Monday, June 9, 2008

Oil Prices: Who will be the Biggest Fool?

From Wikipedia:

The bigger fool theory or greater fool theory (also called survivor investing) is the belief held by one who makes a questionable investment, with the assumption that they will be able to sell it later to "a bigger fool"; in other words, buying something not because you believe that it is worth the price, but rather because you believe that you will be able to sell it to some one else for an even higher price.[1]

In my honest opinion, I think that the oil markets, describable as a bubble, can now also be filed into the category of "bigger fool" investment vehicles.

Just this weekend, Barron's interviewed Arjun N. Murti, a top energy analyst at Goldman Sachs. In the interview, Murti said that we are now in the "later stages" of a "super spike," a dramatic short-term price increase where, he thinks, we will see a barrel of oil hit $150-200.

Murti argues that the price really is driven by supply, unlike the speculation-driven theories of other analysts. However, I took away too other noteworthy nuggets of information:

On the front page of Barron's website (I'm not sure about actual magazine layout), the subtitle of the article throws out a $5.75/gallon gasoline quote. However, in the article, Murti more conservatively states:

"Oil at $150 to $200 a barrel would imply between $4 and $5.75 a gallon."

Though not incorrect, Barron's focus on the maximum estimate is exemplary of the current fanaticism in the oil market. Ignore the reasonable or low-end expectations, but rather, shout the highest ones from the mountaintops.

Even more surprising and important was Murti's long term estimate, which does not get mentioned on the front page. In the article, Murti says:

"Our long-term oil forecast looking out 20 years is [for crude] to fall back to $75 a barrel, or some lower number."

This sentence perfectly states why I think that current oil prices are now reflecting a bubble, or now even a bigger-fool type of market. Murti, who did correctly call $100+ (and now even more expensive) oil, is forecasting that the era of $150 or $200 oil will not last long. Though not too many people could short oil today on the thesis that it will eventually, within five, ten, or 20 years, halve in price, the forecast of an eventually-lower figure shows that speculation does influence, if not control, the current market.

It seems as though investors aren't concerned if oil will be $120 in December or $100 in two years; what's important to them appears to be the prospect of selling their USO ETF (which allows any investor with a brokerage account to essentially buy oil futures) for a couple bucks more in a week or a month.

What started the two-day, $15+ rally in oil was an update price forecast from Morgan Stanley. Stating that Asia will consumer a greater share of Middle Eastern exports, they predicted that oil would hit $150/barrel by July 4th. I am admittedly not an expert, but that prediction, made midweek when oil was as low as $122/barrel, seems to me like MS was a little presumptuous - how could that small change merit a $30, or 25%, price increase?

Oil rallied through the end of the week, gaining $10 on Friday, on that report and a "weaker dollar." Yes, the dollar did drop as much as a few percent against the Euro, but why does a 1-2% drop in exchange rates trigger a 7% increase in the price of a related commodity? (Also, that same day, disappointing employment numbers were released. Normally, I'd expect a economically-bearish news nugget like that to move oil prices downward.)

On this hype, I attempted to short USO on Friday, but was denied as a significant percentage of my portfolio is currently short FSLR and CRM. Oil is down about $3 so far today, but as the previous contraction from about $135 to $122 showed us, all it will take for a nice surge in prices is another bullish report from experts.

My thesis remains that the price of oil resembles that of a bubble, or a "bigger-fool" type of market. In hindsight, I'm glad that I'm not short, because I don't want to be holding the bag if oil does appreciate another 10, 20, or 30%, as many individuals and experts are forecasting (or speculating). However, I agree with Murti's long-term thesis; expensive oil is making alternatives very viable, if not much cheaper compared to hydrocarbon solutions. Maybe $120 or $150 oil will eventually reflect the supply-demand equilibrium, but I don't think that that time is now. I think that the best option is to just sit on the sidelines; maybe you'll miss out on some fast money, but someone is bound to end up holding the bag when rationality defeats speculation.

1 comment:

Anonymous said...

Last I checked, I heard they were predicting $300 a barrel by December. But that seems to farfetched. We need to look into alternative fuels. Look at B5 oil for example. It produces NO greenhouse gases, reduces emissions, and most important, it helps conserve 400 MILLION gallons of oil. Check this link I stumbled on when working for NORA:

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