The oil bubble

Looking for a market play? Bet against peak oil, in the short term.

Published August 21, 2006 5:57PM (EDT)

Is it time to bet against the crowd and put some money on the proposition that the price of oil is set to drop? From a peak oil vantage point, that would seem like crazy talk, and from an environmental perspective, flat out suicidal. But if you're a contrarian looking to pick up some pennies in the market in the short term, it might be hard to resist gambling on black gold losing a bit of its luster. And after ten days of vacation, what better place for How the World Works to get its motor running again than with a quick status check on the fulcrum of the global economy: the price of a barrel of crude?

The theory goes like this: First, there's the supposition that some portion of the spike in oil prices over the last couple of years is speculator driven. Traders are stockpiling oil for sale to buyers at some later date, hoping that in the intervening period prices will continue to rise. Such speculation naturally pushes the price of oil even higher. This is a classic pattern in markets, going back at least as far as the great tulip mania of the 17th century, and there's no reason why oil should be any different from any other traded commodity. And as with all bubbles, once traders start thinking that the price might fall, whoooosh -- the air rushes out.

In the last week, while How the World Works was pretending that the spot market price for crude had no relevance to life in the woods of southern New Hampshire, much has been made in the press of a report by Sanford Bernstein oil expert Ben Dell that an oil price shift downwards is imminent, in part because the global storage capacity for oil is getting tight. So many traders (and governments) are hoarding oil that we are rapidly approaching a point where there is no more room to put it -- one estimate predicts that date could arrive within four to six months. In that scenario, the cost of storage will naturally begin its own rise, encouraging traders to unload their holdings, and thus depressing the price of oil as the market gets glutted with supply.

Plug that in with a highly optimistic report by Cambridge Energy Research Associates (CERA) that predicts production capacity will grow substantially, more than keeping up with demand, over the next five to ten years, and suddenly the recent week-long decline in prices is the start of a medium-term trend, and not a meaningless blip.

Before the peak oilers descend on me, outraged at my falling for CERA's outrageous optimism, or otherwise relapsing into energy complacency, let me stress that fluctuations in oil prices over the medium-term do not mean that we shouldn't be ramping up alternative sources of energy, pushing for more energy efficiency and conservation, and commuting to work on our bicycles in the snow while eating energy bars made from locally produced and sustainably farmed ingredients. But a significant drop in the price of oil still has major implications. If the price of crude goes down to $50 dollars a barrel or below, it could ward off a potential recesssion in the United States that might arrive as early as next year, should the housing market continue to decline and energy prices stay high. A $25 dollar a barrel drop in price could also make a huge difference to, say, venture capitalists betting on a new enyzme that will convert plant waste to ethanol at a price competitive with 70 dollar a barrel of oil, but not 50.

And then there's the rhetorical battle-field. Because you can also bet that energy industry flacks and pundits-for-hire are salivating at the chance to start firing off op-eds like so many howitzer shells as soon as the price of oil bumps down. And every impassioned tirade that uses the current price of oil as evidence for why we must get the government to pour research dollars into cellulosic ethanol or solar power or whatever will just be more grist for their well-lubricated mills.

Even the put-a-happy-face-on-world-oil-markets folks at CERA offer a cautionary warning along these lines. CERA's stance is that peak oil is nowhere near imminent, and that even if production capacity does finally reach a peak, it won't be the kind of a peak where an immediate descent follows, but rather, the beginning of an "undulating plateau" in which production and demand swerve back and forth within a narrow range. In their report, the authors write, "this most recent analysis supports our long-held view that the undulating plateau remains beyond the horizon, and this should allow governments time to develop policies to deal with capacity issues. We are currently in a dangerous situation with so many "credible" estimates of the date of peak oil that when the signposts for the undulating plateau finally start to appear they may well be ignored as yet another false indicator."

In other words, the boy who cried "peak oil" too many times ended up undermining his own village's attempts to prepare for an age of scarcity. That's a highly debatable proposition, but if the price of oil does decline steadily over the next year, it's worth bearing in mind, as we prepare for the backlash.

By Andrew Leonard

Andrew Leonard is a staff writer at Salon. On Twitter, @koxinga21.

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Globalization How The World Works Peak Oil