By on September 18, 2008

Halleluiah! Oil prices are falling. Despite Nigerian revolutionaries attacking Royal Dutch Shell facilities. Despite hurricanes Gustav and Ike disrupting gulf production. And despite all of the hysteria of the last six months trumpeting the end of the era of cheap oil, oil prices have fallen as much as $55 per barrel after being pushed to a peak of $147.27 in July. Once the residual shock to gasoline refining by Ike dissipates over the next couple of weeks, consumers will begin to see a substantial difference at the pump. So is it safe for Americans to recommission their mothballed SUVs and muscle cars? A close look at financial events in recent days indicates otherwise.

First, let’s recap what we’ve seen.

Beginning in 2004 the price of Light Sweet Crude on NYMEX began an almost uninterrupted ascent that added more than $100 to the price of every barrel. A circus ensued. Consumers swooned (precipitously). Automakers faltered (dangerously). Speculators hyped (aggressively). News media sensationalized (despicably). Inflation grew (corrosively). Environmentalists cheered (quietly). Politicians protested (hypocritically). Oil company execs defended (piously). Saudi’s pumped (merrily). Oil peaked (allegedly). Demand evaporated (predictably). Prices fell.

A more revealing analysis shows that the surge in prices was the result of two seldom mentioned factors: a weakening dollar that required that Americans spend more of them to get their fix of black gold. And index fund managers discovered that the commodities market was a good place to shelter their money from falling real estate and stock markets. In May, BusinessWeek summed the market distortion this way:

“[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.

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.

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.”

Whew! So it is safe to say that if you are invested in any of these index funds or if you are due a pension, you likely benefited from the higher commodity prices at the same time you are paying higher prices at the pump.

Since that time, we have seen the market peak followed by a rapid deflation in prices. While it can be argued that demand destruction accounts for some of the effect, it alone cannot approach the 37% fall in price. Rather, the dollar has strengthened (erratically) and investors have stampeded out of the notoriously risky commodities market.

This is good news, right? The bubble, which energy economist Edward Morse calls it the “Oil Dot-com,” has burst. Now consumer prices can be restored to normal supply and demand price points. Yes, but… (There’s always a big but and I cannot lie.)

Monday morning financial markets were ambushed by the announcement that troubled investment bank Lehman Brothers, a 158-year old fixture on Wall Street, has folded. The big B-K. Horrified, the Dow Jones industrials plummeted more than 500 points, the worst day of trading since terrorists slammed hijacked airliners into the World Trade Center.

What of oil futures? Based on recent history one would think that fleeing investors would seek refuge for their money back in the commodities market. Didn’t happen. Instead it followed the trend of the broader market. The inverse relationship between the markets appears to have broken. Which is a good thing – I would rather index fund managers look elsewhere when stocks falter so energy prices that directly impact my pocketbook don’t become unnaturally inflated.

But this is a dire indicator. Rather than the correction of an over-inflated price (I still believe that oil is overpriced and has room to fall further before it achieves an undistorted equilibrium price), this week’s decline shows that investors well and truly have lost faith in the economy. Rather than divert their funds to alternate investments they sold off for cash or stayed pat and suffered a loss in equity.

In other words, factories will idle, business will stop growing, and the transport of goods will slow because no one is buying. All of this points towards corporate downsizing and layoffs.

B&B, be advised: keep your gas guzzlers parked.  It’s going to get worse before things start to get better.

Get the latest TTAC e-Newsletter!

106 Comments on “Oil Prices...”


  • avatar
    GS650G

    Amazing isn’t how announcing more US drilling let the air out of the price balloon. It’s another factor in the future price of oil since unwillingness to drill our own means we buy from people that don’t like us. Open up ANWR and you’ll see 50 a barrel in weeks.

  • avatar
    menno

    Yes, the shite hit the air recirculating device big-time yesterday, and not only in the United States. Russia – who got cocky and too big for their boots REAL fast with a bit of excess oil income over the past 4 years – got their commuppance, too. They had to shut down both of their stock exchanges after they fell – as in, off a cliff-face.

    In the meanwhile, gold – the old standard, usually mocked by “modern money people” gained over $85 an ounce in one day yesterday, and in percentage terms, silver went up even more. I guess there are no atheists in fox-holes and no gold-mockers in a market which just went off a cliff-face.

    As for oil, yes, we probably truly really honestly will find that peak oil WAS reached some time in 2006 or 2007, eventually, in the future once all the smoke clears. That doesn’t have to mean automatic melt-down of the world economy – it can mean that we simply need to plan ahead and make adjustments.

    Looking at “how well” humanity has done those two things in the past, I have to conclude – we’re screwed!

  • avatar
    Rday

    Unfortunately we will experience a lower standard of living and many people will suffer. I would like to know where all of the $Billions of wealth went. I know a minority of wealthy individuals probably prospered greatly. But the scope is hard to comprehend. I guess greed knows no limit. One thing for sure, foreigners will be more reluctant than ever to invest in american securities/stocks. And that spells big trouble for us with our federal deficit. Where were the safeguards that were supposed to prevent this disaster?

  • avatar
    mel23

    Open up ANWR and you’ll see 50 a barrel in weeks.

    Doubtful.

  • avatar
    AKM

    Open up ANWR and you’ll see 50 a barrel in weeks.

    Doubtful.

    Wishful.

  • avatar
    tomaxhawk

    As am armchair economist myself, you have nutshelled the oil and some of US economic woes perfectly. I agree that we’re not at the end of the slippery, manure covered slope yet and won’t be until the proverbial bottom of the housing market slump with accompanying financial sector losses are completely revealed.

