After long thought, I am coming around to the notion that oil may be in a bubble. Why? Because everyone is acting as if the natural trajectory of prices is ever-upward. Sound familiar?



Oil is a fairly easily storable commodity. If you think that you can get a better price for it tomorrow, the natural thing to do is buy it and store the stuff. This should push the price upwards until there is no remaining arbitrage opportunity in buying now and selling later.



The best estimate of the future price is therefore the current price. For it to move upward, rationally, you need new information--i.e., information that none of us knows now. The basic logic behind the predictions I hear of ever-rising prices--the supply is fixed, oil is neat stuff that helps grow economies, there are a lot of economies that want to consume more of the stuff--is all well known to everyone. You should assume that the price is roughly as likely to fall as to rise.



But people are acting as if the overwhelmingly likely outcome is a continuing increase. This shows not merely in the fact that it's damned hard to find a small car on the lots these days, but also in all sorts of policy debates. This suggests a couple of things to me:



1) There are probably more speculators in the market on the upside than the downside, pushing the price above its natural level



2) We are probably irrationally overinvesting in fuel-saving technology.



Now, as I've said repeatedly, I think the price of oil should be higher, helped along by a carbon tax. But there's no reason to think that the wellhead price is more likely to rise than to fall. If I were brave, I'd short oil and buy an SUV. Instead, I'm timidly sharing my thoughts with you, and investing in a small car. But in my defense, small cars are also easy to park.

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