Is Surging Oil Just Another Bubble?

Bubble-watching has been a popular spectator sport all year - commodities, China / Asia, Google and real estate have all been widely associated with unsustainable price surges - and now billionaire publisher Steve Forbes is entering the fray. Oil, he suggested earlier this week: "..is a huge bubble. I don't know what's going to pop it but eventually it will pop - you cannot go against supply and demand, you cannot go against the fundamentals forever.'

One would have thought that it was precisely the imbalance between supply and demand, otherwise masquerading as 'fundamentals', that was driving oil prices higher. The likes of Matthew Simmons ('Twilight in the Desert - the coming Saudi oil shock and the world economy'), of course, would argue that OPEC is essentially lying about supply and that even Saudi output may not be enough to put a cap on prices, particularly in the wake of Hurricane Katrina and her impact on the Gulf of Mexico. 'The Economist' waded in to this debate last week by putting the US and China on its front page as Oiloholics.

Notwithstanding the market impact of 'speculative' capital - these days, it's all speculative - oil prices appear to be flashing an alarming signal to the global economy. The short end of the Treasury curve has already reacted in sympathy; three-year note / two-year note yield inversion can easily be viewed as a harbinger of recession. Ditto the data from the Chicago purchasing managers' index, which showed its lowest reading since April 2003, and a downward revision in Q2 GDP growth.

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Just as not every appreciating asset is automatically a bubble, not everyone opining on the price of oil is an expert, but some practitioners are more expert than others. Barron's Magazine pointed out this week that insiders at energy companies were 'Still Piling into Energy Stocks'. Naureen Malik cited insider purchases at Chesapeake Energy, Nabors Industries and Energy Transfer Partners. To muddy the waters further, not every insider is a buyer: Exxon Mobil CEO Lee Raymond, who presumably knows a thing or two about the oil business, has sold 150,000 shares in his company since the start of August. Dan Lonkevich, writing for Bloomberg News, points out that while executives may not be buying their own stock, they are certainly willing buyers of the competition and its inventory:

'China National's agreement last week to buy PetroKazakhstan for $4.18 billion valued the company's reserves at $10.66 a barrel. Chevron this month paid the equivalent of $10.17 a barrel for Unocal Corp, and the $17.8 billion price was triple what the company spent in the past five years to find reserves... Kerr-McGee Corp is getting $15.15 a barrel for its North Sea oil and gas assets from AP Moeller-Maersk A/S, and El Paso Corp is paying $13.72 a barrel for Medicine Bow Energy Corp... Energy producers are paying a record $8.83 a barrel on average for acquisitions announced in 2005, up from $3.03 a barrel in 2004. They are also doing more deals this year than in any of the past three years.'

Not that takeover activity should be seen as purely economic - the role played by executive ego also has to be considered. But if shareholders in acquisition-desperate oil companies have misgivings as to corporate strategy, there is an easy and market-driven voting solution close at hand.

Russel Kinnel, director of mutual fund research at Morningstar, adds more weight to the argument supporting the 'oil bubble' thesis, in citing the explosion in commodity and natural resources funds. This runs the risk of conflating two different albeit related trends: the rise of commodities markets and the rise specifically of oil. We know that the launch of multiple dotcom-themed funds ended poorly.

Again, not all rising markets constitute bubbles - the oil price may be unsustainably high (we think not, though rich prices are likely in any case to be self-correcting within any global energy environment that permits choice), but the metrics associated with the listed equity of oil majors (dividend yield, just by existing, and price / earnings in particular) are a million miles away from those associated with dotcom stocks during the boom years. Steve Forbes is, of course, entitled to his opinion - but we'd put money on equity markets, for example, cracking for entirely logical reasons associated with economic slowdown some time before the oil price does.

Tim PricSenior Investment StrategisAnsbacher & Co Ltd