Bubbling Crude
Come 'n listen to my story 'bout a man named Jed
A poor mountaineer, barely kept his family fed
And then one day, he was shootin' at some food
And up through the ground come a bubblin' crude
Oil, that is, black gold, Texas tea
Beverly Hillbillies theme
So, are oil prices right now actually a bubble? Could they collapse? Could George Soros be involved? Robert Samuelson asks two out of three of those questions (not the Soros one) in the Washington Post.
Could there be an oil "bubble''? Well, yes. In early 2002 oil sold for roughly $20 a barrel; now it's close to $75. The main cause lies in tightening supply and demand — and the fact that supply (as the present Middle East fighting reminds us) could be interrupted at any time. Old-fashioned speculation may also have played a role, and that raises the possibility of a bubble. But any bubble would be a peculiar beast, and if it burst and prices dropped significantly, we shouldn't delude ourselves into thinking that this might signal a new era of comfortable abundance. It wouldn't.
In financial bubbles, prices become disconnected from "fundamentals." At the height of the tech bubble, stocks of dot-com companies with no profits (and little prospect for them) sold at fabulous prices. By contrast, oil prices aren't unhinged from "fundamentals." Despite all the griping, gasoline is still affordable. Even at $3 a gallon, it costs Americans only about 4 percent of their disposable income, reports economist Nigel Gault of Global Insight. The same is true globally. At $70 a barrel, global crude sales would total about $2.2 trillion annually; that's still a tiny share of the $50 trillion world economy.
So is the price of oil disconnected from reality? Yes and no.
For decades, crude was in surplus. In 1985, for example, the world used 60 million barrels daily (mbd) of oil, while countries could produce about 70 mbd. Refineries were also in surplus; in 1985, U.S. refineries operated at 78 percent of capacity. Loss of crude supplies or refineries didn't create scarcities. "Historically, when something went wrong — and something was always going wrong, a pipeline outage or refinery accident — the problem was made up somewhere else," says economist Lawrence Goldstein of the Petroleum Industry Research Foundation, an industry think tank. Prices moved by a few pennies or dimes. Hardly anyone noticed.
Now demand is about 85 mbd, and extra capacity is 1 to 2 mbd. Even this surplus is more apparent than real, notes Goldstein. It consists mainly of high-sulfur ("sour'') oil, for which there is scant refining capacity. All refineries are stretched tight. The U.S. operating rate typically exceeds 90 percent of capacity — a margin needed for maintenance.
Samuelson makes the case that it really doesn't matter if there is a temporary collapse in price. We still should be finding and using alternate sources. He's likely right, but I suspect that there is no silver bullet, either.
By crosspatch, Wednesday, 26 July , 2006 @ 12:53 am
One thing to keep in mind: The US gets a lot of oil from the Gulf of Mexico. In a normal year, crude supplies are interrupted at random intervals due to tropical storms. So far this year we have had only one Gulf storm and that did not track over major production areas. The result is that we have a lot more domestic crude than we normally have at this time of year because we have had none of the normal weather related production interruptions.