    So , it really was the speculators and not legitimate bona fide commodity producers, buyers and supply and demand forces that was behind the oil run-up. Where the hell was the CFTC in all this? With the gold standard being abandoned by the US government in the 70′s, all of the cash needed for bailouts for various venerable, monolithic financial and manufacturing (DET 2.8) institutions that ‘cannot be allowed to fail’ is going to have to come from, taxpayers, foreign debt, and printing more money. The US government does not hold enough assets (gold) in reserve that can back-up the massive spending it’s now embarking upon. Look for interest rate rises, US dollar devaluation against major foreign currencies, and a general environment of suck for the next few years. But, since the general standard of living is going to fall, oil demand will also fall, at least stateside. China will live larger though.

  • avatar
    Alex Rodriguez

    Finally! Someone who hits the nail exactly on the head.

    The runup had nothing to do with supply and demand. It had nothing to do with peak oil. It had everything to do with big money looking for an investment opportunity.

    PERIOD.

    Now that it is not such an attractive investment, and now that the investment banks are taking it in the shorts, and don’t have billions lying around to play up the price of oil – the price is coming back down. It’s hiccuped today, but the trend line is down, $70 a barrel by the end of the year is likely.

  • avatar
    Robstar

    I have seen prices reported all over the country getting as low as $3.50′ish, however I have only seen a handful of stations ever go under $4 here in Chicago.

    Not that I consider $4 particularly expensive…but it does make me drive my sports car less and the motorcycle more.

    I really find it funny especially on places like CNN’s ireport that 1/2 the people complain of $5.50 price spikes during/immediately after Ike, and the other 1/2 complain every service station around them is OUT of GAS, period!

    You can’t have it both ways, right?

  • avatar
    joeaverage

    So how far are we from a Great Depression style recession?

    FWIW I’d like to watch those that brought this economic downtourn on us really have a bad time of it rather than get gov’t bailouts.

    Good article.

  • avatar
    Juniper

    Uh. Oil just went back up to over $100. Right now anything you write about oil prices will be wrong within a day.

  • avatar
    thetopdog

    Am I the only one planning on investing a relatively large amount of money in oil when it looks like the price has bottomed out at a reasonable level?

  • avatar
    gamper

    Investors are running for the safety of commodities. As soon as panic selling calms, Oil should resume its downward spiral. Low Oil prices seem increasingly likely given the current state of the US and world economy.

  • avatar
    Banger

    “Open up ANWR and you’ll see 50 a barrel in weeks.”

    “Doubtful.”

    “Wishful.”

    Limbaughful.

  • avatar
    Geotpf

    Oil is actually going back up, because nobody wants to own stocks right now, and gold is ridiculously expensive, and certain treasury bills are now paying what is effectively negative interest rates, so people are running out of non-stock places to put their money in, so they are buying oil.

  • avatar
    Paul Niedermeyer

    Alex Rodriguez: The runup had nothing to do with supply and demand. It had nothing to do with peak oil. It had everything to do with big money looking for an investment opportunity.

    Like in most things in life, simplistic answers are not adequate. Actually, your assessment is not accurate: it WAS the perception that supply and demand were increasingly becoming out of balance, due to the rapid increase of consumption in the developing world, that led to a tightening of the market, and an increase in prices. Speculators can only make money, and possibly affect (exaggerate) the market, if it’s already moving in a certain direction. It was because of the fundamentals of the oil market that they jumped in.

    The fundamentals have weakened because of the global economic weakening, and a reduction in demand, both current and predicted.

    Speculators can not change the direction of a market, they can only amplify it.

  • avatar
    faster_than_rabbit

    I would like to know where all of the $Billions of wealth went.

    Who knows?

  • avatar
    austinseven

    That’s a humdinger of an editorial! Almost Pullitzer.
    Makes TTAC a required daily read, in case you miss something really outstanding like this one. OK, now back to the reVOLTing.

  • avatar
    Kevin

    Well welcome to the club, I’ve been blogging about the impending oil collapse since June.

    True that oil’s getting a little mini-boomlet right now as people scramble to figure out where to stash cash. But that won’t last, and everything occurring now augers ill for oil.

    We now know that OPEC does indeed have excess capacity — to the point that it’s their biggest problem right now. At best oil demand worldwide is growing only VERY slowly (1%), and that demand could collapse in this economic climate.

    ANWR and Drill-baby-drill emphatically CAN lower oil prices — it’s obvious now that much of the oil price was speculation as William notes, and expectations of even slightly more excess capacity in the future could substantially deflate oil prices.

    Oh and BTW, Russia can now resume its march into the dustbin of history where it belongs.

  • avatar
    quasimondo

    Oil is actually going back up…

    ….and now it’s down again.

  • avatar
    Stingray

    I’d like to ask the writer of the article, how low he does expect the price to go?

    Living on a oil exporter country, I’m interested.

    I don’t think it’ll get lower than 50… it should stabilize in about 80.

  • avatar
    jl1280

    Drill, drill, drill. And just when do you expect those still-to-be-discovered barrels of expensive oil to be delivered to a gas station nearest you? That joke is worthy of being framed and put in your outhouse. It’s even better than the Volt.

  • avatar
    Albnyc

    You are seeing pure panic in all financial markets — whether physical or paper. You will get whiplash if you try to divine trends from the gyrations over the next few days. Its going to be a cruel — if not cold — winter for many, many of us.

    Oil will continue to decline, further than many experts predict (notice how often the experts are wrong?)

  • avatar

    William,

    Index funds don’t consume oil.
    Ultimately, what counts is the underlying supply-demand balance.

    Maybe, in 10 years, cellulosic biofuel can play a bigger role to keep prices down.
    If cellulosic biofuel can be produced for $1/gallon and at high volume, it will force the price of oil down to $40/barrel.
    Now that’s something to ponder.

