free html hit counter Peak Oil Debunked: 355. BANKS HOARD OIL IN STORAGE TANKS

Wednesday, May 21, 2008

355. BANKS HOARD OIL IN STORAGE TANKS

$130 oil is really working wonders for peak oil websites like this one. I'm getting a nice surge of new visitors lately, so let's do a quick public service message on a little known fact that deserves broader airplay.

An interesting phenomenon has happened in the last couple of days. The oil futures market has gone into a state known as "contango". I'm not going to go into any detail on the specifics -- if you're curious just do some googling. As a layman, all you really need to know is that, thanks to some complicated financial mumbo-jumbo, banks will now begin to hoard oil in storage tanks, driving up the price. And then they will sell that oil back to the public for obscene windfall profits.

Oil storage tanks in Cushing, Oklahoma

Morgan Stanley, Goldman Sachs and Deutsche Bank got into hoarding early in 2004:
A LARGE warehouse in Amsterdam may seem an unusual place to attract the City’s top traders and hedge funds. But, in the past few months, Morgan Stanley has been accumulating warehouse space in the Netherlands to store its hottest new property — oil.
[...]
Meanwhile, banks such as Morgan Stanley are also beginning to move into the physical market to buy oil — or even entire oilfields.
Goldman Sachs recently bought 10m barrels of oil.
[...]
Morgan Stanley and Deutsche bank recently bought the rights to 36m barrels of oil between 2007 and 2010 direct from a North Sea oilfield.Source
Goldman Sachs, hedge funds:
With BP PLC accused of artificially inflating the price of propane by withholding some of its inventory from the market, government officials and energy traders are grappling with a question: When does smart trading cross the line into market manipulation?

The shrewdest competitors in the energy-trading world these days deal heavily in physical shipments of fuel, not just contracts for the future delivery of such commodities. Owning actual oil, natural gas, propane and even electricity has two big advantages. It provides detailed knowledge of regional supply and demand and the pricing power that comes from holding large quantities of commodities.

[...]

An explosion in the number of participants in the energy-trading world has led to an increase in so-called physical trading.

Dominant commodity traders such as Morgan Stanley and Goldman Sachs Group Inc. long have had strategies to own or lease fuel-storage terminals, oil tankers and power plants to give them more flexibility to hold onto inventory or sell it at opportune moments.

More recently, those Wall Street firms have taken physical trading to new levels with bids to buy, not lease, distribution facilities such as pipelines and production facilities including refineries. Hedge funds also have gotten into the game of dealing in physical energy and even metals assets.

Goldman Sachs last year bought a refinery with private-equity firm Kelso & Co. Morgan Stanley this month agreed to buy petroleum-products distributor TransMontaigne Inc. and is negotiating to buy the Heidmar Group of shipping and marine-logistics companies. (Source: Tracking the Numbers / Street Sleuth -- Case Raises a Tough Query: When Do Traders Cross Line?, Ann Davis, Wall Street Journal, Jun 30 2006)
Here's the FYI on oil hoarding by banks during the last contango:
Storing oil became big business. Tank owners and companies that leased storage, including Wall Street giants such as Morgan Stanley, turned sizeable profits simply by sitting on tanks of oil. They would buy oil for immediate delivery and stick it in their storage tanks, then sell contracts for future delivery at a higher price. When delivery dates neared, they closed out existing contracts and sold new ones for future delivery of the same oil. The oil never budged. The maneuver was known as the oil-storage trade.
[...]
Bruce MacPhail, who manages Enbridge's U.S. oil-terminal leasing, estimates financial firms now lease 25% to 35% of the company's storage.(Source: Where Has All The Oil Gone?; After sitting on crude, speculators unload it; The world's eyes fall on Cushing, Oklahoma, Ann Davis, Wall Street Journal, Oct. 6, 2007)
Here's another detailed article discussing Morgan Stanley's tank farms and other aspects of the ongoing Enron-ification of the entire energy system:
What's a white-shoe investment bank doing selling oil? The answer unfolds in Purchase, N.Y., where an army of its commodities traders sit before flickering screens on a vast, domed trading floor staffed 24 hours a day. At the former site of Texaco's headquarters, Morgan Stanley veterans Neal Shear and John Shapiro run one of the most profitable energy-trading operations in the world.

But they don't just trade futures, a common way of betting electronically on commodities that involves buying and selling contracts for future delivery. Morgan Stanley also handles real barrels of oil and generates actual megawatts of power.

The reason is twofold. Having access to barges and storage tanks and pipelines gives the bank additional options, to move or store commodities, that most energy traders don't pursue. And by having its finger on the pulse of the business, it hopes to get a more subtle feel for the market, a crucial asset to a trader.
[...]
One member of [Morgan Stanley's] team, Olav Refvik, has amassed leases on storage terminals around the globe.
[...]
In dealing with crude oil, the Morgan Stanley team at times buys the rights to oil companies' production in the Gulf of Mexico, then turns around and sells it while it is still underground.
[...]
That was the beginning of a quiet strategy that later helped Morgan Stanley muscle into another huge petroleum market: home heating oil.

The trader who largely carved out that dominance is Mr. Refvik. In the 1990s, he made a bold real-estate play along a grimy refinery row in coastal New Jersey near New York Harbor. The New York Mercantile Exchange, the country's main hub for trading oil futures, designates about two dozen sites there and in New York as places where exchange-traded oil can be delivered. Through leases, Mr. Refvik locked up a large chunk of the official storage space. He laid claim to tank farms -- clusters of giant metal storage drums. His team also leases a big storage terminal in New Haven, Conn.

Messrs. Shear and Shapiro worried, at first, that the expensive leases could be albatrosses. But the move has worked so well that traders elsewhere dubbed Mr. Refvik "King of New York Harbor," a nickname that also reflects his occasional tour of the waters with his yacht, Song of Norway. Meanwhile, Morgan Stanley also acquired large amounts of oil-storage capacity in other countries.Source
by JD

65 Comments:

At Wednesday, May 21, 2008 at 7:48:00 AM PDT, Blogger JD said...

As usual, please use the Name/URL option (you don't have to register, just enter a screen-name) or sign your anonymous post at the bottom. The conversation is better without multiple anons.
Thank you! JD

 
At Wednesday, May 21, 2008 at 8:34:00 AM PDT, Anonymous aram said...

Hmmmm... Goldman Sachs has this position, and yet objects to cries that the peaker report that has every one predicting even higher prices is self serving.

After the subprime fiasco and all the failed predictions of of people like Pickens and Simmons and the rest I have to ask the peakers who post here why do you continue to believe people who are consistently wrong and who are so blatantly self-serving?

 
At Wednesday, May 21, 2008 at 9:04:00 AM PDT, Anonymous tr said...

"hoard", "obscene profits".

Why is it invalid to interpret this as healthy free market speculation working to smooth prices and supply? The markets foresee higher scarcity, and speculators are mitigating that scarcity.

What am I missing?

 
At Wednesday, May 21, 2008 at 9:04:00 AM PDT, Anonymous econogeek said...

You can add Robert Hirsch of the famed Hirsch report to another loud mouth spouting off his peak oil agenda on TV:

"The idea is that [world oil production] would hit a sharp peak and then drop off, and what's happened is, we've hit a plateau in world oil production, and that plateau has been ongoing since about the middle of 2004,"

http://www.cnbc.com/id/24725305

I guess ol'boy Hirsch forgot that the reason we plateaued was that OPEC turned off the spigot during 2006-7. Looks like we're now a good 2-3% above his "peak"

 
At Wednesday, May 21, 2008 at 9:45:00 AM PDT, Blogger Akrotiri21 said...

Hello all,

This is my first post, though I've been reading the site for a few months now. Like a lot of folks, I happened on to peak oil sites, nearly had a heart attack, and then started reading voraciously after I recovered somewhat. I appreciate this site (and the really dedicated work by JD) as a counter-balance to a lot of what is out there and as a more compelling assessment of what is in front of us -- some hard times and real adjustment, but do-able and worthwhile. I also welcome the humor that comes through on this site from time to time.

In any case, I am only posting to include a link to an article in today's WSJ. JD posted at some point about how, contra Kunstler, scooters can save suburbia. Appears scooters are taking off, just like the railways -

http://online.wsj.com/article/SB121131620487908103.html?mod=autos_feature_articles

 
At Wednesday, May 21, 2008 at 10:00:00 AM PDT, Anonymous aram said...

