By on May 19, 2008

610x.jpgWhy is gasoline so damn expensive? The mainstream media has rounded up the usual suspects. They demonize oil companies (for excessive profits), lambaste environmentalists (for blocking domestic drilling and refining), and sock it to speculators (for fear mongering over supply). Simply put, the current crisis is a speculative bubble whose impact to American consumers is exacerbated by domestic economic conditions. I fully expect crude oil will trade below $80 a barrel in the not too distant future. Meanwhile, let’s tackle this one myth at a time. 

Oil companies are easy targets for the public’s gas-price-related ire. ExxonMobil recently scooped second on the Fortune 500, with annual earnings of $40.6b. Chevron slipped in at number three, with $18.7b of profit. Surely these under-taxed wicked corporations screwed unwitting customers to amass these ill gotten gains profits.

Here's a politically inconvenient truth: most of the oil companies' profits are the result of volume, not market prices. ExxonMobil, Chevron, et al make in the neighborhood of 10 cents per gallon– whether gasoline costs $1.50 a gallon or four bucks. Big Oil’s making big bucks because there’s record worldwide demand, especially in India and China.

And let’s not forget history. The oil companies we know and despise today are the result of a devastating supply glut during the early ‘90s. That “crisis” pushed these companies to the brink of extinction. Record losses spurred Exxon to merge with Mobil, and Chevron to merge with Texaco.  During the same time frame, Conoco and Phillips combined and British Petroleum gobbled up Amoco.  The mergers lowered overhead expenses by eliminating redundant exploration and administrative overhead expenses.

The second myth is that supply shortages are sending U.S. pump prices skywards.

While demand is certainly at an all-time high with the emergence of the insurgent Chinese and Indian economies, supply is also plentiful. Have we passed “Peak Oil?” As far as the oil future’s market is concerned, it doesn’t matter. Even the greatest pessimists concede that known reserves will last at least another fifty years.  More optimistic (and realistic) estimates stretch hundreds of years hence. Either way, the delivery dates of oil contracts being traded today are days, not decades, from now.

On a more immediate level, fuel shortages are a fiction. I’m not aware of a single gas station that’s unable to refill its fuel tanks or factory unable to obtain required petrochemicals or plastics. To the contrary, in April, U.S. stockpiles grew nearly 12m barrels. Iran is now storing crude in old tanker ships floating in the Persian Gulf because they have run out of space in conventional storage tanks.  The world’s positively awash in oil.

How about this one: America needs more refineries; the greenies are blocking our energy independence.

Although no new refinery plants have been built in the U.S. in a generation, there’s no shortage of refining capacity. Oil companies have retooled to improve the refining capacity at existing sites.  Currently U.S. refineries are operating at only 85 percent capacity. Go figure.

The corollary to this erroneous supposition: domestic drilling would alleviate high prices.

Should Uncle Sam allow ExxonMobil to tap ANWR? As far as today’s oil prices are concerned, it really doesn’t matter. Even if there were pumps in the protected Alaskan field pumping at full capacity right now, crude oil trading in global markets would continue largely unfazed. If we pumped more, the rest of the world would simply pump less to prevent a glut. OPEC makes these kinds of adjustments every time they meet.

So here’s the truth about high oil and thus gas prices: the pain at the pump is the result of a weakening dollar and strengthening speculation. During the last year the U.S. dollar has fallen 14 percent against the Euro, nine percent against the Chinese Yuan, and 15 percent against the Japanese Yen. In other words, it takes more dollars to buy the same goods on the world market.

The other culprits, speculators, are taking their money out of the falling stock market and collapsing real estate investments and pumping them into the red hot commodities market. Buying oil futures has become intensely popular, driving prices heavenward despite an ample supply of product.

Who are these opportunistic speculators that are causing you so much grief every time you fill up your SUV? You. Most of us have pensions, insurance holdings, or various investment funds in our 401K that hedge losses in the commodities market-– usually without the knowledge of the ultimate beneficiaries, you and me.

Market fundamentals don’t support the current high oil prices. As surely and as predictably as the technology bubble burst after a decade of market excess, world oil prices will come tumbling down, as investor dollars flood back into revitalized stock and real estate markets. When will this occur? That’s the trillion dollar question.

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136 Comments on “The Truth About High Gas Prices, Or How I Learned to Relax and Pay $67 to Fill Up My SUV...”


  • avatar
    Alex Rodriguez

    http://www.businessweek.com/bwdaily/dnflash/content/may2008/db20080513_272469_page_2.htm

    Congress is starting to train their sights on the speculator. Just as I predicted, and hoped would happen. Requiring 50% margin is a small step towards getting some badly needed oversight into the Modern Day California Gold Rush that is the oil market. Hopefully other major trading nations follow suit.

  • avatar
    miked

    Thanks William, I give these same arguments every time someone complains about gas prices, you just said it much better than I can. I often focus on your first point. It is true that the big bad evil oil companies make about 10 cents/gal in profit. The Feds take 18 cents/gal and the states take even more, New York and Pennsylvania top the list at over 31 cents/gal, while the lowest is Georgia at 7.5 cents/gal, the average being about 20 cents/gal. That means that the Feds and the States combined (not counting local taxes) are making 3x the profits of the oil companies.

    Also, regarding your point about the evil speculators making money: I always say, that there’s nothing stopping you from being an evil speculator too. Just open an E*Trade margin account, it’s not expensive and they have low minimums, and you can hedge your bets against rising fuel prices (or any other commodity you care about).

  • avatar
    Antone

    It’s great to read a levelheaded editorial on high gas prices. Inflation is the real culprit. What’s inflation? How does a fiat monetary system create inflation? What controls the printing of currency? Good questions…

  • avatar

    Let’s hope the prices come down.

    I just paid $62.40CAD to fill my Mazda3 with 50L of 87 gasoline (that’s 124.8 cents/liter) in Toronto.

    So to be honest, even though I know our federal and provincial taxes make up a significant part of that amount, I’m not quite feeling the agony/despair of Americans filling up their cars and trucks at the moment.

    As an aside, truth be told, the US has a very inefficient fleet of vehicles. Please tell me why again you need a V8 in an Econoline van when a small turbo diesel will do just as well?

    Too bad we all have to suffer b/c of speculators.

  • avatar
    virages

    This is one of those articles that needs so much information from other sources, it would be nice to know where you got the information from. Although there is a lot of oil around to extract yet, it seems that it is harder and harder to do so. That, and higher demand world wide, to me indicates that the price wont go down that far, once the speculation is finished… not that it ever ends.

    The view from here where I spend the equivalent of $130 to fill up a small hatchback is that a strong euro isn’t enough to match the increase in gas prices. In 2002 as I recall, gas was going for about 1 euro per liter, now it’s going for 1.40.

  • avatar
    William C Montgomery

    Congress is starting to train their sights on the speculator. Just as I predicted, and hoped would happen. Requiring 50% margin is a small step towards getting some badly needed oversight into the Modern Day California Gold Rush that is the oil market. Hopefully other major trading nations follow suit.

    Unfortunately, congress cannot write law for the rest of the world. With this proposed legislation in place investors will simply transact commodities in unregulated foreign markets. The politicians will pat themselves on the back for doing something that was really nothing.

  • avatar
    dwford

    Well put. When President Bush went to Saudi Arabia to beg for more oil, they told him no. Why, because they rightly said there is no oil shortage, in fact, they could produce another 2 million barrels per day if they wanted to.

  • avatar
    dwford

    The real question is where do you buy your gas that it only cost $67 to fill your SUV. It cost me $57 to fill my Fusion in CT.

  • avatar
    William C Montgomery

    I last filled up my Jeep Liberty 5 days ago in Flower Mound, Texas, 17.97 gallons at $3.69 each for a total of $66.47 (good guess, RF). I got 15.6 mpg in mixed city/highway driving.

  • avatar
    wytshus

    Follow the money.

    The right side of the aisle welcomes more profits for their oil executive buddies, because ultimately this results in more money in their campaign funds.

    The left side of the aisle welcomes high gasoline prices because this results in fewer people buying and driving those icky gas guzzling SUVs and trucks. This also clears the way for more intrusive legislation giving the government more power over our daily lives.

    It is utter fantasy to think that the US government can fix a problem that they themselves created. I just hope the bottom falls out of the market in time to catch the buzzards with their pants down.

    However, it looks like it will be the same situation as the previous bubbles. The fat cats will cash out and leave the little guy holding the bag once again….

  • avatar
    adam0331

    The truth about high gasoline prices is that the current pump prices do not reflect the curret $125+/barrel price of oil. The independant refiners are being squeezed because the crack spread between finished gasoline and raw crude is leaving no room for a profit. Refineries owned by the major oil companies can make up the difference on the upstream side, but not the guy that’s buying his inputs on the open market. We should be paying $5 or more per gallon based on historical refinery margins. So be thankful the price isn’t higher, it should be. And it’s time to face the reality that the SUV was a product of cheap energy that couldn’t last forever.

  • avatar
    SherbornSean

    Why would anyone look to the government (of all places) for help paying their gas bills?

    Is the mirror really all that hard to look in to?

  • avatar
    Engineer

    Great article, William!
    I would only disagree with the speculator bit: I see a bit of chicken-and-egg: Are oil prices high due to speculation, or are speculators simply taking advantage of an already nervous oil market?

    The way I see it, speculation is a self-correcting force. If speculators bid up the price of oil too high, different speculators would go short on oil, bringing the price down. How come so few speculators are betting on a falling oil price?

    I believe the fundamentals are driving up oil prices (I’ve seen the comment about Iran storing oil in tankers. If true, that would make the market even tighter, won’t it?), and I think the challenge is to distinguish between US and world markets. US consumption is (slowly) declining, due to high prices. World consumption is still growing thanks to gas prices being subsidized in China and many oil-producing nations. Why conserve, if prices are low?

    The best thing we can hope for is that the Chinese government looses its ability to subsidize gas prices, and start to pass on high prices to Chinese consumers. Till that happens, you’d have to make peace with $120/bbl, while it lasts: next stop $130, $140, etc.

    Globalization is great! Except when it aint!

  • avatar
    gamper

    Personally, I blame the media for fanning the flames of fear. You literally cannot open a newspaper, turn on your television without some sort of “the sky is falling” prediction. This in turn is fueling much of the speculation. Demand will continue to drop and by mid Summer (4th of July) it should be readily apparent that we are not running out of oil/gasoline anytime soon, peak summer demand will begin to fall, the sub-prime crisis will hopefully begin to fade and we can all get back to reality.

    Although, I don’t really enjoy spending $70 to fill up my Wife’s Pathfinder, I think the long term effects of higher gasoline prices are positive and are going to be felt for some years to come. I much prefer we get a wake up call many years prior to the disaster than actually have disaster at our doorstep with no plan in place to combat it. Assuming gas prices go down and stay down for an extended period of time, hopefully next time we have a run up in fuel prices we will have a number of small efficient cars on the market, efficient family sized crossovers, hybrids, alternative fuel vehicles, etc, etc.

    Seeing as I can stomach the rising cost of gas (for now), I actually appreciate what it is doing to the automotive marketplace in terms of innovation and sales trends.

  • avatar
    bunkie

    Gamper-

    You’ve hit the nail on the head. Markets are very psychologically-driven. The media loves nothing more than a story that feeds on itself and damn any pain it might cause to regular folks.

    Having said that, my pet peeve is the tax loophole that allows “businesses” (anbody who was willing to lie and file a schedule C) to deduct 100% of a “truck” (anything bigger than 5000 pounds that had some small amount of truck DNA) in the first tax year. This is what led to Volkswagen adding weight to the Toureg so that it would qualify for the deduction.

  • avatar
    menno

    adam0331 said:

    “The truth about high gasoline prices is that the current pump prices do not reflect the curret $125+/barrel price of oil. The independant refiners are being squeezed because the crack spread between finished gasoline and raw crude is leaving no room for a profit. Refineries owned by the major oil companies can make up the difference on the upstream side, but not the guy that’s buying his inputs on the open market. We should be paying $5 or more per gallon based on historical refinery margins. So be thankful the price isn’t higher, it should be. And it’s time to face the reality that the SUV was a product of cheap energy that couldn’t last forever.”

    Look at it this way; crude oil was at about $64 a barrel just post-Katrina. Gas was at $3.89 here in northern Michigan. Crude is now $128 a barrel, and I paid $3.96 this morning (lucky for me, the price temporarily dropped 4 cents a gallon). Just extrapolating, you can see that gas “should” be at about $7.78 a gallon (since some of the taxation is percentage, while some is fixed, this ratio is not exactly accurate, but close enough). That’s $3.82 more than I’m paying, pretty close to your $5 a gallon, though.

    I did some “rough” calculations and figured on $175 per barrel by Memorial Day 2009 (instead of $200, as some experts predict; I was trying to be optimistic and somewhat realistic); I calculated that the margins for wholesale and retail would be going up to about what it historically has been; I also conservatively added “only” $1.50 per gallon (not as much as $5.00 per gallon) due to the impending passage of a “global warming” legislation (read: massive tax increase on fuels) in the US Congress.

    I figured $12.77 per gallon by Memorial Day 2009, but then realizing what this would do to the economy (read: massive recession), I guessed that 1/2 of the 24% “discretionary” driving would disappear as fast as 25 cent soda pop on a hot July day, and taking into account that this “might” bring down fuel prices by 1/2 of the 12%, I figured on (make sure you are sitting down)

    $12.00 per gallon in the US by Memorial Day 2009.

    Unfortunately, I was dead right on my prediction for Memorial Day 2008 ($4.00 per gallon) about 6 or 8 months ago.

    Guess we’ll see in 12 months 1 week, won’t we?

  • avatar
    menno

    Plus, lots of gas stations are now closing down because they can’t make any money. This will mean fewer stations, less competition and eventually, prices WILL therefore rise (and the remaining stations will be able to make historically normal profit margins again).

  • avatar
    Carzzi

    Speculators win big sometimes… but they also lose big sometimes! Congress should get its grubby ig’nant paws out of regulating speculation. Doing so would lower the number of market participants who cushion the risk and spread it around… instead of concentrated losses (that could provoke taxpayer bailouts), any losses would be better spread across a plethora of speculators. Same goes for huge apprecations in value… they are actually spread across more players, unhampered by restrictive Democrat-led soviet-command-economy inspired regs.

  • avatar
    Paul Niedermeyer

    menno: Your calculations are flawed. The high gas prices after Katrina were caused not by oil prices, but actual and/or perceived shortages of gasoline due to refinery issues.