  • avatar
    jl1280

    If cellulosic biofuel can be produced for $1/gallon and at high volumes…! In what time frame? Is that before or after we discover that the ANWR won’t be the solution? Or is that before or after we realize that we have fried the planet? Or is that before or after nuclear fusion is commercialized? But it will certainly be after the USSA has nationalized the banking system by using taxpayer money to protect shareholders and CEO’s – since that’s happening this week.

  • avatar
    Engineer

    Hmmm,
    I see things a bit differently. I’m with Ed on speculators: they can amplify, but they can’t dictate. Note that iron ore (no speculators allowed) was up >100% in 12 months at one point. I specifically have trouble with this comment: 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.

    First problem (true engineer thinking): The Chinese demand growth occurred over a period of time (a year). We are talking about a flow of oil, 920 million barrels per year leaving the market to get burned. It’s gone never to be seen again. The speculators may hold a ton of oil, but ultimately that oil is coming back to the market. The speculators only bid the price up as long as they keep increasing their holding. Obviously, at some point you run out of new speculators, or new money from the same speculators (or both) and then they are just oil traders like the rest of them.

    It is also worth remembering that the much maligned oil speculators include institutions like Southwest airlines. Oil speculation allows them to save a ton of money on fuel compared to their less market savvy competitors. In this case speculation allows Southwest to dampen out the daily noise of a volatile market. Believe it or not, speculation actually has a real life purpose!

    What caused the run up in oil prices? As they say, a picture is worth a thousand words. Of course, (much as we engineers hate it) there is no way to calculate a fair price based on the fundamentals. But it seems to me that the market was slow to respond to flat supply and growing demand. Next the market appears to have overreacted. How much it overreacted, or is overreacting right now, is again, frustratingly, impossible to determine.

    So where do we go from here? Short term: nobody knows – it’s all noise and emotion. Long term: depends. I see two options. Basically oil remains tight: The laborious process of squeezing oil from the sands of Canada, he said, becomes increasingly uneconomic if oil slips below $90 a barrel. Total’s extensive work in the ultra-deep waters of West Africa requires that prices stay above $70 a barrel, he said. In other words, don’t buy the marginal-cost-to-pump-is-only-$40 arguments.

    Or the global economy goes TU, which brings us $20/bbl. Only, we’re so screwed, we hardly notice, let alone celebrate.

  • avatar
    tomaxhawk

    Engineer:
    “It is also worth remembering that the much maligned oil speculators include institutions like Southwest airlines. Oil speculation allows them to save a ton of money on fuel compared to their less market savvy competitors. In this case speculation allows Southwest to dampen out the daily noise of a volatile market. Believe it or not, speculation actually has a real life purpose!

    The commodities markets real purpose, theoretically, is for producers (oil companies, farmers, mining companies, etc) and end users (manufacturer’s, airlines , etc) to lock in prices that they can sell and buy those commodities. It’s called a commercial hedge, not speculation. Speculators in the commodities market add liquidity to the market (again theoretcially). That’s why they were allowed to exist in the old days anyway. Now, it’s a completely different animal. Billions of dollars of hedge fund money poured into commodity index funds and ‘amplified’ the underlying trend exponentially. This is something new and as we have seen recently, affects the pocketbook of mainstreet america. Something needs to be done about that.

  • avatar
    Engineer

    EJ_San_Fran: When cellulosic biofuels finally make it to market (more like $100/bbl minimum, to be competitive), you are going to be one sorely disappointed senior citizen.

    jl1280: USSA? LOL! Can I quote you on that?

  • avatar
    Engineer

    tomaxhawk: Billions of dollars of hedge fund money poured into commodity index funds and ‘amplified’ the underlying trend exponentially. This is something new and as we have seen recently, affects the pocketbook of mainstreet america. Something needs to be done about that.
    Sounds a lot like the Stock Exchange. Should we regulate NYSE just because it has attracted a lot of money? No? You know that all that money completely distorts the market…

    Sounds to me like the US(S)A has a decision to make: Pick a philosophy, and be consistent…

  • avatar
    Pch101

    Tomaxhawk’s post above summarizes the situation nicely. He clearly understands the market.

    It is also worth remembering that the much maligned oil speculators include institutions like Southwest airlines.

    No, they are absolutely not speculators. Southwest is a hedger. A hedger actually cares about the final price, because they will ultimately pay that price, in absolute dollar terms.

    A speculator is largely unconcerned with price. A speculator cares about price movements, and only cares about the price to the extent that it can be sustained during the (usually short) holding period.

    If you don’t understand how traders work, you just won’t get it. Traders want to capitalize on price movements, and are indifferent to the actual price because they will never take delivery of the product and pay that amount for it. They care about price differentials, not absolute price.

    During recent years, hedgers were outnumbered by speculators. Hedgers (users) no longer set the price; instead, the price was dictated by the supply and demand for oil investments, not oil itself.

    Prices are falling as speculators leave the market. As the fundamentals become more important in price setting, speculation becomes more risky and therefore less appealing.

  • avatar
    DearS

    Oil prices keep moving and people taking advantage, indifferent to us. What if we pay Americans to invest in America? Like middle class Americans, we can give them free health care and retirement money in exchange, then create jobs. Like the Army or teachers, just more efficient to the economy. Perhaps then tax the really rich, since their money wont be so important for jobs. We do not need to depend on the stock market so much, or rich people, or commodities. Just an idea.

  • avatar
    Banger

    DearS:

    “We do not need to depend on the stock market so much, or rich people, or commodities. Just an idea.”

    And a novel one, at that. Here, here for old-fashioned American pragmatism and self-reliance. Where there’s a will, there’s a way.

  • avatar
    Snagor

    Since we’re discussing Oil, have you all looked at this article: http://www.theregister.co.uk/2008/09/17/richard_pike_rcs_interview/ regarding how reported oil reserves are always underestimated as they are only providing minimum figures instead of realistic figures?

