Analyst Schork Sees Oil “Bubble”–Heating Oil Price Collapse Could Come Soon

Posted by admin on August 26, 2009 at 11:21 am

Speaking to Bloomberg on Friday, Stephen Schork identified a speculative bubble in the oil market. (image: mises.org)

In a Bloomberg podcast on Friday, veteran oil industry observer and analyst Stephen Schork stated that oil prices are currently being driven by speculation, not supply and demand. According to Schork, if price were determined by supply and demand, crude would cost $50 per barrel, not over $70. Crude inventories are at near record levels; heating oil inventories are the highest since January 1995; and the summer driving season has ended, reducing gasoline demand. As Schork said, “We’re swimming in oil”—there is more than enough excess capacity and inventory to soak up additional demand.

Schork sees speculators pushing prices up. As he put it, “High prices become the justification for high prices.”
•    Speculators point to high prices and say, “See oil is already at $74 a barrel. If the economy improves, demand will increase and the price will go up!” This ignores the fact that prices have already been driven by speculation to 50 percent over their natural, supply-and-demand-dictated level.
•    When traders contract to sell oil at a certain price—say $75—when that number is hit, they need to “cover” the contract by buying oil. If enough traders do that, it artificially increases demand past that required for actual economic activity. Contracts made in anticipation of higher prices, not consumption or use, triggers a wave of trading that seems to justify even higher prices.

Schork sees another speculative bubble building, a bubble that will eventually burst, giving us a replay of the last 18 months. Bubbles burst because the high prices become unsustainable—people and businesses can no longer afford the commodity and modify their behavior. That applies even to behavior as normally intractable (or “inelastic,” in the words of economists) as driving behavior. When gasoline exceeded $3.00 per gallon and went to $4.00, people drove less and bought more fuel-efficient vehicles. In that way, bubbles are eventually self-correcting, when people no longer can or will buy the commodity.

Or, as Schork put it, “High prices are the best cure for high prices.” Unfortunately, until the prices get so high as to collapse under their own weight, we all have to live through high oil prices.  Given today’s falling oil prices, however, there’s a good chance that that collapse will take place before the heating season really takes hold.