    Gas price does not go up in direct proportion to oil prices, because oil is just one cost component of gas. I do not believe your $12.00 gas by next year. Maybe $5.50; or maybe $3.50. I agree with William that there is currently a bubble.

    But beyond the bubble, oil is heading for a global peak all too soon. National geographic has an excellent article this month. The range of forecasts by independent analysts for global peak oil centers on 2015. Meanwhile, the DOE sees ever increasing supply for decades to come. Who do you believe?

    The big mega-fields that are cheap to pump are all in decline, some precipitously. Any addidtional capacity will be much more expensive to extract.

    The reason the Saudi’s won’t pump more? They like the high prices, and have changed their strategy forever: they want their oil to last for future generations (of Saudis). That’s why they’ve given the finger twice to W’s request for more oil.

    If the current bubble does pop (not guaranteed), enjoy it, because it won’t last.

  • avatar
    AKM

    Who are these opportunistic speculators that are causing you so much grief every time you fill up your SUV? You. Most of us have pensions, insurance holdings, or various investment funds in our 401K that hedge losses in the commodities market-– usually without the knowledge of the ultimate beneficiaries, you and me.

    William, thank you! Few media outlets would dare telling their readers/viewers that they may be responsible for anything.
    By the way, I’ve seen more and more ads by oil companies pointing out that most of their shares are in the hands of our retirement funds.

    As commodities go, my firm uses a lot of sulfuric acid. Spot prices have increased 400% over the last 6 months! In the meantime they’re only increased 20% on the european spot market, proving that even speculative bubbles can be local.

    @engineer
    The way I see it, speculation is a self-correcting force. If speculators bid up the price of oil too high, different speculators would go short on oil, bringing the price down. How come so few speculators are betting on a falling oil price?

    It’s partly true, but generally happens in a stampede and falling prices, as previous bubbles have shown. Only a few smart investors go against the grain, and they’re smart only if they do it moments before the dip. Selling oil short now if the bubble keeps increasing for another, say 10 months would be a sure money-loser.

  • avatar
    blau

    The impact to American consumers is “exacerbated”, not “exasperated”, by domestic economic conditions.

    I’m even going to refrain from making a bad joke about this mistake, which is not easy for me.

  • avatar
    Geotpf

    Speculators may be resposible for day-to-day price jumps (and subsequent declines), but the overall upward trend is due to real worldwide demand increases. This is merely what happens when a billion Chinese and a billion Indians all buy their first automobile at the same time.

  • avatar
    Engineer

    Arod,
    Your link includes some interesting opinions. My favorites:
    1. Would U.S. legislation to curb oil futures accomplish its goal? With so little information not only on oil trading but also on global oil supply and demand itself (BusinessWeek, 5/14/08), it’s impossible to say exactly what impact the legislation could have. But considering the vast size and scope of the global oil market, it’s unlikely the bill would significantly rein in prices. Still, debate about the bill and Congressional investigations on speculation may offer more data on a market that is both poorly understood and immensely important to the global economy.

    2. The problem with the proposed legislation is that for the U.S. CFTC to monitor all global oil trades in this vast market, it would need the cooperation of other governments. More regulation of U.S. oil trades would “mean nothing without cooperation from all other countries,” says Fadel Gheit, senior energy analyst for Oppenheimer (OPY). “You cannot close one window and leave the other windows open.”

    3. Unsurprisingly, both the New York Merc and the CFTC oppose raising margin requirements. “Increasing crude oil margins on futures markets regulated by the U.S. CFTC inevitably will force trading volume away from regulated and transparent U.S. exchanges onto dark unregulated venues and onto less transparent overseas markets,” the Merc said in a May 7 press release.

    Wall Street analysts argue that it’s misguided to think the U.S. can legislate global oil markets into submission. “We believe there is a fundamental misperception…that so-called ‘speculators’ are driving up the oil price to supposedly unjustified levels,” wrote Goldman Sachs analyst Arjun Murti in a May 5 report predicting crude oil of $150 to $200 per barrel over the next two years. “Unfortunately, we do not think the energy crisis will be solved by finding and punishing the big, bad speculator.”

    There is also this piece of wisdom: You can’t predict what oil prices are going to do even in the short-to-medium term unless you have a good handle on the forces of supply and demand. And that requires thorough and reliable data—which don’t exist. Regrettably, the world oil market is no more transparent than a fragrant barrel of extra-heavy Orinoco crude. And the situation is getting worse because the world’s fastest-growing oil consumer is also one of the most opaque: China. and

    China, which has grown into the world’s second-biggest oil consumer after the U.S., stands out as a particular problem. Just ask Eduardo Lopez, who tries to dope out the China market as the senior demand analyst for the Paris-based International Energy Agency, an affiliate of the OECD. He says China does not report demand, leaving him and others to figure it out from data on production, trade, and inventories. What’s more, he says, “there are thousands of so-called teapot refineries all over China” that are technically illegal and therefore left out of China’s official statistics.

    Making his job even more trying, China appears to be creating a strategic stockpile of oil, but has never acknowledged it, Lopez says. If Lopez and others are underestimating how much oil China is squirreling away, then they’re inadvertently overestimating true global consumption, and vice versa if they’ve overestimated China’s stockpiling.

    Speculation, Too
    Many other countries aren’t much better. Lopez says Russia produces “awful data” and demand statistics are patchy in countries like India and Indonesia. On the supply side, OPEC nations don’t report their output reliably, sometimes because they don’t want to officially admit they’re producing above OPEC’s quota. That leaves the agencies relying on unofficial “tanker trackers” like Lloyds Maritime Information Services and Petro-Logistics SA, a tiny company that operates upstairs from a grocery store in Geneva, Switzerland. OPEC members also jealously guard critical data about when new fields will begin production and how quickly existing fields are declining, says Matt Cline, an economist for the U.S. government’s Energy Information Administration in Washington. So there you have it: all we have to go by is data provided by a tiny company that operates upstairs from a grocery store. Does that sound like a problem to you?

    Unfortunately, congress cannot write law for the rest of the world. You mistyped, right? Surely you meant Fortunately….

    If you are seriously hoping that Congress, the same people who brought us corn ethanol and the Iraq war (“Would a blank check be OK?”), bring us low oil prices, you are setting yourself up for major disappointment.

    Here’s a more likely scenario: The lobbyists write some legislation that would allow their clients to make a lot of money. Protecting the little guy? Only if it happens by accident. Eager politicians vote to pass the legislation. Come October, your incumbent tells you how hard he worked to reduce your pain at the pump. Now, if only you vote for him, he can keep fighting the good fight.

    Just be glad the incumbent is not running for the White House. Else you might have to stomach the claim that begging the Saudi King to pump more oil equates intelligent energy policy, and may some day work…

  • avatar
    Kevin

    I do believe there is a relationship between the dollar and oil prices that most people don’t appreciate — a positive feedback loop. What makes the dollar weaken? Simple: foreigners find they are holding US dollars that they can’t use or invest, so they want to get rid of them more urgently than anyone wants to acquire those dollars.

    Foreign oil producers receive an influx of dollars for their product, which they could traditionally absorb, because they need some amount of US currency. But at some point they begin to receive more dollars per barrel than they need, so they unload the dollars … this weakens the dollar on the Forex markets, making it less valuable and causing oil sellers to require more of them to trade … leaving them with an even greater surplus of dollars per barrel to unload … which further weakens the dollar and amplifies the cycle.

    Seems this would lead to a runaway oil price (which we’ve been seeing), but at some point the cycle breaks — and oil cheapens and the dollar strengthens, maybe very rapidly. Could be wrong but that’s what I expect.

  • avatar
    William C Montgomery

    Unfortunately, congress cannot write law for the rest of the world. You mistyped, right? Surely you meant Fortunately….

    Touché.

    But actually I meant ‘Unfortunately’ for anyone that thinks that congress can actually help this situation by regulating commodity trades. If you look at the full context of my rebuttal I think it is clear that I agree that this is a really bad idea.

  • avatar
    William C Montgomery

    blau,
    Fixed, thank you very much.

  • avatar

    Krugman at the NYT disagrees somewhat vehemently with the basic premise of this editorial …
    http://www.nytimes.com/2008/05/12/opinion/12krugman.html

    So here are two questions: Are speculators mainly, or even largely, responsible for high oil prices? And if they aren’t, why have so many commentators insisted, year after year, that there’s an oil bubble?

    Now, speculators do sometimes push commodity prices far above the level justified by fundamentals. But when that happens, there are telltale signs that just aren’t there in today’s oil market.

    Imagine what would happen if the oil market were humming along, with supply and demand balanced at a price of $25 a barrel, and a bunch of speculators came in and drove the price up to $100.

    Even if this were purely a financial play on the part of the speculators, it would have major consequences in the material world. Faced with higher prices, drivers would cut back on their driving; homeowners would turn down their thermostats; owners of marginal oil wells would put them back into production.

    As a result, the initial balance between supply and demand would be broken, replaced with a situation in which supply exceeded demand. This excess supply would, in turn, drive prices back down again — unless someone were willing to buy up the excess and take it off the market.

    The only way speculation can have a persistent effect on oil prices, then, is if it leads to physical hoarding — an increase in private inventories of black gunk. This actually happened in the late 1970s, when the effects of disrupted Iranian supply were amplified by widespread panic stockpiling.

    But it hasn’t happened this time: all through the period of the alleged bubble, inventories have remained at more or less normal levels. This tells us that the rise in oil prices isn’t the result of runaway speculation; it’s the result of fundamental factors, mainly the growing difficulty of finding oil and the rapid growth of emerging economies like China. The rise in oil prices these past few years had to happen to keep demand growth from exceeding supply growth.

  • avatar
    rtz

    Gas prices aren’t anywhere near high yet.

  • avatar
    Mj0lnir

    Geotpf :
    May 19th, 2008 at 3:45 pm

    Speculators may be resposible for day-to-day price jumps (and subsequent declines), but the overall upward trend is due to real worldwide demand increases. I have trouble believing that world demand doubled in one calendar year.

  • avatar
    William C Montgomery

    Stein,
    I disagree with many of Krugman’s assertions. Firstly, commodities across the board are high right now. The effect that he claims that is keeping oil high (cost of extraction) would only apply to oil prices.

    Secondly, when I refer to speculators, I’m not narrowing my definition down to a handful of shifty-eyed traders that are pumping a price for short-term gains. I’m talking about a tidal movement of investment dollars that are receding away from falling stocks, real estate, and other securities. I’m talking about institutional buying and selling; about “smart money” investors hedging a weak dollar.

    The law of supply and demand does apply, but in this case it isn’t the demand for oil outstripping supply. Instead, it’s the demand for futures contracts outpacing the supply of paper. There simply aren’t enough contracts to satisfy the flood of demand of investors seeking to shelter their dollars in a weak economy. So price goes up sans physical hoarding or shortages.

    When the dollar strengthens, the stock market revives, and real estate reheats, all of these dollars will flee from the risky (relatively speaking) commodities market and back into more stable (relatively speaking) investments.

  • avatar
    skor

    There are four primary reasons for the surge in world oil prices:

    1) Increased demand from developing nations like China and India.

    2) Decreased exports from major oil producers such as Mexico and Russia. Exports decease because of increased domestic consumption along with depleation of major oil fields. Yes, there is still lots of oil in the ground out there, but the “easy” oil is rapidly being used up. What’s left will cost more to extract, so it’s going to cost more to buy.

    3) America’s decades long current account deficit is now coming due. We buy more stuff from abroad them we sell abroad. The sellers have been taking what amounts to IOUs for a long time now. It seems they have all the IOUs that they are going to accept, they want to get paid, so the dollar takes a beating. That means all the stuff we import is going to cost more, including oil.

    4) America’s Likud driven Mideast policy has destabilized a major world oil producing region. There is a reason why speculators are driving the price of oil higher, they are betting that Washington/Tel Aviv will attack Iran this summer. An attack on Iran(Persia) will most certainly be a disaster for world oil production. You can expect the Iranians(Persians)to retaliate by attacking shipping and oil production facilities in the Persian Gulf. There’s a reason why it’s called the Persian Gulf. It sure looks like an attack on Iran is a done deal at this point. Say hello to $200+ per barrel oil this summer.

  • avatar
    Engineer

    If you look at the full context of my rebuttal I think it is clear that I agree that this is a really bad idea.
    My bad, then – I apologize for that.

    The law of supply and demand does apply, but in this case it isn’t the demand for oil outstripping supply. Instead, it’s the demand for futures contracts outpacing the supply of paper. There simply aren’t enough contracts to satisfy the flood of demand of investors seeking to shelter their dollars in a weak economy. So price goes up sans physical hoarding or shortages.
    Yeah, maybe. But if the real price of oil is somewhere around $80/bbl, as you suggest, why would speculators keep buying @ $125/bbl? If these guys are smart enough to get away with so much of our money, they should know the bubble would pop at some point, and be happy to get out of the market with oil valued at 50% above its estimated long term value. Why is that not (yet) happening?

  • avatar
    Engineer

    It sure looks like an attack on Iran is a done deal at this point.
    It does? How? Maybe I’m naïve, but I don’t see even Cheney being that crazy…

  • avatar
    Adamatari

    This article is right that the price of oil is due in large part to speculation, but makes the mistake of assuming that speculation indicates nothing. This speculation indicates that people think the demand for oil is high relative to supply. This is somewhat true for the time being; demand from developing countries HAS had an effect, and supply (though ample enough) still hasn’t caught up to the level necessary to provide cheap oil. The example of Iran’s excess of oil doesn’t mean much – food prices worldwide have risen, even though many individual countries have stockpiles of grains. One country does not represent the global market.

    What the writer is missing or possibly hiding is this: the one factor most likely to cause a sustained drop in oil prices is decreased demand and conservation. If the price of oil drops, it will have more to do with 1,000,000 Priuses, fewer car trips, and CFL bulbs than with anything else. US demand has already shrunk. While it’s convenient for motorheads to pretend that we magically have infinite oil, the reality is that we react to finite oil with conservation and this reduces prices. This is what reduced the price of oil in the 1980’s, and is most likely to affect the price in the future.

  • avatar
    Jay Bee

    “How about this one: America needs more refineries; the greenies are blocking our energy independence.”

    No, no, and no again. This little fib just won’t die. In a 25-year period, the oil companies put forth a total of one application for a new refinery. Yes, one.

    http://tinyurl.com/5y2j58

    It’s a hell of a lot more profitable to maximize efficiency at existing facilities AND constrain overall output.

    The other points made in this editorial have largely been addressed by other responses, but I won’t let this one slip by.

