Jul 13 2008

There’s no speculative bubble in water

Category: election 2008,energy,middle east,Obama,oil prices,politicsharmonicminer @ 9:00 am

It’s popular to blame oil speculators for the high price of gasoline. These are the people who buy the right to purchase a future amount of oil product at a given price. So when there is a “bubble”, they are betting the price will be higher in the future, and so they’ll pay for that bet, and the price of oil goes up.

Factors the speculators consider include the political situation in the Middle East, rising demand in Asia, the likelihood that new supplies won’t be developed elsewhere anytime soon, etc. It’s important to realize that ALL of these reasons boil down to guessing if there will be enough supply for the demand. Everytime Iran makes a threat, the price goes up, because no one knows what Iran will do in the future, if military action against Iran or by Iran will reduce supply then, etc.

Remember, if the speculators bet wrong, they lose money.

But not everyone buys that it’s the speculators’ fault:

We’ve just seen a bubble pop in the housing market, with home values now plummeting. And before that, the tech bubble inflated, then burst. But the run-up in oil prices is probably different. The housing boom was generated by cheap and, in some cases, fraudulent mortgages, not by a huge increase in the number of people who needed housing. The tech boom was similar to old-fashioned manias, where investors raced in hoping to cash in on a gold rush and bid the price of technology shares way above their inherent value.

But in the oil markets, there is in fact growing demand because of strong Asian economies. And supply is fairly fixed for now, since adding more oil to the market means finding new sources and spending billions to extract it, not just opening a spigot a little wider. “There are pretty strong fundamentals behind this run-up,” says Sarah Emerson, another analyst at Energy Security Analysis. Speculators may be pushing oil prices somewhat higher than they would otherwise be—but a bust similar to housing or tech stocks seems unlikely.

And that’s the point. The basic characteristic of speculative bubbles is that they burst. If they don’t burst, they are not bubbles, they are the new price floor. When they burst, if they do, people who guessed wrong, either in commitment or timing, will lose money, lots of it. So speculators have little motivation to “bid up the market” unless they think they can time it perfectly and get out just in time to stop losses. We have names for speculators who think they can time things that tightly. If they’re betting their own money, we call them homeless people. If they’re betting someone else’s, we call them unemployed brokers.

There is no speculative bubble in water.
Why is that? The main reason is that supply is so great that no one can win by guessing that prices will be higher in the future. Future price is likely to be similar to today’s price.

The lesson here is very, very simple: speculative bubbles are impossible in markets where supply is high. Which means that we CAN drill and develop our way of this, even if it IS a speculative bubble, because the speculators, seeing that new supply entering the market in the future, are going to reduce what they’re willing to pay to bet on future high prices due to limited supply.

Drilling offshore, drilling in Alaska, developing western shale, coal to liquid technologies, whatever, are the guaranteed ways to control future prices, because they will make speculators less likely to bet on future higher prices, they will reduce the vulnerability the USA has to Middle East political crisis, and they will provide extra supply to counteract rising Asian demand.

Obama is against new exploration and drilling because it won’t produce instant new oil. Yet he wants to blame speculators. What Obama doesn’t seem to understand is that simply starting to drill will send an unmistakable message to speculators, and everyone else, and that message will result in lower prices than if we don’t drill.

If we HAD drilled 10-15 years ago, we’d be in far better shape now. If we care about the future, we’ll start now.

Additional points:

1) Of course, in the long term (post 50 years), we’ll seek other energy sources (something better than windmills and simple solar, which are not going to be able to sustain 1950s levels of energy usage, let alone 2050). Do we have to keep saying this whenever we discuss shorter term (next 50 years or so) needs? Apparently.

2) Along with our shorter term fossil fuel development, we should be building a LOT of nuclear power plants. Again, in 50 years, we may need them less, but if we can bring them on line over the next 10 years, our children (and theirs) will thank us. The big roadblock here is extremely short-sighted environmental regulations and a ridiculous permitting process.

3) Our ability to DO the long term investment and development for post-50 year energy sources is dependent on our economic ascendancy over that time.

That means we have two choices:

1) We can develop the shorter term fossil and nuclear options, giving us the economic capacity to do the long term work,


2) We can fail to do the short term work, thus guaranteeing our economic inability to do the long term work, because our competitors ARE GOING TO BE BURNING OIL AND USING NUCLEAR POWER while THEY develop the long term energy sources.

Here is what it boils down to: we can’t do what needs to be done unless we’re rich and we won’t stay rich if starve ourselves for the necessary energy. The USA can be completely eclipsed by China and India over that 50 years, if we do the wrong things, and they do the right things. There is no rule that says even “free market capitalism” (we actually have a “mixed economy”, which is worse) can survive and thrive in the presence of decades of utter stupidity on the part of the government in limiting energy production. We’re two decades into that stupidity now, and we’re hurting. About two more decades of this will put paid to any hope the USA has of retaining its economic dominance, and we can kiss goodbye our chances of leading the world into a new energy future. We’ll be doing well to feed ourselves and not be overrun by more vigorous people and economies.

Unfortunately, politicians of both parties, always eager to pin the blame on someone else, keep prattling about oil speculators. This is pure distraction from failure to allow/encourage fossil fuel development in the USA. In general, that failure lies at the door primarily of Democrats, however, and people who don’t want their kids to have to decide whether to drive a car, heat/cool their homes, eat or get medical care should consider that as they vote in 2008.

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