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Lindley Estes is a business writer for The Free Lance-Star and Fredericksburg.com. This blog is on Fredericksburg-area business. Send an e-mail to Lindley Estes.

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Are bubbling crude prices headed for a bust in the near future?

DRIVERS feeling the pinch of $4-a-gallon gas and praying for a reprieve may want to pick up the June 23 edition of Barron’s.

"Oil Bubble" blares out across the cover of last week’s edition of Barron’s, which makes the case that crude oil will fall back to $100 a barrel later this year. That would represent a nearly 30 percent decline from recent crude prices, and should send pump prices lower.

The bullish case for oil is well-known: rising worldwide demand fueled by the fast growth of India and China, coupled with decreased production capacity.

That imbalance of supply and demand has had an effect that even Economics 101 students could predict. The price increases have led to a reality television show based around three groups of guys trying to find oil first in Texas.

Barron’s suggests that oil’s rapid rise this year "was fueled by more than economics." The article argues that massive institutional investments in commodities have driven crude prices above fundamental values.

In fact, oil prices have run up in a manner similar to the way the technology-laden Nasdaq Composite did in the late 1990s. The Nasdaq has since fallen 50 percent. "Will oil do the same?" Barron’s asks rhetorically.

There’s certainly no guarantee that it will, and some analysts are already on the record predicting $200 crude. Yet Barron’s lays out a number of arguments as to why oil is more likely to slide back to $100, at least in the short term:

  • Saudi Arabia may make good on its promise to increase production, and perhaps Congress will give in to President Bush’s desire for more drilling in places such as Alaska and off the U.S. coasts.
  • Global demand could slow. The Chinese government recently raised fuel prices 18 percent in an effort to slow demand. Americans are starting to drive less in the face of $4-a-gallon gas, and are buying more fuel-efficient cars. Airlines have announced reductions in the number of flights.
  • The Federal Reserve has focused its interest-rate policies on curbing the U.S. credit crunch. But the Fed could start raising short-term rates later this year, which should rally the dollar, stave off some inflation concerns and reduce crude prices.
  • All of this should make crude oil less enticing for institutional investors, which could result in rapid price declines.

What would a decline in oil prices mean for investors? Barron’s argues that the stock prices of major integrated energy companies such as ExxonMobil, BP, Royal Dutch Shell, Chevron and Conoco-Phillips are already assuming $100 crude.

The article makes the case that these stocks, currently priced at less than 10 times earnings, should hold up best in the sector if oil prices decline. Less-diversified exploration and production companies that have seen more rapid increases could get hit harder.

Of course none of this could end up being accurate. Perhaps the run-up still has a ways to go. Barron’s points out that "it’s perilous to call the top in a booming market." But prices don’t keep going up because they have in the past. If fundamentals don’t support it, eventually the bubble will burst.

Just ask anyone who bought a house a few years ago.

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Permalink: http://news.fredericksburg.com/businessbrowser/2008/06/29/are-bubbling-crude-prices-headed-for-a-bust-in-the-near-future/