The Price of Crude Oil, How High Will It Go? | Financial Avisory Articles


The Price of Crude Oil, How High Will It Go?

Although many people don't realize it, open bidding at the New York Mercantile Exchange in New York City sets the price of crude oil. For all intents and purposes, this open bidding, or open outcry, is actually the same as an auction. The New York Mercantile Exchange, the Chicago Board of Trade, or any other futures exchange for that matter, is no different than a great big financial Ebay.

Oil Companies Setting High Prices

It is in vogue to think of rich, evil, oil companies setting high prices on their product, but actuality this is not what happens. It is true that oil companies participate in the bidding, but anyone is free to participate. Besides the oil companies bidding for crude oil, many investors/spectators are also involved in the process.

Fundamental and Technical Trading

When speculators, or companies who are hedging, bid in the open market on futures exchanges, they attempt to predict future prices by using two different types of indicators.

The first types of indicator speculators/hedgers will use are fundamental indicators. In other words, they attempt to determine what the given supply will be in the future for a certain product. They will also attempt to predict what the future demand will be for the same product. If they are accurate, they will be able know whether the price of this commodity will rise or fall.

The second types of indicator speculators/hedgers will use are technical indicators. With technical indicators, investors feel they can simply look at charts and predict whether the price of the commodity is rising or falling.

In the case of crude oil, some time ago fundamentals indicated that its price would be rising. However, there is some controversy about just how high the fundamentals tell us the price of crude oil should be right now.

As far as technical indicators are concerned, when the price of a commodity has gone on for a while in one direction or another, these indicators will no longer be useful because all they do is tell you which way the price is headed. They say nothing as to how far it should go.

The Tech Stock Boom

In the 1990's, there was a tech stock boom. Very shortly into this boom, tech stocks became overbought. In other words, the tech stocks were not, in reality, worth the high price they were selling for. A year or so later, they became extremely overvalued. That didn't stop their price surge though, because the price of tech stocks were increasing very rapidly, they were making money for people. So, more buyers kept coming into the market.

Tech stocks made millionaires out of a lot of people. All a speculator had to do was buy tech stocks, and then hopefully sell them before it was too late. After a few years had gone by, tech stocks were so expensive, new investors just couldn't afford them. Without new buyers coming into the market, the price of the tech stocks stopped appreciating. When that happened many speculators saw no purpose in holding onto their tech stocks. So, naturally they started to sell them.

As you probably remembered, the tech stock market suffered a complete crash once selling became the trend. The NASDAQ tumbled from 5,000 to 1,100. During this time, fortunes were lost. Once the NASDAQ had settled around 1,150, the price of tech stocks had found their equilibrium. In other words, after bouncing around a bit they started to trade at their true worth.

This is the Crude Oil Price Boom

The crude oil market, which right now is trading at approximately $118 per barrel, looks exactly like the tech market boom just before its bubble burst. Other parallels can be drawn between the tech market bubble of the 90's; the housing bubble of 2005-2006 and what the crude oil market is going through right now.

It looks very much like the price of a barrel of crude oil just has to trade at this level for a while before traders realize a lot of new money can not possibly continue flowing into this market. There is no real fundamental reason behind oil's current excessive price, except for market psychology, which is usually based on negative sentiment. Once the price stagnates for a month or so, there will be no indicator telling anyone this would be the time to invest in crude oil.

While I, or no one else can predict the future; I can look at the past with the best of them. When I look at what's going on in the crude oil market, I just can't distinguish anything different from what happened to the tech stock market of the '90s, and more recently the housing market.

Ed Lathrop

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