free html hit counter Peak Oil Debunked: 342. MATT SIMMONS: SPECULATORS SET OIL PRICES

Thursday, March 20, 2008

342. MATT SIMMONS: SPECULATORS SET OIL PRICES

Big hat tip to juan for finding today's tasty nugget: a January 27, 1998 paper by Matthew R. Simmons* entitled Is Another "MG" at Work? (Or, What is Driving Down the Price of Oil?) (paper archived here: Simmons & Co). In this paper, Simmons proves that oil prices are set by speculators, with little reference to the underlying fundamentals.

Some choice quotes from this explosive document (bold in original):
Effectively, the changing perceptions of a small handful of speculators now appear to set the price for West Texas Intermediate crude oil, which in turn sets the general price for almost all other crude grades throughout the world.

If this is true, the world's most important commodity is being priced by a handful of hedge funds or individual speculators who, as a group, invest less than $100 to $150 million at any period of time.
-----
For all those that fervently believe price movement always reflects fundamental changes in the physical markets, the discussion in this paper bears careful reading. Our work strongly suggest that large swings in the funds' net position in oil contracts on the NYMEX have driven virtually every significant movement of crude oil since the MG position was unwound in 1994.
-----
Why Should the Funds Have Such Heavy Influence on Crude?
It seems hard to believe that the buying behavior of a small group of hedge funds could actually move the price of a commodity as important as crude oil. After all, it is the world's largest single traded commodity both in terms of dollars changing hands and in daily volume.

Throughout this period, the commercial buyers generally held three to four times as many contracts. So why would they not be the big drivers of crude prices?

The answer is that few, if any, of the significant commercial traders are charged with betting on the future direction of crude. While the commercial traders do watch the technical charts and attempt to minimize daily losses or make reasonable trading profits, few have the mandate (or the temperament) to make a heavy bet on the direction of crude prices. In fact, a number of the large industry traders have company policies which preclude being able to "bet on the future of oil".

But the funds are clearly a horse of a different color. Their huge shifts between holding big short and big long positions clearly indicate this. Both the velocity and magnitude of their swings, often occurring in a handful of weeks, have become the proverbial tail wagging the dog or Archimedes' famous lever, which moves perhaps not the entire world, but certainly the world of crude.
-----
Thus, if funds are driving the NYMEX price, the NYMEX price drives the WTI cash price and the WTI drives world crude prices, it leads us to the conclusion that a small number of speculators are driving the world price of oil.

In our opinion, this indicates that prices over the short-term tell us nothing about the supply and demand fundamentals for oil. Rather than being a perfect indicator for the fundamentals, price is a perfect indicator for the psychology of a small number of funds.

Matt Simmons: Oil prices driven by speculators

*) Chairman of Simmons and Co., Intl., the world's leading investment bank in the energy industry.

73 Comments:

At Thursday, March 20, 2008 at 5:49:00 AM PDT, Blogger JD said...

Friendly reminder: This is a substantive issue, and I want to discuss it seriously. So PLEASE DO NOT POST ANONYMOUSLY. You don't need to register or sign in. Just type a screenname into the name/URL option. We can't have a coherent conversation when there are too many anons. Thank you!
JD

 
At Thursday, March 20, 2008 at 7:09:00 AM PDT, Anonymous DocDoom said...

Looks like once they sucked in enough suckers (including some big pension funds) they've switched to the other side of the trade! They are doubtless saying "bwhahahaha" as they stare at their screens today.

Seriously though, as someone who has owned (and still owns) some futures contracts, you gotta wonder who you are betting against. Anyone rushing in to buy oil contracts at $110/bbl last week should have asked who was selling them that contract.

 
At Thursday, March 20, 2008 at 7:17:00 AM PDT, Anonymous fugeguy said...

Speculators are a sympton.

Peak oil is the disease.

http://dailyspeculator.blogspot.com/2007/10/aramco-insider-oil-structural-ceiling.html

"This week during an interview, former head of exploration and production at Saudi Aramco, Sadad al-Huseini disclosed that, "oil production had reached a structural ceiling and that the technical floor for the oil price will rise by $12 annually for the next 4 to 5 years as new fields become increasingly costly to exploit." According to al-Huseini, "the technical floor - the basic cost of producing oil excluding factors such as geopolitical risk and hedge fund speculation - is currently about $70 per barrel, meaning the minimum oil price could hit $106 in 2010 and $130 by 2012. Actual crude prices, including financial market factors, could be as much as $125 by as early as 2010."

http://peakoilnews.biz/

Demand destruction in weak and poorer countries has been predicted for years.

Dollar collapse and speculators are partially to blame (roughly $25/ barrel) but what about the rest?

Jesse Livermore coined the concept that the market was a discounter of future earnings (read value for commodities). So yes the market is ahead of the curve on pricing but it is predicting the near (very near) future.

The market is telling us that peak may be very near......there are many "former" traders and speculators who thought they could out guess the market.

Just my 2 cents.

-- GLTA --

 
At Thursday, March 20, 2008 at 8:03:00 AM PDT, Anonymous Greenneck said...

That was written 10 years ago. A lot has changed since.

Sure the price went down in the last couple of days. But what ever happened to the 25$-35$ predicted by the likes of Daniel Yergin (of CERA) and Michael Lynch? If it were just speculation, shouldn't those guys be able to predict that too?

JD, in 2006, you said Peak Oil is here, see, it's not the end of the world! And you took your marbles and went home. That's a big 'change of fundamentals', right? Now you come back to say peak is not here after all. So which is it? At least will you admit you were wrong in 2006?

 
At Thursday, March 20, 2008 at 11:54:00 AM PDT, Anonymous Jake said...

This is an interesting article. Though old, but intersting.

I guess that al-huseini's word is that of God. Perhaps he is correct and we can all dieoff much soooner. Cheers!

 
At Thursday, March 20, 2008 at 12:53:00 PM PDT, Blogger bc said...

Hmm, I have at least two problems with this:
a) economists are somewhat like lawyers, there is an opinion for every angle. One guys opinion doesn't count for much.

b) Matt Simmons, in particular doesn't hold much credibility with me. Robert Rapier, an oil industry expert, has debunked some of his writing on oil biz.

Unfortunately I thought about it some more and came to the conclusion again that speculation doesn't affect the price much. If I buy a front month futures contract which I don't intend to take delivery of, I have to sell it before the contract expires. So the price would rise, but then fall every month as speculators sold out.

The other way of thinking is that supply and demand works on finite resource. If I buy a physical commodity, there is less to go around, hence prices goes up. But there is an infinite quantity of futures contracts that can be made, so the whole supply/demand thing doesn't apply.

What I don't get is that it's well known that supply and demand set the price, but when the price is unpalatable, people ditch the theory and blame a boogieman, whether it's speculators, profiteers, hedges, cartels or government corruption, you name it, anything but supply and demand.

I think the problem is that the invisible effect of supply/demand is too abstract as a reason; people like to have a tangible person or agent to lay the reason on. Thus speculators get the blame, it's an easy target.

The simple fact is that oil production has been flat for a few years, since most economies have been healthy and growing we must assume that demand has been growing . There is now a significant demand/supply gap, therefore as theory predicts, price will go up.

I see no reason to seek other explanations for why the oil price is doing exactly what the fundamentals predict.

 
At Thursday, March 20, 2008 at 3:02:00 PM PDT, Anonymous DocDoom said...

If I buy a front month futures contract which I don't intend to take delivery of, I have to sell it before the contract expires. So the price would rise, but then fall every month as speculators sold out.

Well, you might roll it to the next month though, whether long or short, if your conviction remained. Or it's possible that what is now the front month contract is in fact a long position initiated some years previously. My contracts, for example, are dated out to 2011-12 timeframe. It's a lot cheaper than rolling every month to hold a long position this way. Many years from now, as the date draws nearer, I'll need to close the position and either roll or bail.

 
At Thursday, March 20, 2008 at 3:50:00 PM PDT, Anonymous Europacific said...

No one seemed to notice the speculators when oil was at $10 a barrel.

These explanations do not convince me much. If prices were completely speculative they would not have kept on climbing for a decade or more. This is the most important point of all. Commodity markets are extremely volatile and when prices are out of whack or not justified - they correct themselves rapidly. Anyone who suggests otherwise has no experience of trading in the commodity markets.

The total volume of money that moves in the commodity markets in a day adds up to a few trillion. If you added up the assets of every hedge fund on the planet, they do not amount to more than 1 trillion (and the bulk of those assets are in things like currencies and fixed income securities). There is no way hedge funds could permanently distort the price of something as widely traded as oil.

If Simmons is saying this, he is in total contradiction with himself. It was Simmons who said that the price of oil was too low even at $100 a barrel because at that price it made it several times cheaper than a cup of coffee (because $100 a barrel is about 15 cents a cup - how he manages to equate the two is beyond me).

If people here are hoping for a dramatic drop in oil prices, they will not see it any time soon. Prices are not going to come down by much. Think about this - prices of everything plummeted recently (including gold which went down by more than 10 percent) but the price of oil only went below $100 very briefly and then crept back up again.

Funnily enough, I was talking to an oil trader a week ago and he thought prices were ludicrous and that the right price for crude oil was about $60 a barrel. Either he was just BSing me or he was talking out of his arse.

Markets can bid things up for a time and that can push prices higher. But markets do not remain inflated for a decade or more. Nothing has been rising more steadily in this commodities bull market than the price of oil. So I for one really think that this is a lot of nonsense.

Also, if they want to snuff out the speculators, they will have to ultimately impose price controls. History tells us that price controls simply do not work. It is about time people dealt with this issue in a mature way.

 
At Thursday, March 20, 2008 at 5:37:00 PM PDT, Blogger JD said...

europacific:

No one seemed to notice the speculators when oil was at $10 a barrel.

Actually, that's exactly what Simmons was complaining about in the referenced article. Speculators driving the price to $10 a barrel. Next time, you might try actually reading the link.

The total volume of money that moves in the commodity markets in a day adds up to a few trillion. If you added up the assets of every hedge fund on the planet, they do not amount to more than 1 trillion (and the bulk of those assets are in things like currencies and fixed income securities). There is no way hedge funds could permanently distort the price of something as widely traded as oil.

I don't buy this at all. Total open interest on the NYMEX light sweet crude contract is about 1.3 million contracts. That's 1.3 billion barrels, or about $130 billion. Current margin requirements are about $7000, so the amount of money actually controlling the NYMEX light sweet crude contract is about $9 billion. That's peanuts for hedge funds. And since the NYMEX contract is used as a benchmark in pricing contracts worldwide, it's not hard at all for hedge funds to influence global oil prices.

Note that I'm not saying prices are 100% speculative. That's silly. I'm saying your explanation why hedge funds can't influence the price is baloney.

 
At Thursday, March 20, 2008 at 6:21:00 PM PDT, Blogger Drmatty said...

Thank you for your article. By inference, I presume that it is your opinion that the current price of crude is not a true reflection of supply/demand? If this is so, is it the expectation of the "debunk" community that the price of crude will drop, perhaps sharply, as most speculator-driven price bubbles tend to do? If that is true, then I believe we have an interesting test ahead of us. At what time frame should we expect the spec bubble to burst? If it does not, could this be taken as a sign that the "peakers" are on to something?

 
At Thursday, March 20, 2008 at 6:34:00 PM PDT, Blogger JD said...