  • avatar
    jschaef481

    Middle class Americans are already part of the stock market. Their investments (pension funds, 401(k) investments, etc.) are already part of that landscape. And their investments make up the biggest and most influential players in this market. We are (most of us, anyway) the despised fat cat. We all want our retirement and savings accounts to grow, no? Lots, right? I suppose it makes us all greedy capitalists.

  • avatar
    Engineer

    A hedger actually cares about the final price, because they will ultimately pay that price, in absolute dollar terms.
    A speculator is largely unconcerned with price. A speculator cares about price movements, and only cares about the price to the extent that it can be sustained during the (usually short) holding period.
    Not sure I see the distinction. Do you have to see inside the investor’s head to know whether he cares about price or not?

    And just because a so-called speculator wants price movement, does not imply he can make it happen. If I buy stock in a company, I would like the stock’s price to increase. But unless I’m Warren Buffet, I can’t buy enough stock to actually make it happen.

    I still think the “speculators” reacted to increasing prices, not the other way round.

  • avatar
    ppellico

    While the prices are low, I am desperately trying to find an idiot (buyer) for the trailblazer!

  • avatar
    Steven Lang

    I’m sorry, but this is really a golden opportunity to buy things up. In fact, this past Monday I bought a very nice chunk of Wells Fargo because there are indeed going to be winners in this ‘financial restructuring’.

    There hasn’t been a large oil find anywhere in the world for over 30 years. Period. The rise of the emerging markets, combined with the depreciation of the dollar, is what precipitated the recent run-up in price. There’s no great conspiracy of any sort. Other than that various funds realize the current demand crunch and have acted to profit from it. That does inflate price, but not the fundamentals that are evident in that partiular commodity.

    I’ve seen volatility in a wide variety of commodities. Scrap steel, aluminum, iron ore, copper, gold, lead, platinum… they all have become more volatile because the very economic foundation of the Western world (primarily debt) has become less predictable. Demand does effect price, but volatility has more to do with externalities than direct causes.

  • avatar
    Pch101

    And just because a so-called speculator wants price movement, does not imply he can make it happen.

    When traders dominate markets, they create volatility. As most of their contracts are long, unlike hedgers who tend to be more balanced, they tend to push prices up.

    During the oil peak, 30% of the contracts were controlled by speculators, so their indifference to absolute price certainly influences what everyone else who actually has to buy or produce oil pays for it or sells it for.

    You can naively wish to believe that traders don’t buy or pay differently from users, when in fact their approaches to the market are totally different and their sensitivity to absolute price far lower. As long as there is momentum, they will look for it.

  • avatar
    Landcrusher

    Speculators cannot live without supply and demand. Take an inelastic product like oil, let demand get even close to supply, and the speculators will have a field day. The same guys making money on the way up, are mostly making it on the way down as supply is now clearly greater than demand.

    Pickens is a nut, but his plan isn’t completely crazy. If you go looking for Natural Gas, you will likely find some oil as well. The increased gas supply can reduce the demand for diesel for powering the grid while the extra oil creates the cushion the market needs for stability.

    Drill, Drill, Drill.

    BTW, as I have stated before. Gas prices come down slower than they go up. The refiners were eating small margins on the way up, but they will try to hold on to fat ones on the way down to make up. If they aren’t allowed to do this, don’t look for anyone to build anymore refineries for another few decades (except the ones now financed that will be coming on in the next few years). I expect some populists to knowingly try to advance their power at all our risk by screaming for lower gas prices soon.

  • avatar
    ZoomZoom

    DearS :

    Oil prices keep moving and people taking advantage, indifferent to us. What if we pay Americans to invest in America? Like middle class Americans, we can give them free health care and retirement money in exchange, then create jobs. Like the Army or teachers, just more efficient to the economy.

    But history has shown that “government” running the show with a heavy hand like this is woefully INefficient.

    It’s called socialism. In EVERY country where it has been tried, the people were/are poorer because of it. They were/are colder in the wintertime, they lived/live in the dark because they cannot afford light bulbs or electricity, and they are hungrier all of the time.

    Sometimes, people even DIE because of socialism!

    Perhaps then tax the really rich, since their money wont be so important for jobs.

    “The Rich” are an easy group to pick on. But the result of picking on them (financially/economically) has not been beneficial to the population or economy as a whole.

    Quite to the contrary. In a sustainable economy, money doesn’t “come from the government.” It comes from economic activity in the private sector. That’s you and me, trading, buying, and selling.

    Each person engaged in economic activity is trading something that he has for something that he feels is more valuable.

    You need money to put shoes on your children’s feet, and I need somebody to work in my factory. Your labor is more valuable to me (than my money), and shoes for your children are more valuable to you (than using your time for another pursuit). So if it’s agreeable, then we have a transaction.

    We do not need to depend on the stock market so much, or rich people, or commodities.

    But if you let your government just “take” money from me, then I won’t have that money to spend to hire you so that I can get work done and so that you can put shoes on your childrens’ feet.

    Maybe you “luck out” and get a welfare check from the government for those shoes. But you didn’t work for it, so it diminishes you as a man; as a human being.

    Careless use of the term “rich people” is very dangerous. It allows us to begin to think that they are just a free source of money. This is not only immoral and wrong, it discourages risk-taking, and ultimately it hurts economic activity.

    Just an idea.

    And a very bad one, as history has shown many many times over!

    If you doubt me, look at how the general population lives (or doesn’t live, as the case may be) in countries like North Korea, China, Zimbabwae(sp), Venezuela, Cuba, and Russia.

    They live like paupers. Many don’t get an education. Hunger is rampant. Some die on the streets.

  • avatar
    Engineer

    When traders dominate markets, they create volatility. As most of their contracts are long, unlike hedgers who tend to be more balanced, they tend to push prices up.
    That’s odd. Traders are supposed to stabilize markets – that’s why the trading is originally set up. And why Soutwest, among others, take advantage of it.

