Oil Price Surprises

We’ve all been surprised by the jump in oil prices. Things were bad enough when oil went to $65 a barrel and gas rose over $2.50 a gallon. Now, with oil doubled to $130 a barrel, and gas inevitably headed over $4.00 a gallon, our lives are changing. No more double cheeseburgers; one patty will have to do. Carpooling, last popular when Leave It to Beaver was running in prime time, is making a comeback. Thrift shops are chic. Young urban men are rethinking their metrosexuality as manicures begin to look awfully expensive.

But some people have been really surprised by the oil price rise. If you think you have problems, what about:

Federal Reserve. The Fed’s interest rate cuts have weakened the dollar, which is an important reason why oil prices keep rising. The Fed was trying to bolster the economy. But it may have instead hampered it, putting inflationary pressure on consumers already burdened by stagnant wages and layoffs. This illustrates that not only is stagflation possible, it may actually be spurred by government policy. The Fed’s governors probably haven’t slept that well during the last nine months, but this problem has got to be a real sleep killer.

Bush Administration. W is in the legacy building part of his Presidency, and things don’t look good. Among other things, his erstwhile Arab allies have twice rebuffed him on requests to increase oil production. How many lives has America lost and how many hundreds of billions of dollars have we spent protecting certain OPEC members? W can’t even wheedle a little boost in oil production out of these guys and they were supposed to be his friends. Friends like these will make his legacy worse than he ever imagined.

Banks and Brokerage Firms. Even though an analyst here or there may have predicted maniacal highs for oil prices, most people on Wall Street probably didn’t expect the current stratospheric prices. Remember, though, that petroleum traders buy futures contracts on margin. Banks and brokerage firms extend that margin credit. This means that the lenders could be as exposed, or more so, than the speculators. Let’s not kid ourselves about the speculation. Notwithstanding solemn pronouncements by government officials and cable TV pundits about oil prices being attributable to increased fundamental demand, the 30% price rise in oil this year to date involves a lot of speculative fever. Fundamental demand hasn’t risen that much in the first few months of this year. We have a bubble in the oil markets, and like all financial bubbles it will burst sooner or later, with nasty losses. The recent oil price rise has probably surprised margin loan and risk management people at many major financial firms. The question for the Street and its regulators is whether this time, with yet another bubble ballooning upward, they are prepared for the pop. Or, as with the housing and credit bubbles, will their heads remain in the sand until it’s too late?