Oil: A Bubble, Not a Spike?


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While the rest of Wall Street just can't seem to get enough of the oil market, energy analyst Tim Evans isn't afraid to go against the tide. Evans, a senior analyst at IFR Energy Services, a division of Thomson Financial, thinks that the current run-up in oil prices is much like the Internet bubble of the late '90s. While other analysts are calling for crude to hit upward of $100 per barrel in the next few years, he believes the bubble will burst in the next several months, bringing prices back down into the upper-$20s range.

Evans recently spoke with BusinessWeek Online reporter June Kim about costly crude, what's behind it, and why rising prices will reverse course soon. Edited excerpts of the conversation follow:

Q: Where do you see oil going?

A: [Recently], we saw the highest level of commercial crude oil inventory in the U.S. since June, 2002. Then, we were trading in the range of $26 to $30 per barrel. The current physical fundamentals, not even projecting to a greater surplus down the road, are consistent with a $26 to $30 price.

We first got to $50 at the end of last September after Hurricane Ivan. We've got an all-time high price without a physical shortage.

Q: Then what's driving the uptick in prices?

A: We don't have a physical bull market, but we do have a financial bull market. The measure of the financial market is the open interest on the New York Mercantile Exchange. The futures market is 72% larger than it was 18 months ago. Over that same period, the physical market is maybe 5% larger. What you have on the financial side is a bunch of money being thrown at the energy futures market. It's just pulling in more and more cash. That's the side of the market where we have runaway demand, not on the physical side.

DOE [Energy Dept.] crude inventories have been rising since last September. If demand is outpacing supply, how can inventories rise?

Q: But there's a limited global supply and rising demand in the U.S. and China?

A: First, oil supplies are always finite, and oil reserves are always finite. That's not really headline news.

In terms of rate of growth, world oil demand grew last year by 3.4%. Yes, 3.4% was more yearly growth than we had seen in quite some time. [But] going back to the '50s and '60s, world oil demand during that era was growing an average of 9% per year. We didn't have oil-price shocks then.

Part of our fear really dates back from 1998 and 1999, when we had oil prices down at $12 per barrel. Those prices choked off investment in production capacity. That was the bust part of the cycle, and we're now in the boom part of the cycle. But it's still a cycle. The believers in the long-term steady march to $105 are basically making that it's not a boom-and-bust cycle anymore.

Q: Do you think $105 per barrel is probable?

A: We always say it can't be ruled out, but if we were to put a probability or expectation on it, I think...maybe there's a 5% chance that Saudi Arabia slides into the Red Sea and there's a run on oil supplies.

We have to get to $60 before we can get to $105. We haven't gotten to $60 yet.

Q: Do you consider this a bubble -- like the tech bubble of the late '90s?

A: I do. Some of the bullish analysis specifically warns people away from traditional methods of valuation. They'll say things like, "Inventory levels are no longer relevant, or a meaningful measure." Except that inventories levels are an objective measure. It's not a matter of opinion -- it's factual.

Q: Doesn't the psychology of market account for some of the run-up?

A: In the short run, it's perception that drives markets. In the longer run though, the physical supply and demand, the physical reality, ultimately determines what a sustainable equilibrium price is.

Q: When do you think oil will hit the $26 to $30 range?

A: The next two to three months are going to see oil prices fall hard. I think the market is teetering now. OPEC is still increasing production -- they increased quotas half a million barrels per day for April. And Saudi Arabia has allocated additional oil in its May sales program.

At the same time, second-quarter demand for crude oil tends to fall by something on the order of 2%. The market basically sees that drop because we're no longer heating the Northern Hemisphere. Right in front of us, we have supply that's still growing, demand that's going to step down, and inventories that are already at comfortable levels.

If we could just calm down enough to look at the inventory numbers, we actually have 6% more gasoline inventory than we did at this time last year, and we have 5.2% more stock of crude oil on average than the last five years. It's a high level of inventory as a cushion against possible supply disruption.


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