Friday, June 6, 2008

What do oil and housing have in common?

Boom and bust cycles, driven by sudden changes in demand

both housing and oil supply react to a surge in demand with a long lag. In housing, the lag is caused by restrictive zoning and development laws, especially in coastal markets like California and Florida.

So when the economy roared back in 2002 and 2003, builders couldn't turn out homes fast enough for buyers armed with those cheap mortgages. As a result, prices spiked. They no longer bore any relation to the actual cost of buying and improving land, or constructing and marketing a new house (at some reasonable profit margin). Instead, frenzied buyers were setting the price.

Because builders were reaping huge windfall profits, they rushed to buy and develop land. And sure enough, those new houses were ready just as buyers were retreating to the sidelines because they could no longer afford to buy a home. That vast overhang of unsold homes is what's driving down prices today.

The story is much the same with oil, with a twist. A big swath of the market isn't really paying that $125 a barrel number you hear about seemingly every hour. In China, India and the Middle East, governments are heavily subsidizing oil for their consumers and corporations, leading to rampant over-consumption - and driving up prices even more.

But sooner or later the world won't keep paying those prices: Eventually, the price must fall back to the cost of that last barrel to clear the market.

So what does that barrel cost today? According to Stephen Brown, an economist at the Dallas Federal Reserve, that final barrel costs just $50 to produce. And when the price is $125, the incentive to pour out more oil, like homebuilders' incentive to build more two years ago, is irresistible.

"Cocaine is for horses, not for men; they say its going to kill me but they won't say when."

It's impossible to predict how the adjustment this time will take shape, just as it was in housing. There the surge in supply came in places the experts swore there was "no supply," and wouldn't be any. Builders found a way to extend vast tracts of homes into California's Inland Empire and Central Valley, and even build "in-fill" projects near the densely-populated coasts.


  1. Oil is connected to housing in other ways as well. Heating Oil. Have you seen what people are going through to get their tanks filled and the amount they're paying. Crazy. We should really concentrate on getting them to switch over to a B5 blend. It produces NO greenhouse gases, reduces emissions, and CONSERVES 400 MILLION gallons of oil. Imagine that. It's true, while working for NORA, I found this site:

    Check it out and see for yourself. Oil can also be "green".

  2. I stumbled across this article this morning and found it fascinating considering what we have seen in the oil market over the last few months. Tully predicted "...a few years hence, we could see a sustained period of plentiful oil supplies and low prices, meaning $50 or below" in July 2008.


  3. I don’t know all that, but I definitely feel that this increase the demand of oil and as Forex trader, it makes such a huge difference to be aware of all the market movements regarding oil, if we are not aware of all the stuff then we might struggle. I am fortunate to have quality broker like OctaFX, as they help me in big way especially due to their daily market news and analysis service, it’s free yet seriously effective to follow.