December 7, 2014

Derivatives Of The Mania

An editorial in the Odessa American caused me to ponder the definition of bubbles and what doesn’t qualify as a bubble. From the piece:

“A speculative bubble is caused by exaggerated expectations of future growth leading to price appreciation. Trading volume moves higher as more investors enter the market. Buyers outnumber sellers pushing prices beyond what an objective analysis of intrinsic value would suggest. Finally some move to sell and the sellers quickly overwhelm the buyers. The bubble bursts with prices falling as fast as they rose.”

“Expansive social mood leading to bubbles in nothing new. The Dutch underwent Tulipmania in 1636, the English did the same with the South Sea Company in 1720 while France succumbed to John Law’s Mississippi Scheme at the same time.”

“This column noted a year ago that the phenomenon of $100 was relatively recent. Oil prices had only been in triple digits for a few dozen months. Yet the world from Russia to Iran to the Permian Basin seized on this bubble as ‘the new normal’ for oil prices. This column has detailed derivatives of the mania from a now cancelled 50 story building in Midland to the lights of the Eagle Ford visible at night from outer space to Putin’s double down bet on triple digit oil prices to secure the future of Russia.”

“The players at the table have different aims. The Saudis hope lower prices will stifle production in the USA. However, small­er players like Greenland see increased oil production will enable their independence from Denmark. Canada sees its output bolstering claims to northern areas potentially in dispute with Russia. And so, the Organization of Petroleum Exporting Countries met Thursday in Vienna and decided not to lower its target output. Western sanctions are holding a flood of Iranian oil back meaning OPEC does not have to worry about that over supply, for now. But with a U.S. administration eager for an Iran nuclear deal, those sanctions are liable to be short lived.”

“Halliburton trades at a 12 to 1 P/E; so PTEN could fall much further. Nabors is trading at 80 percent of book value. Transocean took a $2.5 billion write down last week, slumping to a mere 63 percent of stock price to book value-and it is losing money. Comments that various OPEC members are ready to ‘accept’ $70 oil seem eerily out of touch. Valuations for service companies already reflect that and lower prices ahead. Our conclusion is the same as the Saudis, lower prices are ahead, $60 is becoming much more realistic.”

To me, a bubble or mania would involve a large number of ‘players’ acquiring an asset with the expectation that the price would continue to grow to an irrational level, maybe even indefinitely. With the exception of trading in oil stocks or futures, speculation in oil is based more on the what were current price levels being maintained. Not every boom is a bubble. Nor is an outsized growth a bubble, such as the often described credit bubble. I’ve even called bonds a bubble, when it doesn’t meet my definition. It’s an easy term to throw around, I suppose.

In the 1980’s, when the price of oil collapsed in circumstances similar to today, the economic impact was severe. But it wasn’t the loss of oil jobs and companies that resulted in the mass bankruptcy of banks and S&L’s. It was the real estate mania that took the Texas economy into depression.

I don’t think it matters much what we call these things. But if I were to describe what’s happening in the oil markets, I would say it’s a market manipulation or distortion come undone. Lot’s of bets were placed on an artificial price and that is playing out. But don’t be surprised if a real bubble is exposed in the process.

Bits Bucket for December 7, 2014

Post off-topic ideas, links, and Craigslist finds here.