A plateau, eh?

I've just finished reviewing the Oil Report that JD quoted from the IEA in his prior post and the numbers suggest a pretty steady increase in supply growth from 2005-2008; hardly a plateau at all.

The problem seems to be that in light of delayed non-OPEC growth that OPEC is, as econogeek suggests, keeping the spare supply just a little beyond demand, which is getting all the peak doomers hard and causing every idiot to spout off at the mouth about imminent $200.00 oil (with no fundamental support).

 
At Wednesday, May 21, 2008 at 10:19:00 AM PDT, Blogger bc said...

Lol, I wondered when you would stumble on this well known "secret". You turn it into a load of BS of course.

Previously, you argued that trading paper futures inflates commodity prices. If investment banks can do that, why would they bother to lease storage and take physical delivery? That pretty much disproves your earlier thesis.

The amount of oil being "hoarded" is insignificant in global terms. And surely buying something which becomes more valuable in the future is called "investing". These banks are going to lose shedloads of money when the oil price collapses, aren't they? ;)

Did you take a knock on the head while you were away JD? You come back with all this BS about global warming and now "speculators are the boogy man", somewhere you lost your objectivity and traded it for hysteria.

Fact is, oil supply is peaking, and price is going up. Is that too hard to understand?

 
At Wednesday, May 21, 2008 at 10:40:00 AM PDT, Anonymous Babun said...

This just smells like a conspiracy theory. Where are all the numbers? You have two crappy links from 2004 and 2005 to support this view? Get real.

If this was a real reason for the rise in oil prices, we'd see a lot more information about this and JD wouldn't have to google up 3 year old news pieces.

Surely it can't be that hard to make a crude estimate about how much investment banks would be contributing to global oil demand?

A wild guess why it isn't reported anywhere : it's insignificant.

And to aram and econogeek about the plateau : i'm guessing he was talking about crude and not total liquids.

 
At Wednesday, May 21, 2008 at 10:52:00 AM PDT, Anonymous econogeek said...

"This just smells like a conspiracy theory. Where are all the numbers? You have two crappy links from 2004 and 2005 to support this view? Get real."

Conspiracy theory is saying that one or two particular people are purposefully doing this. I don't think JD is suggesting that at all.

Clearly, investment banks are storing oil. What isn't mentioned here is that speculators or investment companies (i.e. Goldman Sachs, Morgan Stanley, pick your favorite hedge fund) as defined by the 1940 Investment Company Act are not supposed to take delivery of oil.

Here is clear proof that the banks are acting illegally and that the SEC or any other regulatory agency could give a crap.

See my earlier post about the dangers of the unfunded commodity liabilities.

 
At Wednesday, May 21, 2008 at 11:28:00 AM PDT, Anonymous Babun said...

Conspiracy theory or not, I don't really see that belief in this is based on anything except faith without seeing the real numbers at play.

And to me the fact that this would significantly affect the prices is just absurd.

 
At Wednesday, May 21, 2008 at 11:39:00 AM PDT, Anonymous aram said...

Econogeek -

Here is clear proof that the banks are acting illegally and that the SEC or any other regulatory agency could give a crap.

Not so much acting illegally as most assuredly the hedge fund activities are under one corporate entity and the commodity hoarding activities are being carried out under another entity which is not bound by the rules.

Immoral? Yes.

Illegal? No.

But it is another in a long list of things that prove that the market has been hijacked by commodity speculators and that the people actually bringing product to market and those wanting to take physical delivery are being marginalized by the children playing in the sandbox because of the situation in equities.

It's true that OPEC and the national oil players aren't helping with their antics, but to call it "peak oil" as though the supply of the commodity is running out is a lowlife scare tactic.

 
At Wednesday, May 21, 2008 at 1:23:00 PM PDT, Anonymous econogeek said...

Hey...I've got some more fun for you.

This is a report by Michael Masters, a prominent hedge fund manager in New York detailing the effects of hoarding via futures indicies.

On page 4 is his chart showing how all the speculation has created stockpiles of futures in "investor" hands. (BTW...this chart doesn't include my personal favorite market the ICE)

Speculative funds now control vs. 2003

6x more WTI oil
5x more brent crude
3.5x more heating oil
3x more gasoline


http://hsgac.senate.gov/public/_files/
052008Masters.pdf

Some interesting quotes:

"Let’s turn our attention to food prices, which have skyrocketed in the last six months.
When asked to explain this dramatic increase, economists’ replies typically focus on the
diversion of a significant portion of the U.S. corn crop to ethanol production.11 What
they overlook is the fact that Institutional Investors have purchased over 2 billion
bushels of corn futures in the last five years. Right now, Index Speculators have
stockpiled enough corn futures to potentially fuel the entire United States ethanol
industry at full capacity for a year.12 That’s equivalent to producing 5.3 billion gallons of
ethanol, which would make America the world’s largest ethanol producer.13" (page 5)

"There is a crucial distinction between Traditional Speculators and Index Speculators:
Traditional Speculators provide liquidity by both buying and selling futures. Index
Speculators buy futures and then roll their positions by buying calendar spreads. They
never sell. Therefore, they consume liquidity and provide zero benefit to the futures
markets.20" (Page 6)

These numbers are gigantic. I think this report pretty much puts to bed the impact that all of this new investment has on commodities (including inexhaustible commodities like gold, silver, copper, etc). Let me repeat: THIS IS NOT JUST AN OIL PROBLEM.

-Econogeek

 
At Wednesday, May 21, 2008 at 1:23:00 PM PDT, Anonymous texastea said...

How much oil is in those tanks? Let's assume that the total volume of oil in those tanks is about 1 Billion Barrels (unlikely but let's assume that for a minute). That oil is, therefore, worth a fortune - $133.7 Billion at current market price. A very large amount.

Now let's assume they dump all this oil into the market to take profits. How much is 1 Billion Barrels? Two weeks worth of global demand??? LOL!!

Some of the arguments on this site have become so idiotic that one doesn't even know where to start. Even if those banks dumped all the oil they have onto market and the market price fell 30 percent, the price would climb right back up in a couple of months.

 
At Wednesday, May 21, 2008 at 1:46:00 PM PDT, Anonymous texastea said...

To expect that there would be no speculation in a roaring bull market is dumb. Speculators will go where the money is - but the money is there because the market has figured out that supplies cannot keep up with demand.

If we weren't in a peak oil situation, we would have had a repeat of the 1970s - when high oil prices spurred so much excess production that prices collapsed from $40 to $8 a barrel. There was so much excess capacity that a raging war in the Middle East that killed half a million people couldn't prop up prices - they collapsed anyway.

Instead of complaining about high prices, we should consider them a godsend. These high prices will rid America of the oil habit like nothing we have seen - no politician, no government policy could have accomplished this.

The link below is a taste of things to come:

http://www.teslamotors.com

If oil hits $200 a barrel, it would no longer make economic sense to use gasoline powered cars as opposed to nimble battery powered vehicles. Fortunately, the battery technology has improved by leaps and bounds and is now able to meet the challenge posed by high gas prices.

 
At Wednesday, May 21, 2008 at 1:48:00 PM PDT, Anonymous juan said...

I should mention a 15 May 2008 Reuters article:

"JPMorgan to start physical oil trade, eyes $200 oil"

"SINGAPORE (Reuters) - JPMorgan Chase & Co will begin trading physical oil by year-end, increasing its exposure in a market that could rise to $200 a barrel, the bank's global head of commodities said on Wednesday.

The bank plans to expand in commodities and energy trading, Blythe Masters said, despite expectations of job cuts in other areas as it prepares to take on staff from Bear Stearns at the same time it deals with turbulent financial markets.

"We will start trading in physical oil and refined products by the end of this year," she told Reuters in an interview. ..."

I may as well also mention that price discovery in futures markets and control over some degree of storage are not mutually exclusive, but a combination which can be used to profit from the derivatives position.

Manipulations can be trade-based, information-based and/or action-based.

Still, these are outright manipulations rather than longer running asset reallocation strategies by, e.g. index funds, and creation of socio-psychological drivers struggling to validate themselves through such notions as 'peak oil'.