More evidence of speculative chicanery in the oil market:

Shift To The Futures Market

The declining liquidity of the physical base of the reference crudes and the narrowness of the spot market have caused many oil-exporting and consuming countries to look for an alternative market to derive the price of the reference crude. The alternative was found in the futures market. For instance, instead of using dated Brent for its exports to Europe, several major oil-producing countries such as Saudi Arabia, Kuwait and Iran rely on the IPE Brent Weighted Average (BWAVE) as the basis of pricing crude exports to Europe.

The shift to futures market was justified by the perceived inadequacies of the spot market which have become vulnerable to manipulation, distortions and squeezes.

Link

 
At Thursday, March 20, 2008 at 6:57:00 PM PDT, Blogger Zed said...

To me Sadad al-Huseini likes the press a oil pessimist gets. I have read most of the things he has said and watched how he has been drawn into the "camp". The data has not changed, just his viewpoint. I have more faith in what Ahmed Zaki Yamani (over at CGES) has to say.

 
At Thursday, March 20, 2008 at 7:33:00 PM PDT, Blogger JD said...

If it does not, could this be taken as a sign that the "peakers" are on to something?

The peakers are definitely onto something. That's not in doubt. There are very real supply constraints on oil in today's world. Ordinary crude still has not increased since the all-time peak set in May 2005.

However, there are also very strong and undeniable signs that the oil markets are being invaded by hot money. Unfortunately the peakers can't frankly admit that, or talk about it, because they are totally locked into the dogma that high prices are due to peak oil, period.

I'm a moderate. I believe the current oil price is comprised of a fundamental component (determined by supply and demand), and (particularly in the last few months) a substantial bubble component comprised of speculation and a rush to "oil as the new gold".

Since the issue of speculation is a taboo subject among peakniks, I'm digging into it in order to provide the needed balance.

 
At Friday, March 21, 2008 at 1:41:00 AM PDT, Blogger bc said...

There's been a number of studies that analyze the data and find no link between speculation and prices, e.g. here.
I haven't seen any studies based on data that shows the opposite.

Of course, doomers will be pointing at the oil price as some sort of justification. However, hasn't Matt Simmons been prediction $300 oil "any day now"? And since, I became aware in 2004ish, doomers have been regularly predicting $150+ prices. The fact that we are now around $100 in 2008, suggests the price is a lot lower than doomers expectations. High oil prices do seem to be self limiting.

But oil is taking a back seat to financial issues. A debt shake out is due, and there is a lot of debt to shake out. As the US economy stalls, that will have knock on effects globally, and the effects will last some time.

For me, I foresee finding work will be a far bigger issue than being able to afford petrol.

 
At Friday, March 21, 2008 at 3:54:00 AM PDT, Blogger JD said...

There's been a number of studies that analyze the data and find no link between speculation and prices, e.g. here.

I think we're partly misunderstanding each other due to terminology. I'm not just talking about the routine background presence of speculators in markets. I'm talking about speculative manias and bubbles. For example, consider the silver bubble perpetrated by the Hunt brothers in the late 70s. Their speculation had a massive distorting effect on the price of silver, in complete contradiction to the studies you refer to (look at the chart!). And it all started with a process you'll recognize from the headlines today: "Inflation had destroyed their faith in the dollar, so early in 1979 they began putting even more of their wealth into a "harder" currency: silver."

Do you believe that speculation had no effect on prices in the absolutely massive Nikkei bubble which popped in 1989? Or the dotcom bubble? Or the real estate bubble? If speculation didn't cause those distortions, what did?

 
At Friday, March 21, 2008 at 4:57:00 AM PDT, Anonymous Europacific said...

"Actually, that's exactly what Simmons was complaining about in the referenced article. Speculators driving the price to $10 a barrel. Next time, you might try actually reading the link."

I haven't seen one comment from you dealing with the flow of excess liquidity into the monetary system. All I see on this site are more rants.

How can these hedge funds leverage themselves to the hilt? Beause we are in an easy money environment. But you won't talk about it because it is easier to rant about "speculators".

If a few hedge funds with $9 billion in total could jack up the oil price, there is nothing stopping others with similar size of funds (financial markets are awash with money) from trying to do the opposite (which Simmons says they did which caused oil prices to stay low in the 1990s). There is nothing to stop others who haven't got in on the act as yet from doing so.

Leveraging works both ways. I can leverage myself to the hilt to make the market move one way and someone can leverage himself to the hilt to make the market move another way. Leverage is not a privilige reserved for the likes of Pickens. Read about Long Term Capital Management - and how it went bust. Remember also that everyone isn't long oil. Pickens actually shorted it in the first quarter. He will get burnt.

Anyway, I thought there was a case to be made for the destruction of the dollar with easy money from the Fed and almost all economists today accept that the high price of commodities in dollars is caused in part by this. That, however, is not something you seem to be interested in.

So I think we are going around in a circle and this achieves nothing. Therefore, I have nothing further to add on this site.

 
At Friday, March 21, 2008 at 5:42:00 AM PDT, Anonymous Babun said...

I have to agree with europacific on the fact that the devaluation of the dollar would also be an interesting thing to discuss. It's really odd that the information about this is almost non-existent, although it seems to be that this is without doubt one of the reasons to a significant part of the rise in oil prices.

What's certain is that at least the investments in the commodity sector have increased a lot. Naturally this effects the futures market, so the only question - i believe - is whether this also has an effect on the spot price.

However, when you look at the supply/demand situation and the falling value of the dollar - it seems to me the market doesn't even need to be considered. In addition to recent development and history the outlook for these two aforementioned issues seem quite bleak.

So my viewpoint is that price increases are [i] mainly [/i] driven by supply/demand problems, and then accelerated by the devaluation of the dollar. The markets have maybe added just a little more value to the price.

 
At Friday, March 21, 2008 at 7:39:00 AM PDT, Blogger JD said...

Anyway, I thought there was a case to be made for the destruction of the dollar with easy money from the Fed and almost all economists today accept that the high price of commodities in dollars is caused in part by this. That, however, is not something you seem to be interested in.

I'm very interested in it. I noted above that oil is being treated as "the new gold", and that the Hunt brothers were fleeing the dollar when they bought silver. We're talking about the same thing, but seem to be having a terminology problem.

Here's the crux of it: When people flee the dollar and move into oil, I would call that speculative activity. They are buying the product for financial reasons, not real economy reasons. They don't actually need the oil for any purpose. They just want to hold it as an investment, or even as money itself.

Certainly, when the Hunts fled the dollar into silver, it was regarded as a case of massive speculation. When a person buys gold because they think it will go up in value, we call that speculation. So I don't think my use of the term is out of the norm.

You guys are breaking down the price like this:

Oil price = (Supply and demand factors) + Speculation + Dollar flight

I'm grouping the last two together:

Oil price = (Supply and demand factors) + Speculation

It seems to bother you that I group it together like that, so let's use the neutral term "financial factors" for (speculation + dollar flight).

I don't think there is any doubt that financial factors (financial interests), so defined, have a significant effect on the oil price today. And that effect could, potentially, get much worse -- the worst case being a total oil mania/shunning of the dollar, where people turn to large-scale hoarding of oil as money, banking with oil etc. To the point where we get an oil spike like the silver spike of the late 70s.

I understand that your solution is to jack up interest rates, but that seems pretty harsh and imprecise. My concern is for the real, productive economy. Why should we nuke the real, productive economy just to control the excesses of the financial economy? Why not just reign in the financial interests? Subject them to closer registration and regulation, just like banks.

 
At Friday, March 21, 2008 at 8:29:00 AM PDT, Anonymous DocDoom said...

This article from the FT may be of interest:

http://www.ft.com/cms/s/0/f063726e-f506-11dc-a21b-000077b07658.html

Of course the hard-core gold bugs would argue with some justification that gold shouldn't be considered a commodity, but rather as an alternate currency.

 
At Friday, March 21, 2008 at 9:09:00 AM PDT, Anonymous DocDoom said...

...destruction of the dollar with easy money from the Fed and almost all economists today accept that the high price of commodities in dollars is caused in part by this...

There's no doubt this is true to a degree, although I would argue that the causal chain is less direct than you seem to think. Your arguement as I understand it is that people are rushing into hard assets to protect their wealth from inflation. I can't quite buy that argument, especially since you also argue that real estate is going to continue to sink; you dismiss that with a form of the "decoupling" argument, to wit that as the US tanks demand for global goods will remain strong.

I would make a less direct argument. People are trying to protect their wealth from confiscation by taxes and inflation.

Due to the current crisis, the US is lowering interest rates, driving them negative in real terms. Note that this would be true even if inflation wasn't rising. I think the jury is still out on whether the current situation is inflationary or deflationary, because interest rates are just part of the picture. The other parts are money supply and (always missed out in these discussions) the velocity of money. (Guess what: you can have inflation or deflation even with everyone using gold as money, because credit is an important component of the "money supply", and because velocity still matters.)

It is IMO a mistake to look solely at a basket of commodities to prove the point about inflation. People do consume those commodities, but they also consume housing, services, and (via manufactured products) labor. So commodities are just one component of the overall inflation picture, and the bear argument for the US seems to include a hefty dose of deflation in housing and in labor.

I don't need a pick-up in inflation for my argument, so I'll simply note that whatever the inflation rate is, it's higher than current US interest rates, and net of taxes, it was higher even before the recent rate cuts. So, a dollar of savings will buy less and less over time, after taxes and inflation have taken annual bits out of it. Now many actors in the debt markets don't pay US taxes (e.g. foreign governments), so for a while this equilibrium could hold as long as the returns were just enough to offset inflation. In this equilibrium, which has been the case in the US for at least a decade, a US saver will be punished by taxes - there is therefore no surprise that the savings rate has gone to zero.

With yields now negative for everyone, a scramble is underway to find a way to preserve wealth. With the stock market and real estate tanking, IMO investors have turned to the only asset class that still had an uptrending chart - commodities. The trend was there for IMO good reasons, having to do with supply and demand. Long-term, the uptrend will remain in place, again IMO. But let's look at some of those price increases, gold went from $800/oz to $1000/oz in 2 months, oil went from $90/bbl to $110. It's very hard to argue that the inflation rate is anything like 25% every 2 months. If it really was just about hyperinflation, we'd be seeing a rush into real estate - but we don't.

Real estate is a much better way to defend against wealth confiscation than commodities, for the simple reason that the tax system heavily favours it. My commodities positions are taxed every year using mark-to-market cap-gains rules set by the IRS. This is only slightly better than getting taxed every year on interest-bearing investments. In contrast, gains on real estate can compound tax-deferred for a long time, and "positions" can be swapped tax-deferred using rules like 1031 exchanges. I could go on and on but you get the idea. Why no big rush into real estate as the inflation monster breaks loose of it's chains? My answer: because the "chart" on real estate has been going down. Hot money is trend-following money, plain and simple.

This need to follow trends IMO also partially answers why hot money isn't flowing into the short side of the trade in commodities and driving down prices, but may have done so in the past as Simmons suggests. Unlike stocks and bonds, commodities futures are very much like placing bets on something, and the short side of the trade is almost symmetric with the long side. I'll note that a lot of hot money is on the short side of many stocks these days, helping to drive prices lower. If we see a sustained downtrend in commodities rather than just a pull-back, hot money can and will pile in on the short side, much more easily than with stocks (where you have to find shares to borrow) or bonds or real estate (where you can short only through derivatives).

