Oil Runup Exceeds Dot-Com Bubble

Faithful readers, I hope you don’t mind if I am less chatty than usual today, since I had some competing obligations, plus some of the material on offer stands on its own.

In the “pets.com redux” category, a reader pointed out this Wall Street Journal story:

Excitement over oil is surging in Brazil….

After creating an oil company from scratch last summer, Mr. Batista, an excitable former powerboat champion, snapped up drilling rights on 21 undersea tracts. Pledging $1.12 billion, he far outbid others at an auction.

Now the 50-year-old Mr. Batista, an entrepreneur already rich from gold and iron mining, is giving the public a chance to join him in his big oil bet. Without having put a drill bit in the ground, he is taking his oil company public.

The offering of OGX Petróleo e Gás Participações SA is priced to raise more than $3.5 billion, twice as much as Google Inc.’s high-profile 2004 IPO. As of March, the company had only 30 employees.

Bloomberg discusses the bubbly qualities of the oil boom:

The rally that drove oil to a record $139.12 a barrel last week surpassed the gains in Internet stocks that preceded the dot-com crash in 2000.

Crude rose 697 percent since trading at $17.45 a barrel on the New York Mercantile Exchange in November 2001, and reached 28 record highs this year. The last time a similar pattern was seen in equities was eight years ago, when Internet-related stocks sent the Nasdaq Composite Index up 640 percent to its highest level ever…

The Nasdaq tumbled 78 percent from its March 2000 peak, erasing about $6 trillion of market value…. Billionaire investor George Soros and Stephen Schork, president of Schork Group Inc., say oil is ready to tumble because prices aren’t justified by supply and demand.

“There’s nothing different between this mania, the dot-com mania, the real estate mania, the Dow Jones mania of the 1920s, the South Sea bubble and the Dutch tulip-bulb mania,” said Schork, whose Villanova, Pennsylvania-based firm advises the Organization of Petroleum Exporting Countries, Wall Street firms and oil companies on the outlook for energy prices. “History repeats itself over and over and over again.”

Oil climbed on growing demand from China and India, whose economies expanded the past seven years at an average annual pace of 10.2 percent and 7.3 percent, respectively. Supply disruptions in Nigeria and Iraq and declining production in Russia also boosted prices. Investors added about $250 billion to commodity index trading strategies since 2003, according to Mike Masters, president and founder of Masters Capital Management, a St. Croix- based hedge fund…

“I don’t know if you can classify it as a bubble or not,” said Masters. “But there is no question that investor demand is having an effect on price. Very little of it has to do with physical supply and demand of crude oil.” Masters testified at a Senate hearing in May on the role of speculators in commodities markets.

Gains in oil are the result of a “bubble” caused by speculation from index funds and a tight balance between supply and demand, Soros said in testimony before the Senate Committee on Commerce, Science and Transportation on June 3. “The bubble is superimposed on an upward trend in oil prices that has a strong foundation in reality,” he said….

Crude futures more than doubled in the past year and surged $10.75 a barrel on June 6, the biggest rise on record and the largest in percentage terms since June 1996. Robert Aliber, a professor of economics emeritus at the University of Chicago Graduate School of Business, says the risk of a “correction” has increased because prices climbed so fast.

“You’ve got speculation in a lot of commodities and that seems to be driving up the price,” Aliber, co-author of “Manias, Panics, and Crashes: A History of Financial Crises,” said in an interview from Hanover, New Hampshire. “Movements are dominated by momentum players who predict price changes from Wednesday to Friday on the basis of the price change from Monday to Wednesday.”

Burton Malkiel, a Princeton University economics professor and author of “A Random Walk Down Wall Street,” says the rise in oil may be justified because supplies are limited and demand in developing economies is increasing. That distinguishes oil from the market for technology stocks in the 1990s, where supply “could be expanded infinitely” and new stock issues helped push down prices, he said.

“The picture is fundamentally different than the Internet picture,” Malkiel said in an interview from Princeton, New Jersey. “I’m not saying we’re running out of oil, but we’re clearly supply-constrained. Five and 10 years from now, the price is going to be higher than $134.”

The Nasdaq reached a record intraday high of 5,132.52 on March 10, 2000, in a rally that started in June 1994. Investors plowed $199 billion into mutual funds dedicated to U.S. equities during the 10-month stretch leading up to the peak…..

“You can look at the chart and say oil’s taking on the characteristics of a bubble,” said James Bianco, the president of Bianco Research. Still, “it may have a long way to go before it eventually peaks,” he said.

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  1. Melancholy Korean

    “The picture is fundamentally different than the Internet picture,” Malkiel said in an interview from Princeton, New Jersey. “I’m not saying we’re running out of oil, but we’re clearly supply-constrained. Five and 10 years from now, the price is going to be higher than $134.”

    OK, I’ll bite. I can accommodate the good professor, if he wishes to back his opinion up with a little wager. After all, since it’s “fundamentally different” than the last great bubble, what’s he have to lose?

    So, 5 years from now, let’s see if oil is trading above or below 134. We don’t even have to adjust for inflation, which is generous of me. A dollar a point, ok? (I’m about to return to school, so no Liar’s Poker stakes–this will have to be about bragging rights more than cash.)

