This is a guest post from Ed Rempel (CFP and CMA).  For those of you joining us recently, Ed has written a number of controversial articles for MDJ in the past.  Today’s article is a continuation from yesterdays post with a counter argument that it’s not peak oil but an oil bubble..  Make sure to participate in the poll at the end.

In his 1998 book, “The Roaring 2002’s”, demographics expert Harry Dent predicted that the large block of baby boomers in their peak earning years would cause one financial bubble after another. Since then, we had the tech bubble, a real estate bubble in the US, nearly an income trust bubble in Canada, Chinese stock market bubble, and now what looks like an oil and resources bubble.

Just like the unlimited potential of the internet that led to the tech bubble, there are real explanations for oil’s rise, but they do not explain a price increase from $10 to $145/barrel.

Arguments in favour of a Oil Bubble

1. Index futures for oil and resources have been created in the last couple of years and have resulted in massive speculation that has driven much of the oil price rise. Many institutional investors are allocating a portion of their assets to commodities primarily through the futures market, which has created incremental “investment demand”. Commodity index futures are about 80% oil. Because of the comparatively high price inelasticity of both oil supply and demand, relatively small disruptions in supply or increments in demand can have outsized effects on price.

According to a May 19, 2008 report titled “Blame It on Your Pension Fund” from Probability Analytics Research in Chicago, open interest in the West Texas Intermediate (WTI) crude and Brent Crude oil contracts traded have more than tripled over the last 5 years, rising by 1.3 million. At 1,000 barrels per contract, this represents incremental demand of 1.3 billion barrels of oil, or about 53% of the increase in world oil “consumption” over that period. Index speculators would not necessarily have accounted for all of that increase in open interest, but Michael Masters (Masters Capital Management), in testimony before a Senate subcommittee on May 20, 2008, estimated that over the last 5 years, index speculators through the futures market increased their net exposure to petroleum products by the equivalent of 848 million barrels of oil, an impact roughly equivalent to the 920 million barrel increase in demand from China over that period.

In a tight market for physical oil, how large a price impact could the incremental investment demand from commodity indexers have had? Probability Analytics Research estimated the equilibrium oil price without investment demand is $60-75 per barrel, with investment demand adding roughly $60 to the price of oil.

2. Demand is not out-pacing supply. In the last 12 months, world oil demand is up only 2%, while supply is up 2.5%. Meanwhile, the price has nearly doubled. How can this be anything other than pure speculation?

3. Most oil experts assume the proper oil price should be between $60-90/barrel. Almost all oil analysts assume a price of $80-90/barrel when valuing oil company shares. The $60-70 range is often quoted by Saudi Arabian oil minister Ali Al-Naimi as being a realistic price for oil, since that is the marginal cost of production for alternative energy sources. In fact, OPEC, which controls 40% of the world’s oil, states that there is “no justification for oil above $80/barrel” and that “fundamentals do not support a price above $80/barrel”.

4. Anecdotal evidence is that the long-awaited demand reductions resulting from high oil prices may have begun. The widely-used quote is: “The cure for $145 oil is $145 oil.” Airlines—choking on $4 per gallon jet fuel prices—are slashing capacity. Sales of gas-guzzling SUVs and light trucks are collapsing in the U.S., while small cars and hybrids are flying off the lot. Public transportation use is increasing. Many are changing jobs to be closer to home, or moving closer to their job. Oil demand is starting to drop off throughout the OECD. Demand responses take time, but we may have reached a tipping point. Gary Becker, an economist at the University of Chicago, has calculated that in the past, over periods of less than 5 years, oil consumption in the OECD dropped by only 2% to 9% when oil prices doubled. But over longer periods, consumption dropped by 60%.

5. Oil supply increases may be on the way. Six years is not a long time in the context of the time it takes to develop an oil field. The last doubling of oil prices has occurred in the last year or so. No supply response over that time frame could have been reasonably expected. The largest new field for years was just discovered in Brazil and is estimated to contain 5-8 billion barrels.

6. Huge amounts of oil are thought to exist off-shore. George Bush just lifted an executive ban that has existed since 1990 on off-shore oil drilling. If the legislative ban is also lifted, then off-shore drilling can finally start. Drilling is banned in many other regions rich with oil or gas resources due to long-term energy strategies and environmental concerns.

7. Oil-producing countries do not necessarily have the incentive to increase production as rapidly as oil-consuming nations may want. They may believe that they will maximize the long-term value of their oil reserves by developing them more slowly.

