Bubbling Crude: Oil Price Speculation and Interest Rates

Abstract

An analysis of the current crude oil price patterns strongly suggests that they are the result of bubble. The classical indicators of a potential speculative bubble in a commodity market are all present: low US$ interest rates, high stockpiling levels despite the fast-growing demand and forward prices in contango. In the 1970s and 80s, the weight of oil on Western economies was so high that high crude prices would invariably result in inflation and therefore in the US Federal Reserve raising interest rates, which in turn would burst the bubble. Today, however, as Western economies are far less dependent on oil, US$ interest rates are also far less likely to be raised in response to an oil price spike, and therefore a bubble can take a lot longer and grow a lot larger before it reaches its bursting point. Among other considerations, this analysis suggests uncomfortable implications for emerging East Asian economies, as their dependency on oil is very high but they have little to no control on the US$ interest rates that can either fuel or cut short a commodity bubble of these characteristics.