Why the oil price means bubble trouble

There are plenty of explanations for what’s happening in the global oil markets. It’s caused by the economic boom in the world’s largest developing countries, particularly China and India. It’s caused by the unwillingness of the oil cartel Opec to pump more crude. It’s caused by the fact that the world has reached peak oil – the moment in our history where supplies of the black stuff start to dwindle.

All of these factors may have contributed to the upward trend in the oil price over the past six years, which has seen the cost of a barrel of crude rise from around $20 a barrel to $135 a barrel today. None of them really explain, however, why the price should have gone up by more than $5 in the past 24 hours and by a third in little more than a month. That sort of price action is the result of a speculative frenzy of the sort that was witnessed in the dotcom mania of the late 1990s. The oil market, to put it simply, is a massive bubble waiting to be popped.

Bubbles have certain common characteristics. One is that prices move extremely rapidly. Another is that prices rise on the flimsiest of evidence. A third is that any piece of evidence can be interpreted as a reason for piling into the market. All three apply in this case; as Nick Parsons, head of strategy at NAB Capital noted: ”It’s definitely a bubble when a firm knows it can come up with a high forecast, stick it in 24-point type and somebody will run it as a headline. I have never seen price action like this that has proved to be sustainable.”

Those who think the oil price is destined to go ever higher might like to consider the recent 40% drop in wheat prices, which was the centre of its own speculative whirl a couple of months ago. They should also look at non-oil commodity prices, which are showing zero year-on-year growth: only to be expected given that the US is either in recession or on the brink of one, and that the rest of the developed world is slowing down too.

But in the oil market, the fundamentals no longer matter. All the reasons for higher prices — strong emerging market demand, inadequate supply response, peak oil — have been known about for a very long time. In a rational market, they would already be in the price. But bubble markets are not remotely rational, which is why it is impossible to say how high the price will go or how long the boom will continue before the bust arrives. But make no mistake, that moment will come. – guardian.co.uk Â

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Larry Elliott
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