BTW, has anyone noticed the declining growth in volume of world trade:

"World trade [by volume] increased by 7.1% in 2007, compared to 9.8% in 2006. 5 This year-on-year reduction is surprisingly strong given the limited fall in global economic growth and strong import growth of oil-producing countries, where oil revenues are rising fast (Table 2). With economic growth being reduced by the credit crisis, world trade growth is projected to soften further, to 4 3/4% in 2008. US imports of goods are projected to fall for the first time since 2001."
(Netherlands Bureau for Economic Policy Analysis (CPB), March/April 2008 International Cyclical Analysis)

And

"(Geneva) World trade growth will slow to 4.5 percent this year from 5.5% last year and 8.5% in 2006, the World Trade Organisation (WTO) said on Thursday."

Which does not indicate such a strong global economy as many wish to believe, or wish others to believe.

 
At Wednesday, May 21, 2008 at 2:10:00 PM PDT, Anonymous juan said...

Texastea,

A company may take a physical position and derivatives position at the same time, with the expectation of sufficient financial gain to more than offset any loss on the physical.

Lets go back to 2001:

"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..."

Or

"Washington, D.C. – The U.S. Commodity Futures Trading Commission (CFTC) today announced the issuance of an order filing and simultaneously settling charges against Marathon Petroleum Company (MPC), a subsidiary of Marathon Oil Corporation, based in Findlay, Ohio, for attempting to manipulate a price of spot cash West Texas Intermediate (WTI) crude oil delivered at Cushing, Oklahoma on November 26, 2003, by attempting to influence downward the Platts market assessment for spot cash WTI for that day.

[...]

The Platts market assessment for WTI is derived from trading activity during a particular 30-minute period of the physical trading day. The Platts market assessment for WTI is used as the price of crude oil in certain domestic and foreign transactions. At the time in question, MPC priced approximately 7.3 million barrels of physical crude oil per month off the Platts market assessment for WTI.

As a net purchaser of foreign crude oil priced off of the Platts spot cash WTI assessment, if its conduct was successful, MPC would have benefited from a lower Platts spot cash WTI assessment. The order finds that, on November 26, 2003, MPC purchased NYMEX WTI contracts with the intention of selling physical WTI during the Platts window at prices intended to influence the Platts WTI spot cash assessment downward. Further, during the Platts window, MPC knowingly offered WTI through the prevailing bid at a price level calculated to influence downward the Platts WTI assessment."

And multiple others. But these are not what has driven the price; neither is physical 'supply/demand.'

 
At Wednesday, May 21, 2008 at 2:27:00 PM PDT, Anonymous econogeek said...

If we had this shortage that everyone claims exists the please explain why Chevron's Vice President before congress says:

"We are investing all we can [in finding new oil] given the limitations of access and our own human capacity," he said. "We have adequate refined capacity, inventories are at an all time high. The issue is the price of crude."

http://money.cnn.com/2008/05/21/
news/economy/oil_hearing/
index.htm?postversion=2008052115

If you wade through the typical mass media horse crap about how we've run out of oil in the rest of the article, you would see we don't have a shortage of oil.

BTW...that 1.1 billion barrels of oil only represents the NYMEX only and not the ICE, which by all indications has trading volume that is several magnitudes larger than the NYMEX.

In every speculative bubble over the last decade, the most intense action is at the top, not the middle or beginning. This too is no different.

 
At Wednesday, May 21, 2008 at 2:34:00 PM PDT, Anonymous Joen said...

Right. A single individual has more information than all the participants who have acted upon the crude oil futures curve. Got it.

Thank God we have futures curves. They were invented 1000's of years ago for Olive Oil, and Wheat. They are among the greatest inventions of humankind, and solve some of humankind's most intracatable problems. Namely, the future.

Now that we are hitting Peak Oil (defined correctly as peak flows of crude oil only) it's a huge gift to society that the crude oil futures curve has moved into contango, which then makes it economic to buy the oil--and store it.

 
At Wednesday, May 21, 2008 at 6:01:00 PM PDT, Blogger JD said...

If this was a real reason for the rise in oil prices

I didn't say anywhere that this is the "real reason" for the rise in oil prices. I simply pointed out that banks are pulling oil off the market, hoarding it in storage tanks, and selling it to the public later for a big fat profit. Even the dumbest person out there is familiar with this form of profiteering. Spin it however you want. I'm simply airing the facts.

Instead of complaining about high prices, we should consider them a godsend.

Who's complaining about high prices? Not me. I favor them, and always have. I personally don't drive, and couldn't care less how high the price of gasoline goes.

I'm simply pointly out the facts: banks are profiteering by hoarding oil in storage tanks, while people are paying skyrocketing prices at the pump. I'll let Joe Sixpack draw his own conclusions . My job is just to dig up and spread the information.

 
At Wednesday, May 21, 2008 at 6:08:00 PM PDT, Blogger JD said...

The markets foresee higher scarcity, and speculators are mitigating that scarcity.

Hi tr, welcome to POD.
Hoarding is a factor which increases scarcity -- such as in a bank run, or when everyone tries to top off their tank in anticipation of a shortage, or in the current situation in the rice market.

 
At Wednesday, May 21, 2008 at 6:20:00 PM PDT, Anonymous juan said...

jzzitjoen,

You are, I believe, treating a market in financial instruments as though it is necessarily efficient, something derived from neoclassical economic theories of 'economic man', rational choice and rational expectations, and given slightly different form some decades ago as efficient market hypothesis which, in very short form says 'the market is always right'.

Given the long history of bubbles, there is evidently some problem here, i.e. the market is not always right but can be and often has been captured by self-fulfilling not-so-rational expectations -- which is where behavioral finance well trumps models/beliefs based on what is more theoretic than real.

Please do not take this as a criticism but only an attempt to clarify.

 
At Wednesday, May 21, 2008 at 6:24:00 PM PDT, Blogger JD said...

Hi Akrotiri21,
Welcome, and great link! I posted it in the Peak Oil Debunked forum, and I'll put it up in the blog later this week.

 
At Wednesday, May 21, 2008 at 9:56:00 PM PDT, Anonymous Babun said...

I didn't say anywhere that this is the "real reason" for the rise in oil prices. I simply pointed out that banks are pulling oil off the market, hoarding it in storage tanks, and selling it to the public later for a big fat profit. Even the dumbest person out there is familiar with this form of profiteering. Spin it however you want. I'm simply airing the facts.

I said a reason not the reason . That is, I don't believe banks would be doing physical hoarding on a grand scale before I see the numbers. Before that it really isn't a fact - but speculation.

I'm not doubtful because it doesn't sound like a sound strategy to make money. I'm doubtful because the media has presented some of the most exotic reasons for the rise in oil prices, but this really hasn't hit the news. That's why I'd like to see some numbers before buying into an argument like this.

As a layman, all you really need to know is that, thanks to some complicated financial mumbo-jumbo, banks will now begin to hoard oil in storage tanks, driving up the price.

 
At Wednesday, May 21, 2008 at 10:00:00 PM PDT, Anonymous Babun said...

The media has also been arguing about market speculation for a very long time.

Also, I'm not arguing here against all speculation - just physical hoarding. I believe banks will mostly stay in the paper business. Any physical oil business will probably remain small. And that means it's not actually hoarding. It's just storing oil for particular purposes - like the story about morgan stanley.

 
At Wednesday, May 21, 2008 at 10:04:00 PM PDT, Blogger recoveringblogloser said...

Why anyone wories about this crap one way or another is something of a mystery to me. There's a kind of arrogance to the thinking on both sides. Both yeas and nays talk/write as if they're in on the "master plan" and are subsequently acting in its furtherance.

Ultimately nobody knows how this mess got started, where it's going or what, if any, purpose it serves (although I'm sure this won't stop many of you from insisting that you DO know, via some time-honored cultually bound hogwash you've been spoon-fed since childhood). So lighten up. Enjoy this while it lasts. Nothing beats entropy. Not even you. Who cares if your right in the end? Then again, maybe you'll get a big medal, advance to the finals and become king of the prom! Ultimately attaining the pussy you so desperately crave. So good luck peakoil lovers/haters. And again ongratulations in advance on your glorious acievements in the great waste of time that is blogging.

Don't bother responding. I just fell off the wagon this one time.

 
At Wednesday, May 21, 2008 at 11:45:00 PM PDT, Anonymous Freak Oil said...

??

 
At Thursday, May 22, 2008 at 4:58:00 AM PDT, Anonymous soylent said...