  • avatar
    Pch101

    But if the real price of oil is somewhere around $80/bbl, as you suggest, why would speculators keep buying @ $125/bbl?

    The same reasons that people bought otherwise worthless internet stocks at high prices, or paid $500,000 for $250,000 houses: Greed and stupidity.

    When people try to make easy money, some of them turn to the greater fool theory. That’s particularly true when they’ve made money doing it so far. Nobody wants to jump off the bandwagon too soon, lest they leave any money on the table.

    Some of those involved really don’t see it — these are the greater fools. The fools will rationalize that things are different now. Invariably, this will be described as a “new paradigm,”, which is code for “things are different now, but I can’t explain it without pushing the envelope of reason to do it.”

    Oil demand has basically been flat for the last two years, and supplies have more or less matched demand. Over that time period, the price has doubled.

    With supplies sufficient and demand flat, there isn’t much reason to believe that the price of the commodity itself should have doubled due to supply and demand, that just doesn’t make any sense.

    When you hear lots of rationalizations and banter about new paradigms when the only fundamental that has changed is price, then you’re probably in a bubble. I’m hearing the same rationalizations today about oil that I did about housing before the credit crunch began or about the internet before the dot bomb went off. Same sh*t, different sector.

  • avatar
    Airhen

    rtz :
    May 19th, 2008 at 6:04 pm

    Gas prices aren’t anywhere near high yet..

    Very true. We are not even up to Europe’s gas prices yet.

  • avatar
    menno

    I sure hope that it’s a bubble. I’d like to be able to pay $2 a gallon for the next 30 years.

    Somehow, I suspect that even if it is a bubble, that after the bubble bursts, oil will still run $80 to $100 a barrel.

    Of course, during the end of the bubble, it could go significantly higher.

    My “faulty” calculations (which were WAG’s – “wild ass guesses” anyway) didn’t even take into account what would (will?) happen if Israel or the US (or both) attack Iran to forestall or stop the nuke bomb proliferation by these folks.

    How high is UP?

  • avatar
    hwyhobo

    Dinu: Please tell me why again you need a V8 in an Econoline van when a small turbo diesel will do just as well?

    California Air Resources Board. You know, greenies.

  • avatar
    menno

    OPEC has us (worldwide) by the short & curlies.

    $200 a barrel oil anticipated by OPEC. Only question is – when?

    http://www.ft.com/cms/s/0/4200dc9e-1521-11dd-996c-0000779fd2ac.html?nclick_check=1

    Here’s what the United States is planning in response.

    http://www.ft.com/cms/s/0/eda93eea-259f-11dd-b510-000077b07658.html

    So,then; why is my projected $175 per barrel by next year so dumb, again? Rhetorical question…

    As for gas prices, I can see that due to the declining value of the US dollar (vs virtually all other currencies and more importantly later on, against gold and silver) oil prices are going up MOSTLY for the citizens of the United States. Canadians used to pay about twice as much (in US dollars/US gallon equivalent) for fuel compared to Americans; now the difference is less than 20%. Britons used to pay as much as 400% more for fuel compared to Americans, and now it is more like 225% more. (Mostly due to taxation in both cases). Oil being priced in Euros by Iran may not be the “deal of the century” for the Europeans after all…

    Yes, it’s pretty much our own fault – here’s why.

    We got rid of sensible financial restraints on a personal indidual basis AND on a national level. It’s difficult to demand that our elected representatives toe the line and use fiscal responsibility, when we individually can’t or won’t.

    We collectively allowed ourselves to be led down a path of fiat money rather than financially stable currency which could not be debased constantly (i.e. making what is described as inflation). Starting with an illegal ururpation of Constitutional authority by President Roosevelt in 1933 when the United States government declared holding gold to be illegal (when in fact, the actual Constitution requires that monies used within the United States BE silver or gold – not paper, not paper backed by gold or silver). Still does; just read it.

    We did not listen to the signs of the times in 1973 and 1979, and deliberately set ourselves a national energy course to eliminate our national dependency on our enemies for our absolute requirements and needs to sustain life. I mean to say, we could have started down another path, such as using the Fischer-Tropsch (sp) process to make motor fuels out of abundant American coal, by gradually adding fully legal and constitutional tariffs on imported oil.

    Clearly, hindsight is 20/20. But there have been voices crying out in the wilderness for literally 8 decades about many of these issues, and all were ignored.

    If we put our national effort into eliminating oil imports by building plants to convert garbage, offal and sewage into oil (a process invented in America) in the same way that we put our national effort behind winning World War II and manned space flight and the moon shots, we can do it in a matter of 5 years.

    We just have to stop, think, elect wise men and women and ignore the mainstream media extolling us to continue on just as we are and vote for the two major parties. Because, in case you hadn’t noticed, it simply isn’t working for us any more.

  • avatar
    Areitu

    Wow. It took $63 to fill up my 350Z. Maybe I should get an SUV to get more utility out of the same amount of gas. Every Carmax I drive by looks like a lawn made of Expeditions and Suburbans.

    After commodities cool off, I wonder what the next big thing is going to be.

  • avatar
    Pch101

    We collectively allowed ourselves to be led down a path of fiat money rather than financially stable currency which could not be debased constantly (i.e. making what is described as inflation).

    Argh. The gold standard would be the absolute worst thing for our economy. We might as well base the value of the dollar upon sea shells or French fries or Mickey Mouse watches, it makes no sense whatsoever.

    When the US was on the gold standard, it experienced several economic depressions. Getting rid of the gold standard allowed it to become the world’s largest economy, and allowed it to replace the pound as the world’s reserve currency.

    Compared to the pound, the dollar is twice as strong today as it was over most of the last 200 years. Between the revolution and World War II, a pound was consistently worth about $4-5. Since 1980, the pound has been worth less than half of that.

    The dollar is currently weak in comparison to its values of the last two decades because it reflects investor concerns about the US’ global entanglements. The value of the dollar reflects the full faith and credit of the US government, which is stretched given its current commitments abroad.

    The dollar began to fall just as the war in Iraq began to sputter. This is no coincidence — the markets see how the US is doing there, and they don’t like what they see. Ending the war should restore the value of the dollar, as investor confidence in US performance is restored.

  • avatar
    romanjetfighter

    In Saudi Arabia, they pay 45 cents a gallon. We’re being jipped!

  • avatar
    thoots

    Oh, geez, another one of these:

    miked :

    It is true that the big bad evil oil companies make about 10 cents/gal in profit. The Feds take 18 cents/gal and the states take even more, New York and Pennsylvania top the list at over 31 cents/gal, while the lowest is Georgia at 7.5 cents/gal, the average being about 20 cents/gal. That means that the Feds and the States combined (not counting local taxes) are making 3x the profits of the oil companies.

    Sigh………

    Golly gosh, so what do you suppose government does with these “profits?” I’m always utterly dumbfounded by people who whine about gas taxes. “Do you drive on a road to get to your place of employment?” Are you saying that you don’t comprehend that GAS TAXES paid for the construction and maintenance of that road?

    Should we all just forge our way on our own, getting SUV’s that truly can slog through wagon trails? Should you buy a boat to get across any river or other waterway that may lie between your home and your business?

    Crimony!

    Our fuel taxes are incredibly minimal compared to most other urbanized countries, and in most areas, they haven’t even begun to keep up with inflation. In my state, they haven’t risen for about fifteen years — how well would you be coping if you didn’t have any form of a pay increase over the past fifteen years?

    Of course, I suppose those who whine loudest about gas taxes probably scream the loudest about traffic and congestion slowing them down — gosh, I guess these people must expect that some kind of Road Fairy comes out at night and builds shiny new roads, free of charge.

    Again, I just can’t fathom how someone who would visit a site like this one — “automotive-centric” — could possibly whine about gas taxes. Automobiles really don’t fare too well unless they have roads to drive on, wouldn’t you think? Personally, I appreciate the roads and bridges my small gas tax contribution helps fund.

    You may now return to your discussion of the price of a barrel of crude oil.

  • avatar

    @ romanjetfighter :
    May 19th, 2008 at 11:38 pm

    In Saudi Arabia, they pay 45 cents a gallon. We’re being jipped!

    No – that’s government subsidy, doesn’t work in America. (Well, McCain and Clinton have proposed some jiggery with the Holiday Gas Tax, but generally government subsidies for gas is a no-no in the US.)
    In Iran they had to hike the price up after decades of selling heavily subsidised gas to Iranians, couldn’t afford to do so any more.

  • avatar
    50merc

    “the actual Constitution requires that monies used within the United States BE silver or gold”

    From http://www.usconstitution.net/constfaq_a8.html#Q154

    “In Knox v Lee, 79 U.S. 457 (1871), the Court ruled that paper money was not unconstitutional: ‘The Constitution nowhere declares that nothing shall be money unless made of metal.’ The Court argued that the Congress can manipulate the value of precious metals to the point where it can be rendered as inherently worthless as paper (the Congress could enact a law that says that 10-dollar silver coins weigh 400 grains in one year and 500 grains the next, effectively devaluing the silver). The Court even noted the arguments of the Framers against “emitting bills,” but wrote that the Framers, one, could not anticipate all governmental needs, and, two, they allowed the Congress to do what was necessary and proper to carry out its powers. In this case, that includes printing paper money.

    So, said the Court, even though paper money is not expressly permitted by the Constitution, it is also not expressly forbidden, and in spite of the extra-constitutional opinions of some of the Framers, the ability to print paper money is a necessary and proper power of the federal government.”

    Consider, also, that money is a medium of exchange–a form of payment. When one buys something, one can pay by check or credit/debit card as well as by currency. All these forms of payment are, therefore, money. Most of the money in America exists in the form of bookkeeping entries by banks.

  • avatar

    I love the griping. Indian drivers are paying more for their gasoline and diesel than American drivers …
    http://www.slate.com/id/2191491/

    When measured on an inflation-adjusted basis, the current price of gasoline is only slightly higher than it was in 1922. According to the Energy Information Administration, in 1922, gasoline cost the current-day equivalent of $3.11. Today, according to the EIA, gasoline is selling for about $3.77 per gallon, only about 20 percent more than 86 years ago.

    Given the ever-increasing global demand for oil products—during the first quarter of this year, China’s oil consumption jumped by 16.5 percent—and the increasing costs associated with finding, producing, and refining crude oil, it makes sense that today’s motorists are paying more for their motor fuel than their grandparents and great-grandparents did.

    Gasoline is also a fairly minor expense when you consider the overall cost of car ownership. In 1975, gasoline made up 33.4 percent of the total cost of owning and operating a car. By 2006, according to the Bureau of Transportation Statistics, gasoline costs had declined to just 17.1 percent of the total cost of car ownership. Of course, fuel costs have risen by about $1 per gallon since 2006, but even with those increases, fuel continues to be a relatively small part of the cost of car ownership. By contrast, the fixed costs of ownership—insurance, licensing, taxes, and financing—have increased nearly fivefold since 1975. Maintenance costs have also quintupled over the same time period. Given those increases and the relatively low price of fuel, it’s not surprising that Americans are opting for big vehicles with powerful engines. Considering the overall cost of owning a vehicle, fuel expenses just aren’t a very big deal.

    (snip)

    American gasoline is also dirt-cheap compared with gas in other countries. British motorists are currently paying about $8.38 per gallon for gasoline. In Norway, a major oil exporter, drivers are paying $8.73. In 2007, out of the 32 industrialized countries surveyed by the International Energy Agency, only one (Mexico) had cheaper gasoline than the United States. Last year, drivers in Turkey were paying three times as much for their gasoline as Americans were. The IEA data also show that in India—where the per capita gross domestic product is about $2,700 (about 6 percent of the per capita GDP in the United States)—drivers have been paying more for their diesel fuel and gasoline than their American counterparts.

  • avatar
    EJ_San_Fran

    William C Montgomery:
    Market fundamentals don’t support the current high oil prices… world oil prices will come tumbling down

    It’s not so simple, William. Why don’t you speculate against oil, if you’re so sure?

    I think the main issue is: the price of oil is ultimately controlled by the OPEC monopoly.

    How does OPEC set the oil price?
    When the oil price declines they lower production; when the oil price rises they do nothing. This has had the effect of a steadily rising oil price over the last few years.

    OPEC can do this as long as they have market power.
    What determines that?
    Primarily OPEC market share and economic growth.
    As long as OPEC retains or increases market share and oil consumption continues to rise with continued economic growth, there is no reason why OPEC would lower the oil price.
    Simple.

    In the past OPEC had competition: from Alaskan oil, or North Sea oil or Russian oil. That competition is not so stellar any more. Norway can’t turn on 3 million b/d any more just like that. Non-OPEC production is pretty much stagnant or growing only slowly.

    What about consumption? Despite high prices consumption is still growing (ironically, in OPEC countries themselves!).
    But this, of course, is key. Consumers need to stop complaining and instead need to stop buying.

    What about alternatives? If everybody would believe William Montgomery, there would be no sense of urgency behind alternatives or conservation and everybody would still be into trucks.
    Even GM doesn’t talk like that anymore.

  • avatar
    Blastman

    All the traders that got laid off at Enron had to go somewhere.

    http://dir.salon.com/story/politics/feature/2002/01/30/hearing/

    Dot 1: Feinstein reported that Enron controlled 50 to 70 percent of the trading market for natural gas deliveries into Southern California from May 2000 to June 2001, and it did so through bilateral sales, which require no public disclosure of their details.
    Dot 2: Natural gas prices drive electricity prices, and California energy prices went through the roof, from $7 billion in 1999 to $28 billion in 2000 and $27.7 billion in 2001.
    Dot 3: At the end of 2000, the price of natural gas delivered to the border of Southern California was $59.12 a decatherm. In the New Mexico coal town of San Juan — just an Arizona away from the California border — the price was $10.12 a decatherm.

    Just apply this to the broader crude oil supply market.

  • avatar
    Dave Wxp

    Record losses spurred Exxon to merge with Mobil, and Chevron to merge with Texaco.

    I’m fairly certain all of those companies made profit in 1998/99. The Exxon/Mobil merger was to save on other overhead, including capital expenses. Companies at the brink of extinction do not post substantial profit.
    Less-than-impressive profits, and serious savings in the face of declining oil discovery, is what spurred these mergers.

    ExxonMobil, Chevron, et al make in the neighborhood of 10 cents per gallon– whether gasoline costs $1.50 a gallon or four bucks.
    I’ve been seeing this more and more, along with the comparison to banking. You should be careful with this, as it does not include reinvestment in different areas. They make considerably more per gallon of refined gasoline(and during refining), but this is reinvested into discovery/extraction.
    Total company profit is different from profit by division.
    Additionally, the impact of buying back shares(or ESPP type accounts) is not factored in – I think they spend about $5-8b/Q, which would add in a couple of cents. I think repurchase actually exceeded reinvestment for the past few years.