The other part of why hot money isn't going short on commodities is that any momentum strategy needs a story to keep the game going. Tech in the late 90s - "new economy". Housing in the early 00s - "limited land". Commodities now - "rising demand vs. limited resources". Gold now - "fiat currency inflation".

The short side of trades also needs a story for it to support a momentum trade. Here are few we're hearing now (some of which may be true). Short side of stocks - "stagflation returns". Short side of real estate - "collapsing bubble, incomes can't support prices". Short side of bonds - "rising inflation".

One amusing thing is that money appears to be running into two asset classes that in the long run cannot both be winners: commodities and low-yielding US treasuries. One is a bet on strong demand and rising inflation, the other is a bet on a stagnant economy and continuing deflation.

 
At Friday, March 21, 2008 at 12:09:00 PM PDT, Anonymous Docdoom said...

So what kind of story would support taking the short side of commodities over a sustained period of time (as opposed to a simple correction that leaves the long-term uptrend intact)?

Here are a couple:

1. Production gluts
2. Depression/recession
3. Deflation/stronger dollar

Don't sound very plausible, do they? OK how about these:

4. Conservation/Efficiency
5. Substitution

They also don't sound very plausible, at least right now. (But years from now, either or both of these could be the story.)

 
At Friday, March 21, 2008 at 3:33:00 PM PDT, Anonymous Docdoom said...

A couple of very intersting articles:

http://tinyurl.com/38pmd8

http://tinyurl.com/2dwcso

When one focuses merely on the speculators - what the CFTC refers to as non-commercial entities - one finds that there is about $24-billion more money bet on higher crude oil, gasoline, and heating oil prices than is wagered on a lower price outcome...I believe that this is a record amount of money skewed to the long side of the market...The typical large speculator that has bet on higher crude prices holds a position of 3,000 futures contracts...or more than $300-million worth of crude! There are 99 such companies that make up this group.

 
At Friday, March 21, 2008 at 4:54:00 PM PDT, Blogger bc said...

Do you believe that speculation had no effect on prices in the absolutely massive Nikkei bubble which popped in 1989? Or the dotcom bubble? Or the real estate bubble? If speculation didn't cause those distortions, what did?

Those markets (and silver) are fundamentally different, they are not futures markets.

As I said before, demand for a limited commodity can drive the price up. In a futures market, there is effectively an unlimited amount of contracts that can be bought. Therefore it's my belief that in a futures market the bubble/speculation effect you allude to cannot occur, or at least is very limited.

In other markets, where there is a limited quantity being chased, then yes, bubbles can occur, and they frequently do.

I guess the proof of the pudding will be what happens to oil prices as the US goes into recession, but it's very hard to pick out reasons.
I expect OPEC to cut quotas, ostensibly to adjust to falling demand, but also very convenient cover for their flagging oil fields.

Therefore even with recession, we may not see much of a cut in prices. OPEC can also blame the credit crunch instead of high oil prices for the recession.

 
At Friday, March 21, 2008 at 5:08:00 PM PDT, Blogger bc said...

On terms: I don't really distinguish between investing, speculating and gambling.

They all amount to the same thing, you take a risk in order to get a reward.

 
At Saturday, March 22, 2008 at 12:43:00 AM PDT, Blogger juan said...

The headline from a Jan 2006 report by the head of a commodity trading desk at one of the world's largest financial insitutions pretty much said it all:

Beyond fundamentals – the funds phenomenon

A flood of investment funds is driving.. prices much higher than can be supported by fundamental analysis of supply and demand. It’s a bubble which could grow a lot bigger before bursting.

[....]

Commodity markets have always been strongly influenced by speculation. For example, surging investor demand contributed to the 1994-95 boom. In this cycle though, funds deployed are perhaps double the previous high.

All commodities are involved All classes of commodities – base and precious metals, energy and softs (agricultural goods), have enjoyed substantial price gains.


As he noted, the commodity bubble 'could grow a lot bigger before bursting', and so it has.

What requires understanding here is not just that fundamentals do not set price but that price has been driven not simply by short-term speculators but portfolio reallocation decisions by many long-only funds such as pension, all seeking a higher returns than available in equities. And, as docdoom and JD noted, this takes on a self-fullfilling/self-justifying quality.

The longer such process lasts the further price becomes divorced from fundamentals, the more fragile the whole thing becomes.

 
At Saturday, March 22, 2008 at 10:35:00 AM PDT, Anonymous http://thesmartcreature.blogspot.com/ said...

It is probably true that speculators play some marginal role in setting oil prices at a level much higher than the cost of producing oil, but only because supply would anyway not be able to satisfy demand if the selling prices were kept lower (as they were before 2004 or 2005). Speculators did not have any leverage as long as countries such as Saudi Arabia acted as “swing producers”, so that oil kept being 1/ produced at low cost, 2/ sold at low price and 3/ nevertheless able to satisfy a growing demand (The three features that generally characterized the exceptional period our world lived from 1945 to about 2005). But now speculators have a leverage (and still will have as long as selling prices keep rising while demand outstrips supply and as long as would-be buyers have enough money to pay) and the profits they get from it just increases the selling prices.
Human evolution has now entered a new period, which will probably end when we reach the energy-production peak. For more details, click on the link above.

 
At Saturday, March 22, 2008 at 2:04:00 PM PDT, Blogger juan said...

Speculators did not have any leverage as long as countries such as Saudi Arabia acted as “swing producers”, so that oil kept being 1/ produced at low cost, 2/ sold at low price and 3/ nevertheless able to satisfy a growing demand (The three features that generally characterized the exceptional period our world lived from 1945 to about 2005).

1. cost of production is not just absolute but relative - marginally higher cost v. relatively much higher price for example.

2. sold at low price assumes away, ignores, changes in oil price regimes over the period mentioned. Essentially from oligopoly pricing by the supermajors to Cartel determined pricing to, in the mid-1980s, 'market pricing', i.e. trade in paper barrels (from which point rose the potential for financially driven pricing and bubble in that which most still imagine to be some theoretic supply/demand relation which fails to take account of even the earlier price regimes.

Supermajors still exist and, as vertically integrated firms operating on a world scale, do not rely on market pricing but intra-firm transfer pricing which, for practical purpose has to do with internal accounting and tax mitigation.

3. Demand is not a linear function.

4. No manipulation pre-2005? Depends upon what's meant by 'manipulation'. If that's taken to be a firm or group of firms ability to move price away from some theoretic equilibrium, well, that's been the case since the latter part of the 19th century and, on an international basis, was spelled out in the Achnacarry and Red Line Agreements of 1928, both available @
http://www.mtholyoke.edu/acad/intrel/energy.htm

Or, from the WSJ, 29 Aug 2006:

The Commodity Futures Trading Commission has sent subpoenas to BP and energy traders in the crude-oil probe, which is focused on possible manipulation of the global over-the-counter market in 2003 and 2004, according to lawyers and traders who have been contacted or briefed in the civil investigation. (The over-the-counter market includes trades conducted over the phone or electronically in products not listed on exchanges, or in marketplaces that regulators can't see.)
[...]
In the broader civil investigation into crude-oil trading, investigators are examining, among other things, whether BP used information about its own pipelines and storage tanks at a key oil-delivery point in Cushing, Okla., to influence crude-oil price benchmarks that are set each day and influence billions of dollars of transactions. It isn't related to the propane case, in which civil claims by the CFTC are pending against BP in federal court in Chicago, as well as a criminal charge against a former BP trader in U.S. District Court in Washington; numerous civil lawsuits seeking damages are also pending. BP has denied wrongdoing in the propane case.

No charges have been brought against BP in the crude-oil inquiry, and many such investigations are ended without civil or criminal charges being brought.

Indeed, an earlier CFTC investigation into BP's crude-oil trading was closed without charges. In 2003, BP agreed to pay $2.5 million in a settlement with the New York Mercantile Exchange to resolve allegations of improper crude-oil trading. The settlement cited 10 oil violations in 2001 and 2002, which included wash trades, or simultaneous swaps of the same amount of a commodity for the same price. BP settled the matter without admitting or denying wrongdoing; the specific nature of the trades wasn't disclosed.
[...]
BP operates one of the world's largest and most sophisticated oil-trading operations. In addition to trading physical oil and gas for its own operations, its traders participate in the energy-futures markets and provide risk-management services to energy producers and suppliers, refiners, shippers and other companies, much like a Wall Street commodities-trading desk. Its actions can affect the world-wide price of crude oil, natural gas, gasoline, propane and plastics.
[...]
In its inquiries to traders, the CFTC asked questions about whether it was common industry practice when a trader manages storage tanks or other assets and uses those assets in trading strategies.

For example, a trader at an oil company may buy a large quantity of oil on Nymex for delivery at Cushing, knowing that his company controls a large amount of the available storage there... The trader's identity is anonymous in such a situation.

A counterparty who decides to sell the oil may have trouble near the end of the month making actual delivery, if the oil company doesn't make its ample storage available.
This could lead the counterparty to sell the oil to someone else at a lower price just to get out of the obligation to deliver it, and lead to a lower price on Nymex.

Meanwhile, the oil company that is a buyer of the oil at a higher price on Nymex may have a simultaneous bet in the over-the counter markets that will benefit from the price drop.


Or the Derivatives Study Center:

Oil Price Manipulation

Tosco won a settlement claiming that Arcadia Petroleum (a British subsidiary of the Japanese firm Mitsui) engineered an elaborate scheme to manipulate oil prices in September of 2001 through the use of OTC derivatives and a large cash market position to corner the market in Brent crude oil. (Brent is a blend of crude oils pumped out of the North Sea and shipped from a terminal at Sheffield Island off Scotland). As a result, the price of Brent Crude soared between August 21st and September 5th and pushed its price to a premium over West Texas Intermediate crude oil (WTI). WTI, which is a higher quality oil, is normally priced about $1 above Brent, but during this period Brent sold for more than $3 above WTI. This artificial price hike occurred at a time of widespread strikes and social protest in Europe.

The list can go on and on but all these beliefs that neoclassical economic theory and its efficient markets have been demonstrated as bunk so often there's really no need.

 
At Saturday, March 22, 2008 at 10:59:00 PM PDT, Blogger Sea Dog said...

It is difficult to accept that "speculators" have driven the price of oil all the way up from $10 to $100.

Also, speculators must sell as well, so I personally give little credence to the "speculators" argument. The "tanking dollar" argument is more plausible, but doesn't explain all of the rise in price.

None of these arguments explain flat oil production of the last few years, so I am afraid that "speculators" seems rather desperate on the part of PO debunked, OPEC and all the others who do not understand PO or who claim not to believe it.

 
At Sunday, March 23, 2008 at 12:21:00 PM PDT, Blogger bc said...

driving.. prices much higher than can be supported by fundamental analysis of supply and demand

I often read statements like that and think "How the fuck does he know that?".

If it is so bloody obvious the price can not be supported, then no sane person is going to buy into a bubble, not even a speculator.

So I conclude a) a lot of these supposed financial "experts" talk bullshit (if not most), and b) a lot of people uncritically believe the bullshit.

Rant over, lol!

 
At Sunday, March 23, 2008 at 3:58:00 PM PDT, Anonymous DocDoom said...