"How much is 1 Billion Barrels? Two weeks worth of global demand??? LOL!!"

Oil is inelastic remember? If 1 billion barrels of oil was horded over 3 years; that's reduction in spare capacity by 1 mbpd; what does that do to the price of oil?

 
At Thursday, May 22, 2008 at 6:43:00 AM PDT, Anonymous jstanley01 said...

Goldman Sachs? Morgan Stanley? Aren't these the same geniuses who lost multi-billions in a real estate market that could only go up?

And now they're betting the foreclosed farm that oil can only go up. The taxpayers' foreclosed farm, that is. After all, oil has "peaked" (thus saith the doomsayers' computer monitors).

Anyone ever heard of "moral hazard"?

Just on general economic principles, whatever the truth behind "peak oil," it sounds to me like a particular pithy definition of insanity is apt for certain players involved in this runup: Trying the same thing in the same way and expecting a different result.

As to why financial markets are bubble-prone, check The Human Foundations of Financial Risk. It's not a conspiracy, it's human nature.

 
At Thursday, May 22, 2008 at 8:55:00 AM PDT, Anonymous luis Dias said...

There are many wrong issues in this blog and comment thread.

1. The picture you present in the post is not a warehouse meant to "hoard" oil, but a giant gas refinery (bonny island). If you want to stick to "facts", then you shouldn't be subliminally deceiving your readers.

Rather, I never see a picture or even a number on those warehouses. You claim to make statements of "facts", and still you can only link to "hearsay" con theorists. That's the LATOC's way. I expected more of you.

2. You are making a wrong rationale in what concerns speculation and backwardation / contango. In a backwardation market, if speculators "decide" that oil is going to the sky, then they don't build warehouses. They buy futures. Get it? In the future's market, you buy the reservation of oil of 2015, for instance. If the market is selling them at 40$ (backwardation) and speculators know it's going to be more like 200$, then they buy it only to sell it at a profit.

In contango, such speculation is no longer possible. Oil futures are more expensive than oil in the present. The only way that speculators make money is by guessing that the futures market is not in sufficient contango in accordance to reality.

So, the thought that if markets are in contango, its a speculator's wet dream is absolutely stupid. Contango kills the speculator market.

The other rationale is also wrong. If they buy present oil to sell later (now 120, then 190$), that will erase the contango feature, because it will increase present price (by increasing present demand) and decrease future price (by increasing future supply).

3. Of course, such moves are only rational if they are profitable, that is, if oil is indeed scarce and with supply problems. The obvious question is, if this was always possible, why is only happening now? Why didn't it, for instance, happened in the nineties?

It is important to realise that the market self-corrects itself. It was the pile of money that the speculators made by betting on oil that the market is killing right now, by aligning itself with the speculator's guess. Of course, the realignment with contango makes the present oil even more valuable, with increased demand (if it is more cheap now, then we'll buy it now), creating an even more steep oil run. Ergo, oil hits 130$.

This rush kills the oil market. In the long run, we are heading for demand destruction, following for substitution and conservation.

Ain't the market amazing?

 
At Thursday, May 22, 2008 at 11:31:00 AM PDT, Anonymous econogeek said...

To the peak oil boys (Babun/Luis), I (and JD as well) think we all have some general agreement about the situation:

1. High prices whatever the cause are a necessary evil in order to fix the supply/demand tightness. Estimates of high priced demand growth destruction from $20 oil range from 5-8 million barrels/day. Biofuels, all by themselves, have contributed to a reduction of oil demand of nearly 1.5 million barrels/day. If we had $20 constant prices from 2000-2, we'd have global demand of nearly 92-95 million RIGHT NOW.

2. From an economic standpoint, the moment at which we hit peak oil is not necessarily the problem, as the doomers concede. The problem arises when demand growth exceeds supply growth. We could very well have supply growth into the next 5-15 years, but if demand growth is faster, we have a problem.

With that being said, what I, JD, and others take issue with is HOW the price rises have taken place and the mis-allocation of investment capital into commodity futures. If even a 2-5% fraction of that $260 billion dollars of passive investment was spent on technology to alleviate the problem, instead of in commodity price indices, where it contributes to the problem, we may very well be looking at a much better situation. I am invested in the oil market, but through stocks of oil producers/services that have alternative energy business too and have made just as much of a return over the past 3-5 years on my investments as anyone else. In most big cities (I live in San Diego), the other costs of driving (parking, tolls, car insurance, car maintenance, car payments) FAR exceed the cost of gasoline (A night out on the town in NYC from New Jersey might cost you $20 in parking/tolls and $12 in gas if you drive a Hummer).

Personally, I think that demand growth projections by the IEA and others have been far too optimistic given the price runup of the last 5 years. At the current rate of demand increase, by 2015, we won't be consuming 98 million barrels of oil. Assuming the average of 1 million/day growth since 06 (still optimistic in my mind), the actual demand number will be closer to 92-93 million, and most likely will be lower than that. Right now, due to hedging and such, the world is currently operating on $100-ish dollar oil, not $135.

Technology will eventually solve this problem, albeit with some economic dislocation along the way.

Here is my personal list of "demand destroyers" that will alleviate the situation (and may actually improve quality of life). Some exist now already, others will become more prevalent over time:

1. Electric cars/Plug in Hybrids
2. Cellulosic Ethanol
3. Algae based biodiesel
4. Conservation
5. Demographic Shifts into areas with readily available mass transit.

BTW..this started in earnest in the early part of the decade in the US, more due to declining birth rates, baby boomers retiring, and people's desire to live closer to city amenities. Driving on the freeway in most major US cities is not fun, regardless of whether gas costs $.50 or $20/gallon)
6. More efficient land use (i.e. combined solar/wind farms in the desert)
7. Movement away from oil to other available feedstocks in industrial/agricultural capacities (natural gas/biological resources for plastics, coal/shale for asphalt, electric tractors/harvest equipment on farms, etc.)

Air travel/global movement of goods/farming, will continue to exist and serve the world. ALOT of today's present oil demand/capita can and will be wrung out of the system.

 
At Thursday, May 22, 2008 at 1:43:00 PM PDT, Anonymous Babun said...

You know econogeek, puking up your ideas about the peak oil -issue as a whole in the comments section of a particular article is not really a good idea.

We all know each others' views so let's just stick to the issues at hand (those discussed in any particular article). Also this "lecturing" type of a comment is not very inspiring. Try to say "in my opinion" or "I believe" or even "according to" a bit more.

We may share some similar views about something but mostly we disagree about everything. Nevertheless, this is not the place to discuss the issue as a whole.

 
At Thursday, May 22, 2008 at 5:09:00 PM PDT, Blogger JD said...

An extremely informative Senate hearing chaired by Joe Lieberman:

Financial Speculation in Commodity Markets: Are Institutional Investors and Hedge Funds Contributing to Food and Energy Price Inflation?

Watched it last night. It's definitely a lot more educational to watch the top authorities hash it out in response to tough questions from the senators. Much more informative than following an internet debate.

Main conclusion: Long-only index traders who roll their positions every month are a major factor increasing prices. No one disputed this, including the Chief Economist of the CFTC, and the Chairman of the Commodities Markets Council.

Many other interesting tidbits as well, highly recommended.

 
At Thursday, May 22, 2008 at 5:24:00 PM PDT, Blogger JD said...

This testimony by M. Masters from the senate hearing has the details on index speculators. As I said, no one at the senate hearing offered a rebuttal to his views, and in fact, they conceded his point.

 
At Thursday, May 22, 2008 at 7:36:00 PM PDT, Anonymous jstanley01 said...

Great link JD. THANK YOU.

 
At Thursday, May 22, 2008 at 9:19:00 PM PDT, Anonymous econogeek said...

JD,

Even the Goldman Sachs super spike report said that without question increased fund flows have boosted commodity prices.

Clearly, there is agreement on this issue.

 
At Thursday, May 22, 2008 at 10:10:00 PM PDT, Anonymous Babun said...

Main conclusion: Long-only index traders who roll their positions every month are a major factor increasing prices. No one disputed this, including the Chief Economist of the CFTC, and the Chairman of the Commodities Markets Council.

Many other interesting tidbits as well, highly recommended.


Nice link. Didn't have time to read up on more than one expert comment though. This was the one by Harris.

Just reading up on this one expert opinion though - it didn't seem to fit your main conclusion.