    You can naively wish to believe that traders don’t buy or pay differently from users, when in fact their approaches to the market are totally different and their sensitivity to absolute price far lower. As long as there is momentum, they will look for it.
    Their approach or motivation doesn’t come into it. Nor can they afford to be insensitive to the real price, as you imply. A trader that buys at $140/bbl, must find someone who will buy that bbl for evern more money, or lose. Eventually, no matter how many traders you have, they have to find a real user (a refinery) who is going to buy that bbl, at a price that makes sense to the seller (i.e. preferably more than what he bought it for).

    You seem to believe (naievely?) that a trader sitting at a keyboard can simply whip up momentum, make a ton of money, and walk away giggling into his mocha, while real people can barely afford to fill their SUVs.

    In the real world it works the other way round: The trader sees the momentum that already exists (or is just beginning to build), decides he wants to jump in and take the plunge. After that he has to hope for the best. If other traders follow suit, it basically means he was right. As we saw recently, there is no guarantee.

    It’s a free market. The traders intention, personality and political convictions does not come into it. He plays by the same rules as everybody else…

  • avatar
    Pch101

    Traders are supposed to stabilize markets

    Yes, and car alarms are supposed to eliminate break ins, and churches are supposed to instill morality.

    Coulda, shoulda, woulda doesn’t necessarily lead to results.

    In limited numbers, traders are a useful source of liquidity. Too many traders create price distortions.

    The same factors that make trading worthwhile for the system are the very same factors that make too much trading problematic. Traders create liquidity — some liquidity is good, too many create price volatility that is disconnected from the good.

    Nor can they afford to be insensitive to the real price, as you imply.

    You have obviously never traded before.

    What’s funny is that just a couple of months ago, when we last went through this, you were busy explaining to me why the equilibrium price for oil was “supposed to be” $135. This discussion seems to have conveniently forgotten that alleged factoid.

    I would like to hear a cogent statistically-based explanation of what supply and demand factors resulted in a 40% price decrease in two months. I think that I know something about economics, and my slide rule just isn’t getting me there.

  • avatar
    John Horner

    True speculators never actually take delivery of or consume the oil in question, so over a reasonable time horizon their actual net “demand” is nearly zero, excepted as required to fuel the personal jet and limo. Every trade eventually has to be settled out, typically either through expiration of an option or through and equal and opposite trade in the other direction. Even companies such as Southwest which use commodities markets to hedge their short and medium term fuel costs rarely take physical delivery of the commodity underlying their trades. They buy their fuel from normal suppliers in normal fueling locations and use any gains in the futures markets to financially offset price changes at the point of use.

    I agree that speculators can exacerbate short and perhaps even moderate term price swings, but in the end they always have to unwind their positions and the purely financial speculators don’t actually effect long term real demand or long term average prices. But, it may take years to even out the noise.

    In a similar vein, note that the SEC is supposedly about to put a temporary ban on short-selling stocks. Again, short selling certainly leads to near term volatility, and in todays environment putting the brakes on it makes sense. But long term it is very, very rarely short seller who determine the price of a stock.

  • avatar
    Pch101

    in the end they always have to unwind their positions and the purely financial speculators don’t actually effect long term real demand or long term average prices.

    That’s accurate. That’s why these speculator-driven markets are parabola shaped and relatively brief (usually a few years at most) and are not permanent.

    The high prices created by bubble investors are supported by the supply and demand of the investment vehicle, not the underlying good. These cannot be maintained permanently and will eventually will deflate. Fundamentals drive the market over the long run, but not every short run transaction is driven by fundamentals.

  • avatar
    Engineer

    Pch101,
    Don’t get too excited, we’ll get back to $135/bbl soon enough – assuming, as I said, that we don’t get a melt down of the global economy, looking more like reality all the time.

    I would like to hear a cogent statistically-based explanation of what supply and demand factors resulted in a 40% price decrease in two months.
    How about lag-and-overshoot? It took the market three years to respond to the fact that demand had gotten ahead of supply. When it finally responded, it overreacted some (100% increase in about a year).

    Meanwhile, the higher oil prices reduced demand (in some countries, where the costs are passed on to the consumers). The global economy, is also, of late, looking kinda fragile, which does not bode well for future oil demand. Hence oil is retreating some.

    For all the talk about what the evil speculators are supposed to be doing, I haven’t seen any data to show that they have abondoned oil en masse.

  • avatar
    Pch101

    Don’t get too excited, we’ll get back to $135/bbl soon enough

    Thanks for the econometric data that I requested that supports your thesis that a 40% decrease in price in two months is strictly a matter of the markets working normally. Very convincing stuff.

  • avatar
    Honda_Lover

    GS650G :
    September 18th, 2008 at 9:47 am

    Amazing isn’t how announcing more US drilling let the air out of the price balloon. It’s another factor in the future price of oil since unwillingness to drill our own means we buy from people that don’t like us. Open up ANWR and you’ll see 50 a barrel in weeks.

    Amazing what just talk of drilling does to prices. Imagine if McCain wins an we actually get legislation to authorize ANWR and offshore. Get ready for another $30-$40 drop if/when it happens.