If it is so bloody obvious the price can not be supported, then no sane person is going to buy into a bubble, not even a speculator.

You're obviously not a "momentum" trader. The only thing they care about is the trend. It's basically the "bigger fool" theory, and a game of chicken where every player thinks he'll "win" by bailing out before everyone else does. Look at the charts of some of last year's momentum names, like GOOG, or FSLR. I suspect the game works for the big players because they suck in a lot of smaller fish to "buy the dip" when the trend reverses, so they don't have to get out at the exact top (nor have been in at the bottom) to make a profit.

It is difficult to accept that "speculators" have driven the price of oil all the way up from $10 to $100.

Agreed. To support a good momentum play there has to be an underlying story, and ideally the underlying story has a kernel of truth to it. I think there's no question the internet was a large net positive for us, so there was some underlying truth to the "new economy" story. Problem is, once the ball got rolling it ran well past what could really be supported by the underlying truth. I think there's no question that there is an underlying truth about oil production plateauing in the face of rising demand from developing countries. There is also no question that the dollar's fall isn't good news if you need to buy oil on the world markets (in dollars). Do these factors support present oil prices, or has it run past the point supported by these fundamentals? Is the current fall a bursting bubble or just a correction in a long-term bull that has more years to run? Only time will tell.

 
At Sunday, March 23, 2008 at 5:42:00 PM PDT, Blogger juan said...

It is difficult to accept that "speculators" have driven the price of oil all the way up from $10 to $100.

As no one has made that claim, it stands as only another strawman meant to distract, or was written wihout having read and thought about both the post and comments, so in that sense is moreless typical.

Also, speculators must sell as well, so I personally give little credence to the "speculators" argument. The "tanking dollar" argument is more plausible, but doesn't explain all of the rise in price.

The term 'speculators' tends to connote short-term so completely ignores the longer run asset reallocation process by long-only funds. This is not about taking/making delivery of physical product but making money. Yes, buying also indicates selling but only in a static universe does this mean that the total is not changed by the interactions of buyers and sellers within and over different time frames. The bidding process as a whole cannot be ignored, Nothing is static.
Nor is a monocausal explanation of much validity, i.e. yes, changing currency relations do enter in; so does social psychology; so does credit availability (which is not directly related to money quantity but more to perceived and expected risk); so do real production cost/supply/demand factors, et cet. An interplay of multiple simultaneous processes
Financially, a popular trade has been long commodities, short financials but, given recent counterparty problems (+ incipient awareness of not-just-U.S. recession) this may be breaking down. There are such things as margin calls and they are not always met other than through an essentially forced selling of 'winners', and sometimes not even then. Just try to remove funds from a fund suffering the latter and has disallowed redemptions.

None of these arguments explain flat oil production of the last few years, so I am afraid that "speculators" seems rather desperate on the part of PO debunked, OPEC and all the others who do not understand PO or who claim not to believe it.

Assumes away production (and field) management in favor of truly speculative beliefs that often have most to do with desires rather than any grasp of the industry. Assumes too much by placing all weight on the geologic.
------

driving.. prices much higher than can be supported by fundamental analysis of supply and demand

I often read statements like that and think "How the fuck does he know that?".


Possibly from having been in the business for a sufficient period to know what bubbles are. Possibly from some understanding of financial and economic history, you know, that stuff which is almost always ignored by those caught up in types of manias and their self-justifying stories.

If it is so bloody obvious the price can not be supported, then no sane person is going to buy into a bubble, not even a speculator.

No one has claimed it to be 'so bloody obvious' but only what any decent commentator or analyst
has known for a long time and relates to more than the oil trade. Large 'speculators' are not one-sided, nor are they 'investing' in a single asset or asset class. Other than for most small specs, absolute price is usually less important than spread(s).
-----

Sorry to repeat a few of your points doc but had not seen your post and don't feel like re-writing.

Thanks

 
At Sunday, March 23, 2008 at 7:12:00 PM PDT, Anonymous satan said...

Hi there,

Have been lurking around for a long time, but this is my first post on this blog.

Anyway, I do not think many people realize the real problem we are facing is a feminization of our civilization. We spend too much time worrying about the monsters in the closet (peak oil, global warming) rather than trying to solve problems as they arise.

The reality is that neither peak oil or global warming are a problem if we deal with them based on facts, as opposed to mathematical models. The problem with mathematical models is that they are an inferior and incomplete representation of reality - we can never be sure we know about all the factors influencing a systems behavior.

Rather than worry about peak oil, why not start building nuclear powered CTL plants. Well if you try - you will run in nimbys, environmentalists and other assorted feminized people. We never talk about things like reprocessing nuclear waste -proliferation concerns. I can go on and on.

Do you honestly think we would have reached (technologically) where we are today by worrying about the kinds of things we worry about? Do you think aircraft, satellites, modern medicine, computers etc would have been possible if we always behaved like we do now.

It all boils to one thing- the inability to analyze a situation and options in a objective manner. We seem to be more interested in perception, feelings, legal BS, interactions etc. I think this behavioral patterns are the effect of feminization of our society.

I will write some more about this and related stuff in a longer post

 
At Monday, March 24, 2008 at 4:03:00 AM PDT, Anonymous Babun said...

To juan :

"Yes, buying also indicates selling but only in a static universe does this mean that the total is not changed by the interactions of buyers and sellers within and over different time frames."

Mind clarifying on this?

"The bidding process as a whole cannot be ignored, Nothing is static."

Perhaps not ignored, but I find it hard to believe anyone could have any cold hard facts about exactly how significantly speculators affect the price of oil.

Now if you claim to understand what can be ignored and what can not (what bothers me most is that you don't use any phrases to imply any insecurity about this) you should understand exactly how the oil markets work.

But if a large part of the price increase is driven by short-term speculation - why isn't the price coming down? If speculation has anything to do with it, then it looks more like it's long-term speculation. That long-term speculation in turn may be driven by actual changes of perception in the physical reality which actually represent the physical reality more accurately. So the root cause may be fundamentals anyway.

If you really know how the markets work in detail, then tell me : How exactly does future trading affect spot prices and what are the most important factors that make up the spot price? (I am actually very curious about this but I suspect you don't really know anything about it)

"Nor is a monocausal explanation of much validity, i.e. yes, changing currency relations do enter in; so does social psychology; so does credit availability (which is not directly related to money quantity but more to perceived and expected risk); so do real production cost/supply/demand factors, et cet. An interplay of multiple simultaneous processes"

Sure, but what's essential is understanding the degree in which these factors affect the result. I don't think he meant to imply it was monocausal either. Just that the degree to which the dollar affects the price would be more significant than speculation.

"No one has claimed it to be 'so bloody obvious' but only what any decent commentator or analyst
has known for a long time and relates to more than the oil trade."

Any decent commentator or analyst? Most commentators and analysts guesstimates about oil prices have gone totally wrong. The ones that believe high oil prices are because of speculators have been predicting the oil price to fall for ages now.

So I believe you should say "what any commentator or analyst (who believes there is a price bubble because of speculation that is about to go bust) think they have known for a long time."

I'm pretty much siding with bc on this : there's no way in hell some idiot in a monkeysuit can tell even what the approximate price of oil should be, that's just ridiculous.

Anyway, my main points are these :

1. The market's speculation effect on recent rise in oil prices is either minimal or non-existant

2. Even if market speculation has affected the oil price, it may be possible that markets are responding to the long-term outlooks of oil supply/demand with long-term investment. That would mean there is no bubble to burst - the price reflects reality.

 
At Monday, March 24, 2008 at 6:58:00 PM PDT, Anonymous fugeguy said...

The speculators are holding down output at Exxon now!

ccccvvvvvv

Exxon projects flat production through 2012 (and it will be at least flat permanently! ) March 21st, 2008
For a company that's gone to greater lengths than nearly anyone else in the Big Oil realm to pooh-pooh Peak Oil, ExxonMobil's recent presentation to analysts sure doesn't do anything to boost the cornucopians' case. During the meeting, Exxon presented a chart projecting its worldwide oil production staying flat for the next four years. A Business Week reporter strikes an incredulous pose:
Ponder that for a minute. Texas-based Exxon is the largest publicly
traded company in the energy business. In fact, it's the most
profitable company in the history of capitalism, earning a record $40.6
billion on sales of $404 billion last year. Yet even with prices at the
pump near all-time highs, Exxon isn't planning on producing any more
oil four years from now than it did last year. That means the company's
oil output won't even keep pace with its own projections of worldwide
oil demand growth of 1.2% a year.
Imagine a chief executive of another growth company making a similar announcement to Wall Street as Exxon Chairman Rex Tillerson. What if Steve Jobs said Apple wasn't going to sell any more iPhones than it did in 2007? What if Howard Schultz said Starbucks' latte production would stagnate, at least until the next U.S. president
embarked on his or her reelection campaign? Shares of both companies
would plummet.
So what gives? Well, Exxon's two biggest producing regions are the United States and Europe… and output there is down 37% since 2000.
Add to that the nature of the contracts the governments of Nigeria and Angola have negotiated with Exxon in recent years: Exxon gets its payment in barrels, and if the price per barrel rises beyond a certain point, Exxon gets to keep fewer barrels as profit. And that's just one aspect of the "resource nationalization" issue.
Exxon plans on bringing new fields online in Russia, the Middle East,
and Africa over the next four years but they won't be enough to
generate growth beyond what the company is losing due to the maturation
of its fields in the North Sea and Alaska, the nationalization of its
fields in Venezuela, and volumes lost due to those production sharing
agreements with other countries. "It has always been a challenge to
grow volumes when you are working off of a base as large as ours,"
Tillerson told the analysts. Indeed, Tillerson got more bad news on
Mar. 18 when a British judge freed up the foreign assets that Exxon had
sought to freeze in its ongoing dispute with the government of
Venezuela.
Still, even as production flatlines, rising oil prices mean rising profits for Exxon. How long before Congresscritters start demagoguing that again?

 
At Monday, March 24, 2008 at 8:57:00 PM PDT, Blogger juan said...

Lets try this,,
spot trade in the few marker crudes is very thin.
thin trade lends itself to pricing inefficiency, i.e. immediate and term physical trade is not so liquid as required. Platts formula based daily assessments are important.

but then you seem to believe that physical trade must determine benchmark prices even though, when, e.g. ANS was still a marker crude its "prices were wholly derived from oil price reporting agencies’ assessments of traders’ perceptions about what the price would be if there were actual
trade in cargoes".

the present pricing system is more virtual than reality based and yes, i remember when it was otherwise. It was not an efficient market then and it still isn't, though the type of inefficiency has completely changed. Why is this so hard to grasp when its been known for so long?

 
At Tuesday, March 25, 2008 at 12:06:00 AM PDT, Anonymous Babun said...

"but then you seem to believe that physical trade must determine benchmark prices"

Umm...are you trying to reply to me juan? Your post was incredibly incoherent so I couldn't tell

 
At Tuesday, March 25, 2008 at 2:45:00 PM PDT, Blogger juan said...

pardon my incoherence but i assumed you to be aware of what thin market means and why relatively few physical trades contradict a particular crudes usefulness as a benchmark, until it becomes more virtual than real.

other hand, you can obtain a more complete answer by looking into platts assessment process and the variable weightings given to swaps and derivatives, spreads, fundamentals, investment flows, etc., and what these are based on.

if looking for some fixed, once and for all, econometric formula which provides all the answers, good luck.