8. Oil price subsidies in many countries will become increasingly difficult to maintain. Higher gas prices in these countries would result in lower demand. The latest jump in oil prices is making subsidies much more costly, and strains on governmental budgets are forcing some nations to lift subsidies. On May 24, Indonesia raised fuel prices by +30%, followed shortly by Taiwan (+13%) and Sri Lanka (+24%). China has just recently increased its gas prices, since the subsidies that amounted to about 1% of GDP.

9. Many European geologists, especially in Russia, still believe in the abiogenic theory. Oil is widely considered to be a fossil fuel in the West, but this belief is far from unanimous world-wide. The abiogenic theory states that oil is created by carbon released by microbes that migrates upward from the earth’s mantle. It has been popularized in the West recently by Thomas Gold, professor at Cornell University. If it is correct, then not only can oil be continuously created, but there may be far more oil in the earth than most believe. Oil companies have not drilled in areas most likely to contain abiogenic oil. Most geologists consider oil to be a fossil fuel, but the abiogenic theory has not been proven false.

10. Governments have not responded with official policies and have not officially expressed concern. Peak Oil has been discussed endlessly in the press and in the financial industry. Governments must know what is going on and are not concerned.

11. Alternative fuel sources will reduce our need for oil. Humans are adaptive. There are many fuel sources available now and high oil prices will make alternative sources much more viable.

12. Peak Oil is being a marketed. Most of the strongest proponents of Peak Oil are in the investment industry working for companies that have made huge amounts of money from rising oil prices.

13. Many oil industry insiders believe this is a bubble. Those that believe this is a bubble include OPEC, Saudi Arabian oil minister Ali Al-Naimi, Richard Rainwater (Texas oil billionaire), and George Soros (legendary hedge fund manager).

What is your opinion?

Many readers of MDJ are well-read in many issues, so your opinions here would be very interesting. What is your opinion? Which are we currently witnessing?

A. The beginning of Peak Oil.

B. An oil bubble.


  1. FrugalTrader on July 24, 2008 at 7:06 am

    Guys, please note that this article was written last week when oil was $140+/barrel. Oil has since pulled back a bit.

  2. Four Pillars on July 24, 2008 at 8:23 am

    Interesting series.

    I’m of the opinion that it’s a bubble.


  3. Traciatim on July 24, 2008 at 8:38 am

    I also agree that its a bubble. Considering that we have enough oil to last my lifetime easily and I’m pretty young, and that over that time frame I’m sure we will find better and more efficient ways to harness the sun with the use of PV, Heating Panels, Algae, etc . . . then demand should slow as other sources become cheaper and more efficient. So over the next 100 years we have to slowly balance our energy needs, big deal . . . I see no major problems here.

  4. FrugalTrader on July 24, 2008 at 8:43 am

    Boy, you guys get up early. I’m of the opinion that the recent $140 run up was a bubblish move, but I think that the peak oil theory explains the expected long term increasing oil prices.

  5. Four Pillars on July 24, 2008 at 8:49 am

    Boy, you guys get up early.

    Actually it’s my son who is the early riser – I’m the reluctant follower! :)

  6. paul s on July 24, 2008 at 9:03 am

    “Many European geologists, especially in Russia, still believe in the abiogenic theory”

    That’s very interesting. Thanks for the insightful articles. I’m off to Google to do some research!

  7. augustabound on July 24, 2008 at 9:22 am

    I haven’t studied it in depth like some others, but from what I’ve seen I believe it’s a bubble.
    I have a question on point 3. I know you can’t judge the future based on the past, but what were the analysts saying of the last oil bubble? They all seem to think oils sweet spot is $80-$90 ish so it’s currently about 50-60% overvalued. Were they saying the same in the 70’s? Or maybe a better question would be, how close are we to the same situation from then to now? Was the problem back then reserves, new exploration and production or high consumption………or maybe all of the above?


  8. Cannon_fodder on July 24, 2008 at 9:51 am

    I think the current price is not sustainable – for now. I think oil will pull back strongly within the next 2 years but the long term trend is up until there is a viable alternative coupled with increased emphasis on conservation.

    What I’d also be interested in hearing is how some oil-producing countries are taking the huge revenues from oil (via taxation) and investing that into other countries and industries. From what I remember, Canada isn’t following that path very diligently.

  9. quanta on July 24, 2008 at 11:29 am

    I believe it’s a mix. In the short term, yes, speculation is driving up pricing. Overall however, long-term supplies appear to be depleting to the point that once prohibitively expensive extraction modes – such as squeezing oil out of tar sands – are now considered attractive.

    BTW, I would just like to point out that the abiogenic origin theory has never been conclusively demonstrated and frankly borders on bad science.