  • avatar
    DearS

    ZoomZoom

    I’m not referring to Socialism I do not think. I mean the people voluntarily pool the money in their pockets and invest in jobs. In return the Government will help them with health care and retirement. The American people basically pay themselves back for helping America. Americans themselves are responsible for creating jobs. Its not like a stock were equity is given, what is given a guaranteed health care and help with retirement. Americans will by their voluntary contribution keep the economy going. Americans will have the responsibility to keep the economy going. Unlike usual capitalism were jobs are create by folks trying to make a profit ie. they are looking to go overseas. Taxes can be targeted to give money back to the folks that helped create profits ie. workers. In the proposed system Americans are responsible for themselves, not the Government, not rich with lots of power. Americans already want this, given they want to buy American. Without your investment I do not have a job. Again like the army or teachers except not funded by taxes and its business not education or protection. Perhaps run my those who gave money for it, but without stocks or ownership, only run by folk. The Government will not own the business, its responsibilities will be to enforce ethics voted by the people, also help look for places were the money can be invested in. In the end though the people choose were the money goes. Neither will People own the business, a business will just run or fail or change hands, perhaps in exchange for credits for folk to get into over businesses. Not money to buy a Veyron. Although a black market may result. Also if the business fails, a lot of jobs will still have been created in the process, at least temporarily. New ideas will also be tried, perhaps better than today. Wall street will still exist, but with more competition.

    Also as far as I’m concerned, taxes of any kind is a form of socialism. And Human men/beings cannot be diminished. We were bore inherently worthy. We cannot mess that up, only relate to in a dysfunctional way, which causes dis-ease. Its called E-V-I-L ie. L-I-V-E backwards. It does not function, its not being true to our self. Hence we do not “feel” like humans. We still are humans, just not honoring it.

  • avatar
    joe_thousandaire

    Just wanted to say that this is the best article I’ve ever read on TTAC. Flawless. I’ve been involved in the commodities market in one way or another my whole life, and IMHO every word of this piece is dead-on. Nice work.

  • avatar
    mdf

    Engineer: You seem to believe (naievely?) that a trader sitting at a keyboard can simply whip up momentum, make a ton of money, and walk away giggling into his mocha, while real people can barely afford to fill their SUVs.

    When this is done on a small scale, it’s called a “pump and dump scam”, and the operators are prosecuted. When a large, venerated, financial institution is writing up the multi-megabyte PDF’s about the coming era of $225/bbl oil and $2/L gasoline, and other repackaged “peak oil is nigh!” claptrap, well, that’s just savvy business acumen.

    I mean, just ask Jonathan Lebed:

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

    Like pch101, I’d be interested to know how the insertion or extraction of who knows how many billions from the oil investment market can change the _fundamentals_ of the physical market for oil proper … you know, oil supply, or oil demand, cost of pumping it out of the ground, or shipping it around the planet.

    The amount of money speculators transiently have in the system seems to me to be as important as the phase of the Moon.

    The only way the price of an oil contract — a few bits of data in a database table on some server at NYMEX — can have a direct effect on the price of oil is, well, to simply define it, by fiat, axiomatically, to be that way. Which, it turns out, is exactly the case:

    http://peakoildebunked.blogspot.com/2008/07/366-futures-prices-determine-physical.html

  • avatar
    cos999

    Please repeat after me:
    DRILL IN THE ANWR
    DRILL IN THE ANWR

    Lets look at facts on US CRUDE OIL imports and production
    http://www.eia.doe.gov/basics/quickoil.html
    We produce 5 M barrels/day
    We import 10 M barrels/day. Of that the largest single supplier is Canada at 1.88 M barrels/day. OPEC countries accounts for 5.98 M Barrels/day.

    http://upload.wikimedia.org/wikipedia/commons/b/b1/Alaska_Crude_Oil_Production.PNG
    Alaskan oil production peaked at 2 M BPD in 1988 and is now less than 750,000 BPD. Drill in the ANWR to get production back to 1988 levels and double our imports from Canada (that can be done via all the new OIL SANDS investment happening) and we cut our OPEC reliance in half.
    http://www.canadasoilsands.com/en/overview/
    So, yeah, each new barrel means less from OPEC. It may not drive the price down given demand in India and China, but it will provide a step toward OPEC independence.

  • avatar
    DearS

    I think a bosse’s job , official,s and owner,s job is to make things possible. Its not to make profit, profit is just ok. Its a responsibility tied to the rest of the world. I believe in karma though, so things work out no matter what ie. you reap what you sow. Its easy have a perverse idea of what responsibility is,. I think the human egos job is to actually aid in perverseness to help deal with stress. Its through learning to be true to ourselves that we end karma. Its a process, one I think includes going through hell. Mistakes are mandatory, that is how we truly learn. We need to learn to set boundaries for those in power, to protect ourselves, but we need to know we are worthwhile. That is a process. Again it includes going through hell, till we are forced to look for a different way. I personally think we need to turn to a higher power (god), and our spirit for answers. Considering our humans weakness, its a work in progress. We are a work in progress, a work in process. We are inherently worthy, just we need to be response-able,. We are here to learn about our response-ability. That is what Karma is about.

  • avatar
    jschaef481

    DearS – What does any of that mean? Supply and demand do not recognize karma. Business is amoral. A capitalist’s job is to make money, not make things possible (whatever that means.) The benefit to society is a satisfied need which also happens to create jobs and wealth.

    A capitalist considering those things to which you refer makes charity part of the labor transaction, filling his/her own need economically to feel better about their relationship with their spiritual being. But that still boils down to just another economic transaction.

  • avatar
    Aegea

    Demand for oil is quite inelastic in the short term, and global production has been essentially flat for the past three years, while demand has continued to grow, primarily from developing countries like China and India. Internal consumption in oil producing countries has been growing rapidly (e.g., about 7% annually in Saudi Arabia) since the price of petroleum products is often held artificially low in those countries.

    Many people believe that there is almost no oil short-term production expansion capability globally. The Saudis only managed to increase production by a few hundred thousand barrels a day (of undesirable sour crude) because their big new field is coming on line to offset the production decline from Ghawar. At the same time, there was a lot of liquidity looking for a profitable investment, thanks partly to very low interest rates in the US. So the stage was set for a speculative boom in oil prices.