" Yet even with prices at the
pump near all-time highs, Exxon isn't planning on producing any more
oil four years from now than it did last year. That means the company's
oil output won't even keep pace with its own projections of worldwide
oil demand growth of 1.2% a year."


which could be taken to imply an inability to increase production or could be understood within the context of strategic planning, or some degree of both.

companies like exxon do engage in production management which has a longer temporal horizon than simply produce flat out because price is high.
having experienced and helped generate overproductions, they attempt to smooth that sector's boom/bust cycle.

no particular genius is required to see that the world's largest consumer is either in or entering into recession nor to see that, within a world of global production lines and uneven consumption, there will be no 'decoupling' but demand destruction (and further increased tension between real world fundamentals and financialized prices). But I guess that doesn't play well with those who take high price as proof of 'peak production'.

i think that you mentioned forwards looking psychology as a price determinant and, yes, as had already been brought up, that's very true. But you then have to ask what are the determinants of that general psychology, how have these beliefs been formed, why, and how probable it is that they be realized.

now if you would like an additional twist, you might attempt to determine the flow of petrodollars into such as u.s. treasury paper and agencies, or, the extent to which we depend on such flow to perpetuate deficit financings.

differently, to what degree we depend on perpetuation of high oil prices.

there has in fact been a fair amount written about this by e.g. brad setser, though most seem to have not discovered the importance of third party transactions but instead look only at strictly national categories.

 
At Tuesday, March 25, 2008 at 3:38:00 PM PDT, Anonymous Babun said...

No juan i will not pardon your incoherence since you just seemingly made another totally out-of-the-context post. Maybe i'm just stupid, and you can explain. Or maybe you just like to rant about things you have read about or know but you have no idea about how it relates to the matter being discussed.

To me it sounds like you've googled up some economics articles but you actually have no clue what they mean. Sorry, but i'm just very intolerant of intellectually dishonest people.

 
At Tuesday, March 25, 2008 at 8:52:00 PM PDT, Anonymous fugeguy said...

juan,

That was a very well thought out and constructed post.

However, it was complete gibberish.

In simple terms- what you said:

I talked to a drunk guy in bar once whose father-in-laws third cousin works for XOM and they have enough oil for the nest 10,000 years capped and they keep the spigot closed just to jack up the price.

Sorry Mr. Nixon but we are NOT all Keynesians yet!

Check out http://www.wikinvest.com/stock/Exxon_Mobil_(XOM) and look at the graph of US production.

- fuge

 
At Thursday, March 27, 2008 at 3:53:00 PM PDT, Anonymous Anonymous said...

Oil funds are drastically changing the way the prices are set. These funds buy paper barrels with borrowed money on 4-6% margins for the contract. These "investors" can leverage $1 of assets into several hundred. ETFs and hedge funds provide the initial dollar and the sky is the limit from there.

To us housing insiders, this is really familiar. Speculators were buying homes with no out of pocket money down in 2002-2006 (I buy land for one of the 5 largest homebuilders for a living so I know alot about this). Everything was overvalued. On the ground, the demand looked and felt real.

Personally, I feel that the government wants the higher commodity prices in order to prop up the investment banks. Goldman Sachs and friends actually maintained profitability over the last quarter solely b/c of commodity trading. In order to prevent financial armeggedon, the govt needed to come up with a vehicle to generate profits for these guys. Lower interests rates and more money into the system helps these guys. Joe Sixpack takes it in the rear end.

Clearly, based on inventories, supply and demand is not at issue as inventories are fairly similar to where they were last year in both the US and OECD. Refinery margins suck and demand is awful in the US/Eurozone (which comprises 60% of total oil use). Other than the peak oil whackjobs, who have been predicting the downfall of oil for 25+ years, the supply/demand balance is improving. Colin Campbell/Matt Simmons oil supply analyses are about as reliable as a projection by a 5th grader. Why listen to the guys that have yet to be right in 25 years?

My take...however, is that this situation will not improve until margin requirements are raised significantly or the consumer has a stronger backlash to higher prices.

 
At Thursday, March 27, 2008 at 7:57:00 PM PDT, Blogger juan said...

babun,

Since, prior to the ad hominem style post, you did raise important, or at least interesting, questions, I will once again attempt to overcome my failure to communicate and do so with the belief that disagreement is a plus.

My use of the term static in re. purchase and sale meant that any purchase is obviously a sale and vice versa. A transaction price of, say, 100, is only what one side recieves and the other pays; it says nothing about why that 100 is 100, i.e. says nothing about the process of price formation.

Spot, while representing a physical transaction, is influenced not only by cost of production/supply/consumption and storage variables but also by earlier expectations and associated risk management. What created those expectations and do they impact price formation.

Spot is a snapshot; even a stack of snapshots is not a movie and the movie we are in is one in which the price of benchmark crudes is primarily determined by trade in financial instruments, which does not negate supply/demand relations but has made them of secondary importance.

Next to this also, as previously mentioned, intrafirm transfer pricing which, again, has more to do with internal accounting than fundamentals.
But then, when we know of at least one larger firm which, through physical trade, attempted to influence Platts daily assessment in order to gain from its paper position, it may not be quite so 'next to' as 'inside'.

 
At Thursday, March 27, 2008 at 10:50:00 PM PDT, Anonymous Anonymous said...

That same exxon mobil has increased it's cap-ex budget by 2.5x from 2001.

High prices do spurn on development but with a lag time. Oil is alot like large scale real estate development in that the new projects take awhile to come online from the first investment.

Also, alot of publicly traded companies do hide assets off of their balance sheets until they can actually provide a utilitarian benefit. I'm sure that all of the major oil companies do not disclose all of their projects to everyone as that would reduce their competitive edge and raise the prices on acquisitions in the vicinity of the project.

Having worked in finance for a major publicly traded company, all sorts of stuff about future projects gets hidden. As a result, us laypeople probably do not really know what's going on in terms of new oil finds.

 
At Friday, March 28, 2008 at 2:14:00 AM PDT, Anonymous JD's new fan said...

http://www.simmonsco-intl.com/company_clientlist.as

I had a little bit of time tonight, so I snooped around Simmons client list.

A little pop quiz for all y'all: How many of the major integrated oil companies has Mr. Simmons himself worked with in 2007?

Answer: NONE

I've been following the energy industry for quite awhile and the only name I've heard of on this list is XTO Energy.

2007 was a banner year for the energy industry. As the "leading" energy investment bank, you'd actually think he'd have real clients (like any oil company that produces more than 100k bb/d) instead of this horsecrap.

Wow...some expert.

I also find it amazing that he complains about how speculators are distorting prices on the way down, but you don't ever see him on tv while prices are going up.

 
At Saturday, March 29, 2008 at 3:15:00 AM PDT, Anonymous Babun said...

"Spot, while representing a physical transaction, is influenced not only by cost of production/supply/consumption and storage variables but also by earlier expectations and associated risk management. What created those expectations and do they impact price formation.

Spot is a snapshot; even a stack of snapshots is not a movie and the movie we are in is one in which the price of benchmark crudes is primarily determined by trade in financial instruments, which does not negate supply/demand relations but has made them of secondary importance."

So what exactly are "earlier expectations" and "risk management" and why do you think they are more important factors than long term outlooks on supply/demand? Afaik what has hit the news about speculators is how they speculate on short-term disruptions in supply. So looking at long-term oil reports, it would only be reasonable to assume that long-term speculation is happening too (if futures contracts allow for this - I don't know).

What i would also like to know is what actually determines the price of futures. Do increased trading volumes raise prices?

What I do know is that the price of futures is what makes up the spot price which i believe is most important, BWAVE.

"Next to this also, as previously mentioned, intrafirm transfer pricing which, again, has more to do with internal accounting than fundamentals.
But then, when we know of at least one larger firm which, through physical trade, attempted to influence Platts daily assessment in order to gain from its paper position, it may not be quite so 'next to' as 'inside'."

Yeah, isn't this why they switched from Platts assesment to BWAVE? Afaik this argument is not really valid anymore, at least not when it comes to what i believe is the most important spot quotation.

 
At Saturday, March 29, 2008 at 4:47:00 AM PDT, Anonymous Babun said...

"I also find it amazing that he complains about how speculators are distorting prices on the way down, but you don't ever see him on tv while prices are going up."

Actually that's just when you do see him on TV because prices going up gives him more credibility.

I haven't quite made up my mind regarding Simmons yet.

 
At Saturday, March 29, 2008 at 4:58:00 AM PDT, Anonymous Babun said...

By the way, speaking about decent commentators or analysts : what do you think about Jeff Rubin - one of the few analysts that have actually correctly predicted the rise in oil prices (as opposed to those "decent" analysts that were saying it's all short-term speculation and prices will drop as a stone soon)?

Here's a few informative links related to the pricing of oil :

http://www.oxfordenergy.org/pdfs/WPM31.pdf
http://www.oxfordenergy.org/pdfs/comment_0806-2.pdf

 
At Saturday, March 29, 2008 at 12:32:00 PM PDT, Anonymous JD's new fan said said...

Babun,

I apologize for mis-speaking.

"I also find it amazing that he complains about how speculators are distorting prices on the way down, but you don't ever see him on tv while prices are going up."

What I meant to say is that he only complains about speculators when the price goes down. When it goes up, it's "supply and demand". The reality is that since 2001

My point with that post is that Simmons doesn't know his ass from a his face (they both are probably the same size and resemble each other).

I just don't see how someone with essentially zero transactional experience with major oil companies can accurately assess their pipeline and their future projects.
He is not a leading investment banker, does not manage major projects, and based upon his client base is dependent on high oil prices. This makes sense given his unusually big mouth. If I ran a large oil company, he'd be about the last guy I'd use.

He was on CNBC the other day explaining how all of the major oil companies were in liquidation, even though 2/3 of them have reported reserve replacement ratios (SEC defined, which is a much more narrow definition than real reserves) have exceed 100% this past year.

Frankly, I see him as a weak investment banker who sees himself as a Donald Trump figure in the oil world. He wrote a sensationalized book on the Saudi oil industry based upon fragments of technical documents written in the 1980s that has been proven false time and again by real petroleum geologists. CNBC, the government, investment banks, and anyone influential should not treat him as an expert of anything except different brands of potato chips and a quick calculation of the oil price on a per cup basis.

 
At Saturday, March 29, 2008 at 1:32:00 PM PDT, Anonymous Babun said...

"What I meant to say is that he only complains about speculators when the price goes down. When it goes up, it's "supply and demand". The reality is that since 2001"

Well imo predicting oil prices is not an exact science.

"I just don't see how someone with essentially zero transactional experience with major oil companies can accurately assess their pipeline and their future projects."

Why not? Is it about something else than looking at numbers?

"He was on CNBC the other day explaining how all of the major oil companies were in liquidation, even though 2/3 of them have reported reserve replacement ratios"

Afaik recent announcements about reserve replacements have been bs on the behalf of some companies. They reported reserves they already lost the right to develop.

The reserve replacement ratio has overall been very poor, that's the truth.

 
At Sunday, March 30, 2008 at 2:58:00 AM PDT, Anonymous Anonymous said...

"I just don't see how someone with essentially zero transactional experience with major oil companies can accurately assess their pipeline and their future projects."

