Friday, December 5, 2008

The Oil Bubble Has Burst—What Now?

oil prices fallingI think it is safe to say that the oil bubble has gone the way of the housing bubble, exploding with a loud pop. The price of oil this morning has fallen below $42, and some analysts see it falling as low as $25 next year. That is a far cry from the high price we saw not too long ago of $147. During the oil boom, everyone was focused on doing what they could to conserve oil, and alternative energy investments were the rage. Oil companies were vilified and at the same time oil workers and oil dependant economies were rolling in cash. We have seen oil booms and busts before, but we kept hearing arguments that this boom was different: This one would never end because there just wasn’t enough supply. In the long run we will surely succumb to supply issues, but for now the world is flush with oil and the boom is over. What does this mean, though?

What this likely means is that Americans will once again return to their old ways. That means that instead of fighting over hybrid cars, people will once again buy SUVs. Instead of doing what we can to conserve energy, we will revert to our wasteful ways. As for the government, there was a lot of talk about new alternative energy projects, and how we wanted to eliminate our dependence on foreign oil. However, with oil prices in check you can bet that the government is going to be much more concerned with the financial crisis on hand rather than starting alternative energy projects that won’t offer returns for several years.

The reason why we continue to see these oil booms and busts is because each time they come around we fail to adequately prepare. During the boom we talk about all the wonderful things we are going to do to prevent this from happening again, but then once the boom ends we fail to start or finish the projects that will actually solve the problem. Obama seems intent to follow through on the alternative energy plans he so heavily promoted during his campaign, but I have a feeling that his priorities once he takes office will reflect other, more immediate needs.

That means that this won’t be the last oil boom and bust cycle, and one thing is certain: The next time around is going to be even worse than this one. Each time we fail to solve the problem, the cycle becomes more painful. In the meantime investors might want to think twice before investing in those alternative energy projects and companies that they are hoping Obama will give a boost to. Real estate investors might also want to rethink investing in oil dependant economies. As existing contracts run out, and oil companies cut back on new projects, these economies are going to feel the pinch. Many of these areas look great on paper, because they seemingly have avoided the real estate bubble, but now that the oil bubble has popped, so too will these local real estate markets.

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