Oil bubble or trouble?

I refer to 3 articles I came across in the latest issue of The Economist, May 31st-June 6th 2008:

1. Recoil - Painful though it is, this oil shock will eventually spur huge change. Beware the hunt for scapegoats
   
2. Energy - Double, double, oil and trouble
3. Fuel subsidies - Crude measures
   

Oil bubble?

Believers of peak oil (a point in time when oil production rate hits the maximum and go decline from there) would doubt the current surge in oil price as a bubble, pointing to the sluggish crude production last few years while demand from emerging economies (esp. China and India) powers ahead.

In contrast, others believe the high oil price would had dampened demand (signs are showing) and the current surge is just the act of speculators (traders of crude future contracts, funds and other investment institutions).

If it really is the act of speculators that result in the price surge, I'll not be so worried, since all bubbles must come to a spectacular burst one day.

Oil price --- sustainable?

Whether or not its the act of the speculators, after reading the 3 articles above and doing a bit of research myself, I do believe current sky high prices cannot be sustained for long. It would have been better if the speculators are indeed responsible because the eventual price correction when the bubble burst would be substantial and swift. Otherwise, it will be a long and painful journey ahead before any respite occurs when the demand and supply curve rebalances again.

Less demand or more supply?

Sustainability of demand

According to the 3rd article,

...
Emerging economies accounted for more than the whole increase in world oil consumption last year—because demand in the rich economies fell...


While US and Europe are fighting slowing growth (analyst, experts etc kept saying US is in recession but its GDP always manage to scrap through with a positive figure), the emerging economies continue to power ahead.

Growing economies resulting in growing demand for crude oil comes as no surprise. But most of the fuel sold in these countries are heavily subsidised. As the crude price escalates, the government subsidies balloons, diverting resources from areas that the money could have been better spent (education, health and infrastructure). Subsidies as such cannot grow indefinitely and many are already cutting back. The eventual result of a rising crude price will see a plunge in demand, even in emerging economies, either a direct result of more conservation or slowing growth.

I- Increase in supply --- more aggressive search for oil fields

The runaway price of crude oil already spur a surge in oil explorations. Announcements of oil field discoveries are not uncommon nowadays, given such intensive search. However, even with these, supply will not jump suddenly because it takes years before the first commerical drop of oil is extracted, more so for new fields that are found in deep waters or difficult locations, .e.g. the Arctics.

II- Increase in supply --- alternative sources of fuel

As the price of crude oil climbs, alternative sources of fuel become viable. A google search for "alternative sources of fuel" easily turn up 800,000+ results. Research into these areas are already underway ever since the first oil shock.

1. Tar sands
2. Oil shale
3. Coal & gas conversion
4. Thermal depolymerization
   
5. Biofuel (from sugarcane, rapeseed, soya bean, palm oil and even algae!)
   

These alternative sources of fuel are not cheap and requires a sustained crude oil price to remain feasible. If crude prices remain sticky for a sustained period (a few years???), supply from the above sources would obviously jump.

Other factors

Continue weak USD

While the plunging USD was blamed for the initial surge in crude oil price from USD $80++ per barrel to $100++, not one article mentioned about the USD devaluation now. Seems like the search for the scapegoat have moved on. I would wonder when the USD eventually strengthens, would oil price come down? I doubt so, because strengthening USD should be a result of a recovering economy, brining along an increase in fuel consumption again -- another excuse to keep the crude price up.

What this means to me

While I have no choice but taking a much passive reactive approach in my life, i.e. tighten my belt with the current oil spike induced inflation (food, transport etc), I can continue to be active in my investment.

Market sentiment is obviously bad right now and the only remaining sexy sector are the oil and gas (or related) sectors. Thus I would think the Great Singapore Sale on SGX should not come to a close anytime soon, even though it had lasted so long, from August 2007. While I'd avoid the oil and gas sector, I believe there are still bargains to look out for.