    If it costs $1-$30 to extract a barrel of oil(generally available industry numbers), how on earth do you say that the 28 gallons/barrel of oil only make a profit of 10c? And that’s without the diesel, distillates or NG(making up B.O.E) making a profit.

  • avatar

    great article

    the weak dollar may be good for our manufacturing industry (18% of total economy) but its piss poor for CONSUMERS (100% of the total population).

  • avatar
    geoff03

    Demand for gas in the US is down for the first time in years, but the price of gas continues to go up. The reason is not speculators but the fact that China and India continue to increase their demand while the American dollar continues to fall.

    There are going to be roughly double the amount of cars on the road worldwide by 2030, but the amount of oil produced by then is not going to double and some even predict it will fall below today’s levels. Add to that the fact that air travel and shipping travels are increasing every year, and its pretty obvious that supply is going to have a hell of a time meeting demand.

  • avatar
    Geotpf

    Mj0lnir :
    May 19th, 2008 at 6:13 pm

    I have trouble believing that world demand doubled in one calendar year.

    But gasoline/oil prices have a very inelastic demand curve. That is, if demand goes up, but supply is stable (which is the current situation), it takes a large price increase to reduce demand to match the supply (which is also the current situation).

  • avatar
    Pch101

    When the oil price declines they lower production; when the oil price rises they do nothing.

    Between 2003 and 2007, the world supply of oil increased by about 5 million barrels per day. During that period, OPEC increased its supply by 3.55 million barrels per day. So OPEC is not only increasing its production, but it is increasing it at a faster rate than the overall market.

    58% of the world’s oil comes from sources other than OPEC. OPEC is a powerful oligopoly, but it does not have monopoly power.

    I’m no fan of OPEC, but it is not accurate to claim that they can set the market on a whim, or that they alone determine the course of pricing. In many ways, they react to the market price, like the rest of us.

    Unfortunately for us, the market price these days is being manipulated in part by traders who are trying to make money from price movements, instead of the commodity itself, which is bound to create a bubble.

  • avatar
    Busbodger

    Now for a wholly different take… What if the oil industry sees the end of their cake party in another decade or two and are beginning to pump the markets for all they can get? I mean oil might never run out but cheap oil will.

    Transportation technology has taken a big jump forward technologically in the past decade and in another decade may do away with the need for fossil fuels entirely for a large portion of the civilian population i.e not commercial traffic.

    Did ships see the coming of the airplane? Did trains see the coming of the buses? Did the buses see the coming of the airplane? Maybe this is the coming of the EV and the twilight of fossil fuels.

    This time instead of saying we can go electric while leaning against a goofy looking golf cart vehicle from the 1970s, we can simply see a fellow citizen drive by in a very normal looking CUV or sports car.

    If the Volt goes 50 miles per charge and average person needs less than that to get around daily their fossil fuel needs end essentially except when they go to Grandma’s house.

    If the Rav4-EV has been getting 100 miles per charge for the past decade and the secret is out, how long until some other company begins building these vehicles again once the batttery patent is licensed or some alternative battery technology reaches maturity? Lithium is looking pretty good these days.

    For us 100 miles is all the charge we’d need to go all the way to Grandma’s house. Charge over night and we can come home again without a drop of gasoline. Bye bye Chevron/BP/Exxon…

    Standford has recently developed batteries (silicon nano wires I read were the key) that increase the energy capacity of a battery by two to three times. Either you get a smaller battery and the same range or two/three times the range in a bigger battery. That makes an EV a reasonable touring vehicle if the battery will charge in 20 mins (and some do).

    All it would take is some fast chargers at gas stations and a shift in American habits. Drive 300 miles and then stop for a cup of coffee and some time to chat. Not a bad way to travel, we have done it many times – drive/rest/drive/rest.

    My point is that we may be on the beginning of the chapter where gasoline and diesel engines for light vehicles becomes obsolete. This technology would be better suited for short distance drivers as found in the northeast and in Europe but the RAV-EV would do just fine here in TN too.

    This chapter might only last 10 years before we wonder why we ever used gasoline to haul our families around. No pollution in the car, the highways would be healthier, no explosive liquids on board, quieter, less gear shifting… I remember how air conditioning went from an option to a must have item in about ten years. Can yuo even buy a non-a/c equipped car these days in the USA?

    The big corporations like GM, Chevron, Ford, BP – have got to have good analysts whose crystal balls is much better than JoeAverage’s crystal ball.

    We amateurs are much smarter than ever before b/c we can research using the internet but the big guys have whole departments of people who read the figures every day and people who develop strategies using this information. I’ll bet they have their ball game planned out a decade in advance. Surely they see information that never reaches the public.

    Remember Chevron owns the battery technology patents for the large format NiMH batteries found in the RAV. I mean to say NiMH works NOW and works well but Chevron (thanks to GM) has them locked up. Lithium has required alot of time (years) to develop and ultimately might be the better battery but for the past decade we could have been driving around on NiMH batteries while Lithium was developed.

    I suggest you search for Chevron NiMH, Chevron Cobrasys, and NiMH patents.

    We’d be 10 years ahead in technology if it weren’t for GM and Chevron (among others).

    By the way the patent expires in 2015 and I have seen a few articles speculating that that will also be when gasoline prices will peak.

    Think of what could be electric today – normal vehicles I mean: mail delivery vehicles, pizza delivery vehicles, most commuter vehicles, parts runners for repair shops, maintenance vehicles for college campuses and city governments, urban delivery vehicles. What’s that leave? Heavy vehicles, interstate vehicles, law enforcement vehicles, and JoeAverage pulling his boat across the county for a little water skiing.

  • avatar
    William C Montgomery

    UPDATE: This from Reuters

    Lehman [Brothers] estimates that total assets under management in commodity indices ballooned to $235 billion by mid-April from only about $70 billion at the beginning of 2006.

    “Of this $165 billion increase, about $90 billion is accounted for by financial inflows to these indices, with the remaining $75 billion increase stemming from price appreciation of the original underlying investment, [Lehman analyst Edward] Morse said.

    By my math, that means that the amount of money invested in the commodity’s market more than tripled in little more than two years. As noted, price appreciation is a lesser factor than the flood of dollars entering the commodities marketplace.

    Additionally, the Reuters piece elaborates: Inflows have seen a major spike since December last year, with the lion’s share of the contribution coming from the energy-heavy S&P GSCI index .SPGSCITR, [Morse] said.

    Sounds like a bubble to me. A big one.

  • avatar
    nonce

    Have any actual economists said that there is an oil bubble?

    I know there are quite a few who say that there absolutely cannot be one, and some more who say that an oil bubble cannot be disproven. But that is very different from saying that there is an oil bubble.

    If there is a bubble, it’s going to crash hard and fast as soon as it pops. Are we going to see a series of “Oil Bubble Death Watch” news posts that stretches out over 10 years, each one more sure than the last of the “inevitable” popping? (This mirrors the modus operandi of the “peak oil” crowd so closely I almost feel like I’m in a Shakespeare drama.)

    As for inflation being the sole cause: no. You can see that oil prices have risen in countries that don’t use the USD as their currency.

  • avatar
    William C Montgomery

    I’m fairly certain all of those companies made profit in 1998/99. The Exxon/Mobil merger was to save on other overhead, including capital expenses. Companies at the brink of extinction do not post substantial profit.
    Less-than-impressive profits, and serious savings in the face of declining oil discovery, is what spurred these mergers.

    Look at the early ’90s. That is the timeframe I referenced. These are the years that triggered the merger madness. I wouldn’t characterize any of the profits recorded in that period as substantial (with the exception of Exxon) given the billions in revenue that these companies take in. Look at the numbers year-over-year. And remember that GM, Ford and Chrysler showed profitable income statements for decades while their companies were in tragic decline.

    The crisis was greater for these companies than what shows on their annual financial reports. I lived in Houston during the period and have many close personal contacts within these companies. Furthermore, the bank I work for has entangling financial relationships with most of the companies. In my role, I had almost daily contact with the finance departments most of the big oil industry players over a seven year period. I witnessed the widespread layoffs, downsizing, pay cuts, reduction of exploration activities, etc. that this crunch elicited. In addition to these deep spending cuts there was some balance sheet wrangling. It was far more brutal than the 10K lets on.

  • avatar
    EJ_San_Fran

    OPEC is a cartel (not a monopoly) that acts as the ‘swing producer’. When prices go up they simply fill purchase orders. They’re also expanding production capacity. When prices go down, a single press release about production cutbacks is enough to stop the slide. That happened in Q1 2007.

    The speculators have provided a great service to OPEC: they have helped demonstrate that oil prices can rise without triggering an economic crash.

    So now OPEC can give price support at, say, $100/barrel, whereas last year they did that at $50 dollar/barrel.

    Interestingly, OPEC has been making statements about limiting future production capacity increases. They say things like “Is there really enough demand?”. Or: “We want to preserve resources for future generations.”
    That raises a lot of questions:
    Do they see the writing on the wall with global warming and the need to cut back on fossil fuels?
    Are they running into peak oil themselves?
    Do they simply want to drive up prices?

  • avatar
    Engineer

    1. ExxonMobil recently scooped second on the Fortune 500, with annual earnings of $40.6b. Chevron slipped in at number three, with $18.7b of profit.
    2. ExxonMobil, Chevron, et al make in the neighborhood of 10 cents per gallon– whether gasoline costs $1.50 a gallon or four bucks.
    These two statements don’t add up! The US consumes ~21 million bbl/d, so if statement #2 was right the total annual oil company profit would be:
    21 million * 365 d/y * 42 gal/bbl * $0.10/gal = $32.2 billion/year.

    According to statement #1, though, ExxonMobil alone made more than that, and ExxonMobil and Chevron made twice as much. And it is not as if ConnocoPhillips, BP and Shell were loosing money either. So what is going on here?

    The answer is buried in Dave Wxp‘s somewhat inaccurate post: If it costs $1-$30 to extract a barrel of oil(generally available industry numbers), how on earth do you say that the 28 gallons/barrel of oil only make a profit of 10c? I believe it costs at least $5/bbl to pump oil, Dave, and note it is 42 gal/bbl, not 28.

    Now, I don’t have the exact number, but I believe the US pumps ~40% of its own oil. The worst case (costing $30/bbl) total profit on that would be:
    40% * 21 million bbl/d * 365 d/y * ($120 – 30) = $276 billion.
    Of course, oil has not been at $120+/bbl for a full year, but now you know what kind of returns Big Oil will report this time next year.

    The point remains: $276 billion (for pumping)completely dwarfes $32 billion (for refining). Even with declining US production, Big Oil (US) is still making a lot more money pumping oil than refining it.

    The bad news is this bit: How much profits are we sending overseas, to those allies from which we are buying our oil? At a minimum:
    60% * 21 million bbl/d * 365 d/y * ($120 – 30) = $414 billion.

    What about those select few allies that pump oil @ $5/bbl? Trust me, you don’t want to know!

  • avatar
    ppellico

    William…
    I thank you for the voice from the wilderness.
    There are so very few that I get depressed.
    Its not that I don’t like the prices…in fact I do.
    I am enjoying the rush to R&D at the manufacturers and the fact that perhaps now, we will break down some of the forced do-gooder laws preventing my freedom of choice.
    By that I mean…bring me my diesels!!!!

  • avatar
    ppellico

    By the way…in the spirit of the good old American business way, when the collaps happens, get ready for yet another bailout of some greedy ass’s debt to save the economy and whatever else they can claim as the reason.
    Remeber the Alimo.
    Remember the Savings and Loans crisis.
    Remember the Housing crisis.
    Everybody get ready for yet another bail-out.

  • avatar
    Dynamic88

    … I fully expect crude oil will trade below $80 a barrel in the not too distant future.

    Any prediction what petrol prices will be when oil is at $80/barrel? I’m seeing some really good deals on lightly used pickups and SUVs right now.

  • avatar
    jthorner

    I don’t see a single reference posted in the article to back up the many assertions made.

    Poking at the first one “most of the oil companies’ profits are the result of volume, not market prices. ExxonMobil, Chevron, et al make in the neighborhood of 10 cents per gallon– whether gasoline costs $1.50 a gallon or four bucks.”:

    Reading any of the major oil company’s annual reports will show you that much of their business is based on crude oil extraction. Refining and marketing are the smallest part of their business empires, not the marginally profitable 10 cent per gallon business posited in this editorial.

    For a starter, you can see BP’s 2007 annual report here:

    http://www.bp.com/liveassets/bp_internet/annual_review/annual_review_2007/STAGING/local_assets/downloads_pdfs/ara_2007_annual_report_and_accounts.pdf

    You will find much more in that report about exploration and production than about the refining and marketing end of the business. Similar things can be found by looking at the financials for Shell, ExxonMobil or Chevron.

  • avatar
    William C Montgomery

    These two statements don’t add up! The US consumes ~21 million bbl/d, so if statement #2 was right the total annual oil company profit would be:
    21 million * 365 d/y * 42 gal/bbl * $0.10/gal = $32.2 billion/year.

    The U.S. isn’t the only market that consumers ExxonMobil or Chevron fuel. In 2007, only about 38% of XOM petroleum product sales were in the U.S.

    If you prefer, in 2007 XOM’s Net Income of $40.6b was 11% of their total revenues of $358.6b. In 2006, they were 11%. In ’05 it was 10% and in ’04, 9%. So there is some variability in profitability on a percent basis, but nowhere near the increase you would see if they were the primary beneficiary of price gouging as many claim (which was my point).

    And before someone says, 11% of $4.00 a gallon gas is $.40, not $.10, let me point out that we can’t baseline the number that way because most of what XOM sells is not gasoline to American consumers. Last year they sold 7,099 bpd of petroleum product sales (gasoline, kerosene, diesel fuel, aviation fuels, heavy fuels, and specialty petroleum products), of which gasoline was 40%. They also produced 27,480 bpd in their chemical division and 4,180 bpd (oil equivalent) of natural gas. The revenue streams and margins are too diverse to do that kind of quick logic check.

  • avatar
    vento97

    Everytime I hear people complain about high gas prices, I shake my head. These are the same people that are STILL driving the big gas-guzzling Ford Explorers, Expeditions and Excursions, Toyota Sequoias and Land “Bruisers” (and their Lexus equivalents), Durangos, Aspens, Tahoes, Yukons, Suburbans, Nissan Armadas (and their Infiniti Equivalents), VW Touaregs, Audi Q7s, Porsche Cayennes, BMW X3s and X5s, Mercedes G-class, GL-class and M class SUVs, etc., etc., etc.

