The Oil Price Bubble - When Will It Pop?

Why have petroleum prices soared so high so fast? Presently we are seeing the highest spot price for crude oil ever in the month of March. Is it because there is a decreasing supply of oil coming onto the world market?

2010's figures are not yet compiled for worldwide production, but this table tells the tale. Oil production has held steady since 2004 except for a small surge in 2008 (when prices topped $150 per barrel, so you can bet anyone with a derrick was pumping). But even 2008's production was significantly less than 1 million bpd more than 2007's. When oil prices fell in 2009, so did production, but only back to about the same level as before.

Of course, production is only half the equation of whether there is a shortage. The other half is demand. Just as oil production fell in 2009, so did consumption, though not quite as much. But production and consumption are very closely correlated with supply keeping up with demand. There are, after all, no long lines at gas stations. In fact, as gasoline prices have risen, there are pretty much no lines at all at gas stations.

Are oil prices rocketing skyward because of unrest in the Middle East - Egypt, Libya, Syria, Bahrain, even some in Saudi Arabia? Partly, but the unrest does not account for nearly as much of the price increase as you might think. After all, supplies from the Middle East have remained almost entirely uninterrupted. Egypt's hardly burbled and Libya's disruption accounted for such a tiny proportion of world supply that its effect was marginal. IMO, the oil futures market, which is an aggregated risk assessor, has already discounted the possibility of future unrest regarding supply.

No, it seems the real reason oil prices have risen so much is because we, the American people, gave hundreds of billions of dollars to banks that then turned around and put our billions into investments in oil and other commodities funds rather than making loans to businesses. It all started with Ben Bernanke (no surprise):

This run-up in oil prices started with Fed Chairman Bernanke`s Jackson Hole speech where the big banks realized they were going to get a bunch more juice in the form of POMO operations by the Federal Reserve to play around in markets with.

And what did the large financial institutions do with this newly created juice? Instead of allocating the almost zero percent money they are all borrowing to productive activities such as lending loans to small businesses which will create jobs and stimulate the economy, the big banks have decided that since the fed is electronically printing money and providing extra liquidity/juice for financial markets that this is inflationary and devalues the dollar.

All Fed Juice Leads to Commodities

And just to make things worse, the big banks have decided to take their cheap capital they borrow at basically zero percent , and invest into commodities, i.e., agricultural futures like Wheat, Corn, and Soybeans, energy futures like Oil (NYSE:USO) and Gasoline (Fig. 2), and industrial and precious metals like Copper (NASDAQ:CU), Gold (NYSE:GLD) and Silver (NYSE:SLV).

Hence, inflationary pressure on those commodities resulted, which explains why food prices have risen along with oil prices. The rise in oil/commodity prices is being driven by investors and speculators (maybe not much of a diff).

What we have here is a 2008 redux. The Brent contract on the ICE exchange is being used to engineer prices up, as it is an unregulated exchange with no real transparency on position limits by the Big Banks. The Big Banks are also piling a bunch of money into commodity related ETF`s and mutual funds, which in turn have to buy exposure to the futures market in all these commodities. Add in the hedge funds, pension funds, money managers, and retail traders, and voila! you have these bubbles created which have no relation to the underlying fundamentals.

This situation is very much like the loose money policy of the Fed under Alan Greenspan regarding mortgage leveraging, and we know how that turned out.

Speculative bubbles always pop. The problem is that no one knows what the trigger will be or when it will come. But watch for signals from the Fed that its monetary policy might get tightened up some. The bubble might not pop, but it won't get bigger, either.