To highlight this fact more clearly, Chart 10 plots the prices and the market share of one group of active speculators (managed money traders) over the past 22 months. Notably, while WTI futures contract prices have more than doubled during the past 14 months, managed money positions, as a fraction of the overall market, have changed very little. Speculative position changes have not amplified crude oil futures price CFTC PAGE 16 OF 21 changes. More specifically, the recent crude oil price increases have occurred with no significant change in net speculative positions.

In fact there was a lot of stuff in this pdf that didn't fit your main conclusion. Recommend that everyone read up instead :) These people seemed to actually talk about the numbers which I have been asking for for a long time in order to debunk / confirm the magnitude of the effect of speculation.

 
At Thursday, May 22, 2008 at 11:28:00 PM PDT, Blogger JD said...

Babun,
Read the Harris material more carefully. He draws a distinction between managed money traders and index traders. It's index traders that are being fingered as the source of upward price pressure.

There are two basic types of trading activity that tend to be referred to as“funds.” Each is identified to some degree of accuracy in our Large Trader Reporting System. The first represents traditional speculative monies that enter the futures markets through various forms of managed money (hedge funds, commodity pools, etc.). Managed money funds can be either long or short in our markets, depending on their speculative beliefs about future prices. The second type—referred to as “index funds or commodity index traders”—has become important in recent years. These funds seek commodities exposure as another asset class (like stocks, bonds, real estate, etc.). Aggregated, index fund positions are relatively large, predominantly long, and passively positioned— that is, they simply buy exposure to commodities in futures markets and maintain their exposure through pre-specified rolling strategies (before the futures enter delivery months). It is the equivalent to the“buy and hold” strategy common in the stock markets. (P. 6)

In the video of the hearing, Erickson (Chairman of the Commodity Markets Council) explicitly concedes Masters' point that index traders are exerting upward price pressure.

Harris stated during the hearing that the CFTC has clear information on the share of index traders for agricultural commodities, but basically no information at all on the share of index traders in energy markets. This is because much of the interest from index traders comes through over-the-counter swaps, where banks (like our buddies Goldman Sachs) act as their agent in the futures market. These banks are classified as commercial traders, and have been explicitly granted exemptions from trading limits. The CFTC can't separate out index traders from the rest of the OTC swap trade because it is totally opaque and hidden from the regulators.

 
At Thursday, May 22, 2008 at 11:59:00 PM PDT, Anonymous econogeek said...

JD,

Check this out

``What we have here is a situation where essentially higher prices aren't generating any more supply,'' Paul Sankey, an analyst at Deutsche Bank Securities in New York, said in an interview with Bloomberg radio. ``What we have to do is keep pricing the commodity higher until demand starts falling,'' which ``is around $150 a barrel.''
(See source below)
http://www.bloomberg.com/apps/news?
pid=newsarchive&sid=a_GLOk1M9aws

Looks like we now have a "manifest destiny" in the oil pits. I didn't realize that the investment banks HAD to do this.

Oil traders are now the saviors of the free world and are doing us a favor by driving up the price.

I really want to send them Christmas cards now.

 
At Friday, May 23, 2008 at 12:41:00 AM PDT, Anonymous Zoltan B. said...

Hoarding is a fact. It was obvious in the previous oil crises. We know that the US, and also Germany are filling up strategic reserves, that is 'hoarding' as well. When we reach peak oil in 1-2-10-20 years (make your choice) hoarding will also exacerbate the situation.

 
At Friday, May 23, 2008 at 3:05:00 AM PDT, Anonymous Luis Dias said...

Econogeek, let's get this straight. I'm no "boy", and definitely no "peak oil boy". Bokay? It shows off that your mind cannot get past simplistic polarizations.

Let's not get nasty.

About what you said, bingo, I agree with you 100%, all through your optimism and your solutions, except when you say that current hike on petro prices are not due to demand/supply situation. Because just after you say this gem:

"In most big cities (I live in San Diego), the other costs of driving (parking, tolls, car insurance, car maintenance, car payments) FAR exceed the cost of gasoline"

... which completely debunks your thesis. Oil shows its color here: it is still damn cheap. People won't change their habits until alternatives become cheaper than gasoline. And that only happens when gas turns expensive, or when alternatives turn cheap. It seems that the former will happen first.

Just another glitch:

"The problem arises when demand growth exceeds supply growth. "

That's not the only problem. Producing countries aren't paying 130$ for a barrel of oil. So, oil market is not working as it should, but some countries are paying a lot less than us. Those countries are the ones driving demand upwards. If USA and Europe get their demand to fall, they will only be able to offset part of the whooping demand growth in these countries. Which countries? Russia, Brazil, Venezuela, Saudi Arabia, Mexico, even Angola, you name it.

 
At Friday, May 23, 2008 at 3:21:00 AM PDT, Anonymous Luis Dias said...

``What we have here is a situation where essentially higher prices aren't generating any more supply,'

Econogeek. You happen to know that if this is true, then the spike is not a "saviour", but the only logical response of the market, right? I mean, it's econ 101.

So, apart from the messenger, take the message and try to debunk it. Oh right, you can't. Because since 2005, we are still only producing a little glitch over that year. And as you said, you don't need peak oil to do harm, only demand outstripping supply. It's what's been called "Peak Oil Lite".

Next Big Future is now predicting that supply will get to 87mbd in sep2008. Now, if he's correct, then that will mean a drop in price. Markets work a little irrationally, because they also depend on human subjectivity. I don't call off a panic price surge, and I also don't call off that people are making money out of fear. But this isn't a deliberate bubble. If it pops, it will never pop to values less than 80/90$, only to increase them later.

Let's face it people. Oil is going through a rumble. Fasten your seat-belts and get out of its way.

 
At Friday, May 23, 2008 at 7:38:00 AM PDT, Anonymous aram said...

LD-

Which countries? Russia, Brazil, Venezuela, Saudi Arabia, Mexico, even Angola, you name it.

The problem here with these countries (and you may as well ad China to the list with its massive subsidies) is that there actual demand and demand growth are not so fantastic given their size and what their economies are currently doing.

If the IEA's chart is even close to being correct then China's demand for oil is easing only slightly upward from 2004 until now. For a country as large as China with a growing middle class and an economy which is literally moving at ludicrous speed to only demand a little less than two million barrels of oil per day more than it did 4+ years ago is nothing short of amazing, and vastly overstated in the media as "soaring." It's more like inching slightly upward over a pretty decent amount of time.

We already have JD's article about India (the other favorite of the media when it comes to "soaring" oil demand) as being not quite soaring but more like a .5-1 incline on your average treadmill.

These relatively slight moves upward are really just a drop in the bucket compared to the oil demand per day in the US, which over time is going to fall as vehicles become more fuel efficient, more people start driving electric cars and hybrids and more of the right types of biofuels become more popular.

And, if we could get even a little domestic drilling done, the US could conceivably raise its per day output by a couple of million barrels.

The US alone could solve the whole issue of supply/demand growth if it just added 2 million barrels a day of production, which is VERY conceivable and it could, with just a little conservation, probably trim a million or two barrels per day of demand.

This rush kills the oil market. In the long run, we are heading for demand destruction, following for substitution and conservation.

These are not bad things, and in the medium-run they will have an impact.

It doesn't change the fact that in the short run we have a huge problem with speculation driving the price to artificially high levels which could shortly translate into artificial supply shortages which could evolve into REAL supply shortages in the form of OPEC production cuts.

 
At Friday, May 23, 2008 at 8:28:00 AM PDT, Anonymous Babun said...

Babun,
Read the Harris material more carefully. He draws a distinction between managed money traders and index traders. It's index traders that are being fingered as the source of upward price pressure.


Sorry, where exactly does he state this?

Harris stated during the hearing that the CFTC has clear information on the share of index traders for agricultural commodities, but basically no information at all on the share of index traders in energy markets.

Is this in the pdf somewhere? I draw completely different conclusions having read the pdf.

Here are a few quotes from the pdf (I'm really puzzled if he said that in the hearing since he is presenting graphs about these index traders in the pdf):

Chart 8 also demonstrates that the growth in swap dealer trading in the near-term futures contract largely represents flows from commodity index funds.
Given the substantial increase in open interest in crude oil futures markets, OCE utilizes the Commission’s extensive data to examine the role of all market participants and how their positions might affect prices. Although longer-term studies show a slight increase in non-commercial market share in the crude oil futures market, OCE analysis shows that the more recent increase in oil prices to levels above $120/barrel has not been accompanied by significant changes to the participants in this market.


