$80 Oil In 2008???

Well, I promised some good news in the next post so here it is: It has recently come to my attention that energy market funds have become all the rage in light of all the attention energy prices have been getting. These investment vehicles are engineered to follow the price of crude more closely than any oil company or trust does. They are essentially hedge funds, which are designed for companies that genuinely need to minimize risk exposure to ensure predictable profits. The airline industry is a good example of an industry that needs to hedge itself against the price of oil. Were it not for hedging, many airlines would be in much worse financial shape.

Fund	Symbol	Launch Date
US Oil Fund LP (ETF)	USO	April, 2006
US Natural Gas Fund LP (AMEX)	UNG	April, 2007
12 Month Oil Fund LP (AMEX)	USL	December, 2007
US Gasoline Fund LP (AMEX)	UGA	February, 2008
US Heating Oil Fund LP (AMEX)	UHN	April, 2008

The problem is, that these funds (and I suspect many others around the globe) are available to everyday investors. NYMEX crude oil contracts require minimum trade increments of 1,000 barrels at a price of $13,000 each. Not too many small investors would want that kind of exposure in such a volatile market. These energy funds allow investors to effectively buy oil in much smaller basket increments (on the order of one barrel or even less). Since the funds I've listed (and I suspect many others) only originated recently (end of 2007 to early 2008), it's quite possible that they have added considerably to a speculation bubble that has yet to really burst.

While I do not in favour of excessive government interference in free markets on the grounds that they do not and can not lower long-term prices, I do believe that it can help moderate short term prices as well as stabilize volatility. Yet the commodity exchanges are already heavily regulated and there is little indication that more price controls are the answer. Price volatility has been very high with massive ups and downs in the past year, which is certainly an indicator that speculation is trumping fundamentals. As I said and continue to say, market bubbles will eventually always burst, but unfortunately they can often leave deep scars in the process. I think there is a very real possibility that the price of oil could continue to correct itself downwards by as much as 30-40% in the coming months.

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Ed. Note: I just checked oil prices this morning (Monday, August 4) and they have tumbled below $120 (down $4) in intraday trading.