Oil Bubble ?

Are Oil prices driven by economic fundamentals (supply and demand theory) or are speculative investors (pension funds, index funds and hedge funds) to blame for the very high rise of oil prices in recent months?

China is one of the cornerstones of the energy bull story. It is widely assumed that it will have an almost endless appetite for oil over the next few decades. An economy very dependent on industrial production combined with rising living standards, or so the argument goes, will demand enormous quantities of the black gold.In reality, though, Chinese oil consumption has actually decelerated in recent years. The chinese have accumulated a lot of disel in the first quater of 2008 in view of the Beijing olympics. Once the games are over there will be a big surplus of diesel inventories.

According to Morgan Stanley, half the world’s population currently enjoys fuel subsidies of some kind. As the price of oil continues to rise, the situation becomes increasingly vulnerable for most of the governments providing these subsidies.Egypt raised petrol prices by 40% only a couple of weeks ago. So did Indonesia (+33%) ,Sri Lanka (+25%) and India (+10%).

Saudi King Abdullah told UN Secretary General Ban Ki-moon last Sunday that the kingdom would do everything it can to bring “abnormally high” oil prices to “adequate levels.” OPEC blames speculators for inflating oil’s rally and adding to volatility and wants increased regulation of futures markets. Investment funds have pumped billions of dollars into oil markets as they look to diversify holdings and flee other poorly performing asset classes.

Saudi Arabia’s oil meeting on Sunday is key to setting the direction of the oil price, which this week hit a record high of $139.89 a barrel. On Friday, oil prices closed at $135.13 a barrel, up 40 per cent since January.Saudi Arabia could announce some kind of production increase together with a reduction in the prices it charges refines around the world, particularly to the politically sensitive US, but also to Asia.

The Oil prices are bullish in the long term ( based on the growing economies and GDP growths of India and china) but in the short term oil is heading for a sharp correction. Oil may correct to levels of $110 a barrel or less in the coming weeks.