The Oil Bubble

Some people are now predicting that, like the housing market in the United States, the world oil market is going to crash sometime soon.? Their reasoning is basic economics, which dictate so many of the world’s markets.

The oil bulls are correct in their explanations of why prices have jumped. It’s indisputable that worldwide demand has surged, chiefly driven by strong growth in China, India and the Middle East. It’s also true that most of the world’s reserves are controlled by governments in places like Russia and Venezuela that mismanage production, thus curtailing supply growth.

But rather than forming a permanent new plateau for prices – as the bulls contend – those forces are causing a classically unstable market that’s destined for a steep fall.

Unstable, yes.? Everyone can see that.? Trying to narrow down the economic forces for why something becomes costly is almost impossible.? It’s why saying that gasoline is expensive because “we can’t drill in Anwar” or because “we haven’t built a refinery in 25 years” or whatever your explanation is becomes too simplistic.? There are probably a hundred factors driving gasoline prices passed $4-a-gallon.

The question is however, how quickly will the market for oil correct itself?? If new methods of producing oil are being developed, like tar sands or oil shales and consumers are using less as the fiduciary crunch becomes more apparent, at what point does the supply and demand reverse itself and the cost of gasoline snaps back to it’s actual cost? Because right now, a barrel of oil doesn’t really cost $140 even though that is what it is selling for on the future’s market.

The story is much the same with oil, with a twist. A big swath of the market isn’t really paying that $125 a barrel number you hear about seemingly every hour. In China, India and the Middle East, governments are heavily subsidizing oil for their consumers and corporations, leading to rampant over-consumption – and driving up prices even more.

But sooner or later the world won’t keep paying those prices: Eventually, the price must fall back to the cost of that last barrel to clear the market.

So what does that barrel cost today? According to Stephen Brown, an economist at the Dallas Federal Reserve, that final barrel costs just $50 to produce. And when the price is $125, the incentive to pour out more oil, like homebuilders’ incentive to build more two years ago, is irresistible.

It takes a while to develop new supplies of oil, but the signs of a surge are already in place. Shale oil costing around $70 a barrel is now being produced in the Dakotas. Tar sands are attracting investment in Canada, also at around $70. New technology could soon minimize the pollution caused by producing oil from our super-plentiful supplies of coal.

“History suggests that when there’s this much money to be made, new supplies do get developed,” says Brown.

That’s just the supply side of the equation. Demand should start to decline as well, albeit gradually.

“Historically, the oil market has under-anticipated the amount of conservation brought on by high prices,” says Brown. Sales of big cars are collapsing; Americans are cutting down on driving. The airlines are scaling back flights.

If there is a collapse, much like what happened in during the gas crunch of the 70’s, is that we cannot allow ourselves to forget.? Consumers and companies need to remember that affordable energy, like food and shelter, is not only a necessity but a precious commodity.? This energy pinch must be the final push for not just America but the world to create a stable energy policy, to spur invention so that we are not relying on one energy source for transportation or heating homes in the winter.

We have an opportunity to change the course and to create a world that we want to live in.? Stable and affordable: energy, food prices, clean transportation.? Now is not the time for innovators to rest on their laurels.

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