Publicly traded oil companies don't exactly let Joe public see everything they are working on. The reason is that if another big oil company knew Exxon was working on a project in Texas that had X billions barrels of oil in it, they would try to purchase acreage around it. This would reduce Exxon's ability to purchase that same surrounding acreage at a discount.

Why do you think oil companies constantly decline to comment on projects? At the end of the day, oil extraction is still a competitive business.

Since Matt Simmons has not proven that he has access to this type of information, he can't really make an accurate prognosis. This is why he screams constantly for more disclosure. He's not as much of an oil insider as the world has him hyped up to be.

Dan Yergin and CERA may not be on the mark either, but at least he has access to this information and can hazard a better guess.

"Afaik recent announcements about reserve replacements have been bs on the behalf of some companies. They reported reserves they already lost the right to develop."

Two comments to this

1. Of the major integrated oil companies, Shell, Exxon Mobil, Conoco Philips, Petrochina, BP, and Petrobas all have reported reserve replacement over 100% in 2007. Chevron, Total, and Statoil did not. That's 6 over 100%, 3 under. If I'm forgetting a company, let me know. I don't want to throw bad info out there.

2. Just b/c you lose the rights to develop an oil field doesn't mean the oil disappears. The state oil companies who seize the projects acquire the reserves and can develop them.

Your comment is akin to me saying that if I hit you over the head and stole your wallet, then the money that I took just disappeared into thin air. It didn't. I gained assets equivalent to what you lost(and maybe a business card or two).

For the SEC filings, oil companies report two sets of numbers (one showing all reserves, one showing reserves minus divesitures).

I do agree with you that reserve replacement has been an significant issue but not to the extent that it has been hyped up by the media. Big oil companies aren't the best oil explorers anyways because they are more risk averse and they don't need to enhance their portfolio as much as small companies. Lots of smaller companies have found oil all over the place (Anadarko, EOG, Transocean, Marathon, Occidental, Apache, Devon, Cairn, Chesapeake to name a few that are expanding). Yes their resource base is smaller than big companies (so that will skew percentages to some degree), but they play an important role and are good investments too :-).

Big Oil is beholden to the needs/desires of it's shareholders not everyday people. I don't fault them for it.

As JD's disclaimer suggests, peak oil does exist and will happen, but my guess is as good as yours as to when. Unless you know everything about every oil reserve and every undiscovered pocket of oil, you can't make that prediction and be accurate. We do need to diversify away from oil into more sustainable fuels.

Unlike Matt Simmons, I won't even try to hazard a guess as to when that would happen based upon incomplete information and ancient technical documents I don't understand.

On a side note, I do appreciate the civil debate and think that it is healthy to discuss our opinions regarding this issue.

 
At Sunday, March 30, 2008 at 4:21:00 AM PDT, Anonymous Babun said...

"1. Of the major integrated oil companies, Shell, Exxon Mobil, Conoco Philips, Petrochina, BP, and Petrobas all have reported reserve replacement over 100% in 2007. Chevron, Total, and Statoil did not. That's 6 over 100%, 3 under. If I'm forgetting a company, let me know. I don't want to throw bad info out there."

That is if you don't count the expropriation of their reserves. Afaik Shell, Conocophilips and Exxon have lost a lot of their reserves. In the official reports you can also find the numbers including expropriation. Do you think it's correct to use numbers which include reserves you don't have?

All of these three have less than 100%, some of them very small numbers when including expropriation.

"2. Just b/c you lose the rights to develop an oil field doesn't mean the oil disappears. The state oil companies who seize the projects acquire the reserves and can develop them."

Well thank you for pointing out the obvious. What's important however, is how it will impact actual production. You have probably seen worrisome comments in the media regarding nationalization of reserves. My bet is that this means delays will be seen and increasingly less influence of particular interests. And it does not change the fact that the oil majors are actually doing bad and like to fiddle with numbers.

 
At Tuesday, April 1, 2008 at 6:17:00 PM PDT, Anonymous mk said...

Thanks for your great blog JD, and thanks to juan for his insight.

There is no shortage of crude.
When tankers have to sit around waiting to discharge because the refinery product tanks are full, that tells us we have a demand problem, not a supply problem
When the product tanks are full, they can't process any more crude because there is nowhere to put it.
The reason the product tanks are full is because the tankers are not taking it to the filling stations.
The filling stations don't want so much because they are selling less.
Demand related shutdowns are being disguised this as refinery maintenance and refinery breakdowns.

"...to every one's surprise and indeed comfort, markets seem to have taken a U-turn and an abrupt one.
Indeed market fundamentals changed the scenario — almost overnight — if one could dare say so, underlining once again the crude markets were not in control of the simple demand — supply dynamics.
There are additional, extra-market forces, controlling the markets in a big, big way."
http://arabnews.com/?page=6§ion=0&article=108324&d=28&m=3&y=2008&pix=business.jpg&category=Business

http://www.nowandfutures.com/images/frodor_crude.png

And this,
""Qatar's oil minister has reiterated that the oil market is well supplied and there is no need for Opec to boost output at its February 1 meeting.
In the past week, US President George W Bush and his Energy Secretary Sam Bodman have both urged the producer group to pump more oil to ease the impact of record prices on the world's largest economy….
…..The Qatari minister blamed the high price of oil on speculation in futures markets rather than on any problem in supplies.
...."You have to segregate the physical market from the paper market," he said."
http://www.stuff.co.nz/4366756a13.html

 
At Wednesday, April 2, 2008 at 9:19:00 AM PDT, Anonymous Babun said...

"There is no shortage of crude.
When tankers have to sit around waiting to discharge because the refinery product tanks are full, that tells us we have a demand problem, not a supply problem
When the product tanks are full, they can't process any more crude because there is nowhere to put it.
The reason the product tanks are full is because the tankers are not taking it to the filling stations.
The filling stations don't want so much because they are selling less.
Demand related shutdowns are being disguised this as refinery maintenance and refinery breakdowns."

Do you actually have any sources that imply that these things would be in any way significant compared to e.g recent shortages in China? (where demand has been growing at the fastest pace)

 
At Thursday, April 3, 2008 at 3:19:00 PM PDT, Anonymous juan said...

So what exactly are "earlier expectations" and "risk management" and why do you think they are more important factors than long term outlooks on supply/demand?

'Earlier expectations' - depends on whether we are speaking about actual users of crude, in which case it would mean planning and purchase decisions. For example, how much of which grades of crude will be needed when, so also expected demand for the different products, optimiztion of output process, volumes, etc, and overlapping this, spot and forward purchase at best prices + attempts to mitigate, manage, or profit from price risk via use of futures, options, swaps. And then on the product side use of other financial tools such as crack spreads. No doubt there are formulas which integrate the possibilities but I don't happen to have one but would say the above applies to what I think of as legitimate commercial hedgers. They may be gambling but they are also producers, users, storage companies.

'Earlier expectations' also and increasingly so over the last years applies to those whose sole concern is the financial side and change in the price of paper barrels which, in the simplest form, would be the purchase of futures contracts or options on futures with the expectation that price will continue rising or will fall. Longs and shorts, the bidding and asking interactions of which, along with the real commercials, is a process of price discovery and formation, and one which - as you acknowledge - is centered in the financial.

Expectations feed expectations. Which is not circular but self-fulfilling. Momentum draws towards itself and as we've repeatedly seen can take what is financialized price(s) beyond fundamentals, a process which has been assisted through portfolio reallocation strategies by long only index funds that, as the attached might clarify, have been misrepresented in the CFTC's Commitment of Traders Reports as 'commercials' and have flowed not inconsiderable money into the energy markets, including through the conduit of swaps dealers.

See: http://commitmentsoftraders.org/?p=4

As you will see in above, these long only financial players do take a longer term or 'stickier' perspective, so yes, speculation is not limited to the momentary trade but portfolio theory, index weighted, positions that in my mind also function as part of a type of soft floor for price, i.e. can assist in holding it above what a price based on fundamentals would be so also assist in supporting/perpetuating unrealistic expectations.

Maybe this all boils down to whether one accepts financial markets to be necessarily efficient, to accurately capture all available information hence provide an accurate representation of the real. Certainly this notion is inherent to neoclassical economics with its embedded beliefs in 'rational actors'.

I, on the other hand, would say that behavioral finance gets closer, so, a short clip:

"The efficient markets theory is the idea that speculative asset prices always incorporate the best information about fundamental values and that prices change only because new information enters the market and investors act in an appropriate, rational manner with regards to this information. This idea dominated academic fields in the early 1970s. Efficient markets theory is an elegant attempt to tether asset prices to fundamentals through the common-sense notion that people would not behave in irrational ways with their money in financial markets.

[...]

Behavioral Finance abandoned the quest of the efficient markets theory to find a rational, mathematical model to explain fluctuations in asset prices. Instead, behavioral finance looked to psychology to explain asset valuation and why prices rise and fall. The primary representation of market behavior postulated by behavioral finance is the price-to-price feedback model: prices go up because prices have been going up, and prices go down because prices have been going down. If investors are making money because asset prices increase, other investors take note of the profits being made, and they want to capture those profits as well. They buy the asset, and prices continue to rise. The higher prices rise and the longer it goes on, the more attention is brought to the positive price changes and the more investors want to get involved. These investors are not buying because they think the asset is fairly valued, they are buying because the value is going up. They assume other rational investors must be bidding prices higher, and in their minds they “borrow” the collective expertise of the market. In reality, they are just following the herd."

See: http://angrybear.blogspot.com/2008/04/sammy-on-failures-of-efficient-market.html

BTW, yes, Oxford Energy, Robert Mabro et al, has done some good work over the years. In one of JD's eearlier posts I had quoted extensively from one of Mabro's 2005 papers, The International Oil Price Regime: Origins, Rationale and Assessment

From p13, a decoupling between price movements in the futures market and the economic fundamentals of the supply of, and demand for, the physical barrel may occur from time to time.

A tidy mind will find it odd that the reference price for a physical commodity should be borrowed from a market where people buy or sell a contract that carries its name but which is only partly related to it.


'From time to time' need not mean only a few days or weeks. "Earlier expectations" and long term outlook, which is more to do with the outlook for price change and price differentials, are not divorced but integrated. Right now though, they may be in some contradiction as the former is faced with the longer term outlook of a slowing global economy, i.e. finding it more difficult to maintain the global growth story.

Insofar as Brent Weighted Average (BWAVE), I'm not sure but you might know: was this originated in its current form by the InterContinental Exchange (ICE) prior to its acquisition of the LIPE in 2001? That is, before Platts shifted to I think a 30 minute window assessment which may not have helped its standing?

 
At Friday, April 4, 2008 at 5:10:00 AM PDT, Anonymous mk said...

Re the problems with fuel supply in China.
China has price controls on fuel.
Nations with fixed exchange rates (pegged currencies) usually have related price controls on essential items such as food and fuel.
China has price controls on fuel.
Th rising crude price have wedged them.
They are currently subsidizing all fuel apart from that produced by negotiated price suppliers, both domestic and international.
A lot of gas and and oil is bought and sold in this manner.
They are often long term supply arrangements.
They may or may not be related to a spot market price.
Chinese fuel supply problems are related to their market controls, not to any physical shortage.

 
At Friday, April 4, 2008 at 1:41:00 PM PDT, Anonymous Babun said...

