By Arnold Kling
Any time a price increases rapidly, somebody argues that there is a bubble (although I have not heard anyone proclaim a health care bubble). Here is Frank P. Leuffer on oil.
IEA figures for the first half of the year show an increase in world oil demand of 3 million barrels a day against an increase in supply of 3.5 million barrels a day. About 60 percent of the supply increase is coming from OPEC and 40 percent from non-OPEC sources.
Excess supplies are borne out by rising inventories. In the U.S., crude oil inventories increased by 50 million barrels in the first eight months of this year, the second-largest build in history, and oil inventories for the OECD (the Organization for Economic Cooperation and Development, which includes 30 member countries) increased by 83 million barrels in the first seven months of this year.
Recently, the growth in oil demand has begun to slow in response to high prices and slower economic growth. According to the American Petroleum Institute, U.S. oil demand rose only 0.5 percent in August, owing to a fall in gasoline demand. Oil demand through August is up 1.7 percent, compared with growth of 2.9 percent in the second quarter. Demand-growth in August for China, at 10 percent, was less than half the rate estimated for the first half of the year.
It comes down to this: Fundamentally speaking, oil prices should today be in the high-$20-a-barrel range. That’s based on an assessment of supply/demand economics and current inventory levels (adjusted for hurricane effects). Eventually, that barrel price should decline into the low $20s as oil inventories rise. Why the more-than $20-a-barrel difference between where prices are and where they should be? In large part, speculation.
What he is saying is that oil market participants who are accumulating inventories at a price of $50 a barrel are going to wind up selling it for less than $30 a barrel. He could be right, and I hope he is, but I doubt it. The Hotelling argument is that people will hoard inventories only if they expect the price to increase. The market is telling us to expect price increases, albeit slower price increases than what we have observed so far this year.
For Discussion. If you are handy with Black-Scholes, try using option prices to figure out the market’s estimate of the probability of oil hitting $30 a barrell in the next six months.