Oil!

Story Highlights:

• Oil recently hit $135/barrel, and many fear prices are too high and supply will run out.
• Though many fear an oil bubble, prices are high on fundamentals, and high prices haven't historically been bad for stocks.
• Oil supply may be finite, but we'll never run out. We'll switch to an alternative before then.

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"What are you looking so miserable about? There's a whole ocean of oil under our feet!"
-Daniel Plainview, There Will Be Blood

Good luck convincing everyone, Mr. Plainview. Fact is folks are pretty miserable about oil; they usually are when prices surge. And surely this time prices will tank the markets and economy. Surely this time supply's peaking.

Analysts Say Oil Is the New Dotcom Bubble
By Kathryn Hopkins, The Guardian
https://www.theguardian.com/business/2008/may/30/commodities.oil

People liken oil's run to Technology stocks in the late 1990s, but in our view, that's way off. Euphoria inflated the Tech bubble. Companies with negative profits saw stock prices skyrocket, and IPOs glutted the market until supply outstripped demand and prices crashed. Oil's rise is different. Prices today are demand-driven, not speculative, and there certainly isn't a glut of supply. And there's a ton of skepticism—most energy analysts see oil prices falling precipitously once this "bubble" pops. But as long as the global economy grows and developing countries demand oil, prices will remain firm or rise further. There are only two ways prices can materially drop for an extended period of time: 1) Demand plummets—a bad thing, as it would signal a slowing global economy, or 2) New supply comes online. But bringing new supplies online from discovery to production and building new deepwater rigs takes years.

Another point: Despite rising oil prices in recent years, demand continues growing. That's bullish—a sign of a robust economy demanding energy to fuel growth. Yet some still think high prices are trouble:

Record Oil Fuels Markets' Worst Week in 3 Months
By Kristina Cooke, CNBC.com

Headlines about high oil causing trouble for stocks are common. Yet oil and stock prices aren't meaningfully correlated historically. Even recent history disproves this belief. We're in the fifth year (and counting) of an equity bull market during which oil prices more than doubled. Don't expect higher oil prices to kill stocks—in fact, they'll probably continue to provide great investing opportunities in the Energy sector.

There's no magical oil price that will kill the markets or the economy. Four dollar gasoline? Europe's still growing with $9 gas, so $4 shouldn't make us holler—it's a relative bargain! Eight years ago, conventional wisdom said $50 oil would sink us; three years ago they said $75 oil; two years ago they said $100 oil was doom. Fact is US energy consumption is still near its long-term average as a percentage of per capita income.

Still, demand is only part of the equation. Folks worry about supply too:

Oil Exporters Are Unable to Keep Up With Demand
By Neil King Jr. and Spencer Swartz, The Wall Street Journal
https://www.wsj.com/articles/SB121200725158327151

The last sentence in the previous article sums it up: "The sense in the market is that peak oil is here and that things will only get worse." This might be worrisome … if it weren't an old song. Peak oil disciples have prophesied doom for decades, and they've been wrong every time. Yes, oil is finite, but we won't know when production peaks until well after the fact, since we can't know how much supply remains or when it will become available.

But that's no bother because we won't run out of oil. Ever. Higher energy prices accelerate a substitution effect, creating incentives to find alternatives. Of course this can't happen overnight—it will take time for such changes to catch up with surging demand. Nevertheless, we are seeing some evidence of a forming sea change: France and Italy are ramping up nuclear power, Gordon Brown recently announced plans to do so in the UK, and the US could easily follow suit. Switch to nuclear and peak oil fears go poof. But our cars won't run on nuclear! Supply limitations spur innovation there too—just five years ago, hybrid cars were a pipe dream. Today, they're an increasingly viable technology because companies have a great incentive to develop technology quickly.

Naturally, some folks want a quicker government fix:

Europe Fuel Protests Spread Wider
By Staff, BBC News

Someone stop them! First, blockades don't solve anything—they just disrupt the supply chain, causing price spikes. Second, governments and regulators can't "fix" high oil prices—any legislation will undoubtedly cause unintended harm. We don't need protection from high prices, we need protection from regulators.

The best changes and solutions are market-driven. Expect increased investment in innovation, exploration and extraction of existing oil in all its forms. This can help supply pace demand until we all live happily ever after with clean, nuclear energy—or whatever gets innovated next. And that ocean of oil under Daniel Plainview's feet? It'll be a long time before anyone drinks it all up.