Oil Boom Turns to Bust

In May I wrote the following:

In January 2007 oil was at $50 barrel; in May 2007 it was at $60. Today, May 21, it traded at $134. So in a period of 1 year it the price of oil has more than doubled. In 16 months it has nearly tripled.

When prices rise quickly in a very short time you are in a bubble. It doesn’t matter whether you are talking about commodities, internet stocks, or tulips. When you have the feeling that you are on a rocket and the only way to go is up, then you are actually standing on the surface of a bubble. And bubbles always burst.

I even went so far as to predict that the oil bubble would burst the last week of July. As far as an educated guess goes, I wasn’t that far off the mark. Oil peaked on July 11. Oil is trading as I write, October 10, 2008 at $77.32 - a 47% decline from it’s high.

What happened? Several things. First demand slackened and the dollar strengthened. These two factors caused speculators to realize that the downside of oil was greater than the upside. As money started to flow out of the commodity, investors expecting the price to rise were forced to cover their positions. This lead to the slow deflation of the bubble until the last weeks of September.

For the last weeks panic has gripped the stock market as irrational exhuberance switched to fear caused by the credit crisis. Now everyone is expecting a deep recession which will caused demand for oil to plummet. What had been a perfect storm supporting the these of “peak oil” has changed into a “perfect storm” where the value of oil has collapsed.

As a contrarian by nature, I believe that the panic occurring in the market is ignoring the fundamentals. If I gambled, I would be plowing money into the market, buying stock in companies with solid fundamentals that have been caught up in the, I believe the economic term is “hoopla”. As for Oil, OPEC is going to cut supply, but the organization has a terrible track record in stabilizing prices so I don’t expect the official cut to do much (or stop countries from selling on the side to make as much money as possible before the oil price falls even further). Russia and Venezuela, two countries that have ridden high on the boom in oil prices will be hit the hardest.

So what does this prove? It shows that for every boom there is a bust, that economic gravity still exists. There is no need for exotic explanations like “peak oil”. I doubt we will be hearing that term much more over the next few months.

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  3. bullet:

    Gasoline in Louisiana has finally caught up with the plunging oil prices. The gas stations in my area went from 3.27 to 2.99 in a day, 2.89 the next and 2.79 today. Some crisis!

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