    Throw in those high-powered sports cars and huge pickup trucks driven to the office by metrosexual yuppies trying to project a “manly” image (that isn’t there), and it only serves to compound the issue…

    (NOTE: If you aren’t a farmer, construction worker, rancher, service industry worker, or work in an occupation that requires a suit and tie or business casual attire – you have NO business driving a pickup truck to work – other than to falsely project the “manly” image mentioned above….)

    From my first car to the present, the only car I’ve owned with more than 4 cylinders was a 1977 Datsun 280z – and that was over 20 years ago. Speaking only for my personal automotive needs, I didn’t see the need for the SUV behemoths then, nor do I see the need for them today. I’m glad I didn’t fall for the SUV market-droid drivel that the car manufacturers (led by the BIG 2.8) have been spewing over the years:

    “Buy a Chrysler, and your gas will be $3.00/gal for the next x number of years”…

    Yeah, Chrysler, good luck with that one…

    But then again, there will probably be a sufficient number of buyers (who fall for that marketing gimmick) that will make P.T. Barnum smile in his grave from ear-to-ear…

    The only advice I can give these gas price complainers involves using a mirror…

  • avatar
    nonce

    I fully expect crude oil will trade below $80 a barrel in the not too distant future.

    So, how much money have you put into which futures?

  • avatar
    Dave Wxp

    I believe it costs at least $5/bbl to pump oil, Dave, and note it is 42 gal/bbl, not 28.
    Saudia Arabia can bottom out at $1 and change, though I’m not sure if Exxon has any contracts with them in this range. I do think their average is around $5/bbl though.

    The 28 I gave comes from the creation of gasoline only from oil – neglecting diesel, jet fuel, chemicals and whatever else gets extracted. My apologies, I should have been more clear. I’ve seen ranges from 20-28, which I think is in part dependent on what type.

    Of course, oil has not been at $120+/bbl for a full year, but now you know what kind of returns Big Oil will report this time next year.
    True, but take XOM – I think they refine about 5.5M bbl/day, but only extract 2.5. Without knowing their contracts, they’re buying on the open market.

    Look at the early ’90s. That is the timeframe I referenced. These are the years that triggered the merger madness.
    Oops, saw merger and went to the date.

    If you prefer, in 2007 XOM’s Net Income of $40.6b was 11% of their total revenues of $358.6b. In 2006, they were 11%. In ’05 it was 10% and in ’04, 9%.
    Net income is flexible when you have a giant pool of cash. It would have been ~$70B without stock repurchases, but keeping it at 10% gives a nice constant and keeps people from keeling over.
    This way, they can put out the message about how profitable they are in relation to other companies. 10% is much nicer to say than 20%, when there is already a bit of agitation over pricing.

    Return on capital is a much more interesting way of looking at things – I think they go over 30%, which is far above other industries.

  • avatar
    Dynamic88

    (NOTE: If you aren’t a farmer, construction worker, rancher, service industry worker, or work in an occupation that requires a suit and tie or business casual attire – you have NO business driving a pickup truck to work – other than to falsely project the “manly” image mentioned above….

    Oh dear, am I projecting an image as a metrosexual yuppie? I bought my PU when I was in construction. I have a steadier job now, but I still drive the PU (when I’m not riding my recently restored Raleigh 3 speed).

  • avatar
    M1EK

    Folks, the Saudis are lying. Plain and simple. When they say they can pump a lot more oil tomorrow, they’re lying; it’s very obvious – they had to vastly increase the number of rigs in country just to keep production relatively flat. They don’t particularly want oil this high, because even their stupidest customer (us) are experiencing enough pain to begin weaning ourselves off the stuff.

    That is, if people who still think the environmentalists have any real power don’t screw it up by continuing to subsidize SUVs and suburban sprawl.

  • avatar
    ppellico

    William C Montgomery It’s like talks with my family. I have 11 brothers and sisters and any family get together always experiences a discussion of anything around the table that eventually ends up awash in a sea of voices all more interested in hearing themselves than the points. The pecking apart of the article is not being done with any real sense of openmindness (? well, it’s a try) or attempt of truth finding. Many replies are purposefully or accidentally leaving out specific points. But it makes no difference. William could continue to respond to each reply without end, ad nausea (again, work with me her people). The truth will soon be seen. Let's all agree to revisit this when the whole thing shakes out one way or another.

  • avatar
    Engineer

    Let’s all agree to revisit this when the whole thing shakes out one way or another.
    Oh, I agree, William did a great job of myth busting. I would love someone to do this in the presence of one of the candidates, and to tear apart their stupid ideas (Gas Tax Holiday, my @ss!).

    I only disagree about the effect the speculators are having (although that Reuters quote has me thinking) and his contention that it is not supply and demand: The world’s positively awash in oil. Well, yeah, US stockpiles are up. But that hardly means the world is awash in oil. It is more a question of the rate of consumption getting awfully close to the rate of production. IMHO, this is why the speculators are having a field day.

    On a more immediate level, fuel shortages are a fiction. I’m not aware of a single gas station that’s unable to refill its fuel tanks or factory unable to obtain required petrochemicals or plastics.
    Well, yes, that’s what the free market does. It prevents shortages, in part, by increasing the price to almost $4/gal. Shortages happen when some clever politician tries to put a lid on prices. That increases consumption and decreases production, leading to shortages.

    The way I see it, we have to thank $130/bbl for preventing shortages. Tomorrow it may need to go up even further, since we’re not really conserving that much, just yet…

  • avatar
    Pch101

    It is more a question of the rate of consumption getting awfully close to the rate of production.

    That’s the point — this hasn’t changed. Demand is stable, and supplies are being produced at rates that are adequate to serve demand.

    With flat demand and sufficient (not abundant, just sufficient) supplies, oil prices should also be fairly flat and uneventful. Yet they aren’t, they have actually doubled during this period of plateau.

    The price increases of the last two years really make no sense at all, in light of the supply and demand numbers. Oil should be a fairly boring commodity with ho-hum returns and no growth factor.

  • avatar
    Engineer

    Demand is stable Beg to differ, champ, and EIA agrees with me, line 39 in the referenced table shows Total World Demand. Note that Q4 2007 (the most recent on record) demand (86.61 million bbl/d) is the highest on record. Ditto for 2007 calendar year (85.35 million bbl/d).

    If you have data that shows different, I’ll be happy to consider it.

  • avatar
    Engineer

    Also of interest: if you calculate the difference between supply (line 26) and demand (line 39), you’ll see that demand exceeds supply on an annual basis for the first time in 2007 (by 760,000 bbl/d). Interestingly Q1 2007 and Q4 2007 shows roughly the same excess demand (1.13 million bbl/d). Anybody betting against Q1 2008 demand exceeding supply by an even larger number?

    So much for the speculators. It is all supply and demand.

  • avatar
    Pch101

    Beg to differ, champ, and EIA agrees with me

    I’m looking at the same data. Demand for 2007 increased a whopping 8/10th of a percent from 2006, which is a slowing in growth and a modest increase in consumption. The deficiency is about the same amount, and is offset by draws as supply ebbs and flows, as it does over time.

    Nothing in that data suggests that oil should have doubled in price, in light of the supply and demand. For all intents and purposes, the figures are static.

    Supplies are sufficient. If they weren’t, we would have rationing because we would have to prioritize our usage according to the national interest. Clearly, we can function on the current supply level, or you’d be seeing substantially greater problems than higher prices.

  • avatar
    nonce

    Crude closed at $133 a barrel today, up over $3.

    All those people claiming that this is “just a bubble” can make an absolute killing on the futures market when the bubble pops.

    Have you done so? Have you put your money where your mouth is?

  • avatar
    Engineer

    I’m looking at the same data.
    Apparently not. Did you fail to notice that supply is not keeping up with demand, as I pointed out above?

    Nothing in that data suggests that oil should have doubled in price, in light of the supply and demand. For all intents and purposes, the figures are static.
    Except that supply is failing to keep up with demand.

    Demand for 2007 increased a whopping 8/10th of a percent from 2006, which is a slowing in growth and a modest increase in consumption.
    Supply, OTOH, has been flat since 2005, as shown by the average supply figures:
    2005: 84.63 million bbl/d
    2006: 84.60 million bbl/d
    2007: 84.59 million bbl/d

    Compared to that your 8/10th of percent growth in demand. Doesn’t sound like a lot, unless supply does not keep up…

    Supplies are sufficient.
    No, there was a 760,000 bbl/d shortfall for 2007, on average. In spite of high prices. Expect prices to keep rising until supply and demand pull level again…

    If they weren’t, we would have rationing because we would have to prioritize our usage according to the national interest.
    Think of $4/gal as a form of free market rationing. As in: How badly do you need to drive today?

    Clearly, we can function on the current supply level, or you’d be seeing substantially greater problems than higher prices.
    You really don’t get supply and demand, do you? We can function at any supply level. The question is just what the price would be to make it work.

    That’s the beauty of capitalism: there’s never a shortage – just some (potential) consumers priced out of the market.

  • avatar
    William C Montgomery

    UPDATE #2: this from BusinessWeek today.

    “[Commodities] are experiencing demand shock from a new category of speculators: institutional investors like corporate and government pension funds, university endowments, and sovereign wealth funds,” said Michael Masters, managing member of Masters Capital Management, a Virgin Islands-based hedge fund. “Index speculators are the primary cause of the recent price spikes in commodities.”

    The explosion in the number of financial players in the energy markets has occurred particularly in the past two years—also a period of soaring energy prices.

    Speculative activity in commodity markets has grown dramatically over the last several years. In the past decade, the share of long interests—positions that benefit when prices rise—held by financial speculators has grown from one-quarter to two-thirds of the commodity market. In only five years, from 2003 to 2008, investment in index funds tied to commodities has grown twentyfold, from $13 billion to $260 billion.

    Some analysts say that as commodities markets have been deluged with investment bank money, supply and demand has been rendered less relevant, to the detriment of consumers and producers and marketers. In a May 9 research note, Lehman Brothers (LEH) economists argued that oil’s recent rise has been fueled by “non-supply-demand factors and by potential inventory misperceptions.” In other words, the dollar weakening and “investors’ desire to be exposed to real assets” has spurred increased inflows from investors biased toward long positions. Additionally, hedge fund director Masters points to data showing that over a five-year period, China’s demand for oil has increased by 920 million barrels, while over the same period, index speculators’ demand has increased by 848 million barrels.

  • avatar
    Pch101

    Have you done so? Have you put your money where your mouth is?

    The average person reading this doesn’t have enough money to buy futures contracts and cover the margin calls, so that point is moot.

    You’d have to substantial wealth or institutional money to speculate in this market. You can’t just go to your Etrade account, throw a bit of 401k at it, money and benefit from your forecasting.

  • avatar
    Pch101

    Did you fail to notice that supply is not keeping up with demand, as I pointed out above?

    What you fail to notice is that the relatively small amount of demand not met by supply is fulfilled from stock draws, so there is no shortfall net to the consumer. Sometimes we add to supply, other times we draw upon it.

    Just so long as the imbalance is within a modest range, as it is now, the system still works. If there were bona fide shortages, we would have rationing. Supplies are sufficient as they stand today. We aren’t bursting with oil, but we aren’t short of it, either.

  • avatar
    menno

    See my above (1st comment) on this stream about my prediction for next Memorial Day 2009 – $12 pe gallon.

    I’m really NOT psychic, my friends.

    http://www.businessandmedia.org/articles/2008/20080521145247.aspx

    Plus I have no more “inside information” than anyone else, in fact, probably less.

    And no, I didn’t see his February article either.

  • avatar
    Engineer

    What you fail to notice is that the relatively small amount of demand not met by supply is fulfilled from stock draws, so there is no shortfall net to the consumer. Sometimes we add to supply, other times we draw upon it.
    Fair enough. And what would continued draw on stocks do to prices?

    If there were bona fide shortages, we would have rationing.
    No, in a free market system you have super-spikes in price. You will always be able to get all the oil you can pay for. It is just that the oil you can pay for changes.

    We aren’t bursting with oil, but we aren’t short of it, either.
    And that is @ $130/bbl. If you predicted $130/bbl a year ago, most people would have assumed it would lead to:
    1. Riots.
    2. Drastic reduction in demand.
    3. Explosive growth in supply.

    At the moment none of the three is happening (remember we’re talking global demand), suggesting that more expensive oil is in our future.

    Additionally, hedge fund director Masters points to data showing that over a five-year period, China’s demand for oil has increased by 920 million barrels, while over the same period, index speculators’ demand has increased by 848 million barrels.
    How does that work, William? Surely the 850 million bbl the speculators demanded was/is/will be returned to the market. There can’t be any sustained demand from speculators, can there?

    I don’t know, maybe the speculator bubble bursts, bringing us all the way down to $100/bbl (cheap!) at Labor Day, before we climb back up to $150/bbl by New Years. I just don’t see that speculators are a significant factor in this.

  • avatar
    nonce

    See my above (1st comment) on this stream about my prediction for next Memorial Day 2009 – $12 pe gallon.

    I’ll say the same thing to you that I say to the folks who are predicting a massive crash in oil prices: if you really believe this, you can make a fortune. You’ll beg, borrow, or steal to get the capital needed, and live like a king for the rest of your life.

    My dad was a private school teacher and found money to invest in currency options. Of course, it’s a lot easier to peck wildly at your keyboard than it is to call up your broker and ask him how you can invest in oil.

    Or the folks predicting the massive prices increases can get together with the folks predicting massive price collapses and just make some bets.

  • avatar
    Steven Lang

    It’s already happening. There are over 70 exchanges where you can use either a futures or forward contract to bet on the price of oil.

    I seriously hope we get this monkey off our backs in the next few years. No thought makes me more ill than the possibility of spending thousands of dollars to support these corrupt and inhumane ‘OPEC’ governments.

  • avatar
    menno

    Just found this on autobloggreen, thought I’d share.

    I pretty well can’t add much to this, since T. Boone Pickens is the oil expert of oil experts.

    http://www.autobloggreen.com/2008/05/21/avfi-2008-t-boone-pickens-lays-the-future-of-oil-and-alternati/

    But in case you’re too busy or lazy to copy and paste the link to read it, I’ll quote the most important part for you here:

    “The main problem, Pickens said, is that 85 million barrels a day is as much oil as the world industry can produce. That’s it. More simply isn’t possible. The trouble is, in the next quarter, demand will be around 86.5m barrels each day”

  • avatar
    jerseydevil

    If these are the same speculators that caused the real estate implosion, we should be realy scared.

