Oil ‘bubble’ will burst

Tamsin Carlisle

• Last Updated: May 19. 2008 11:24PM UAE / May 19. 2008 7:24PM GMT

Battles on the bourses: Investment analysts are at polar opposites over whether oil will jump to the $200-a-barrel range or hit a major correction in coming months. AFP

A leading global investment bank has predicted a sharp correction in oil prices, probably within the next few months, after concluding levels were being driven higher by factors other than the fundamentals of supply and demand.

The prediction contrasts with a rival bank’s forecast of a “super spike” in oil prices that could extend the current bull run in commodities for another two years.

“We see many of the essential ingredients for a classic asset bubble,” Edward Morse, the chief energy economist of the US-based investment firm Lehman Brothers, said in a special report on energy released yesterday.

Analysing how the flow of investment capital into commodities had affected oil prices, Mr Morse noted a “major spike” in investment inflows since December had strongly correlated with US dollar weakness and rising inflation. He also found evidence of “a significant amount of momentum-chasing” by commodity investors seeking ever higher returns.

The phenomenon of investors ploughing funds into sectors where prices had already risen, thus causing a further price appreciation, could create “fertile ground” for an asset bubble to grow, Mr Morse argued, especially when it was combined with general lack of information on market fundamentals.

In the case of oil, uncertainty over “the true state of inventories in China or space production capacity in Saudi Arabia” may have delayed a market correction, he said.

Mr Morse did not take issue with a prediction earlier this month by the Goldman Sachs analyst Arjun Murti that oil prices could reach US$150 to US$200 a barrel within six to 24 months.

But rather than seeing the current bull market in oil prices as sustainable, he took the view that an oil-price bubble was forming and would burst.

“Once uncertainty about the physical state of the supply demand balance clears, in terms of both inventories and spare production capacity, markets may face a sharp correction. We think this is likely to happen around the turn of the year,” Mr Morse wrote.

Mr Murti made his mark on oil markets three years ago, when he predicted that oil prices would reach triple digits. Yesterday, the price of light crude oil reached US$127.77 a barrel, just short of the record US$127.82 a barrel set on Friday.

In his most recent forecast, Mr Murti said only “a multi-year decline in global oil demand” could bring prices down.

He noted that non-Opec oil producers had been struggling to boost crude output with production capacity falling in Mexico and Russia, while Opec member nations had also collectively failed to raise production.

Mr Morse, however, said investors could have “forgotten” that commodities prices were cyclical by nature, fluctuating around a long-term equilibrium value.

“Adjustment to a higher equilibrium price may mimic superior return in the short term, but they are unlikely to last forever.”

tcarlisle@thenational.ae