Oil bubble. (image: Jedi Tutor via flickr.com)

The oil market’s tepid response to a rather dramatic week could serve as an indication that the oil bubble is about to pop, or at least deflate. On Wednesday the Wall Street Journal reported that despite dramatic events in the oil world, oil prices are slowly ebbing away from the $80 a barrel mark. It all began on Monday when the Iranian navy detained five British nationals who strayed into Iranian waters when yachting from Bahrain to Dubai. Although the event spurred a rise in oil prices to $77.45 a barrel, the Wall Street Journal’s Brian Baskin asserts that the event was only good for a one dollar and one day boost. That same day, the market also yawned at the news of the hijacking of a U.S.-bound oil tanker by Somali pirates. Finally, on Wednesday it was reported that Iranian oil minister Masoud Mirkazemi threatened that Iran would cease exporting oil if economic sanctions continue.

The market’s ho-hum reaction to a series of dramatic events is a clear indication that very different forces drive today’s oil markets than they were as recently as two years ago. Back then, one could arguably rely on supply and demand being the two biggest influences on market prices. If such events occurred in 2007, oil prices would likely have increased dramatically. However, rising oil prices over the last six weeks despite high supply combined with the market’s indifference to such events suggests that today, a weak dollar, investor speculation, and a dreary economy are determining the price of oil. Because of the sluggish economy, the value of the U.S. dollar is down. The value of oil is expressed in dollars. Therefore, when the value of the dollar is down, “it takes more of them to buy a barrel of oil, increasing oil’s nominal price”.

Investors are also playing a role in determining the value of oil. Numerous economists and energy experts have recently asserted that the price of oil is greatly overvalued. According to financial analyst Jason Schenker, oil is currently valued so high because investors are trading as if the economy were fully rebounding and demand for oil was on the rise.

The ultimate indicator that oil prices are no longer driven by supply and demand is the fact that the United States currently possesses vast stockpiles of oil and yet prices seem largely unaffected by the excess supply. As of November 23, “heating oil stockpiles are at their highest point since Christmas in 1998,” yet this has not resulted in a drop in prices. Energy expert Daniel Yergin also asserts that today’s oil prices are not reflective of supply and demand, yet he is optimistic that over time supply and demand will once again take over as the primary influence of crude prices.

While it is too early to tell if supply and demand are slowly reclaiming their control on the value of oil, recent drops in crude prices and the market’s disinterest in traditional upward influences could be an indication that this is the case. After weeks of rising on even the least significant bullish indicators, this week’s reversal of that trend may very well mean that the steadily-rising tide of crude oil prices is beginning to recede.

T. Boone Pickens. (image: Center for American Progress Action Fund via flickr.com)

As reported by bnet.com on Friday, oilman-turned-natural-gas-entrepreneur T. Boone Pickens is talking about oil prices spiking…again. The outspoken Texan predicted in October that oil would reach over $75 a barrel before the end of 2009. Now he’s claiming that 2010 will see even higher oil prices, with crude potentially reaching $100 per barrel. Pickens doesn’t see the buck stopping there either—he thinks that, within a decade, oil could go as high as $300 per barrel.

Pickens, through his company BP Capital Management, is invested heavily in natural gas and wind power, which may be why he continues to shout, from the rafters, about oil prices sky-rocketing. His stance is in conflict with a number of other experts, including oil expert and former U.S. government advisor Philip Verleger, who predicted in July that oil could go as low as $20 per barrel this year. Although crude has recently been hovering at $80 per barrel, it slipped to it lowest position since October on Friday. This dip could be the start of a price reckoning for crude, which many in the Verleger camp say has been overvalued for months now, as optimism about the country’s economic recovery on Wall Street has not been falling in line with the realities of what’s still happening on Main Street, where the recession hasn’t abated and unemployment continues to rise.

Jason Schenker, President of Prestige Economics. (image: opec.org)

Why are crude and heating oil prices so high? That is the question being asked by millions of consumers who cannot understand why crude oil is nearly $80 a barrel despite the fact that there is a recession, oil is widely available, and demand is low.

On Thursday, Jason Schenker, president of Prestige Economics—an economic consultancy and advisory firm based out of Austin—explained on Bloomberg radio why oil is currently valued the way it is and what his expectations are for crude and heating oil prices. In regards to the current cost of crude and heating oil, Schenker asserts that oil is overvalued as a result of the irrational optimism of medium-term economic expectations. What this means is that despite the existence of recession and rising unemployment, investors continue to trade as though economic recovery has already begun and oil demand is on the rise.

HeatingOil.com noted a similar observation made by Energy Security Analysis, Inc., which blamed current oil prices on investor overconfidence in a recovering market (in addition to speculation and a weak dollar). According to Schenker, when the market is optimistic, the trend is for prices to rise. However, he does not believe this optimism will last much longer and eventually the market will undergo a correction, bringing prices down to what is justified by supply and demand (which Schenker estimates to be in the mid-sixty dollar range). What Schenker’s predictions ultimately mean is that, if he proves right, consumers will simply have to wait until those on Wall Street come to grips with reality and lose the optimism that is driving them to keep prices high.

Artificially high oil prices will influence the actions of consumers who have interruptible natural gas contracts. These contracts are available to consumers who have fuel switching capacity—typically commercial buildings, condominiums, or apartment buildings—meaning they can heat with oil or natural gas. As HeatingOil.com reported on August 6, having the capability to heat with either natural gas or heating oil “allows flexibility in moving to the most advantageously priced fuel, especially at times of peak demand, like a cold snap”. The United States currently has a glut of natural gas, and that has made natural gas prices remarkably low, so consumers with the option will likely opt for natural gas.

But what’s good news for commercial consumers with interruptible natural gas service contracts could also be good news for home heating oil consumers who lack the ability to switch fuel capacities. As a portion of consumers opt for gas—and that portion is largely made up of commercial customers, who burn much more oil than homes do—overall demand for oil goes down, and home heating oil prices should sink with it. So according to Schenker, the existence and use of abundant low-priced natural gas should limit this year’s winter run-up in heating costs across the board, including heating oil prices.

While it’s frustrating to think that investors’ confidence in medium-term gains is affecting oil prices now, it is encouraging to know that Schenker and many other experts agree that heating oil prices will drop. If only they could guarantee us when that will happen.