Business | Oil & Gas
Oil's 697 per cent rise signals turnaround
The rally that drove oil to a record $139.12 a barrel a week ago surpassed the gains in internet stocks that preceded the dotcom crash in 2000.
- Bloomberg
- Published: 00:01 June 14, 2008
New York: The rally that drove oil to a record $139.12 a barrel a week ago surpassed the gains in internet stocks that preceded the dotcom crash in 2000.
Crude rose 697 per cent since trading at $17.45 a barrel on the New York Mercantile Exchange in Nov-ember 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 per cent to its highest level ever, according to data compiled by Bloomberg and Bespoke Investment Group.
The Nasdaq tumbled 78 per cent from its March 2000 peak, erasing about $6 trillion of market value, as investors concluded that prices weren't supported by profits at companies such as Broadcom and Amazon.com.
Billionaire investor George Soros and Stephen Schork, president of Schork Group, say oil is ready to tumble because prices aren't justified by supply and demand.
"There's nothing different between this mania, the dotcom 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 firm advises the Organisation of Petroleum Exporting Countries (Opec), 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 per cent and 7.3 per cent, 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 hedge fund.
Money inflows
Money is flowing into oil as the global economy slows. The worst US housing slump since the 1930s and more than $390 billion of writedowns and credit losses at banks will slow global growth to 2.7 per cent this year from 3.7 per cent in 2007, according to the World Bank.
The US economy's expansion may slow to 1.3 per cent this year from 2.2 per cent in 2007, dragging down oil demand by 240,000 barrels a day, according to economists surveyed by Bloomberg and Energy Department data.
In China, the second- biggest fuel consumer after the US, economic growth may fall to 10.1 per cent from 11.9 per cent, the Bloomberg survey shows.
"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.
Commodity index traders account for about 40 per cent of the open interest, or outstanding contracts, in the 12 agricultural commodities for which the Commodity Futures Trading Commission reports data, according to Chicago-based Bianco Research.
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.
Different picture
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 US equities during the 10-month stretch leading up to the peak, including $36.5 billion in February of that year, data from TrimTabs Investment Research in Sausalito, California show.
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