    What happens next? I’d expect continued wide gyrations in prices as demand growth/demand destruction and production declines/increases battle it out in a tight market. Wild claims will continue to be made based on short-run events. Long run, I expect the days of really cheap oil are gone for ever, and that the price trend will be upwards with higher highs followed by lows that are above the previous lows. And speculators and hedgers will continue to do their usual things, which sometimes exaggerate the price swings.

  • avatar
    ZoomZoom

    DearS :

    I think a bosse’s job , official,s and owner,s job is to make things possible.

    Just because you think it, that doesn’t make it so in real life.

    “Things” are possible only when human beings are free to conduct economic activity.

    For example, clams for a thatch roof. With the roof, the kids might not get sick so often, so the roof-buyer can then focus on the next goal in life; maybe spending more time in the clam beds, or maybe making a better net or fishing boat so that more clams can be obtained.

    This is arguably the most efficient way that wealth is built; through the self-reliance of each economic participant making his situation better or more efficient.

    Government intervention (such as dictating the cost of goods and services, or requiring “good works” to be done and thereby raising the cost for selected economic participants) is like an anchor, weighing down each participant. This makes it more expensive to contribute to the economy, to get into business or to continue to do business, and consequently holds back the efficiency of economic activity. Ultimately it retards the advancement of civilization.

  • avatar
    DearS

    Guys thank you for the feedback, I hope I’m not being stubborn, ignorant and/or demeaning to anyone.

    jschaef481–

    By “making things possible” I mean we need to take the initiative to create jobs, the economy depends on jobs and the circulation of money. I just threw in Karma to say that we humans need to do good things to be motivate everyday. We are not trying to be just capitalists IMO. I think if we use our morals and business sense combined we can accomplish more. We’ll be more motivate, clear headed and calm.

    ZoomZoom

    Welfare, Military, Education, Health care, Pensions, Trust funds, Greed, corruption, Construction, protecting the environment they can all be said to retard the advancement of business. Still they are good works. Humans have weaknesses, We need step in and put boundaries to keep things going. Good works have been necessary, perhaps until people grow up a bit more. People have much more than just desire to conduct economic activity for profits. Also an economy is probably only as strong as its weakest link.

    I believe in capitalism, but capitalism alone is not enough. We need to be spirited to succeed. We need to use and trust our inner spirit. Our spirit wants to succeed, get our needs meet and help others. Money is only truly needed for survival. Humans buy a bunch of materialistic stuff to be happy, we can also fill our needs to be happy a bit by doing “good works”. We can do good, make money, work smart and help each other. Being capitalist and efficient is not enough motivation IMO. If that was the case this site would not be here, and we would not want to talk about the cars we love. The economy would not even exist. We would not exist. Life would not be worth living. We would have quit the fight for survival a long time ago, its our free spirit, which knows no bounds that brought us here. Again I think America wants to do something like I mentioned. That is why this idea resonated with me. Also its not about simply doing good, Its also about getting something back, and responsibly putting our money were our mouth is. People talk all the time about economy sucks this and government sucks that, what about what we can do for our country? What pay taxes? ok, we got road, education, protection and capitalism, our taxes cannot cover everything though. The Government can only be so efficient anyhow. Thats why I say we need to be responsible for creating jobs ourselves. I think it can be done without killing business to much. Also business failures can be ok, if people have more job offers..

    I may be wrong though.

  • avatar
    autocorrelation

    First of all, the amount of speculative froth in commodity markets was/is WAYY overblown. People like to pretend that hedge funds/etc. investing in commodity futures drove up the market, but that is simply not true. At no point in the past year have speculative holdings made up more than 10% of future contracts. This is all public data available from the CFTC. I don’t claim to have a complete answer for the run-up, but a pretty decent explanation is general economic growth, a continued belief in the decoupling theory, some speculative froth (not as much as everyone seems to claim), which was rapidly ended in the past few months. In my view, anywhere from $95-120 (broad I admit) is “the new normal”. I definitely expect volatility in the price to only increase as time goes on.

    As for drilling in Alaska, while I certainly have no problem with it on any kind of moral/ethical/etc grounds. The price difference that oil will make on the market will be small at best. While it would certainly help, any dreams anyone might have of US energy indendence are completely nonsensical. Oil sands, while certaily helping, are still a 5-10 year prospect at best, and while current models make them profitable at 75$ a barrel, that will rapidly change with cost overruns that continue to plague pretty much all of the major projects. Brazil is a bright light, but the size of field/online time remain serious concerns (and serious unknowns). The economics of extraction are an even bigger question.

    I would certainly be willing to expand on my analysis if anyone is interested/cares.

  • avatar
    Landcrusher

    DearS,

    The only items on your list that retard business are – Welfare (not always), and corruption. Welfare can be necessary for a free market for labor. If the workers are being forced to take jobs to avoid starvation, then they are not bargaining freely when they sell their labor and bargain for pay. Don’t get confused when capitalists argue against bad welfare or too much welfare.

    Engineer,
    If you are going to argue with PCH, you are going to need to bring a better game. Trust me, I know.

  • avatar
    Engineer

    Thanks for the econometric data that I requested that supports your thesis that a 40% decrease in price in two months is strictly a matter of the markets working normally. Very convincing stuff.
    It’s a pleasure. Would that be all, sir? Oh, you want to meet Santa Claus? Just a minute, sir, as I send for him…

    When this is done on a small scale, it’s called a “pump and dump scam”, and the operators are prosecuted.
    Exactly. If you have evidence of such, please forward to your elected representative. He would love to bask in the glow of uncovering the evil plot.

    When a large, venerated, financial institution is writing up the multi-megabyte PDF’s about the coming era of $225/bbl oil and $2/L gasoline, and other repackaged “peak oil is nigh!” claptrap, well, that’s just savvy business acumen.
    You’re changing the subject, here. We are no longer talking about just too many traders, throwing too much money around. It’s getting to the “it’s all a big conspiracy” level.