  10. Dividend Growth Investor on July 24, 2008 at 11:30 am

    The markets can remain irrational for as long as possible. When the oil bubble bursts we would all be writing on our blogs ” I told you so”, but yet few of us would have actually gone short..
    There’s one thing that I don’t agree with in this article –
    “1. Index futures for oil and resources have been created in the last couple of years and have resulted in massive speculation that has driven much of the oil price rise”

    Futures on OIL in US have been trading on NYMEX ever since 1983.
    What the author might be referring to is the creation of an oil ETF in USA – USO.

    The reason why oil shot up so fast is because a lot of people were short, thinking that the economic slowdown in US will cause a slowdown in China which will cause a lower demand for oil.. Thus they all went short but since the price never fell, they all started to cover at the same time.

  11. Acorn on July 24, 2008 at 3:12 pm

    Currently, the oil price chart represents a perfect example of “Bump and Run” reversal formation. Technically, the next stop will be at $100. Then, we will see…

  12. Krishna on July 24, 2008 at 5:39 pm

    I do believe that its more a speculation than supply demand hypothesis however, the most important question is will it drop below $120? If I remember correctly, according to the article I read on Bloomberg, if it does not go down below $120, the BRIC nations see the reverse economic trends. Correct me if I am wrong. Thank you for all the hard work you do in providing valuable information.

  13. Brian Poncelet, CFP on July 24, 2008 at 7:50 pm

    Hi FT,

    One thing is for sure, oil is a resource we use. If you factor China and India you have a lot of new users. Like cod fish, everyone knew that would last forever (the commerical fishing) look where it is now.

    T. Boone Pickens an oil man, thought we peaked last year. Alternative energy is still a long way off to make a big difference.

    What will bring prices down (we may be seeing it) is a major global slow down. But I do not think gas prices are getting back below a $1.00 a liter any time soon.



  14. Kait on July 24, 2008 at 10:04 pm

    I don’t really feel educated enough on the subject to comment decisively one way or another, but I did find this article pretty encouraging and very informative. I’m sick of hearing people talk about the high prices being due to “supply and demand.” Too many people seem to think that the demand is higher than the supply, but it’s not–at least not yet.

  15. Senk on July 25, 2008 at 4:29 pm

    I’m of the belief that the recent run-up to $145 was a bubble but we are at or near the beginning of peak oil.

    The abiogenic theory theory is an interesting one. I definitely need to look into it.

  16. WKG on July 25, 2008 at 7:41 pm

    A couple of thoughts on the price of oil. If the depreciation of the US dollar into account, the price rise hasn’t been as dramatic as it initially appears. The US dollar depreciation has been a factor in the price appreciation of all commodities.
    Some of the world major oil companies has been investing heavily in the Alberta oilsands. These include Shell, Total, Conoco, and Exxon. These companies employ many professionals whose only job is to assess risk in investing capital. The oil that is produced in the oilsands is some of the most expensive production in the world, with a new production cost of over $50 a bbl.
    Many of the places in the world are becoming unsafe or hostile toward multinationals producing their oil.
    The developing world consumption will play the biggest factor in oil prices in the coming years.
    Having said all of this, I believe that there is going to be a pullback in the price of oil in the shorter term. I am however 100% invested in 4 Canadian oil and gas companies. I believe that in four years time they will be worth significantly more than they are today
    I believe that the cheap oil in the world is gone

  17. Gates VP on July 25, 2008 at 9:11 pm

    In the last 12 months, world oil demand is up only 2%, while supply is up 2.5%. Meanwhile, the price has nearly doubled. How can this be anything other than pure speculation?

    It could just be a money grab by oil producers, maybe they’re using to offset the costs of generating this extra 2.5%? Maybe demand is actually down as a result of the cost?

    Supply, demand and price are always chasing each other, so the snapshot mentality is not really accurate. Graphs are definitely required here.

    This is definitely the weak argument out of an otherwise compelling explanation for an Oil Bubble. I think it’s really relevant to note that current oil / gas prices are at “crisis levels”. By this, I mean that they’re causing lifestyle changes. US transit ridership is basically up everywhere, car-pooling is now easier than ever to organize. And everyone is talking about less general travel.

    The truth could honestly be that both are true. We may well have reached “Peak Oil” but be on the verge of an “Oil Bubble”. Oil could be “over-prospected”, but this may be a self-fulfilling cycle. It could be that “over-priced” oil will keep itself that way until reality catches up.

