/ 20 June 2008

Dotcom crash, credit crunch … oil bubble?

The dotcom boom and bust shook the world economy almost a decade ago, last year the credit crunch seized up financial markets, and now an oil price bubble may cause more havoc.

A rapid price surge, big investment inflows and a chorus of bullish analysts are some of the characteristics of the oil market that have echoes of the internet boom of 2000.

In the dotcom era, securities analysts and strategists talked of a new economic paradigm created by the internet and high-tech companies. It didn’t matter that many ”new economy” companies had barely any revenues or profits.

This time analysts and economists point to a structural shift in the price of oil. Supply will struggle to keep pace with huge demand growth from China and India for years to come.

The word ”bubble” has started to appear regularly in investment bank research and in the media, given oil’s virtually uninterrupted climb this year.

”Bubblemania” was the title of a Barclays Capital note published earlier in June.

If oil were to reach $150 a barrel, it would bring the market capitalisation of oil and gas equity in the S&P 500 United States stock market index to more than 25%, exceeding the valuation of technology stocks at the peak of the dotcom bubble, Deutsche Bank estimated in a research note.

”The obvious parallel in our mind is we think oil is overvalued where it is priced based on the underlying fundamentals, which is a parallel to the dotcom boom and bust,” said Michael Waldron, oil analyst at Lehman Brothers.

Oil has doubled in price in the past year and has climbed by 40% since the start of 2008 to nearly $140 a barrel.

The Nasdaq stock market index, where many dotcom companies listed, hit a peak of more than 5 000 in March 2000. But by the end of that year it had halved in value.

Some predict a similar fate for oil.

”If there is a genuine downtrend in industrial growth, there is going to be a fall. If that happens, then you can expect a fall as sharp as the rise has been, maybe even sharper,” said Sunjoy Joshi, a former Indian Oil Ministry official now at the International Institute of Strategic Studies in London.

Speculators
Politicians in the US and Europe, facing protests over high fuel costs, blame speculators for the price hike. They point to hedge funds, investment banks and even pension funds, which have moved into oil and other commodities in search of portfolio diversification.

In 2003, 10 investment banks paid out $1,4-billion in a settlement linked to conflicts of interest in equities research after a regulatory crackdown that followed the Dotcom crash.

US politicians are already looking at possible curbs on pension funds, institutional investors and investment banks in the crude-oil futures markets. One proposal would ban pension funds and institutional investors with more than $500-million in assets from futures markets; another would set trading limits on investment banks.

Barclays Capital has estimated investment flows into commodities totalled about $225-billion at the end of the first quarter this year, but the bank does not believe there is a price bubble. ”Nor do we see the involvement of institutional investors as being a cause of price rises,” it said in a note.

While dotcom parallels exist, there are also some major differences.

”Oil is a physical commodity with a finite amount while internet stocks had an unlimited supply that was created out of thin air,” said Evan Smith, of asset manager US Global Investors.

Analysts point to real supply constraints in the oil market that result from under-investment, both upstream and downstream, that has coincided with the emergence of China, India and the Middle East as new large consumers on the world scene. — Reuters