MK, i asked you to provide sources - i don't see any.

And Juan - I'm sorry but it just takes too much time and energy to try to understand those poorly written messages.

 
At Friday, April 4, 2008 at 2:32:00 PM PDT, Anonymous Babun said...

Juan :

"As you will see in above, these long only financial players do take a longer term or 'stickier' perspective, so yes, speculation is not limited to the momentary trade but portfolio theory, index weighted, positions that in my mind also function as part of a type of soft floor for price, i.e. can assist in holding it above what a price based on fundamentals would be so also assist in supporting/perpetuating unrealistic expectations."

As far as I can see, your argument boils down to this.

Ok - let's just clarify here. What is "A price based on fundamentals" and how do you think it relates to futures markets? I'd say you're talking about the present and the future in the same sentence and saying that the present isn't the future. Or is it something else you're saying?

 
At Wednesday, April 9, 2008 at 3:54:00 PM PDT, Anonymous Realist said...

Fraud and speculation in the the oil market....never....

Let me list a few of the big ones since the Enron loophole opened:

1. Enron
2. Amaranth
3. BP Propane
4. NYMEX Director just recently getting indicted


Don't worry guys...there's no speculation in crude oil futures. Peak oil is here...run for the hills.

 
At Thursday, April 10, 2008 at 12:27:00 PM PDT, Anonymous babun said...

"Fraud and speculation in the the oil market....never....

Let me list a few of the big ones since the Enron loophole opened:

1. Enron
2. Amaranth
3. BP Propane
4. NYMEX Director just recently getting indicted"

Afaik the enron scandal wasn't about speculation on the oil markets. And do you mind clarifying on these other ones? How have they, according to you, manipulated markets to achieve a higher oil price?

 
At Thursday, April 10, 2008 at 12:38:00 PM PDT, Anonymous Babun said...

I find it very puzzling that some people insist in there being some kind of manipulation going on in oil prices even though we can read news about tight oil markets nearly every day.

Nobody is saying that the formation of oil prices is simple and based on merely supply and demand - but you people need to differentiate between the underlying cause and factors that reinforce the trend. Even if there are other factors, they all stem from the root cause - tightening oil markets.

So saying that we're in a world of high oil prices because some mean boogy man is manipulating prices is just infantile. High prices are here to stay. People talk about "floor prices". The rest is up to these factors you are talking about, but they are rather insignificant and pointless to talk about in the grand scheme. That is unless you're into stock market gambling.

 
At Thursday, April 10, 2008 at 3:10:00 PM PDT, Anonymous JD's new fan said...

"I find it very puzzling that some people insist in there being some kind of manipulation going on in oil prices even though we can read news about tight oil markets nearly every day."

Ok...lets talk about fundamentals in the oil market.

1. Opec spare capacity: Since 2005, opec spare capacity has risen to between 2-3 million barrels/day. (Source IEA, EIA)

2. Inventory: US and OECD inventories are at the high end of their average range. Instead of a typical seasonal drop over the first quarter of 2008, we've had a pretty significant build in inventories. (EIA)

3. Demand: non-oecd demand has risen. However, OECD demand has basically fallen off of a cliff. Just look at the weak ass refining margins. Stupid high prices=demand destruction. (EIA)

I'm not arguing that prices should be $10/barrel (or anyone else here), because the marginal costs for new supplies are between $60-70. But $110???

Lets look at the last time we had oil prices this high in inflation adjusted terms:

During the 1981 Iranian Revolution, supplies were really cut off. Gas lines were blocks long. A real supply shortage (not the one shown in the media today) was really happening.

Is the market a little tight for comfort???...Probably. But in no way do the fundamentals justify this.

So what is really driving the price if fundamentals are improving?

1. Dollar has declined somewhat (8/10% in the last year)
2. A global credit crunch has ensued causing investors to "flee for hard assets".

Babun, I think you are guilty of believing everything you see on tv. Don't.

 
At Thursday, April 10, 2008 at 10:26:00 PM PDT, Anonymous Babun said...

"1. Opec spare capacity: Since 2005, opec spare capacity has risen to between 2-3 million barrels/day. (Source IEA, EIA)"

Can you point me to an online source? Could this be something else than the heavy crude nobody wants?

"2. Inventory: US and OECD inventories are at the high end of their average range. Instead of a typical seasonal drop over the first quarter of 2008, we've had a pretty significant build in inventories. (EIA)"

This was news to me. However, as you argue below, oecd demand has dropped - so i guess it's no surprise that stockpiles are increasing then too.

"3. Demand: non-oecd demand has risen. However, OECD demand has basically fallen off of a cliff. Just look at the weak ass refining margins. Stupid high prices=demand destruction. (EIA)"

What about total demand? Isn't that what counts?

"Lets look at the last time we had oil prices this high in inflation adjusted terms:

During the 1981 Iranian Revolution, supplies were really cut off. Gas lines were blocks long. A real supply shortage (not the one shown in the media today) was really happening."

The world is slightly different today than it was in 1981, yes.

"Is the market a little tight for comfort???...Probably. But in no way do the fundamentals justify this."

I think they do. But if you have better info on that I'd sure like to read it.

"So what is really driving the price if fundamentals are improving?"

Yes - if. I haven't seen any such compelling arguments (or actually read sources) that would imply fundamentals are improving.

"1. Dollar has declined somewhat (8/10% in the last year)
2. A global credit crunch has ensued causing investors to "flee for hard assets".

Yes, i'm sure these are part-factors in the increase of the price.

"Babun, I think you are guilty of believing everything you see on tv. Don't."

Oh, are we posting ad-hominems now? I will change my opinion if i see a compelling argument. Saying i believe everything i see on tv when i make educated guesses about oil issues is just infantile. Why don't you try to actually present me with those arguments needed to strengthen your case instead of throwing tiresome ad-hominem clichés?

 
At Thursday, April 10, 2008 at 11:24:00 PM PDT, Anonymous Anonymous said...

Babun,

I have yet to see a single source on anyone of your posts.

But since you asked, I'd be more than happy to give you a few:

EIA Short term report: This will show you the increases in inventories and OPEC spare capacity.

http://www.eia.doe.gov/emeu/steo/pub/contents.html

You will notice a nice increase in spare capacity since 2005. Now, unless you know more than the EIA or can point to a more reliable source, I'll take their view over yours.

If the market was truly based on supply and demand and not speculation, the oil prices would have topped out in 2003-2005 and would be on a steady downtrend. My guess is $40-50 in 2003 dollars, which would translate into $50-70 in 2008.

BTW....here's a another source from Energy Intelligence Weekly. It's good stuff and proves my point.

http://www.energyintel.com/DocumentDetail.asp?document_id=210901

Since we both agree that today's market is fundamentally not as tight as the 1980s, since there are no shortages, and no gas lines, then we should not have prices that reflect these fundamentals. But we do.

However, since the market can remain irrational longer than I can remain solvent, I would not try to hazard a guess as to when this trend will break.

 
At Thursday, April 10, 2008 at 11:27:00 PM PDT, Anonymous Anonymous said...

http://www.energyintel.com/DocumentDetail.asp?
document_id=210901

Sorry...that hyperlink got cut off

 
At Friday, April 11, 2008 at 9:31:00 AM PDT, Anonymous Babun said...

"Babun,

I have yet to see a single source on anyone of your posts."

True. If you have anything you're having difficulties believing in i'll be happy to tell you where that piece of information came from.

"But since you asked, I'd be more than happy to give you a few:

EIA Short term report: This will show you the increases in inventories and OPEC spare capacity.

http://www.eia.doe.gov/emeu/steo/pub/contents.html"

Indeed it does. It doesn't tell us what kind of spare capacity that is however. The other link you provided had some info about that though. Afaik most of the spare capacity rise has been just this heavy crude.

Here's a quote from that link :

"The quality of Opec spare capacity clearly matters, as was seen at the end of 2004, when Saudi Arabia had to dip into its heavy offshore Safaniyah and Manifa fields to meet rapidly growing Asian demand. Sweet-sour differentials ballooned as a result -- the Brent-Dubai spread went from less than $1 per barrel in March to nearly $13 in October."

About stockpiles then. Check this graph:

http://www.eia.doe.gov/emeu/steo/pub/gifs/Fig11.gif

..and note that a part of it is forecast.

Although even if stockpiles would've risen, i wouldn't say it's a good argument for the worldwide supply/demand picture. You use the argument of rising stockpiles to support the fact that markets would be less tight. I argue that OECD stockpiles don't really matter. They don't e.g tell us anything about high demand in Asia.

"You will notice a nice increase in spare capacity since 2005. Now, unless you know more than the EIA or can point to a more reliable source, I'll take their view over yours."

I have no problem believing EIA data. More often it's about how you interpret data where you get it wrong. That's particularly why I ask for sources.

"If the market was truly based on supply and demand and not speculation, the oil prices would have topped out in 2003-2005 and would be on a steady downtrend. My guess is $40-50 in 2003 dollars, which would translate into $50-70 in 2008."

Let me reverse this for you : Spare capacity of crappy grades have risen to almost average rates when prices are at record highs. Stockpiles are pretty much the same as they have been (the change in per cent is not large). What's the reason for the price to be lower? That China could consume even the rest of that almost average spare capacity?

And let me stress that this is the 5 year average. It used to be a lot more before. So it's just wrong to try to argue that the markets wouldn't be tight.

Maybe, if spare capacity grows further and demand slows down - then there will be lower prices and less tight markets. But please, don't fool yourself that prices are high because of some market boogy man. We do have tight markets - demand remains high, even at this price. That's the main reason. Then there are other reasons which reinforce the effect.

"BTW....here's a another source from Energy Intelligence Weekly. It's good stuff and proves my point.

http://www.energyintel.com/DocumentDetail.asp?document_id=210901"

Wow, i mean - do you actually even look at the graphs you link to? So they estimate we will about 75% of what the spare capacity was in 2002 and then go back down again. That's pretty much the picture i have as well - that we will see a little loosening for maybe a year or so, but then we'll go on tightening and tightening and tightening...

Another thing : so if institutions are already predicting this, why would there be a disconnect between investors' anticipation and fundamentals? (i don't know if futures contracts allow for this - but i think they do).

"Since we both agree that today's market is fundamentally not as tight as the 1980s, since there are no shortages, and no gas lines, then we should not have prices that reflect these fundamentals. But we do."

Actually we don't agree on this. I was just saying that these are very different times. The nature of the tightness was quite abrupt in 1981 and it's more like a slow thing we're going through (no gas lines, not so much noticeable to the bare eye). Also, in my view the dependence on oil is of quite another nature in today's world compared to the 1980's one, which is why smaller disruptions or tensions in the system have a more acute effect on prices today. Also the pricing system of oil has completely changed - your argument is just invalid on so many levels.

"However, since the market can remain irrational longer than I can remain solvent, I would not try to hazard a guess as to when this trend will break."

Ok - so your viewpoint is that evil market men have taken control of oil prices, perhaps forever?

My view is that market prices mostly reflect fundamentals and fundamentals are only likely to change a little (for the better) in the near future, only to continuously get worse in the longer term future.