And

OCE has also studied the impact of speculators as a group in oil markets during the most recent price run-up. Specifically, we have closely examined the relation between futures prices and positions of speculators in crude oil. Our studies consistently find that when new information comes to the market and prices respond, it is the commercial traders (such as oil companies, utilities, airlines) who react first by adjusting their futures positions. When these commercial traders adjust their futures positions, it is speculators who are most often on the other side of the trade. Price changes that prompt hedgers to alter their futures positions attract speculators who change their positions in response. Simply stated, there is no evidence that position changes by speculators precede price changes for crude oil futures contracts.

To highlight this fact more clearly, Chart 10 plots the prices and the market share of one group of active speculators (managed money traders) over the past 22 months. Notably, while WTI futures contract prices have more than doubled during the past 14 months, managed money positions, as a fraction of the overall market, have changed very little. Speculative position changes have not amplified crude oil futures price changes. More specifically, the recent crude oil price increases have occurred with no significant change in net speculative positions.

OCE has also studied position changes of commercial and non-commercial traders by category, finding similar results.

In no case do we find net position changes of any category of non-commercial traders preceding significantly changes in crude oil futures prices. Chart 11 highlights the fact that commercial and non-commercial open interest has grown during the most recent 22 months, but generally remains balanced between long and short positions for each trader group.


And

We compare April 2008 participation in the natural gas contract with participation in April 2005 in Charts 12 and 13. In April 2005, non-commercial participants held 47% of the open futures positions, with hedge funds comprising the majority (31%) of those positions. In April 2008, non-commercial participation increased by a modest 5%, with 3% of this increase coming from hedge funds. These aggregated figures suggest that speculative participation in natural gas futures has not grown substantially while prices have risen more significantly during the past three years.

Now I'd say this sounds a lot like debunking speculation as a major contributor to recent price rises, wouldn't you?

 
At Friday, May 23, 2008 at 9:13:00 AM PDT, Anonymous Babun said...

I read the pdf by Masters and was impressed by his arguments. But I guess this just highlights how cheap oil is compared to how full the markets are with money.

This raises an interesting question however. If this is considered as a problem, will the regulation of markets be a good or a bad thing? What is a fair price for oil considering we have to replace it soon? I think we need to have prices that hurt in order to rapidly move away from oil.

 
At Friday, May 23, 2008 at 10:12:00 AM PDT, Anonymous Luis Dias said...

aram, it is quite telling that you dismissed china and india as growing demand countries, when I never mentioned them. That's called "Strawman", you know?

"And, if we could get even a little domestic drilling done, the US could conceivably raise its per day output by a couple of million barrels. "

You begin to sound as Al Gore. "If this, If that, If, If, If..." Now, if I was unborn I tell you, I wouldn't have to deal with this. That's for sure.

"These are not bad things, and in the medium-run they will have an impact."

You wouldn't be as optimistic if you lived in Portugal, where gasoline is hitting 8.5 dollars per gallon, and that's only spending the oil that hit 100$. The extra 35$ are still in the pipeline.

Still, where in the hell did you read that I thought it was bad? It will hurt, it is hurting my country already, agriculture and fishing in shambles, but it will just have to be that way, I guess. We'll have to learn to adapt. My optimism isn't cornucopian, it is rather the same optimism that the WWII troops had in 1940.aram, it is quite telling that you dismissed china and india as growing demand countries, when I never mentioned them. That's called "Strawman", you know?

"And, if we could get even a little domestic drilling done, the US could conceivably raise its per day output by a couple of million barrels. "

You begin to sound as Al Gore. "If this, If that, If, If, If..." Now, if I was unborn I tell you, I wouldn't have to deal with this. That's for sure.

"These are not bad things, and in the medium-run they will have an impact."

You wouldn't be as optimistic if you lived in Portugal, where gasoline is hitting 8.5 dollars per gallon, and that's only spending the oil that hit 100$. The extra 35$ are still in the pipeline.

Still, where in the hell did you read that I thought it was bad? It will hurt, it is hurting my country already, agriculture and fishing in shambles, but it will just have to be that way, I guess. We'll have to learn to adapt. My optimism isn't cornucopian, it is rather the same optimism that the WWII troops had in 1940.

 
At Friday, May 23, 2008 at 11:16:00 AM PDT, Anonymous aram said...

LD-

aram, it is quite telling that you dismissed china and india as growing demand countries, when I never mentioned them. That's called "Strawman", you know?

???

While demand in those places may be on the uptrend, like China and India, their demand growth is not so phenomenal to be described as "soaring."

And each of those countries has the potential to produce a lot more oil than they currently are, given the right political and economic climate.

These are booming times for oil producers, provided they manage their affairs properly. Obviously Venezuela is not moving in that direction. Fine. Venezuela's mark on global oil demand isn't all that much, however much you want to make something of it. Leftist trash like Chavez don't last forever because the conditions that permit him to keep prices low and artificially inflate demand will not last.

Russia will come around. They had a boom in the post-soviet era in their oil industry and now they realize they've made some mistakes. Medvedev will turn things around in Russia and they will produce more. And their demand is not all that it's made out to be.

I'm not even going to discuss Angola and all six people that live there.

And as for Brazil? They are more in tune with moving from oil to alternative fuels than even Europe is! They are using NG to power vehicles like nowhere else! They are moving ahead full steam with sugarcane based ethanol. Oh, and their proven oil reserves are swelling. They're making new discoveries all the time and soon will be bringing them to market.

 
At Friday, May 23, 2008 at 11:26:00 AM PDT, Anonymous Morgoth said...

http://www.atimes.com/atimes/Global_Economy/JE24Dj03.html

More stuff on speculation in the market.

 
At Friday, May 23, 2008 at 1:48:00 PM PDT, Anonymous Anonymous said...

I'd like some clarification on what is "interesting" about contango in the futures market. It is the very simple and common phenomenon of the futures price being higher than the spot price.

Second, where is the complicated financial mumbo-jumbo? All I see is banks buying oil in the spot market and paying to store it.

 
At Friday, May 23, 2008 at 4:43:00 PM PDT, Anonymous Luis Dias said...

"And each of those countries has the potential to produce a lot more oil than they currently are, given the right political and economic climate."

Read: With a gun pointed in their heads.

Seriously, why should they do it otherwise? Why should they waste their reserves on supporting countries that have such a bad use of it? Why do americans always think that every goddam resource should be "available" to all? Haven't you heard of "private property"? Or "Territorial sovereignty"?

It's not up to others to decide. It's up to them. And until americans understand that, we do live in dangerous and criminal times.

@anon.
Precisely. I also don't get some people's hysteria about this issue...

 
At Friday, May 23, 2008 at 10:06:00 PM PDT, Anonymous Juan said...

babun,

The OCE is apparently not breaking index funds out of the commericial category which they should not be but, as they operate through swaps dealers, are included in. That is, the index funds are classified as commercials when, by regs, they should not be.

Failure to break them out provides a false picture while claims that this can't be done are contradicted by the CFTC's own supplemenal report to the weekly Commitment of Traders report.

A look at the latest supplemental will provide an idea.
See: http://www.cftc.gov/dea/
options/deaviewcit.htm
[NB the long/short numbers shown are contracts each of which represents a large multiple of, in this case, bushels. Lots of leverage involved]

Further, a quote from a Barron's article which I'd posted last month:

The speculators, now so bullish, are mainly the index funds. To see how their influence on the market has become outsized, just look at how they operate. Nearly $9 out of every $10 of index-fund money is not traded directly on the commodity exchanges, but instead goes through dealers that belong to the International Swaps and Derivatives Association (ISDA).

These swaps dealers lay off their speculative risk on the organized commodity markets, while effectively serving as market makers for the index funds.

By using the ISDA as a conduit, the index funds get an exemption from position limits that are normally imposed on any other speculator, including the $1 in every $10 of index-fund money that does not go through the swaps dealers.

The purpose of position limits on speculators, which date back to 1936, is clearly stated in the rules: It’s to protect these relatively small markets from price distortions. An exemption is offered only to "bona fide hedgers" (not to be confused with "hedge funds"), who take offsetting positions in the physical commodity.

