Oil: The Next Bubble Has Arrived

I suspect that virtually ALL of the reasons given for the oil pricing crisis are to some degree true.
The question is: How are they related? This post, while far, far from being comprehensive, suggests a broad outline of the relationships and problem.

1) Oil speculation. This refers primarily to the investments of financial institutions (i.e. banks) and financial instruments (i.e. investment vehicles such as hedge funds). The sub prime mortgage collapse created huge losses for both, via essentially overvalued real estate, whether based upon actual housing value or the value of the mortgage packages put together for investors. These losses are being written off and banks are now, across the board, raising new capital to replace the losses. However, the new capital must promise a healthy return and consequently must be invested in something, somewhere - e.g. commodities, of which oil is the leading example. Of course, there must also be some "rationale" for such investment - e.g. like the high tech stock bubble in which investors were "sold" based on arguments of the "New Economy," globalization, an almost certain future DJ average of 20,000, etc. A sort of "the market will always go up" mentality that sucked in investors who had missed the initial rise and were hesitant to enter the market too late. The same thing happened in the sub prime mortgage market with the argument that real estate will never fall. Any substantial "bubble" has to have some rationale that the investment of choice will ALWAYS get better and the risk of a turn around is minimal, if not impossible. This is where the other factors enter.

2) Supply and Demand and Peak Oil. The simple argument for speculation is that the world is running out of oil. In other words, if supply and demand is not an immediate problem, it most certainly will be within the next 5-10 years, as demand rises and with the failure of the world's single largest consumer to produce any meaningful long-term energy plan (i.e. the United States). The anticipation of a supply and demand problem drives up the price of oil futures, which in turn drives up current market prices. This aspect of the problem has recently worsened due to the growing acceptance of Peak Oil, which is the point wherein regardless of demand (which is anticipated only to increase) oil production will begin to decline due to a lack of sufficient reserves. Recently, increasing evidence that Saudi reserves are far less than the Saudis claim has hit the market and oil industry. This also fuels speculation.

3) Global warming, ANWAR, Off-Shore drilling, etc. Here, I would contend that one factor driving oil futures up is the gradual acceptance in the west that global warming is for real and that it is not a good thing to continue to put a lot of CO2 emissions into our atmosphere. Investors are basically betting that western environmentalists have won or will win, particularly with a Democratic President and Congress in 2009. This means that additional oil (or any fossil fuel) is NOT the answer, because it only delays the inevitable and continues to poison the planet while doing so. [Note: Global Warming, as a phenomena, is close to being considered "a fact," as is the conclusion that adding CO2 to the atmosphere hastens the process. What is debatable is the degree to which man-made CO2 emissions contribute to global warming.] Oil companies, who make their living on carbon-based, fossil fuel energy, naturally want to frame the argument in terms of more oil to meet certain rising energy demands. In sum, it is an argument between those who believe additional oil will solve the short-term economic problem versus those who believe that additional oil will only serve to worsen the long-term environmental problem of CO2 emissions. Shale oil and coal-conversion to liquid energy forms are other arguments, but to date lack the technology to "cleanse" the fuels of CO2 emissions and in some cases require more energy to process than they yield. This logic, however, does not apply to the rising economies in China, India, Russia, et al. Investors are "betting" that while oil demand will decrease in the west, it will continue to rise in the east; that market-oriented economies in the west will be able to adjust faster to alternative energy forms than state oriented economies in the east, whose on-going demand will hold the high oil prices.

4) Miscellaneous Causes. These range from failed foreign and domestic economic policies to a lack of refining capacity. Trying to bring democratic-capitalism to the middle east is perhaps the largest of the foreign policy failures. The Saudis and the Persian Gulf states are basically tribal-based dictatorships. Iran is a religious dictatorship. Indeed, one is hard pressed to find a democratic-capitalist system in any of the OPEC countries or among their future big customers (India may be a somewhat confusing exception to the latter). In other words the New World Economy, dominated by the USA, as the single surviving super-power has failed, largely through inattention to our own problems at home and failures abroad. We have precious little of value left to sell and what there is, is over-valued. Foreign investors can help drive up the price of overvalued stock or real estate, but they have little control over falling prices, other than to stand by and watch their investments drop in value. The impact of all of this is that the world has lost a great deal of confidence in the United States, both in terms of our military incursion in Iraq and our failure to look after their U.S. investments at home. The outcome of this may well be a global shift in the status of the dollar as the world's reserve currency. Ironically, the present shift of investment from speculation in real estate to speculation in oil may forestall this event temporarily, as long as oil is priced in dollars, but substantial improvement in our position will come only through restoring our economy at home and an improvement of our image abroad.

Refining capacity would seem to be a relatively minor blip in contributing to rising oil prices and may be little more than an excuse to avoid environmental regulation and/or an excuse not to invest in long-term and massive capital expenditures in face of a society that has become convinced that it needs less reliance on oil than more. If ways can be found to "clean oil," there may still be a future for Big Oil, but at the moment Big Oil is spending more of its profits in buying back their stock, than in R&D. Long term, there seems to be the attitude within Big Oil itself that they will either make the transition to non-fossil fuel based energy companies or liquidate over the next fifty years.

In sum, the future of the United States as the dominating power in a post-Cold War world does not look bright, over the short-term. However, because of our size, innovation, and one would like to think, democratic system, we may yet return to our former status based on a rebuilding of our own society upon more solid economic ground than we have had over the last twenty years.

Note: The rising price of oil may actually be seen as a "tax" eventually beneficial to the American economy (if it doesn't destroy that economy). Rival world economies, such as India and China, must also pay the higher prices, usually with U.S. dollar reserves. If the shift of western investment into oil pays off, those dollars recirculate largely to our own economy, bringing more tax revenue to the government, with which to rebuild our own society (assuming a future Democratic Presidency and Congress, which will raise taxes on the wealthy). In a sense, the present spike in oil prices may be the last chance of western capitalism as we know it today. If prices break and fall, the investment community will take another round of huge losses and the "oil bubble" may become the last great bubble of our times. Sort of "double or nothing" as the last Big Casino bet.

Either way, short-term, things do not bode well for the "average American." Having been lulled into complacency and laziness over twenty years of both government and financial institution coddling through cheap money and easy credit, the country is going to need more jobs, producing more income, and perhaps most of all, more savings. With inflation to be certainly around the corner, it will be difficult to achieve this, with rising prices. While the wealthy are undoubtedly going to get hurt by increases in taxation and more regulation of our financial markets, this in itself will not eliminate the disparities in wealth and may, in fact, accentuate them - e.g. the wealthy will be paying more taxes, while the rest are losing their homes, paying $5.00/gallon for gas, etc. This will certainly test social stability. Being or appearing to be poor may become "politically correct."