(Another) Oil Bubble

Oil prices have been rising lately, probably caused by a multitude of factors. As the economic recovery quickens, demand will increase and so price along with it. Adding to the increases are all of the revolutions going on in the Middle East. Concerns are abound about Iran and Saudi Arabia in particular.

An important point that is often lost on people is that oil producers like Iran are in sort of a catch-22. In the event of an actual geopolitical crisis (a war, for example) with a subsequent disruption of oil supplies, the price of oil would indeed skyrocket. But if Iran isn't selling their oil, they don't benefit from that increased price. Thus it is in Iran's interest to increase tensions and concern of a geopolitical crisis without precipitating one. That way, the price of oil goes up and Iran makes a juicy premium on what it would have exported anyway.

Then you think about what would happen if there was actually a disruption: say a conflict in the Strait of Hormouz or a revolution in Saudi Arabia. The price of oil would skyrocket, possibly to close to 200 dollars a barrel. Consider though that both of those nations are heavily dependent on oil to keep their countries running. In the event of a disruption and subsequent price spike, that nation has a huge economic incentive to get their oil back to market ASAP to take advantage of the high prices. I don't care who takes over Saudi Arabia: you factor in the number of barrels they can export every day times a 200 dollar per barrel price, and its obvious that any disruption will be short lived.

Finally, I think its pretty clear that the demand for oil is pretty plastic. Americans waste a ton of fuel. Dressing warmer in the winter and heating homes less could save a lot. Carpooling, taking a bus, or riding a bike would save more. These are all things that we don't do now because gas is only 3 dollars a gallon; they are things we will do if gas hits 5-6 dollars a gallon. Adding to the flexibility of demand for oil is the fact that there *are* substitutes. Natural gas, nuclear power, and coal for example (the latter two could power cars via batteries).

Commodity speculators were almost certainly behind the spike of oil to 140 dollars per barrel that we saw a couple of years ago. A price at that level was not economically sustainable. With all of the aforementioned variables causing uncertainty in the oil market, the speculators no doubt will be at it again. All things being considered, we will almost certainly see another oil bubble soon. I suspect that prices over 130 dollars per barrel are not sustainable over the long term. If I had some financial assets I'd be ready to short anything above that. You'd have to be crazy to not short anything above $ 160 / barrel, which I wouldn't be surprised to see at some point in the next year or two.