The basic argument put forward by the CFTC for exempting swaps dealers is that they, too, are offsetting other positions — those taken with the index funds.

Position limits on speculators, in some commodities specified by CFTC rules and in others by the exchanges, are generally quite liberal. For example, the position limit on wheat traded on the Chicago Board of Trade is set at 6,500 contracts. At an approximate value of $60,000 worth of wheat per contract, a speculator could command as much as $390 million of wheat and still not exceed the limit.


Complete at:
http://commitmentsoftraders.org/?p=32#more-32

Further:

The Commodity Exchange Act addresses excess speculation in commodity markets, and states that “the Commission shall…fix such limits on the amounts of trading which may be done or positions which may be held by any person.” The only exceptions are “to permit producers, purchasers, sellers, middlemen, and users of a commodity or a product derived therefrom to hedge their legitimate anticipated business needs”(7 USC 6a).

The CFTC regulations 17 CFR 1.3(z) further spells out who is to be considered a bona fide hedger in such intricate detail as to make it unmistakable that exemptions to speculative limits are intended only for those commonly known as “the trade” who carry on a cash business in the commodity itself.

The Commission acknowledges that speculative limits apply to indexers: “Mutual funds (or for that matter institutional traders) who want to gain commodity exposure”, whether in an individual commodity future or in several commodity futures that make up an index, are not entitled to an exemption as a bona fide hedger.”

But what agency takes away with one hand, it gives back with the other: “Swaps dealers that have swap agreements with clients that provide the clients with a return on an index of commodities can hedge the exposure from that agreement by buying futures contracts in the commodities underlying the index.”

The illogic of limiting position sizes for indexers dealing directly in futures while exempting indexers who use a swap deal intermediary has apparently not escaped the Commission’s attention. And it has a proposal on the table to correct this inequity. In November the agency proposed new exemptions for “risk management positions,” which would open the door to all indexers while, of course, leaving the swap dealer exemptions in place.

[...]

In proposing the new exemptions, the CFTC acknowledges that index-based positions differ enough from bona fide hedges as to make hedge exemptions inappropriate under current law. It does not state where it found the authority to classified swap dealers as hedgers in the first place. It is also unclear why swap dealers should be accorded special treatment.

Their cozy arrangement began during the Reagan Administration under CFTC Chairman Wendy Graham (the other half of the Texas Senator Phil Grahm’s duo that Barron’s dubbed “Mr. & Mrs. Enron”). She began exempting swaps from CFTC oversight in 1989, and in 1992 granted Enron regulatory exemption for its energy-swap operation just five days before resigning her Chair to join Enron’s audit committee.

In 2000 the CFTC officially granted dealers broad relief with the result that today swaps are cleared through the US futures clearing systems alongside futures contracts, thus affording exchange level payment guarantees to non-exchange traded and non-regulated derivative contracts.


Complete:
http://commitmentsoftraders.org/?p=28#more-28

Beyond the vanilla stuff we get into things like commodity linked structured notes of various types and other somewhat more exotic commodity related structured products which may not have the same effects on pricing but, at least for 2006, had surpassed $8 trillion in notional value.

 
At Sunday, May 25, 2008 at 6:57:00 AM PDT, Anonymous jstanley01 said...

For me, when the same banks that were blowing air into the real estate bubble show up as speculative traders pumping billions into a skyrocketing oil market, that "can only go up," it's hard not to cast a skeptical eye at the assertion that peak oil is the root cause of the runnup.

It's noteworthy that between 1980 and 2000 -- times of "cheap energy" and a resulting boom in sales of gas-hog SUVs and pickup trucks -- spending on oil products as a percent of US GDP fell from 6% to 2% (Adam E. Sieminski, World Oil Market Outlook, March 2000, PDF, p. 13). Which is most likely the reason that the US economy is weathering $120+ per barrel oil in 2008 without sliding off a cliff. (I've been unable to google up more recent figures, which in-and-of-itself is telling.}

It may be that the peak oil Cassandras -- in addition to having far too much influence among investment bankers -- may be taking an altogether too-narrow view of the mitigating dynmamics that JD is kind enough to document on this site.

 
At Sunday, May 25, 2008 at 9:28:00 AM PDT, Blogger bc said...

LOL! It gets better. "Because some dumb idiots in congress believe it, it must be true".

The only thing that politicians are experts in is getting votes. I wouldn't trust them to tell me the time.

If you can't trust hedge fund managers who claim that it is down to supply and demand, on the basis they have a vested interest, them you must also dismiss claims made by oil execs who are desparately trying to avoid windfall taxes. Although it's worth noting that increasingly oil execs are saying that there is a supply problem.

The only people left who have expertise are oil analysts and economists, although I don't trust the latter much. Among this group, the majority are of the opinion that speculation makes little difference, and it is supply and demand that is driving the price.

Professor Hamilton has recently published a detailed study on his blog, for those interested in rational analysis rather than silly rhetoric.

 
At Sunday, May 25, 2008 at 2:30:00 PM PDT, Anonymous Babun said...

Found a good article relating to this index speculation :

http://news.goldseek.com/MillenniumWaveAdvisors/1211819877.php

Why has the price of oil risen so much in the past few months? Is it a supply and demand issue as some believe; or is it because of an out-of-control futures market driven by the proliferation of commodity index funds and rampant speculation, as everyone tries to get in on the rise in commodity prices? This is a very complex issue, with a lot of emotion attached to it.

Those Nasty Index Speculators
Is Correlation Causation?
Where Are All the Tankers?
Where Will Oil Prices Go?
Is it 1980 All Over Again?

 
At Sunday, May 25, 2008 at 4:42:00 PM PDT, Anonymous Texastea said...

Oil probably has a decade left at best as the preferred fuel for transport.

Check this out:

http://www.youtube.com/watch?v=J95Lh3NnL4A&feature=related

 
At Sunday, May 25, 2008 at 4:44:00 PM PDT, Anonymous Texastea said...

More on this:

http://en.wikipedia.org/wiki/Eliica

 
At Sunday, May 25, 2008 at 6:17:00 PM PDT, Blogger JD said...

Professor Hamilton has recently published a detailed study on his blog, for those interested in rational analysis rather than silly rhetoric.

Professor Hamilton has argued on a number of occasions (i.e. here) that a broad range of commodities are being pumped by speculation (negative interests caused by the FED, resulting in people trying to hedge inflation by buying commodities). He says:

"Instead I believe that Harvard Professor Jeff Frankel has the correct explanation-- commodity prices at the moment are being driven by interest rates, with a strongly negative real interest rate increasing the incentives for speculation in any storable commodity."
Source

The major problem with the "it's only supply and demand" story of oil is that we are seeing massive inflation in all storable commodities simultaneously. That strongly suggests a financial effect.

Furthermore, there have been very serious dislocations in the agricultural futures markets due to excessive speculation: failure of futures to converge with the cash market, inability of farmers to market their physicals at the futures price, and inability of farmers and grain elevators to meet surging margin calls due to their limited access to credit. This has gotten so bad that the CFTC had to call a hearing to address the complaints of irate farmers in April.

Here's Billy Dunavant, head of cotton merchant Dunavant Enterprises:"The market is broken, it's out of whack—someone has to step in and give some relief."Source

Here's Tom Buis, president of the National Farmers Union: "There's something wrong. I have doubts whether the CFTC is the place to rectify the problem - it may warrant congressional intervention. When regulators say a problem doesn't exist, despite the fact farmers cannot market their commodities that sounds an alarm."Source

The futures market exists to benefit farmers -- to help them to transfer their risk to traditional speculators. It doesn't exist as a playground for institutions and individuals to "invest" in commodities. When the farmers are up in arms because speculators have invaded their futures markets, and those markets are not serving their interests anymore, we need to pay attention. Facile market-fundamentalism is a crock in this situation. Dismissing the concerns of farmers as "silly rhetoric" -- telling them to shut up and go home because everything is hunky-dory and it's "all just supply and demand" is dangerous, irresponsible and wrong. We need to look very closely at what is happening in commodity futures markets.

 
At Sunday, May 25, 2008 at 8:13:00 PM PDT, Anonymous econogeek said...

http://ap.google.com/article/
ALeqM5i6GXwx2chQltK3liINhxHz_
uEGSwD90SI8G80

I wonder if stories like this mark a top in the market

 
At Monday, May 26, 2008 at 9:05:00 AM PDT, Anonymous Babun said...

