief effect because, when interest rates revert to normal to reflect better economic conditions, investors switch from bonds into equities.
The more fundamental worry is that oil prices are rising to what had been regarded as “crisis” levels in seemingly normal economic conditions. Brent crude, the benchmark for Europe, has traded at about $10 per barrel above the top of Opec’s $22 to $28 target range.
Demand is stronger than expected, only in part because of the sensational rate of increase in China’s imports. Opec really did underestimate the impact of China and of America’s economic recovery when it agreed to cut quotas by one million barrels per day from April. In reality, however, oil producers have probably raised supplies because many Opec members have broken their quotas to satisfy long-standing customers long before Saudi Arabia and some other producers agreed to raise supplies in June.
The excess demand has come largely from momentum hedge funds and other speculators, who have spread like a computer virus from foreign exchange, traditional commodities and shares to a sector where they can do more general damage. A sustained $10 per barrel rise in crude oil is projected to cut world growth by 0.5 percentage points and oil has triggered two of the worst postwar recessions.
Speculative froth is bubbling on the top of conflict in Iraq. The fear is that terrorists or responses to terrorism could interrupt or cut oil supplies. When bad vibes are about, it is easy to scare people so as to justify market positions. Fear that China’s economy will run off the rails, for instance, has been enough to send metal prices crashing from ridiculous speculative peaks. The putative impact on oil demand is naturally ignored.
At some point, the sooner the better, the oil price bubble will burst and buoyant oil shares will tumble. The message has been buried deep into the psyche, however, that oil discoveries are no longer keeping pace with demand as the sub-continental economies of India and China take off.
Shell’s repeated markdowns of its own reserves show poor management but stem from obsolete rules maintained by the US Securities & Exchange Commission. These were designed for nodding donkey wells in Texas.
Shell has that oil and gas, though it cannot quickly be delivered. Its bigger problem will be lawsuits from self-righteous American share traders. But the apparent “loss” of reserves touched a nerve.
Long after the speculative bubble subsides, oil and other resource stocks are likely to stay in long-term demand. There will almost certainly be another boom in alternative energy shares ranging from genuine winners to those offering little more than the philosopher’s stone. As usual, it should pay to get in early and leave early too.