The rise of Petro exuberance: how oil today is in straits similar to those of the late-1970s U.S. economy.

• Author: Verleger, Philip K., Jr.

Alan Greenspan coined the phrase "irrational exuberance" during his tenure as Federal Reserve chairman. He used it in a 1996 speech in reference to the excessively high prices of "dotcom" companies. He worried that assets were overvalued. Four years later, the dotcom bubble burst, confirming his concerns. As it deflated, many companies whose executives had been irrationally exuberant also collapsed.

Seven years ago, several home building firms acquired thousands of acres of vacant land on which to build new subdivisions. "Exurbia" became the location of choice for young middle-class Americans to settle. While this was occurring, executives of firms such as Ryland Homes told investors their business plans were sound. The housing boom was unstoppable, they said. These individuals also suffered the after-effects of irrational exuberance, as did their firms when the housing market collapsed.

Presently we are observing the last gasps of irrational exuberance in petroleum. Call it "petro-exuberance." This malady became apparent during a session on oil market issues at the World Economic Forum in Davos, Switzerland. Some panelists clearly had a case of irrational exuberance, an overenthusiasm no different from what we saw at the end of the dotcom and the housing crises. Claudio Descalzi, CEO of Eni, and the International Energy Agency's chief "economist" Fatih Birol showed the most distinct symptoms. Both seem under the illusion that oil price levels today are temporary rather than characteristic of a new ceiling that producers will welcome in a year or two.

In his remarks, though, Descalzi unintentionally advanced an explanation for recent developments and the likely way forward for global oil markets:

What we need is stability.... OPEC is like the central bank for oil which must give stability to the oil prices to be able to invest in a regular way. His observation, if correct, promises a prolonged period of low prices and a harsh climate for those producing oil.

Panel moderator Daniel Yergin joined the dialog and asked the participants whether the central bank of oil was making a mess of things. Their answers made one thing obvious: they had no concept of the role central banks play in economies. If they had, they might have said this:

Not at all. A major central bank of oil finally responded properly in November when a decision was made not to cut output. While the action came late, the bank took away the punch bowl, just as really good central bankers must do from time to time. Market participants had become irrationally exuberant, investing billions upon billions in high-cost projects. In refusing to cut production, one central bank of oil (Saudi Arabia) followed a script written by Paul Volcker thirty-six years earlier. Volcker became head of the U.S. central bank in August 1978 when inflation in the United States was out of control. Readers may recall that he took over as chairman just when inflation reached 13 percent. At the time, Volcker worried not just about inflation but also about "the important factor of expectations." His concerns regarding inflationary expectations might seem commonplace now since these expectations are a key focus of every central...