The major problem with the "it's only supply and demand" story of oil is that we are seeing massive inflation in all storable commodities simultaneously. That strongly suggests a financial effect.

If you read the conclusion by Hamilton here, I think it's a rather conclusive presentation of the situation. While I also believe there are multiple causes to the situation I get the feeling what you are trying to do here is place a different emphasis on the reasons, which according to hamilton can lead to very different conclusions.

I see supply/demand as the root cause, something that fuels these other factors. I feel it's rather pointless to argue if the last price spike in oil prices can be attributed to fundamentals or something else. That is especially considering the purpose of this blog - it seems to me you are trying to marginalize supply/demand issues. I believe price spikes can always to some extent be attributed to fundamentals because I believe it is the root cause for speculation.

Why do i consider it the "root cause" ? Because removing any other factor of the equation only provides a minor or temporary improvement of the situation while remedying supply/demand as a whole resolves the problem as a whole.

If future prospects for future oil production would include no problems whatsoever, we'd have a lot less speculation, no? Iraq and nigeria wouldn't matter? There would be no speculation? Nationalization of reserves wouldn't matter?

I get the same kind of feeling about your agendas as Kurt Cobb (gets about CERA) in this article :

http://www.energybulletin.net/44849.html

It's as if the supply of oil as a reason for high prices is a taboo subject when considering the amount of publicity received by different reasons about the price rise.

Of course it is also important to understand what the other issues (in addition to supply/demand) are about, but they should not be used to try to undermine the reasoning behind the root cause.

And that's precisely where public attention gets it wrong. It's like teaching math to a 7-year old and starting with complicated equations instead of addition, substraction and division. Sure enough equations are important, but start with the basics.

 
At Monday, May 26, 2008 at 1:46:00 PM PDT, Anonymous Ryan said...

Hi folks,

Interesting debate here. I have a few comments.

Supply and demand do have an important role in the speculative environment. However, other factors such as the following ones can create a disproportionate price rise:

1. Cheap money by the federal reserve. Investment banks take their worthless subprime debt to the goverment and get money for it. The fed funds rate at 2% discourages savings by investment banks and increases speculative asset investment.

2. The depreciation of the US dollar, the major pricing instrument for oil. The euro and the yen have appreciated by nearly 50% relative to the dollar. What that means is that in 2001, oil was worth $30 in euros. Today, it is about $75ish. Adjusting for inflation at 5% YOY, that $30 in 2001 should be approximately $40 today. (BTW...the increase in the value of euros reflects dollar depreciation, not an increase in the inherent value of the euro.)

This to me tells me that oil from purely a fundamental supply/demand standpoint is responsible for about half of the increase in the price of oil.

I believe that closing loopholes and beating up on oil speculators will have little effect because these things do not address the underlying market dynamics Until the fed stops devaluing the dollar, this will not stop.

Additionally, the decreasing value of the dollar diminishes the desire of major oil producers to invest in new production, thereby exacerbating the problem. Why spend money to bring new oil supplies to market if the dollars you're going to get paid back in are depreciating every year?

In my opinion, both sides of the debate are partially correct. Without tight fundamentals, we wouldn't be in this situation to begin with. However, without the other factors I listed above, the price would be far lower than it is today.

Peak oil theorists may or may not have the supply picture correct (I'm not really in a position to argue either way). However, demand destruction cannot and will not occur evenly as the price increases. Every increasing penny to the price gasoline will create demand destruction at a greater rate than the prior increase. In the US, where the market is largely unsubsidized, at $2 US/gal, demand increased by 5%, at $3US/gal, demand stayed constant, at $4US/gal demand has decreased (according to the latest Mastercard Survey) roughly 5-7%.

The other element of the peak oil religion (once again separating LATOC, the oil drum and others from the theory of peak oil) that is somewhat questionable is it's outsized impact on agriculture. Since most oil use is for personal transportation and if we really had a severe shortage, government intervention would ration oil supplies to necessary uses first (agriculture/trucks to transport food). In the US, we import about half of our transportation fuels, far less than what is used in present day agriculture.

Don't get me wrong though...high prices in the long run are a great thing. What's different between now and the 1970s is the vast improvement in technology available to us. From a purely technical standpoint, America could have a power grid that's 100% renewable using solar thermal power plants and Sodium Sulfur batteries and transport based on electric cars right now. These types of advances would be a bit more challenging in other places but still doable.

However, as we all can see, the biggest disadvantage that we have going forward is that opportunities to grow oil supplies clearly are not growing at the rate that they had in the past.

 
At Monday, May 26, 2008 at 7:01:00 PM PDT, Blogger Shane said...

Amazing. It's been covered in MSM, it's been discussed in front of Congress, some OPEC members have openly expressed puzzlement at what's going on, and even long-time commodities traders are scared about what's going on (and are dismissed with a flip "this time it's different," just like people do with any other bubble)...but no, let's keep living in denial, let's keep pretending this fits the Peak Oil agenda.

I saw two stories on MarketWatch within the past few days that caught my interest.

The first I saw was discussing commodities traders running for Dubai now that Congress is talking about regulations on speculative trading. The overwhelming response is that this is how America is ruining itself, by running off business. The lost message there was that it's all but confirmation that speculation is a huge problem.

Shortly after that, there was a story about how hundreds of banks could start failing soon. The timing was impeccable, the message pretty clear to a conspiracy-theorist-minded person such as myself: This isn't a peak oil issue, this is a damage control issue, and the gig is almost up.

The amazing thing that's happening is that banks also seem to be pouring that toxic debt into alt energy projects. Petrodollars are reportedly flowing into such projects as well.

I acknowledge that oil will be scarce someday, and that the United States is likely to be less than prosperous for a few years, which is why I have a garden at this house for the first time ever, and I'm blowing a wad of money on home and auto improvements, recognizing that I'll probably not be able to afford it for a while. But this doesn't seem to be the real deal this time. Hopefully, though, the price of oil will stay just high enough to put pressure on everyone to get those alternatives in place.

 
At Monday, May 26, 2008 at 9:59:00 PM PDT, Anonymous Babun said...

Amazing. It's been covered in MSM, it's been discussed in front of Congress, some OPEC members have openly expressed puzzlement at what's going on, and even long-time commodities traders are scared about what's going on (and are dismissed with a flip "this time it's different," just like people do with any other bubble)...but no, let's keep living in denial, let's keep pretending this fits the Peak Oil agenda.

You can keep your straw man arguments to yourself. I can't see anyone claiming what you're trying to counter.

I acknowledge that oil will be scarce someday, and that the United States is likely to be less than prosperous for a few years, which is why I have a garden at this house for the first time ever

You have a garden, lol. Survivalist!

 
At Monday, May 26, 2008 at 10:58:00 PM PDT, Anonymous stuck in shizuoka said...

More speculation on speculation from the WSJ. Supply and demand having a bigger effect than earlier commentators admitted (or suspected?).

Interesting thought here though--is OPEC hoarding (and, in effect, hedging) simply by leaving the stuff in the ground?

An interesting update

http://online.wsj.com/article/SB121175335973420383.html?mod=googlenews_wsj

 
At Thursday, May 29, 2008 at 2:08:00 AM PDT, Blogger JD said...

Senator Bingaman is following the crude hoarding angle:

"Bingaman also said a recent trend of institutional investors buying petroleum storage capacity has led to "concerns regarding potential market manipulation strategies," and asked the CFTC about how it tracks such trading activity."
Link

 
At Thursday, May 29, 2008 at 10:08:00 AM PDT, Anonymous Babun said...

Get back to us when they actually start making propositions for increased regulation.

I believe this will stay on the political sandbox level.

 
At Tuesday, June 24, 2008 at 9:27:00 AM PDT, Anonymous Jeremy said...

Keeping strategic goods in storage ("hoarding") is not a bad thing. It's no diffeent then having a couple weeks of food in your house in case there is a natural disaster. Contango and backwardation are just the signposts for people in the storage business to make decisions. Stores of grains and energy are not excessive. For oil it is no more than 10 days of use in private hands. There are other "inventories" out there but those are necessary just for the system to operate and includes oil moving through the pipelines, etc.

It's easy to look at someone with 50,000 barrels of oil in a tank and say it's excessive but that's very little in the context of the population.

 

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