    Think of it this way. Consistently high-priced oil will force industry and consumers to react. They’re already doing this, but I don’t think the change has really “happened”. If gas prices went from $4/gallon to $3/gallon next month, then life here in the US would simply return to normal and demand would quickly outstrip supply. However, if gas prices went nowhere, then these consumer and industry changes would continue to happen.

    If gas prices went from $4/gallon to $3/gallon in August 2009 (one year), they simply won’t have the same effect, people would already be driving less or using more public transit and the sudden drop in prices would be unlikely to undo the usage habits.

    I believe that it’s a really complex machine, and I don’t know that even in these great articles we really have enough information to make a decision one way or the other. I honestly think that there are simply too many variables to make this call one way or the other.

    It’s evident that current prices are causing significant changes, and this really breaks the supply / demand curve.

  18. Patrick on July 26, 2008 at 12:01 am

    This pair of articles has confirmed what I thought before: peak oil is coming, but this recent bout of skyrocketing prices is not it. My personal opinion is that we’re going to see oil prices fall soon, then rise again a decade from now, at which point it will truly be a permanent increase.

  19. VVi11 on July 26, 2008 at 7:33 pm

    Please refer to Paul Krugmans arguments for why this is not speculation. The only viable counter argument I have heard is one report that OPEC has recently used futures prices to affect spot prices. Otherwise, Krugman outlines the mechanics of this market to show that speculation in the futures market is not causing this.
    Also, several commentators have pointed out that the dollar decline is a major culprit, as oil has not gone up so much with respect to other currencies. Supply/demand is a secondary factor in the current run-up.
    If you don’t already, you can get more information from which gives great information. Recent oil field finds have not been great winners.

  20. paulette on July 26, 2008 at 11:26 pm

    Its just a matter of supply and demand imbalance. If the middle east countries will trade water to south east asian countries i think both will no longer have a problem on water shortage and oil.

  21. MiningOil&GasGuru on July 31, 2008 at 8:14 pm

    I think there are strong arguments for both sides. But I have to believe that their truly in increasing demand from the emerging nations and that supply wasn’t able to keep up with demand. Things might have calmed down for now, but oil will see a steady rise in the long run as we quickly tap the Earth dry. Great Article Btw.

  22. Ed Rempel on August 5, 2008 at 6:13 pm

    Hi Everyone,

    Interesting comments. The score, as best I can figure out is 9-5 for oil bubble. This is somewhat suprising, since based on the news for the last year, I was expecting Peak Oil to be the popular winner.

    Also interesting is the plunge in oil prices since this article was published. Is the recent colllapse of oil prices the start of the popping of the bubble or a technical correction?


  23. VVi11 on August 5, 2008 at 6:54 pm

    Hi Ed,

    BTW – same last name as me! Yo Cuz – Kitchener farmer’s sausage all the way…

    I’m not in the industry but just someone who keeps up with this topic.
    To clarify, I take Peak Oil seriously and it is very possible that we are in the beginning stages. Why the expansion in the oil patch?
    Don’t know enough to say, so I’ll take a guess — technical correction.

    FYI, one guy at theoildrum opined that a peak oil trajectory would be slow and steady, not the sudden jump we got.


  24. Peter Halim on August 15, 2008 at 2:52 am

    One thing I don’t understand, gasoline inventory has been down the last 3 week and quite significant too. I just read the article from DOT that American drove 14.2 million miles less than last year. I mean with OPEC having record output in July and American drive less we should see significant build up on gasoline but the reality is the other way around. Can someone explain it to me please?

  25. Ed Rempel on August 30, 2008 at 12:23 am

    Hey, Will,

    I just noticed your post. So, there are more of us? I’m still looking for a good Kitchener farmer’s sausage. I still import from Winkler. I checked the geneology – tons of Rempels not related to me.

    One possible reason that oil is not in a slow steady rise is that it is possible that speculators are giving us advance warning about the Peak by bidding up the price prematurely.

    It looks like this article was quite timely. Oil has been plunging, so it appears the bubble is popping.


  26. Ed Rempel on August 30, 2008 at 12:25 am

    Hi Peter,

    Good points. It makes it look like entirely speculation, doesn’t it? Supply and demand do not seem to be the main drivers of oil prices.

    Part of it can be explained though. Gasoline inventory declines now is seasonal. They stock up before the summer driving season and then let it decline near the end.


  27. Acorn on September 9, 2008 at 9:31 pm

    As predicted, $100 (see comments 11)… Charts don’t lie… It’s time to take a profit.

  28. Cannon_fodder on September 10, 2008 at 7:26 am


    Looks like the time to take a profit was weeks ago… even 1 week ago would have been much better than now.

