How long will the bubble in oil prices last, and how high will oil prices go before they peak? Will it take governmental manipulation to puncture the bubble, and would such manipulation work long term?

No one can predict prices for the next week, month or for years ahead.

But based on the history of the 1980 bubble in oil prices, economists and analysts think that the current oil bubble might last a long time, according to wsj.com.

It takes a long time to increase oil production in response to increasing demand and high prices. Some think that because oil production is controlled by dictatorships, oil production may not increase as it would if the major oil companies owned and managed the world’s oil reserves. And it takes a long time for consumers to reduce consumption significantly.

In most markets such as housing, autos, corn, wheat and other foodstuffs, high prices cause producers to increase supplies and consumers to find alternative products. That causes prices to peak and bubbles to burst relatively quickly.

But, the theory goes, because oil isn’t renewable, and demand from China, India and other emerging markets appears insatiable, it will take consumers a long time to wean themselves from petroleum-based products. So today’s high oil prices may not be the top.

Last week oil futures topped $135 a barrel and closed Friday more than 100% above year ago prices. In the stock markets, there always are a few stocks that are trading two or three times what they were trading at 12 and 18 months earlier and commodity prices frequently double and triple over short periods. So a tripling in oil prices wouldn’t be unprecedented.

In most markets, such a run ends with a major price correction as consumers stop buying and speculators take profits.

The problem with the comments by The Wall Street Journal’s sources is that they aren’t taking into account several new factors that could end or at least slow the surge in oil prices.

Governments can manipulate markets in ways that would put private traders in jail, and they often do. The current boom in corn prices can be blamed in large measure on presidential candidates and members of Congress who forced taxpayers to subsidize the production of ethanol as an alternative fuel. Those promises, which were made years ago, bought votes and power for President Bush and members of Congress, but they have done and will do nothing to make the U.S. less dependent on oil imports.

What can consuming countries’ governments do to dampen demand for oil and oil prices?

Congress probably will be talking about taking institutional speculators out of the futures markets. And other consuming countries such as China and India could end the gasoline subsidies that are making their consumers insensitive to soaring prices, as I’ve written here and here.

In the last few years, pension funds, mutual funds, hedge funds and exchange traded funds have become major speculators in the commodity futures markets. Lacking money-making opportunities in securities and other financial markets, portfolio managers are increasingly speculating in the risky futures markets. And they appear to be mostly buyers, not sellers.

They say they know how to manage their risks.

But the buyers of subprime mortgages said the same thing before their markets and careers crashed.

Congress is not good at policy making, but it sure knows how to demagogue private businesses, and as the election nears and politicians need excuses for soaring food prices, look for the demagoguery against commodity speculators to soar not only in Congress but in legislatures and parliaments around the world.

Demagoguery isn’t doing much to the oil futures prices, yet, but that’s because it’s aimed at big oil companies, not the institutional speculators and foreign governments who are most to blame for soaring prices.

If and when politicians refocus on institutional speculators, the institutional money managers will quickly rethink their missions and strategies and try to get out of the way of the bad publicity that is already beginning to put them in the spotlight.

As speculators increasingly fear new governmental manipulation of the futures markets, they will sell and prices will correct. This will take some major buyers out of the market quicker than economists and many speculators are anticipating. Once prices break, there will be a rush for the exits.

The question then becomes, if institutional speculators, but not individuals nor hedgers, are taken out of the futures markets, will actual supply and demand fundamentals begin to be reflected in the markets?

What prices will more accurately reflect the actual supply and demand fundamentals and expectations for changes in supply and demand?

It’s hard to say. Oil bulls are predicting $150 oil by year's end and $200 oil by 2010. Yet there are plenty of people who think oil currently is vastly overpriced for the near term and the long term. But they’re only guessing. As noted above, no one knows for sure.

Governments can manipulate global money and commodity markets only so much. And it takes awhile to figure out what the next attempt at governmental market manipulation will be and whether political tinkering with the markets will have long-term effects or not.

Even if American politicians try to take U.S.-based institutional speculators out of the futures and commodities markets in the U.S., they can’t control speculation in futures markets that are outside of the U.S. And they have no control over the governments that control most of the world’s oil reserves and have the most control over the supply side of the oil markets.

For governmental manipulation of the oil markets to have any long-term effect, the governments of other oil importing countries will have to conspire with American politicians to dampen speculation and consumption.

And that may happen, because consumers around the world are feeling the effects of institutional speculation in the commodity markets, and they will take it out on politicians unless the politicians take it out on institutional speculators.

The final unknown in the oil markets is whether the governments of oil producing countries that are the most to blame for soaring oil prices will decide that high prices will reduce consumption so much that it will be in their best interest to join consuming countries in manipulating prices in an effort to make them more acceptable to consumers. High oil prices in the early 1980s caused consumption to decline. As a result, oil prices were depressed through most of the 1980s and 1990s.

Oil market bears think and hope that will happen again. Bulls pray and say that a crash in oil prices is unlikely.

• Gustav and the Oil Volatility Index  »
• Energy Conversion Devices, Inc. F4Q08 (Qtr End 06/30/08) Earnings Call Transcript  »
• Does CFTC's Investigation Signal a Peak in Crude Oil Prices?  »
• Oil Manipulator Named: Gustav  »
• Solarfun Down Despite Reporting a Strong Quarter  »

Donald Johnson

• Bio & more articles
• Visit author's site