  • avatar
    Martin B

    The Lehman Brothers quote is from OPEC’s “Monthly Oil Market Report” from http://www.opec.com. There’s lots more in there. They also say the OPEC nations could pump 3 mb/d more, so supply shortage is not the cause of high prices. There’s no hoarding of crude by speculators (stored stocks are normal.)

    OPEC puts high prices down to speculation on the futures market. Obviously when buyers and sellers are haggling about the price, the sellers can say “Buy now at this high price because it’s going to get even higher,” and the buyers are looking at futures prices and believing them. You don’t get what you deserve, you get what you negotiate.

    A couple of other points from the OPEC report. Since 2000, diesel demand has risen 5.2 mb/d but gasoline demand has risen only 2 mb/d. However, refiners have built an extra 1.2 mb/d gasoline capacity but only 0.7 mb/d extra diesel capacity. Conclusion: Diesel will be expensive for a long time to come.

    To produce diesel where the refinery isn’t optimised for diesel, they have to use expensive sweet crude rather cheaper sour crude as feedstock, pushing up the price even further.

  • avatar
    Engineer

    Take a look at this graphic of supply and demand. It makes pretty clear which way things are going. I also suggests that supply is leveling off, leaving only lower demand as a control mechanism, a view supported by comments from the IEA. So far there is little indication that price is throttling global demand, although America seems to be leading the world on that one.

    OPEC puts high prices down to speculation on the futures market.
    And you believe them? Boy, they have some (more) black gunk the want to sell you! Do you believe them when they blame high oil prices on low refinery capacity in the US? Think about that one: refineries buy oil and make gasoline. Low refinery capacity should mean low oil prices, but high gas prices. Currently we are seeing the opposite, although gas prices seem high, thanks to the astronomical oil prices. Still, these market conditions are killing refiners.

    Interesting points about diesel, though.

    If these are the same speculators that caused the real estate implosion, we should be realy scared.
    A large part of the real estate bubble was due to creative financing: “Bad credit? No problem! Buy with a low rate and no money down! We beat any other offer!” Hopefully these speculators are playing with (more of) their own money.

  • avatar
    Pch101

    A large part of the real estate bubble was due to creative financing

    Not really. The real estate bubble of the late 80’s was created with exotic loan products, but the bubble that is bursting as we speak was created by rather straightforward loan products, but with low loan-to-value ratios and aggressive marketing. There was a lot of money chasing deals, so the investors were willing to accept low returns (the equivalent of paying high prices) to get into those deals.

    Which is the point that Mr. Niedermeyer is making. Speculators aren’t buying oil to burn, they’re buying oil futures contracts. The premium being exacted is really being paid for the privilege of playing in the market, not for taking delivery of the oil.

    The flood of capital into the speculative market, coupled with flat demand for the product itself, is a classic indicator of a bubble.

    And like these mortgages that went bad, commodities are also highly leveraged. You can control a 1,000 barrel contract of oil with about $10,000. They are just as leveraged as were all those mortgages securities that just imploded.

  • avatar
    Engineer

    The flood of capital into the speculative market, coupled with flat demand for the product itself, is a classic indicator of a bubble.
    We’ll know soon enough. At these prices they can’t be attracting too much new money. When the new money disappears, the pyramid scheme collapses, and the price will be set by supply and demand.

    I’m not expecting much of a drop. We’ll see.

  • avatar
    carlos.negros

    I have to believe that the high prices are more than supply and demand because the price of crude oil has doubled in just the past year. What has happened just over the past year to increase demand that much? The other factor is speculation. But speculation could be tamped down if the government or OPEC wanted to do it. Releasing oil now and again would put more risk into the speculation.

    Anyway, if it only a matter of the cost of the crude, why would Exxon and the other pirates be making record profits? Something is rotten in Washington.

  • avatar
    Engineer

    Anyway, if it only a matter of the cost of the crude, why would Exxon and the other pirates be making record profits? Something is rotten in Washington.
    Carlos,
    I believe you are confusing production cost with supply, specifically the ability to increase supply. As Dave Wxp mentioned, it costs the Saudis on average probably about $5/bbl to pump oil. So, true, @ $130/bbl they are swimming in profits. It does not imply that they can simply open a tap and significantly increase their production, although they keep assuring us they can. As you would expect them to.

    Did any of you see the Energy Secretary, Sam Bodman, testify before the select committee on energy independence and global warming, yesterday? He explained that he believed the current prices are driven by supply and demand, and along the way he also sounded like he knew what he was talking about, unlike many of the Congresspeople.

  • avatar
    carlos.negros

    Engineer,

    If the current high prices are due to supply and demand, then why have they increased so much so recently? Can you point to some specific development in China or India, for example, that would have reduced the supply so much to account for these price increases?

  • avatar
    Engineer

    Carlos,
    The recent price increases are partly a delayed reaction to the supply/demand mismatch shown in this graph. The graph would suggest that $40, 60 and 80/bbl did little to reign in demand. Before you know it, we’re zeroing in on $140/bbl.

    Of course, the numbers are probably not 100% accurate, and it would be nice to have more recent figures, but let’s make lemonade with what we have.

    Also of interest: Note that stock draws (line 48 in the Table I referenced above), goes from negative (i.e. people building their oil stocks) to positive for the first time in 2007. Well, I would guess that some of these sellers got nervous over the last few months, and either stopped selling, or maybe even started building their stocks again, perhaps believing that worse lies ahead.

    Other factors keeping demand high, include subsidized gas prices in China and many oil exporting countries (who can afford it), as well as China’s chronic shortage of electrical power (with the difference made up by diesel burning generators).

    To that mix add Hugo Chavez playing roulette with his oil fields (After kicking out Big Oil: “Lost production? No problem, prices would just go up!”) and Russia’s determination to extract respect via oil price from the West.

    And then we haven’t even talked about the usual suspects (OPEC, Iran, lost oil production from Iraq, etc.).

  • avatar
    carlos.negros

    Both China and India subsidize their domestic fuel prices. No change over the past year.

    Chavez: How much lost production can you site?

    Russia: No change over the past year in policy, AFAIK

    Iraq: No change over the last year. In fact, any change since the oil stopped after the invasion in 2003?

    OPEC: No change over the last year.

    IRAN: Part of OPEC – what are you saying they cut back production?

    Investing in oil stocks should not raise the price of oil. If anything, it gives oil companies more money to invest in drilling.

    Demand: Again, I have not seen that demand is that much higher versus supply than one year ago.

    Two theories you don’t mention: 1) Collusion by the oil industry (it HAS happened before)
    2) Market speculation and manipulation by big market makers.

    My personal vote is for some powerful market speculators. I am waiting for the New York Times to come out and tell us who is doing this. I also wouldn’t be surprised if whomever is doing this is a covert agent working in the interest of a foreign power.

  • avatar
    Pch101

    To follow on to what Mr. Niedermeyer posted in respect to increased commodities investments, consider the following:

    -Since 2005, world demand for oil increased by 2.0%.

    -Since 2005, the number of open interest crude oil futures contracts roughly tripled.

    -Over that time, the price of oil increased from about $50 per barrel to its current level.

    Compare those first two figures. Demand for the commodity (people using oil for its intended purposes) increased 2%. The rate of demand for oil investments (speculators attempting to profit on the price of oil, but who have no intent of using it for themselves) increased by about 300%.

    It’s not surprising that the price of oil went up, given the flood of capital that has joined the fray. Very much a replication of what just imploded in the mortgage markets. As was the case with this, the demand for home mortgages by legitimate end-users (people buying homes to live in them) was well outpaced by investors jumping in trying to profit from mortgage-backed securities.

    This article provides a helpful summary:
    http://www.timesonline.co.uk/tol/comment/columnists/anatole_kaletsky/article3980797.ece

  • avatar
    carlos.negros

    Pch101 – Great article. It makes the point I was trying to make, only much better.

    The take away was:
    “The good news is that the world is not as impotent as is often suggested in the face of this danger, since soaring commodity prices are not the ineluctable outcome of some fateful conjuncture of global economic forces, but rather the product of a typical financial boom-bust cycle, which could be deflated – especially with some help from sensible political action – as quickly as it built up.”

  • avatar
    nonce

    Compare those first two figures. Demand for the commodity (people using oil for its intended purposes) increased 2%. The rate of demand for oil investments (speculators attempting to profit on the price of oil, but who have no intent of using it for themselves) increased by about 300%.

    Without knowing the scales of those 2 numbers, we cannot draw any conclusions such as “the recent price increase is due to a market bubble.”

    That 2% increase in demand means a lot when demand was starting at 85 billion barrels a day, especially when the demand curve is inelastic and supply is difficult to raise. That 2% means a daily increase of 85 billion dollars a day at the old price of $50 a barrel.

    But what does a tripling(*) of options means? If we’re putting $165 billion more into the options market, that’s less than 4 days of oil supply at the old price (and less than 2 days at the new price).

    Of course Congress needs to “do something,” and blaming the eeeeeeevil market is always a winner.

    (* Someone who calls a “tripling” an “increase of 300%” probably isn’t someone from whom you want to get your investment advise.)

  • avatar
    Potemkin

    Shell Oil in Canada recently shut down their Sarnia Ontario refinery for “unscheduled maintenance”. This caused a shortage of gas a several Shell station. Sound familiar? In it’s good times Enron was scheduling uncheduled maintenance which caused artificial power shortages which in turn boosted the price of energy on the energy market.

  • avatar
    carlos.negros

    Nonce: The two percent increase in demand is over the last three years. The doubling of crude prices is over the last year. It would appear that the demand figure does not explain the price increases over the past year.

    I don’t think pointing a finger at unregulated hedge funds is the same as “blaming the eeeeeeevil market”

    Transparancy is vital to a free marketplace. Hedge funds that operate under the radar are the issue. What is to keep rich oil producers from using these hedge funds to drive up the price of oil futures without anyone noticing?

  • avatar
    Pch101

    Without knowing the scales of those 2 numbers, we cannot draw any conclusions such as “the recent price increase is due to a market bubble.”

    You most certainly can. There was an active, mature oil futures trading market before 2005. The number of contracts in the market tripled by the end of 2007.

    It’s pretty obvious what’s going on here. Futures contracts have ceased simply being a hedge for producers and have morphed into a giddy betting frenzy for the investment community. Commodities have become the next playing field for short-term capital plays, and a lot of hedge funds and institutions are trying to profit from it.

    As noted in the Times article above, there isn’t just supply and demand for the commodities, but also demand for the chance to bet on the commodities. This changes the dynamic because this pushes the futures markets well beyond the hedge function that they were intended to serve, and it invariably heats up the price of the underlying commodities for reasons other than supply and demand for the actual products.

    This is dot.bomb and mortgage meltdown redux. When this party ends, they’ll have to find another place to play. If you can figure out what that sector is before the fact, you’ll make money, too.

  • avatar
    Pch101

    The first chart linked below tells the tale. Notice how the number of open interests were consistently fluctuating within the 500,000-1,000,000 range from 1996 until about 2005.

    Since then, that number of contracts has soared sharply and tripled in number. Odd to find all that interest for investments in a commodity whose actual demand increased by 2% over the same timeframe.

    http://levin.senate.gov/newsroom/supporting/2008/energycharts.051208.pdf

  • avatar
    limmin

    A decent article, and I know the author was short on space, but his major facts are wrong.

    In fact, U.S. refineries are operating at full capacity, not 85 percent. There are temporary lulls as the refineries retool for summer blends….but 85 percent is just plain wrong.

    If we drilled in Alaska, and along our coastline, it would increase supply, thus lowering price. That’s a basic economic tenet. OPEC would not decrease production because there is worldwide demand not just from the U.S. But drilling on our own sends a message to OPEC: America wants energy independence. That’s a big incentive for them to keep pumping.

    If the author’s logic were true, then why was gas so cheap 10 years ago? 5 years ago? Why didn’t OPEC adjust its drilling to keep the price high?

    There is a shortage of supply and that is no myth.

  • avatar
    nonce

    Without knowing the scales of those 2 numbers, we cannot draw any conclusions such as “the recent price increase is due to a market bubble.”

    You most certainly can. There was an active, mature oil futures trading market before 2005. The number of contracts in the market tripled by the end of 2007.
    Horsefeathers. You just ignored my point and repeated your assertion.

    If my neighbor quintuples his gasoline usage, it doesn’t mean squat for oil prices, even though “400% increase” looks bigger than “2% increase.”

    A tripling of the futures market might mean something if it put trillions of dollars into the market. But when billions of dollars of oil are consumed every single day, you need a big scale to push things around.

    Now, you might only need 2 people with irrational exuberance to bid an auction up to infinity, but this is a very vibrant market that gives people the ability to bet against the bubble. The obvious question is why none of the investment banks have moved against this market. Puts are just as liquid as calls.

  • avatar
    Pch101

    You just ignored my point and repeated your assertion.

    No, I just pointed out the core reason why your argument falls flat.

    For an extended period of time, we can see that the oil futures market comprised some quantity of oil. Within a short period of time, we see three times more oil entering that market, climbing rapidly as part of a notable, unusual spike that is a historical anomaly.

    Clearly, something is going on here which is unusual. The current figures defy the norm. Since data tends to move around equilibrium points around a norm, what is occurring today is not part of a normal trendline.

    If three times as many Americans died, or got cancer, or bought peanut butter, or whatever, in 2007 as compared to 2005, and if the figures for the decade prior had been stable, then we’d all ask ourselves what’s going on here.

    The oil futures market was not invented in 2005. It has been with us for a long time, so it is noteworthy to see a market that had a stable amount of investor attention suddenly triple the number of contracts that is being traded through it.

    You can bang on all day trying to claim that bubbles are impossible, but it’s really difficult to believe that you could earnestly believe that bubbles aren’t possible when we just had two sizable bubbles burst within the last eight years.

    Those bubbles would be for the internet and mortgage markets, of course. The pattern here is exactly the same: some legitimate uptick in end user demand catches the eyes of investors, who then run in trying to take advantage of it to such an extreme that prices start rising as they compete with each other to buy more investments. In the case of the mortgage markets, that extreme increase in attention also served to push up the prices of the underlying product (homes and real estate) paid by the end user, just as it has with oil.

    So yes, a tripling in the number of contracts in a mature market, over a period of time that the demand for the product rose 2% (meaning an unimpressive annual compound growth rate of less than 1%) is notable and unusual, and it helps to explain much of what is happening today.