    I was surprised that OPEC said that they wouldn’t cut production – but they quickly reversed that position.

  29. Acorn on September 11, 2008 at 7:17 pm

    Well, I’ve covered my short positions… It’s time to buy at $80 -$90… It will re-test $150 for sure…

  30. UK on December 26, 2008 at 12:33 am

    It was a bubble

    Good call Ed

  31. Duncan on December 26, 2008 at 2:16 pm

    Great call! However I think it’s almost time to begin buying oil. Once Asia’s economy begins to ramp back up, I think $45-$60 a barrel is very likely in the next 12-18 months. World supplies are indeed diminishing and the “untapped” oil is highly costly to extract(I think $50.00/bbl is the break even point for many extractors). Oil was way overshot to the upside, but has now also been overshot to the downside. Look at the MASSIVE volume on many of the long/double long Oil ETF’s(USO, HOU.TO, DXO). Meanwhile there’s been extremely light volume on the short ETF’s(HOD.TO, DTO). Interesting(could the smart money be buying in?). GS an MS were touting oil to $200.00/bbl right before it imploded and they shorted it all the way down. Now they’re flooding the world with news that oil could hit $25.00/bbl. History repeats itself? If so, we should do the opposite of what they are telling the flock. Further proof: The world is stock piling oil at these current low prices, even delaying tankers from port. New exploration/extraction has been suspended by all of major producers. The US dollar is also artificially inflated and China is running out of steam to keep buying up US T-Bills. The Fed keeps printing money and will soon be forced to buy back their own Bonds . We could see hyper inflation in the next 2 years as a result of the Hank and Ben show. Either way, Oil and soft commodities will outperform equities over the next decade. Warren Buffet thinks so. Look at the Conoco Phillips purchase and how much he paid when he bought his shares! The fundamentals of these things have not changed. The fundamentals of US Equities have changed. I put my money on the former.

  32. Ed Rempel on January 3, 2009 at 10:45 pm

    Thanks, UK.

    In retrospect, the timing of this article was quite fortunate.


  33. Ed Rempel on January 3, 2009 at 11:24 pm

    Hi Duncan,

    The strange part is that with so much speculation in both directions, figuring out a real price is challenging. The rise in oil from $20 to $150 and then fall back to $40 all within 6 years makes the fundamentals hard to see.

    All the way up, most experts were predicting it would stabilize a bit below wherever it was. At $45, they said it would setlle back to $35; at $70 they said it would stabilize at $60; at $90, they said $80; and at $150, they said it would come back to $120.

    Now on the way down, most predictions are a bit higher than whereve it is. Your prediction of $45-60 is the range most are talking now.

    There are a lot of similaries between the oil and tech bubbles. It is quite clear now that somewhere between 50-90% of the rise in oil from 2003-8 was pure speculation. This is similar to the tech bubble in the late 90’s, which we can now see was mostly speculation. Both started with a reason that seemed valid (unlimited potential of tech and China). In both cases. the rise was eerily consistent so that the volatility of the sector was low during the rise. And in both cases, the believers in the bubble clung to their beliefs for a year or 2 after the collapse and kept predicting it was a temporary decline.

    From all the forecasts I’ve read lately, it seems like there will not be a real supply/demand issue for at least 3-5 years and possibly 10 years or more. There are enough people believing in oil that we could easiily have another bubble and collapse, but Peak Oil and real shortages appear far off. In the mean time, we may see hybrids and other fuels reduce demand.

    It is better if oil does stay higher, though. At $45, many of the new projects will be shelved and the drive for alternates will be less. We will still eventually hit Peak Oil, so a higher price now will help us later.

    We are still much more confident in stocks, however. The are understandable and companies can always find ways to adapt to any situation and still eventually make money. There is tremendous pessimism about stocks, especially US stocks, so probably all the bad news and more is already built into current prices.

    Meanwhile, the price of oil is heavily inflenenced by both speculation and politics. I could give you a solid argument that the price of oil in 10 years could be $25 and another solid argument for $300. The fundamentals of oil are that most of the “demand” from China was mainly than speculation on futures contracts. The demand form China will be reduced for a few years. Warren Buffett’s purchase could be nothing more than diversification and planning for Peak Oil far in the future.

    Betting on oil is a gamble. We are much more confident in the stock market over the long run, even US stocks in the next several years. This is especially true when the market is very cheap and pessimism is massive.


  34. UK on January 3, 2009 at 11:24 pm

    You are welcome ED.

    Where do so you see oil heading next?

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