Shock waves spread as oil bubble bursts

THE exposure of the oil price boom as a speculative bubble has been the catalyst for a change in world financial flows, and the ripples are now spreading through currency, commodity and financial markets.

[…] Evans cites the definition of speculative bubbles by Yale economist Robert Shiller, who says they arise when news of price increases spurs the enthusiasm of an ever larger class of investors who, despite doubts about the real value of the investment, “are drawn to it partly through envy of the other’s successes and partly through a gambler’s excitement”.

Peak oil — the theory that the world’s oilfields are in irreversible decline — was the elixir that got investors going.

“They argued that being long in the oil market was a safe play because they’re not making any more of it,” Evans says.

New classes of investors joined the market, with the rapid growth of index funds as prices rose ever higher. Demand growth was suffering. It reached a peak of 3.8 per cent in 2005, dropping back to 2.1 per cent in 2006, 1.3 per cent in 2007 and was estimated by the IEA last week to rise only 0.9 per cent this year.

Evans says the oil bulls were not worried by the demand destruction, because they believed supply was in permanent decline.

The Australian