Wednesday, May 07, 2008

Is Oil's Bubble about to Pop?

Oil prices have surged past the tech bubble and well on its way to surpassing the homebuilders. From Paul Kedrosky:

Of course, in itself the graph doesn't prove much (as oil could really 'be different'), but I don't think there are very many people who consider these prices to be sustainable. So the more interesting questions are what will cause oil to collapse and how far will oil fall when the bubble does burst. Before I had an ability to remember, following the energy crisis of the 70s, by 1986, oil prices fell below $10.

A general rule of thumb is that commodity prices eventually revert to the marginal cost of production - which is the highest price it costs to produce the last bit of oil being consumed. Now as to where this is given higher levels of global demand is a source of debate. Oil companies are using a "working assumption of $15-30" a barrel (versus today's close of close to $120). Others aren't so sure (with Goldman Sachs weighing in at $70). Of course, I suspect these prices discount the possibility of both more efficient usage and alternatives.

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