In March 2008 Goldman Sachs outlined a ‘super-spike’ view of oil prices in which a major oil supply disruption could lead oil prices to rise to $150-$200 a barrel. At the time of the report Brent crude was just over $100 per barrel. It eventually peaked four months later, 45% higher. Today, Morgan Stanley issued a report warning that Brent crude prices could fall to as low as $43 per barrel in 2015, almost 40% below the oil price.
Is the oil market now trapped in a negative bubble, an inverse version of the type the oil market experienced in 2008 when oil prices spiked and oil was seen as a one way bet? Now though participants in the oil market are locked into a downward cycle of uncertainty, not knowing where the limit is that marginal producers start to shut-in production or that OPEC producers will react with production cuts.
According to Citi the oil market has now suffered “an unprecedented speculative sell-off”, of a level that even exceeded the post-financial crisis rout. The net long position through futures and options held by hedge funds and other money managers have slumped by two thirds since June. Oil prices are now vulnerable to ‘short-covering’ if geopolitical risk escalates, demand jumps or OPEC responds with a large cut.
The essence of a bubble is that prices tend to overreact and overshoot the level needed to re-balance the market in the short term. As with March 2008 prices could move sharply lower before a sustained platform towards higher oil prices is built. Unless you are trading the oil price it might pay to take a longer term outlook of whats sustainable and factor that into your hedging strategy.