Oil spike: A bubble that will burst?

Last Updated: Sat, Jun 28, 2008 07:14 hrs

Much has been said about the recent surge in commodity prices, particularly crude oil. The world is now speculating about the invisible hand that triggered crude’s bull run. Those who seek to explain the crisis have organised themselves into two distinct camps.

One contends that commodity prices are driven by economic fundamentals (a function of supply and demand).

The other blames speculators (those dealing in pension funds, index funds, or hedge funds). But most analysts – except the fundamentalists – agree that there is a bubble in the making. The fundamentalists’ argument is based on the peak oil theory, which says that global oil production would experience a fall in crude oil production, aggravating the current demand-supply mismatch.

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On the other hand, US department of energy believes that continued economic growth, fuel subsidies, and increased oil-fired power generation are supporting increases in non-OECD (Organisation for Economic Cooperation and Development) oil consumption.

According to Prayesh Jain of India Infoline, there are fundamental factors at play behind the spike in crude oil prices. In addition, apart from demand-supply mismatch, geo-political tension in oil exporting countries is one of the major reasons.

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“However, the run-up in such a short duration is primarily due to speculation, which may take price to as high as $150 per barrel, but it may not sustain at those levels,” Jain added. He said that in the long-run, the prices may follow fundamentals, but recent spike warrants some cooling-off after touching $150 per barrel, as it has run-up in a very short span of time.

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“Oil’s recent rise has been fuelled by non-supply-demand factors and potential inventory misperceptions. This situation is identical to the bubble in credit markets a year ago, where nobody wanted to buy sub-prime mortgage bonds, but there was plenty of demand for 'financial derivatives’ that allowed investors to bet on the future value of these bonds,” says the report by economist Amit Anand

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