  2. Richard Kline

    The quote from Schork on historical bubbles, like other such short lists making the rounds these days, misses several which are very telling in the present circumstances re: oil. Railroad stocks twice had major bubbles, in the 1830s centered in the UK though with a concommitant bubble in nascent railroads and more in canals in the US, and a second bubble in the US in the 1870s. In both cases, there were profound _and real_ upward demand and profitability trajectories for railroads—but not at the pace and to the levels that rank mania drove speculation in their stocks in both cases. Furthermore, railroad companies where notoriously opaque and manipulative in their ownership and investment structures: no one really knew what they were buying, who controlled it, and how financially sound any layer in between was. Sound familiar in the context of Foamy Oil 2008? Both railway bubbles ended in severe crashes because they took down big chunks of the banking industries both times; I don’t expect that in the same way quite here.

    Another historical comparison, and one I think better, is the boom-more-than-bubble in Argentinian wheat before the First World War. Europe had growing populations and money to throw around—i.e. surging demand—and prices for Argentinian wheat went up. Argentinians got, frankly, rich. European wealth and demand took wild gyrations in the disruptions after that war, and by the Second World War other supplies and global changes kicked the props out from under supply. Argentinian wealth got sharply downsized by WW II, and has never really recovered.

    Commodity demand and supply links don’t turn around quickly, and they don’t turn around completely, but their are deflection points. And even in situations of growing absolute demand, speculative manias can, have, and do occur. I seriously doubt that oil prices are going back to double digits for any extended period until and unless techonolgical alternatives truly come online. But we could easily see oil come down by $30+ a barrel, with volatility rolls well lower, which just might shave a couple o’ hundred billion off today’s manic wheeler-dealers.

  3. Anonymous

    ☺☺”There’s nothing different between this mania, the dot-com mania, the real estate mania, the Dow Jones mania of the 1920s, the South Sea bubble and the Dutch tulip-bulb mania,” said Schork…

    When I hear statements like this, I am reminded of the story of how the East Texas Field was discovered.

    Dad Joiner was the promoter who drilled the Daisy Bradford No. 3, the discovery well for the enormous field. He had a geologist who worked for him called Doc Lloyd.

    Lloyd took a map of the world and on it he located all the major producing oil fields that existed at the time. He then drew lines through these various fields, and the intersection of those lines he called “the apex of the apexes.” That was where the Daisy Bradford No. 3 was drilled.

    Schork’s “analysis” and “science” is of about the same quality as that of Doc Lloyd.

    But hey, Dad Joiner got lucky, and maybe you will too if you listen to guys like him.

    Which brings us back to another popular oil field saying: “I’d rather be lucky than skillful any day.”

  4. mxq

    Anon @ 11:03: “But hey, Dad Joiner got lucky, and maybe you will too if you listen to guys like him.”

    Hey, you also might get lucky if you think there is absolutely nothing wrong with 0 productive assets and a $22bn market cap.

    Btw, there’s also another popular oil field saying: “an oil well is nothing more than a hole in the ground that is owned by a liar.”

  5. trotsky

    rising prices are in and of themselves not evidence of a ‘bubble’. contrary to internet stocks it is very difficult to judge whether a commodity’s price is or is not ‘too high’. the point is that you have no yardsticks by which to make such a measurement. oil doesn’t have a yield, it has no p/e ratio and no book value. so how do you know if it’s too expensive? maybe it was too cheap between 1980 to 1998, and is simply repricing to a more normal valuation? the only valid measure by which one can judge oil’s price are the prices of other goods, and best suited is probably real money, i.e. gold. in terms of gold, oil has indeed also become very expensive, which is a hint that the price rise won’t stick. however, this could also be resolved by gold beginning to rise faster than oil, so there is no guarantee that oil will decline to revert to a more normal real price.
    note also, in the 1970’s bull market, oil rose far more than it has so far in the current one. a roughly equivalent rise in percentage terms would see oil at almost $400/bbl. – and arguably, the outlook for new supplies coming on stream was a lot better in the late 70’s than it is today. spare capacities in the industry have been whittled down to a bare minimum – after all, there had been no significant investment in bringing new supplies on stream for a very long time, and these things don’t happen overnight. meanwhile, the world’s largest oil fields, which provide a big percentage of the daily supply, are all aging and beginning to experience production declines. should therefore a large additional supply disruption occur (for example a war with Iran), the market will immediately experience a marked supply/demand deficit. all that said, the best guarantee for lower prices at some point in the future is to let prices rise until demand rationing and new supply bring it back into balance. in commodity markets the best cure for high prices are high prices!

  6. Anonymous


    Your comment offers yet one more example of the problem I have with the oil price bubble theorists.

    You imply that what drives the investors in OGX Petroleum is emotion and not fundamentals. That’s a pretty easy sale to make, which you have sucessfuly done, and I agree.

    But it is your next step that gives me pause, for that step is to conflate the OGX investors with those who question the oil price bubble theory. The implication is that both are driven by emotion.

    And while this might be a good rhetorical strategy–it’s called setting up a straw man and then knocking him down–it does not reflect an attitude of inquiry or truth seeking. Quite the contrary, it reflects an attitude of someone who is trying to peddle something.

  7. mxq

    Anon @ 7:49

    “Quite the contrary, it reflects an attitude of someone who is trying to peddle something.”

    You are being disingenuous. Your response is less analytical and more parapraxic in its intentions than you are willing to admit.

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