The Oil Problem

http://www.ft.com/cms/s/0/23928598-36c1-11dd-bc1c-0000779fd2ac.html - Gazprom, Russia's gas monopoly, says oil could reach $250/barrel by 2009.

The story proffered by financial journalists and economic institutions has been one of rising global demand as emerging markets' increased wealth brings greater energy needs; never mind George Soros' testimony to the US Congress that the recent commodity market's price appreciation has been a bubble driven largely by speculation.

At the beginning of 2007 NYMEX crude oil prices were at a relative low of $50/barrel. This was down from a previous high of $75/barrel in mid-2006. Prices have steadily climbed since the beginning of 2007 to today's high of $137/barrel. Over the past year (52 weeks) oil has appreciated by $71.24/barrel, or 108.22%

Has worldwide demand increased by 108.22% in the past year? And will it increase by a further 80% (the amount needed to bring crude oil to $250/barrel, assuming no supply increases)?

The answer, I believe, is a resounding NO. As fast as the global economy is growing, it cannot possibly be growing at such a rate to justify the doubling of crude oil prices in such a short period. While the equilibrium price of oil is probably above the $50 low at the beginning of 2007, and may even be above the $75 high of mid-2006, I highly doubt that the hysterical speculative excesses we are witnessing are a true reflection of the underlying supply/demand situation of oil.

Assuming that this recent runup is a price bubble (which I believe it is), the question then remains: how do you profit from it?

I don't think it's possible to know when the bubble will pop, but it may be possible to know that it is popping through a combination of rapid and continual price depreciation and highly negative and doomsday-esque market sentiment/press coverage. When one is sufficiently sure that the bubble is popping, load up on puts or short positions and ride it all the way (or at least, most of the way) to its completion.

Care is needed, though.. the recent single-day 8% price runup was the result of fear-mongering over potential war in Iran, a Wall Street report saying oil would show further increases, a relative decline in the dollar and the subsequent covering of short positions by traders who thought that oil prices had peaked. See http://www.ft.com/cms/s/0/e34d30e0-366c-11dd-8bb8-0000779fd2ac.html for more information.

Bernanke's statement today warning of increased inflation may be a signal that the Fed may be ready to raise rates. Assuming the Fed follows through, this should alleviate dollar woes and eliminate the dollar's role in the increasing price of oil.

http://www.ft.com/cms/s/0/290efeb4-367d-11dd-8bb8-0000779fd2ac.html