  • avatar
    nonce

    The oil futures market was not invented in 2005. It has been with us for a long time, so it is noteworthy to see a market that had a stable amount of investor attention suddenly triple the number of contracts that is being traded through it.

    Cum hoc ergo propter hoc. Tripling of oil options has occurred, but that doesn’t explain rising oil prices, besides “they both happened at the same time.”

    You can bang on all day trying to claim that bubbles are impossible.

    Straw man. I’ve never claimed that. (Some very prominent economists have insisted that this absolutely cannot be an oil bubble. I’m not convinced that that’s so.)

    If someone wants to claim we’re in a bubble, it’s their job to prove their claims, not up to others to disprove them. And I have the same demands for people predicting $12 a gallon gasoline based on fundamentals.

    You are painting a picture that there is a massive amount of free money sitting on the table that the investment banks and hedge funds and pension investors and wealthy individuals and normal individuals could just grab, but aren’t. It’s a lot easier to short-sell an options bubble than a biotech bubble or a real estate bubble.

  • avatar
    Pch101

    Tripling of oil options has occurred, but that doesn’t explain rising oil prices, besides “they both happened at the same time.”

    Of course it does. Investor interest and the resulting dumping of capital into the market serves to bid up prices.

    It’s a lot easier to short-sell an options bubble than a biotech bubble or a real estate bubble.

    That misses the point. Investors betting on the greater fool theory take long positions, because they assume that the greater fool will bid them up. That’s precisely what happened with internet stocks.

    It is a mistake to confuse short-term price movements with long-term demand trends. Under random walk theory, we already know that prices don’t typically march in one direction over the short-run. When they do, as has been the case with oil recently, then that’s another classic sign of a bubble. What goes up must come down.

  • avatar
    Engineer

    Great debate guys!

    The first chart linked below tells the tale. Notice how the number of open interests were consistently fluctuating within the 500,000-1,000,000 range from 1996 until about 2005. Since then, that number of contracts has soared sharply and tripled in number. Odd to find all that interest for investments in a commodity whose actual demand increased by 2% over the same timeframe.
    Pch, I note that since January 2007 the number of contracts increased from ~2.4 million to 3 million, or by ~25%. This caused a (more than) doubling of oil prices? Why did the increase from 700k (Jan 2004) to 2.4 million have such a small effect, relatively speaking?

    Since 2005, world demand for oil increased by 2.0%.
    True. But somehow supply cannot keep up, even at $130/bbl. 2% sounds like nothing, but it can have a huge effect, if the necessary supply fails to come to market.

  • avatar
    Engineer

    Two theories you don’t mention: 1) Collusion by the oil industry (it HAS happened before)
    2) Market speculation and manipulation by big market makers.
    1. Horse manure. Unless you have facts to prove it happened.
    2. This has been investigated numerous times, as mentioned: Whenever gasoline prices surge unexpectedly, Congress routinely vents its anger by ordering the Federal Trade Commission to investigate the oil industry for collusive practices. Invariably, the studies exonerate the industry. (Emphasis added)

    I know, I know. These evil oil companies are too clever to be caught. They have the politicians in their pockets. Along with the patents for cars that run on water. Blah-blah-blah.

    More likely: there is nothing there. But who’s going to let the facts spoil a nice story?

  • avatar
    Engineer

    Shell Oil in Canada recently shut down their Sarnia Ontario refinery for “unscheduled maintenance”. This caused a shortage of gas a several Shell station. Sound familiar? In it’s good times Enron was scheduling uncheduled maintenance which caused artificial power shortages which in turn boosted the price of energy on the energy market.
    You gotta be kidding. These guys work with a very flammable product, as several recent refinery fires prove. S**t happens. Unscheduled maintenance is like taking your car in because it died in traffic. It does not mean you are (cleverly) trying to slow down the traffic on the freeway.

    Also note: While the ensuing higher prices is great for all its competitors, Shell looses money while that refinery is doing the unscheduled maintenance.

    Yes, Enron did manipulate the electric market. Even they did not manage the same thing in the liquid fuels market. What does that tell you?

  • avatar
    Pch101

    Pch, I note that since January 2007 the number of contracts increased from ~2.4 million to 3 million, or by ~25%. This caused a (more than) doubling of oil prices?

    Wrong time period. As I noted above (and check the graphs in the linked PDF file), the surge in speculative activity began around 2005.

    During 2004, oil demand increased 3.4%, as part of a global economic boom, while oil prices fluctuated between $30-40, as it had the year prior, but double what it had been around 9/11.

    Combine this with the quagmire in Iraq creating uneasiness about conditions in the Middle East and the weak dollar, and speculators got excited around 2005. They dived into the market — by the end of 2006, they were so numerous that they served to increase the number of futures contracts by 2.5 times, an unprecedented level well above anything seen in the prior decade.

    At this point, the prices of contracts are feeding the market. Futures traders betting against each other are doing more to pricing than actual demand, which is slowing. Demand growth for oil during 2006 and 2007 combined was just 2/3rd’s of what it was during 2004 alone, the year that triggered this surge of investing. The rush to oil has been on the investment side, not in the consumption side. (And no, there are no genuine supply shortages, otherwise we’d have rationing.)

    All of this points to a bubble. There are signs that the futures market may be weakening. The number of open positions is starting to decline, and recessionary news won’t help.

    What could pop the bubble would be an immediate cessation of the war, as that has stimulated a lot of the betting, as has the weakening dollar that is also the byproduct of the war. What would make it hiss is the economic decline, which appears to be taking hold throughout the west and is sure to impact China’s exports and domestic GDP growth.

    Prices will probably surge before they fall, but a decline is probably coming. If a Democrat wins in November, that should push it over (all bets are off if McCain wins), but recession news alone might just be enough.

  • avatar
    nonce

    How much of the current price of oil is attributable to the bubble?

  • avatar
    Engineer

    And no, there are no genuine supply shortages, otherwise we’d have rationing.
    You still don’t get it, do you? The reason we don’t have rationing (or gas lines) is $130/bbl and $4/gal. Those things are keeping supply and demand in balance, for now.

    At some point these sky high prices would lead to increased supply (apparently not yet) and lower demand (slowly starting to happen). Eventually, this would lead to lower prices. Apparently, we are not there, yet.

    To get rationing, you need a dimwit politician (such as Richard Nixon) to try to put a cap on prices. Will that happen again? Quite possible, given the supply of dimwits in Washington DC. Let’s hope the demand for dimwits stay low, although that can’t be guaranteed.

    Demand growth for oil during 2006 and 2007 combined was just 2/3rd’s of what it was during 2004 alone, the year that triggered this surge of investing.
    You have to remember that 2004 brought an unexpected spike, which pretty much caught the market with its pants down. Some claim the 2004 spike was related to demand for electric power in China, which the grid could not satisfy, and was ultimately satisfied by diesel-burning generators.

    Also of interest: a claim that ANWR oil would reduce the oil price by… wait for it, $0.75/bbl. Whoopee!

  • avatar
    Pch101

    You still don’t get it, do you?

    Er, I’d whip suggest that you break out your mirror out before you start pointing fingers.

    You’ve begun contradicting yourself. Now, you’re arguing that supplies are in balance (which is odd, since that’s what I’ve been doing throughout this discussion.) Yet despite supplies being in balance, and demand slowing down, you see a rational demand-based reason for prices to increase about 2.5 times and demand for oil contracts to increase by 3 times.

    I’m curious — have you ever before spotted a speculative bubble before the fact, or have you always steadfastly believed that markets never get overheated? I get the feeling that had we been talking about mortgages two years ago that your points would be identical, i.e. that the capital markets are always rational. Until, of course, they aren’t.

  • avatar
    nonce

    Pch101:

    How much of the current price of oil is attributable to the bubble?

  • avatar
    Pch101

    Nonce, I get the feeling that you are a vigorous proponent of Peak Oil.

  • avatar
    nonce

    If you read what I actually write, instead of what you wish I had written, you’d see that I am just as suspicious of the peak-oil and $12-a-gallon people as I am of the it’s-just-a-bubble people.

    The big problem I have with peak oil was the non-falsifiability of it; every month that peak oil didn’t happen, they got more convinced that it was going to happen. That’s pretty much what I’m seeing here; every month that the oil bubble doesn’t pop, some folks become more convinced that there’s a bubble.

    That’s why I’m trying to get you to say something that’s testable. For example, how much of the current price of oil is attributable to the bubble?

  • avatar
    Pch101

    OK, Nonce, I gotcha — you just want to be angry with everyone.

    I’ll throw out some numeric ranges (I actually have done this on other discussion threads on this website, so I’m not adverse to doing so), but I’m curious to know what data you have to defend your position, and for that matter, whether you have a position aside from being a contrarian.

    I’ve gone to great lengths to detail why I see a bubble. You can disagree with it, but clearly I didn’t pull that supposition out of thin air, nor is it based upon a conspiracy theory.

    What you base your antipathy on, I don’t know. So a bit of transparency on your part might be nice.

  • avatar
    nonce

    You can try and make this about me as much as you want. And I don’t really care if you insult me. I’m not in middle school so I’m not hurt when some random person accuses me of “being angry with everyone.”

    My position is “science is good.” Science doesn’t try to “take sides”; it evaluates evidence.

    I’d really like some falsifiable hypotheses that we can use to test your theory; for example, “if oil is still over $100 a barrel twelve months from now, there wasn’t a bubble.” You can choose another test if you wish.

    I’d also really like to know how much each marginal unit of investment increases the marginal price of oil.

    There are those and the other questions I’ve asked that have all been ignored, so I’ve just tried to settle on one, that I ask for the fourth time here: how much of the current price of oil is attributable to the bubble?

    If insulting me first makes answering that question easier, that’s okay. I’ll take one for the team. Just have the decency to answer the question after doing that.

  • avatar
    Pch101

    My position is “science is good.”

    Pardon me for pointing out that such a statement (a) is nebulous, (b) fails to address my question requesting whatever data, if any, that you may have used to formulate your position, whatever that position may be, and (c) need not be accompanied by your clear penchant for evasive condescension.

    I can sense that you want to manage and moderate this thread, but that is not your prerogative. If you want to have a conversation, that’s fine, but I am not going to ask “How high?” when you rudely demand that I jump.

  • avatar
    nonce

    More insults but no answers.

    I’m sure enough other people have now seen that you are either unwilling or unable to answer the straightforward question how much of the current price of oil is attributable to the bubble?

    If you want to promote your position, you have the burden of proof.

  • avatar
    Pch101

    I’m sure enough other people have now seen that you are either unwilling or unable to answer the straightforward question how much of the current price of oil is attributable to the bubble?

    Not sure how that’s possible, as I have actually posted that on other threads of this website. I’m making no secret of my position on this topic. At this point, I’d prefer that you just search for it yourself, given your obvious charms.

    If you want to promote your position, you have the burden of proof.

    I have done that in abundance, as you will note in the links and data that I have referenced above.

    You, on the other hand, have provided nothing but shrill rejoinders. Other than being fond of science as you define it, I’m curious to know what issues you have with the information that I’ve provided thus far. So far, you seem to find it objectionable, but you’ve kept it a secret as to why you might.

  • avatar
    Engineer

    I’m curious — have you ever before spotted a speculative bubble before the fact, or have you always steadfastly believed that markets never get overheated?
    Thanks for asking: Actually I have. I saw the housing bubble long before it happened, too long as it turns out. If I’d simply taken the plunge five years ago, I probably would have come out ahead, in spite of recent developments.

    Which brings up the matter of timing: right now, with oil trading at ~$130/bbl US demand is taking a dive. World demand: who knows? Based on the fact that prices are subsidized in many markets, I wouldn’t be holding my breath. At some point though, even world demand has to face up to reality. Just how much can any government spend on these subsidies?

    I don’t consider it likely, but it is certainly possible that $130/bbl will hurt demand enough so that prices start going in the opposite direction. But as you point out with the example of the housing bubble, it is almost impossible to predict when this will happen.

    Now, you’re arguing that supplies are in balance (which is odd, since that’s what I’ve been doing throughout this discussion.)
    Forgive me, but you still don’t get it. You seem to think that since there are no shortages (as happened in the 70s), oil prices should be lot lower ($80/bbl?). Now if only we could rid ourselves of those pesky speculators.

    My point is that this is exactly how the free market operates. According to the market, we need $130/bbl (and $4/gal) to prevent those shortages you (and author William) are looking for. Suppliers and consumers agree about this, even though one group is obviously much happier about this than the other. If you’re not happy with $4/gal, don’t buy. Easier said than done, I know, but that’s the free market for you.

    Again, timing comes into this. $4/gal may hurt like hell, but you might not have any short term options to relieve the pain. If prices stay at these levels, or even increase further, you’d start to make long term adjustments: you may move to reduce driving, buy a move fuel efficient car, etc. to reduce you consumption. Hence it may take a while for us to see the full effect of these prices.

  • avatar
    Pch101

    Forgive me, but you still don’t get it.

    Here’s another guy who apparently doesn’t get it: George Soros. His recent comment on the subject: “The price has this parabolic shape which is characteristic of bubbles.”

    My point is that this is exactly how the free market operates.

    And that’s not a very good point. Because while the free market of commodity users has been growing at a below-average rate for the last two years, in comparison to the last 25 years’ worth of demand growth, the interest of investors trying to profit from it has tripled over the last three years.

    You don’t realize it, but you’re contradicting yourself. Your argument is effectively, There can’t be a bubble, because the free market creates equilibrium prices by default. Except you’ve already admitted that a bubble did burst in the real estate sector, which proves the point exactly that prices are not always near equilibrium.

    Free markets don’t prevent bubbles. On the contrary, active speculative markets encourage bubbles when speculation soars above a normal level.

    There are two forms of demand: demands from end users of the product, and demands from traders. The product is ultimately the same, but those who want to consume the product view it very differently than those who consume investments in the product.

    Usually, the traders are a small enough group that they don’t influence the price, there usually aren’t enough of them to make a difference. But at times like these, when their number of positions has tripled compared to normal and when they keep trying to day-trade their way to success, they do become important factors in determining the final cost, but only temporarily. Just as we saw with real estate, and prior to that with internet stocks.

    The speculative interest in oil is based more upon the ongoing Iraq war and the uncertainty it brings than demand for oil itself, which is growing at 2/3rd’s of its normal pace. If you look at US stocks, you can see that those levels are in line with the norm, so there is no shortage. There’s no need to panic about supply when demand has been tapering off since 2006, when oil was half this price.

    Free markets don’t change basic math: Ample supply + relatively low demand usually equals moderate prices. Prices today are anything but moderate.