It's a funny thing, since your viewpoint cannot really be disputed with changes in the oil price. If the price falls, you think the evil market men have lost. If the price rises, you think the evil market men are freely allowed to plot again. Quite difficult to try to convince anyone otherwise with that viewpoint. I guess we'll have to wait about a decade until fuel lines actually start forming. If we have a horrible economic disaster which completely devastates the world economy you can blame it on the market men. (yes, this is my view at this moment. It's open though, i respect the complexities of energy production and its relationship with human development)

 
At Saturday, April 12, 2008 at 3:12:00 AM PDT, Anonymous Babun said...

To MK:

"Re the problems with fuel supply in China.
China has price controls on fuel.
Nations with fixed exchange rates (pegged currencies) usually have related price controls on essential items such as food and fuel.
China has price controls on fuel.
Th rising crude price have wedged them.
They are currently subsidizing all fuel apart from that produced by negotiated price suppliers, both domestic and international.
A lot of gas and and oil is bought and sold in this manner.
They are often long term supply arrangements.
They may or may not be related to a spot market price.
Chinese fuel supply problems are related to their market controls, not to any physical shortage."

Well actually there's two ways of looking at it. I've also read about why there are fuel shortages in China. You could say it's because of subsidies and price controls. Or you could say it's about the rising oil prices which turns profits into losses for the private sector refineries. This has lead to private refiners not refining products for which they would only accumulate losses.

It's not related to a physical shortage directly, but probably indirectly it is.

But if you blame this on price contols, you might as well blame high oil prices worldwide on them too. There's no way consumption would have reached these growth levels in China with higher prices and without subsidies.

Hell, China isn't even nearly the only one subsidising fuel. I know at least a handfull of them and they all consume plenty of fuel.

Do you think they should all abandon subsidies and go into a depression? In my view, since the world is so globalized these days - saying this means essentially "Let's let the world economy go into a depression". Sure, you could get rid of the problem this way, but I think eliminating price controls equals destroying demand.

I don't think price controls or subsidies were a good thing to start with (at least not on the level they are controlled). But now once we're in the situation we are, it's quite problematic to get rid of price controls. I accept that price controls can be seen as a reason - but please note that without price controls we wouldn't be in this situation here, now. Demand would have grown a lot more slowly and we wouldn't be having a supply shortage. All in all it's a supply/demand thing where you choose demand as the reason and i choose supply.

 
At Saturday, April 12, 2008 at 1:48:00 PM PDT, Anonymous Anonymous said...

Babun, (from JD's new fan)

The link I sent you is a two-4 year projection, not a 40 year one. Extrapolating the future based on that graph to 2015, 2020, and out to infinity is somewhat useless.

As for my point about speculators, I don't think they are evil, bad, or anything like that. Frankly, I've made a boatload of money off of this mess by investing it (with tight downside protection controls of course). My commodity investments have actually made me far more money than what I will ever spend on filling up my gas tank or heating my house.

The macro-economic forces of the fed inflating the crap out of the currency, the advent of ETFs, and the nearly 500% rise in oil futures investment in the last 5 years makes a whole lot more sense than the supply/demand fundamentals. If you put $250 billion dollars of new investment into anything, the price will go through the roof. Barrons, Businessweek, and a few other news outlets have demonstrated this.

Looking at that link, there have been several instances in the 1990s where we actually had the same level of surplus capacity that we do now (the gulf war, the period right before the Asian financial crisis).

Personally, I think two financial factors have made this commodity bull market go ridiculous:

1. Real low interest rates. Investors have to park their coin somewhere and interest rates at most banks stink.

2. The ease in which money can go into the commodity market. For about $5,000, you can take part in this too.

I'm a realist, supply and demand play a role, but commodity derivatives have amplified this in a ridiculous manner.

Prices will eventually go down, mostly because people won't be able to afford to pay insane prices for gas in market economies and emerging markets like China will go broke paying for the subsidies.

There was a "housing shortage" two years ago in the southwest US, even though there were plenty of available homes for sale. Today's there's an "oil shortage" even though every major consuming nation has access to oil if they are willing to pay market prices.

"I guess we'll have to wait about a decade until fuel lines actually start forming."

Ok...sounds good to me. Too bad by then I'll be driving past you in my new Tesla Roadster laughing at you while you'll be sitting in line with all the other poor fools

 
At Sunday, April 13, 2008 at 2:34:00 AM PDT, Anonymous Babun said...

"The link I sent you is a two-4 year projection, not a 40 year one. Extrapolating the future based on that graph to 2015, 2020, and out to infinity is somewhat useless."

Thank you for your straw man argument. I did not extrapolate anything based on that graph. I said it concedes with my view of future oil production.

"As for my point about speculators, I don't think they are evil, bad, or anything like that. Frankly, I've made a boatload of money off of this mess by investing it (with tight downside protection controls of course). My commodity investments have actually made me far more money than what I will ever spend on filling up my gas tank or heating my house."

Yeah, right. Haven't we all? No really, actually i have made some. Perhaps not quite a boatload though.

"The macro-economic forces of the fed inflating the crap out of the currency, the advent of ETFs, and the nearly 500% rise in oil futures investment in the last 5 years makes a whole lot more sense than the supply/demand fundamentals."

Have you considered that some of these may be a result of supply/demand fundamentals?

"If you put $250 billion dollars of new investment into anything, the price will go through the roof. Barrons, Businessweek, and a few other news outlets have demonstrated this."

Yes, but this is apparently something completely else than short-term speculation. I thought this topic was about evil short-term market manipulators who are conspiring to make money on high oil prices?

"Looking at that link, there have been several instances in the 1990s where we actually had the same level of surplus capacity that we do now (the gulf war, the period right before the Asian financial crisis)."

Hmm, i could not find this information. I only see data from 1997 onwards in the EIA link.

"Personally, I think two financial factors have made this commodity bull market go ridiculous:

1. Real low interest rates. Investors have to park their coin somewhere and interest rates at most banks stink.

2. The ease in which money can go into the commodity market. For about $5,000, you can take part in this too."

Yes probably these have affected investment. But look at supply/demand in different commodities and you can see strains in a lot of them. Agricultural products, metals, energy products.

"I'm a realist, supply and demand play a role, but commodity derivatives have amplified this in a ridiculous manner."

Yes, the question is which one is to blame more. I acknowledge that supply/demand could be a lot worse. But the fact that it's tight regarding many commodities and the future outlooks don't really bring better news leads me to believe markets may just be acting accordingly.

I'm anything but sure about these things, but I know it's what I'll be basing my investment decisions in.

"Prices will eventually go down, mostly because people won't be able to afford to pay insane prices for gas in market economies and emerging markets like China will go broke paying for the subsidies."

Wow, you made a future prediction. I have to agree it's a potential scenario. My view is that prices will go down slightly in the near term because of increased production capacity and a bleak economic outlook. But if the economy revives itself quickly, I believe we will see record prices in the beginning of the next decade.

"Ok...sounds good to me. Too bad by then I'll be driving past you in my new Tesla Roadster laughing at you while you'll be sitting in line with all the other poor fools"

Hm, i thought you didn't believe we had a problem with oil supply in the future?

Do you think the car is suitable for winter conditions, hm? I wonder who'd be lol'ing at who :)

http://personal.inet.fi/luonto/amigo.jardin/Kuvat/Auto_Talvella.jpg

 
At Sunday, April 13, 2008 at 3:39:00 PM PDT, Anonymous Anonymous said...

(FROM JD's NEW FAN)

"Do you think the car is suitable for winter conditions, hm? I wonder who'd be lol'ing at who :)"

I live in San Diego next to the beach. We don't have winter.

I now have something else to laugh at you for. Not only are you completely out of touch with reality but you're freezing your ass off for six months of the year.


HAHAHAHAHAHAHAHAHAHA

 
At Sunday, April 13, 2008 at 10:08:00 PM PDT, Anonymous Babun said...

"I live in San Diego next to the beach. We don't have winter.

I now have something else to laugh at you for. Not only are you completely out of touch with reality but you're freezing your ass off for six months of the year."

Well you were talking about driving past me in the fuel line. That won't me in San Diego - so have a nice ass freezing.

Out of touch with reality? Is this where your arguments end? I thank you for your good arguments though. They brought some new information to my attention and I think the arguments were sensible too.

You just have to understand that we come from two completely different places. I won't change my mind until i see some concrete proof or irrefutable evidence about that I would be wrong (e.g that production would notably increase in the next decade, that would be absolutely contrary to my view). However, when it comes to pricing - I believe it's quite impossible to accurately attribute what rising prices are based on.

 
At Wednesday, April 16, 2008 at 4:30:00 PM PDT, Anonymous juan said...

babun,

when I say 'fundamentals', I mean the conditions of the global capital system, the real economy of production and consumption, of employment and wages, of gross non-financial investment and avg rate of profit (not earnings), whithin which physical crude oils are produced, consumed.

Given that global growth rates began a decade by decade slowing from 1970 and that this was related to a strong, then undulating, fall in rate of profit, it's no wonder that investment flows oriented increasingly towards financial returns -- something which, thanks to the (hyper)reflationary efforts to counter crises, has only exacerbated the gap between real and financial.

One part of that gap has been investment in paper commodities, and one increasingly large part of that investment has come from long-only index funds which, through swap dealers, have been able to exceed CFTC and Exchange set position limits.

To degree possible, this might give an idea of why I consider commodities prices to have been, and remain, inflated relative to underlying conditions:

http://commitmentsoftraders.org/?p=32

You may also want to take a look at Index Traders positions as of 8 April, 2008.

http://www.cftc.gov/dea/options/
deaviewcit.htm

Too bad the CFTC refuses to expand coverage.

 
At Wednesday, April 16, 2008 at 7:30:00 PM PDT, Anonymous Econogeek said...

How about the real negative interest rates too?

In economic terms, when the fed funds rate is below the CPI, this causes traders/investors to flood commodity markets in order to maintain the value of their money. I don't think it's any accident that as soon as Bernanke cut the rate from 5.25% when inflation was at 3.5% to 2.25%, oil went ape shit.

Real negative interest rates do a few really nasty things:

1. Commodity producers delay expanding production. Why produce today if you're going to get a higher price tomorrow? This force creates insane pressure on front month futures contracts

2. Cheap money enables consumers to purchase long dated contracts and hold them for little carry. As a result, you see a "remarkable" strength in the long dated contracts as well.

3. Consumers, fearful of constantly increasing prices, will increase their purchases on the front month for fear that prices will continue to skyrocket.

This cycle, started between 2001-2006, stopped for about 4-6 months when the interest rate was raised (that was when we had the massive buildup in inventories btw), and then started again in 2007 when the credit crunch hit.

 
At Thursday, April 17, 2008 at 7:23:00 PM PDT, Anonymous Juan said...

Agreed econogeek,

and was trying to capture some of that with my shorthand phrase "(hyper)reflationary efforts to counter crises..."

 
At Monday, May 26, 2008 at 8:41:00 AM PDT, Anonymous Pete said...

Bottom line, If the funds that buy
commodities get more money, they
have to invest it.
There is only so much oil, rice,
corn etc.
For example, if there were 5 funds
bidding for 4 oranges the price
could go to $1000 per orange. Even
if the world consumption is only
for 3 oranges. Since these funds
MUST invest in oranges what else
can they do?
If it were only those that refine
the oil buying it this would not
be occuring. But, with these NEW
funds and the new money going into
them the price is being bid up.
The speculators are US, You and me
in these new investment vehicles.

 

Post a Comment

<< Home