    As George Soros notes, steep short-term price increases indicate a bubble. Short-term trends that move sharply in one direction are not sustainable over the long run, because prices don’t normally behave like that when demand is normal or below normal.

  • avatar
    Engineer

    Here’s another guy who apparently doesn’t get it: George Soros.
    Wowa! You mean Soros is going to be wrong for once? Amazing!

    Your argument is effectively, There can’t be a bubble, because the free market creates equilibrium prices by default.
    Tell you what, let me tell you what my point is, effectively or otherwise. You tell me what your point is.

    Bottom line: as shown by the graphs I linked to, its supply and demand. Not that markets are always in equilibrium. These prices may well cause long term demand destruction. Whether that means lower prices will depend on how much supply these prices can bring to market. So far it’s not looking good. We’ll get back to that.

    Just as we saw with real estate, and prior to that with internet stocks.
    There are some key differences between speculation with real estate and speculation with oil futures. Let’s review:
    – Real estate: There is no physical difference between a speculator and someone buying a house to live in. The speculator can hold onto the house for decades, if the market stays strong that long. In fact, a rising market would encourage the speculator to increase his portfolio. The only thing that limits how much a given speculator can buy, is his access to credit. Given the creative financing (call it aggressive or risky if you must), the speculators kept buying and the bubble kept inflating.
    – Oil futures: The oil future trader obviously cannot hold onto his contract for a long period of time. To get more speculator demand, you need more speculators or more money flowing from the same speculators. As you have shown, over the last few years the number of contacts has increased. This is confirmed by some of the numbers that William reported. Obviously this has had some effect on oil prices. However, the severity of this effect is related to the rate at which new contracts are issued, i.e. the amount of fresh money entering the market. In other words, the upward pressure goes away when there is no more fresh money flowing into oil futures. Your own figures would suggest the number of contracts, while still growing, isn’t growing at a high enough rate (~25% since Jan 2007) to cause significant upward pressure.

    Free markets don’t change basic math: Ample supply + relatively low demand usually equals moderate prices. Prices today are anything but moderate.
    Talk about fuzzy math. Ample supply? Says who? Remember: Just because you don’t see gas lines does not mean ample supply. Refer to the graph again. Supply has stayed flat for three years, while demand has grown.

    And it appears to be getting worse: Fresh data from the U.S. Department of Energy show the amount of petroleum products shipped by the world’s top oil exporters fell 2.5% last year, despite a 57% increase in prices, a trend that appears to be holding true this year as well.

    Relatively low demand? On what planet? Remember, the US is not a planet (yet). Check the graph. Read up on what is happening in the rest of the world: Soaring oil prices have not slowed China’s consumption of oil as statistics show that China’s apparent consumption of crude oil and refined oil products both hit record highs in the first quarter of the year.

    According to statistics released Tuesday by the China Petroleum and Chemical Industry Association (CPCIA), China’s apparent consumption of oil products composed of gasoline, diesel and kerosene rose by 16.5 percent year on year to 52.73 million tonnes in the first three months, and crude oil, rose by eight percent to 91.8 million tonnes.

    So let’s correct your statement, based on the facts: “Free markets don’t change basic math: Ample Restricted supply + relatively low growing demand usually equals moderate increasing prices. Prices today are anything but moderate increasing, proving the oil market is acting like a free market.”

    Well said! ;-)

  • avatar
    Pch101

    Ample supply? Says who?

    The market says who. Oil is available for purchase. You might link to some blog that claims otherwise (I’ll stick with Soros, thanks), but when oil is demanded by a purchaser, there is a supplier ready to provide it.

    So demand is being met. You claim a supply “restriction” that doesn’t exist.

    The oil system is essentially similar to a just in time production system. Most of it stays in the ground until not long before it’s needed. Producers don’t pump out years of supply ahead of time, because the earth serves as a gigantic underground storage tank that allows the oil to stay right where it is until the market is ready to absorb it.

    If there was an oil shortage, you would know it, and not because some blogger claims that there is. It would become obvious because there would real-world limits and restrictions on buying it.

    Demand growth during 2007 was 2/3rd’s of the average, a figure not to get excited about. With an economic downturn underway which may be labeled as a recession soon enough, demand growth should slow further still, not just in the US but internationally, just as it has been.

    Your math “correction” is wrong, and fallacious attempts to explain why oil is the magic commodity that can’t possibly flounder don’t aid understanding. To agree with you would require believing in a supply “restriction” that does not exist. As oil demand growth slows down even more than it has been since 2005, this will become more obvious until hedge funds are left holding this bag, just as they were left clutching that bag of mortgages that also wasn’t supposed to deflate. (They don’t build more land, you know, so it can’t possibly happen…)

  • avatar
    Engineer

    The market says who. Oil is available for purchase.
    Sigh! You got to get this idea out of your head that just because you don’t see lines at the gas stations, supply is ample.

    Here’s what the market is saying: Oil is available for purchase at the grand bargain price of $130/bbl.

    You might link to some blog that claims otherwise (I’ll stick with Soros, thanks), but when oil is demanded by a purchaser, there is a supplier ready to provide it.
    Blogger? Who needs a stinking blogger, when the facts are right there in black and white in the liberal media WSJ? Or are you saying Soros in infallible?

    So demand is being met. You claim a supply “restriction” that doesn’t exist.
    And now for the facts, courtesey of the WSJ: Among the world’s biggest oil exporters, only Russia put more crude in the market last year compared with 2006; all the rest, from Saudi Arabia to Venezuela, produced less oil and used more at home. In many cases, the lower production and higher consumption go hand-in-hand.

    Or, how about this: Saudi Arabia is the poster child. Production fell by about 400,000 barrels a day from 2006 to 2007. Domestic demand rose almost 200,000 barrels. Exports were indeed down almost exactly 600,000 barrels.

    Demand growth during 2007 was 2/3rd’s of the average, a figure not to get excited about.
    Growth is growth. Increased demand means upward pressure on prices, even if the increase is small.

    So, we still have: [Supply leveling off, or decreasing] + [Demand increasing, even if slowly] = [Prices increasing, as expected]. Elementary, my dear Watson.

    No magic required!

    And regarding speculation, MSNBC reports: After Thursday’s inventory report, prices initially strengthened, then fell. The ambivalent reaction partly reflects a deeper battle between investors who believe prices have risen far beyond levels that can be justified by underlying supply and demand fundamentals and those who believe speculative money will continue flowing into oil futures, sending prices higher regardless of the market’s fundamentals.

    “You’re seeing some big funds in there throwing money around on both sides of the market,” said Jim Ritterbusch, president of Ritterbusch and Associates in Galena, Ill.

    But the magnitude of the day’s price decline suggested to some analysts that the bullish momentum that pushed prices over $135 as recently as one week ago may be running out of steam.

    “This was the first time we’ve had a bearish reaction,” to news that in the past would surely have driven prices higher, Cordier said.

    Who knows? We may know soon how much of this run-up was speculator driven. They may even do us all a favor, and start driving the price down. I’d be surprised to see prices drop by as much as $30. Stay tuned.

  • avatar
    Pch101

    Oil is available for purchase at the grand bargain price of $130/bbl.

    You’re behind the times. Oil fell below $130, by more than four bucks today.

    Which illustrates the absurdity of the situation. The fundamentals today are pretty much the same as they were yesterday, as they were a week ago, as they were a month ago, and for that matter, as they were a year ago. Yet an uneventful report from the EIA can trigger a $4+ price movement, an amount that would have been next to unthinkable before a few years ago.

    Those spikes and declines are not based upon fundamentals, but upon overeager traders trying to get into and out of positions at the right time. That’s what George Soros seeing, as am I.

    Growth is growth.

    Not at all true. Rapid growth can create disruptions because it can’t be absorbed efficiently enough by the market over the medium term. Slow growth can be anticipated and managed accordingly, while stocks can be built to offset interim shortages.

    We heard that the price of housing would never fall, because they don’t build more land. As it turns out, it is true that they can’t build more, so they got half of it right, but that doesn’t mean that demand can’t topple, anyway.

    Between the traders betting on uncertainty and OPEC trying their best to manage supplies to maintain prices, we have temporary upward pressures in the market. S**t happens.

    But demand always ends up determining the final outcome, for ultimately, there is no market without demand. Demand rates are falling, and the OPEC cartel will break, just as it did before back during the last sky-is-falling doomsday period.

    A year ago, oil was about $50-60. The price has doubled since then, yet the fundamentals are essentially the same as a year ago. The only substantial thing that changed during that time frame is not supply or demand, but the number of open positions in the market.

    George Soros understands what that means, because he has built his fortune on taking open positions and betting on what his fellow speculators are thinking.

    If you can’t understand that the demand for investments can change the price of the stuff that is being invested in, then you simply won’t comprehend this concept. It happened with the internet companies (new paradigms were supposed to keep those sky high), real estate (no new land, of course) and now, oil.

    It’s all the oil hype of the seventies, but without any of the actual shortages that we had at the time. At least the earlier panic was somewhat justified. What our excuse is going to be in retrospect, I have no idea.

  • avatar
    Engineer

    You’re behind the times. Oil fell below $130, by more than four bucks today.
    Background noise. Tomorrow it may be up $5, or down $10. Surely we shouldn’t be basing our argument on daily fluctuations?

    Demand rates are falling…
    Can you read? Boy, you sure don’t let the facts get into the way of your story. For the umpteenth time: US demand is beginning to fall. World demand, based on the latest information, is still trending up.

    If you have more recent facts, I’d be glad to learn otherwise. But your (endlessly repeated) opinion doesn’t cut it.

    A year ago, oil was about $50-60. The price has doubled since then, yet the fundamentals are essentially the same as a year ago. The only substantial thing that changed during that time frame is not supply or demand, but the number of open positions in the market.
    Again, here are the facts, as listed above:
    1. The number of contracts is up by 25% since Jan 2007. Not enough to cause a doubling of price.
    2. Supply is flat.
    3. Demand is up.
    4. This, in spite of prices doubling.

    So put it all together, and you have: So far prices have had no apparent effect on either supply or demand. The logical conclusion: Even higher prices are needed to reign demand in, and to attract more supply. This is what the speculators are betting on. Perfectly rational, when you think about it.

    You seem to think that because there is no shortage at the bargain price of $130/bbl (ignoring daily fluctuation), the market should be in equilibrium at $80/bbl. How does that work? Why stop at $80/bbl? How about $60? Or $40? $20! No! $10? $5! Yeah, afterall the Saudi’s can pump it for that. Darn it. Why do they need any profit?

    Add sentiment and timing into the mix, and things get fuzzy. A year ago the market was perhaps way behind schedule. At $130/bbl, we may be a bit ahead of schedule. These things happen. That’s why prices change over time.

  • avatar
    Pch101

    Background noise. Tomorrow it may be up $5, or down $10. Surely we shouldn’t be basing our argument on daily fluctuations?

    I’ve said all along that random walk theory tells us that short-term price movements are not meaningful of long-term trends.

    Still, you missed the point. The price of oil just moved $4 (the direction doesn’t matter) based upon what was really nothing. This sort of thing has become just another routine day in the oil market. That casualness of this event signifies a substantial amount of volatility exists in the market.

    That kind of volatility makes no sense, given that oil demand growth is below average. Under normal circumstances, a moribund business or commodity gets no such strong reaction. Yet these days, oil rockets around in price for no good reason.

    It just dropped $4 for no good reason. The day before that, it went up a couple of bucks, for no good reason. The fundamentals today are really no different than they were on Monday or Tuesday.

    Not long ago, these would have been dramatic price changes. Now, they’ve become routine. When the absurd becomes normal, that’s a classic sign of a bubble.

    Volatility and bubbles go hand and hand. Volatility suggests that supply and demand are not determining prices. That’s particularly true when demand growth is below normal.

    The number of contracts is up by 25% since Jan 2007. Not enough to cause a doubling of price.

    This is false, and I’m frankly discouraged that you keep saying this when I’ve provided a convenient chart that makes it obvious that this is not true.

    Here’s the reality:

    -Up until late 2004, open positions tended to range in the 500,000 – 1 million range.

    -By the end of 2005, that figure was about 1.5 million

    -By the end of 2006, that had soared to the low 2 million range

    -By year end 2007, it had 3 million positions.

    To put it another way, the marginal increase in the number of positions during one single year — 2007 — was equal to the maximum size of the entire market up until 2004. That is a massive shift in capital, not a minor non-event to be brushed off or overlooked.

    In any case, that figure isn’t 25% by any stretch of the imagination. In comparison to 2005, when this party began, it is triple its previous size.

    Essentially, we took the market size peak of 1995-2004, and added two more markets right along side the original. Imagine tripling the population of a city in just three years’ time, and this is the level of drama and hysteria that we are talking about.

    And as is generally the case with everything else, there is a time lag between the initial ramp up of buyers and the price increasing. Demand precedes pricing changes. The price increases of 2007 were built upon the swelling of investors pouring capital into it during 2005 and 2006.

  • avatar
    William C Montgomery

    UPDATE #3: Speculation–but Not Manipulation at BusinessWeek

  • avatar
    nonce

    William C Montgomery:

    Are you going to put a timeframe on your “I fully expect crude oil will trade below $80 a barrel in the not too distant future” prediction?

    If you say, for example, “I meant within 12 months,” then we can look back in twelve months, and determine whether this prediction was right or wrong.

  • avatar
    William C Montgomery

    Are you going to put a timeframe on your “I fully expect crude oil will trade below $80 a barrel in the not too distant future” prediction?

    No. I’m not a prophet. How’s this: between 3 months and 5 years from now.

  • avatar
    Engineer

    Thanks for the link, William! The money quote: CFTC experts testified that market forces are driving prices. Hmmmm, experts believe it’s market forces? I rest my case.

    BTW, Pch, I see oil prices are back up at $134/bbl. As for your concerns about volatility, sometimes that’s just how the free markets work: chaotic and unpredictable, but efficient over the long run.

    How’s this: between 3 months and 5 years from now.
    Sounds like Rick Wagoner talking about GM’s infamous turn-around strategy…

  • avatar
    Engineer

    William,
    Here’s a good summary why I don’t think it’s speculators. My favorite paragraph: The uncertain connection between speculation and price trends is clear in recent history. The Commodity Futures Trading Commission reports how much paper oil is bought and sold by commercial users — oil companies, refiners — and how much is bought and sold by speculators. During the first seven months of 2007, speculators as a group tripled the amount of paper oil they owned, buying it from commercial players. But since last August, speculators as a group have not added to their positions — yet this was when oil prices went skyward. Emphasis added.

    Still going up, as I’m sure you’re aware…


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