    Explain how you know the analysis you refer to is inaccurate? Because you don’t like the idea of $225/bbl? Do you have a definitive hypothesis about the underlying flaw in the Peak Oil Theory Religion? I’d love to hear it.

    Even if you did, it does not support your logic. Even if you could prove definitively that Peak Oil is complete bunk, it does not prove that your analyst had ulterior motives when he published his analysis.

    JD’s theory sounds interesting, but it is just that. He may have some clever people who believe that futures prices determine physical oil prices, but that’s hardly proof.

  • avatar
    Engineer

    DearS:
    The solution is not to isolate America from the rest of the world. Quite the opposite.

    Of course, our currently crop of elected prosti… eh, representatives are spending like drunken sailors and signing the country away to China and petrodictators. Not very encouraging.

    But we need to trade intelligently, and be prepared to show that we actually stand up for our ideals. We need to play by the rules, and then encourage others to do the same. We need to identify critical resources (such as oil) and work strategically to find viable alternatives.

    Playing with ourselves is not going to get us very far.

  • avatar
    jerseydevil

    i think we should have more windmills. if they power our homes and offices, we will have lots of oil to use in cars. cheap too – reduce the demand of a commodity, the price goes down.

  • avatar
    autocorrelation

    The problem with windmills is location. Most of the best spots are in very remote places. Building the infrastructure to move that electricity to where it is useful can be quite expensive.

  • avatar
    DearS

    Thank for the feedback Landcrusher,

    Engineer,

    I agree trade is very very important. I’ve been thinking about that. We need boundaries to do intelligent trading. I think by developing jobs here and letting them fall when overseas competition can do better is a perhaps possible while maintaining a healthy economy. That way trade is fair and can be welcomed. As long as we keep putting more jobs on the table, creating markets in the process. So we do not isolate ourselves by doing more here, just we do it without waiting for others. We continue competition with the rest of the world. We need to keep money in peoples hands, so we need projects and jobs to keep things moving along. We do not need to wait for the private sector and their search for profits. As long as money is moving we can help each other, while being productive, no matter if we encounter some failings and the business is only temporary. We just continue making new business and working in other areas that can improve our standards of living. I think it just takes a bit of financial backing by America, but it may work if we get started. Again we are not messing with trading, we are just ahead of the competition. While investing in things we need like wind farms, something we are already planing to do.

  • avatar
    mdf

    Engineer: We are no longer talking about just too many traders, throwing too much money around. It’s getting to the “it’s all a big conspiracy” level.

    I have no idea what you are talking about now. You said, previously:

    You seem to believe (naievely?) that a trader sitting at a keyboard can simply whip up momentum, make a ton of money, and walk away giggling into his mocha, while real people can barely afford to fill their SUVs.

    Where you really talking about “too many traders, throwing around too much money” here? It certainly doesn’t read that way. Are you trying to change the subject?

    Explain how you know the [$225/bbl] analysis you refer to is inaccurate?

    http://www.nymex.com

    I see $104 right now. What do you see? This is up from a low of $92 or something earlier, and only up because ka-billion of cash have been injected into capital markets. Maybe even in part because the US government has decided to socialize trading.

    I guess at some point it could well be $225/bbl. I mean, yeah, Israel could nuke Iran tomorrow. But then again, Goldman Sachs (or someone) was all about the price dropping to possibly $70 recently. Both of these predictions can’t be right at the same time, can they? Quite a spread too: if I predicted that you were between 60cm and 200cm in height, how impressed would you be?

    Even if you could prove definitively that Peak Oil is complete bunk, it does not prove that your analyst had ulterior motives when he published his analysis.

    I did not say that “peak oil is bunk”: I said arguments of the form “peak oil is nigh” is nonsense. At some point oil will, must, peak; it just isn’t happening now.

    As for the “ulterior motive”, as far as I am concerned, when a chief economist for a large Canadian bank that was still in the process of recovering from a massive kick in the testicles re: subprime gets up and starts on about peak oil this and peak oil that and $2/L gasoline, you would have to be more than a little dense not think said bank is now long in oil, and said economist is serving as a mouthpiece for said position.

    Good grief man, if that bank was short in oil, would they be publicly predicting $200/bbl oil, when the current price was only O($100)?

    He may have some clever people who believe that futures prices determine physical oil prices, but that’s hardly proof.

    Well, the cited article has numerous references that say the “clever people” are the ones pumping the oil out of the ground. If that’s not good enough for you, well, I guess there isn’t much I can do about that.

  • avatar
    Pch101

    Oh, you want to meet Santa Claus?

    No, I wanted to see the economic data that you were using to support what you had been claiming to be an economic argument. I take it from your data-free reply that you’ve abandoned the pretense that you had anything quantitative to support what was supposed to have been a quantitative position.

    For those who don’t earn fees from trading, devotion to the “peak oil” god seems to be the main driver. For those who saw soaring oil prices as a sort of Second Coming, these falling prices must be trying to one’s faith.

    He may have some clever people who believe that futures prices determine physical oil prices, but that’s hardly proof.

    Apparently, you don’t grasp the point of a futures market or how they work.

    Its entire purpose is to create an efficient price mechanism for commodity goods. If a futures market wasn’t setting prices, there would be no point in having it in the first place.

    Everyone who participates in the market is part of the price discovery (setting) process. If a bloc of price setters who are indifferent to absolute price — we refer to these as “speculators” — enter the market en masse, then it’s understandable that prices will become volatile for a time. If the trader’s tendency is to go long, then it’s not surprising that the volatility will tend to move prices upward.

    The problem isn’t with speculators, per se, but with the quantity of speculators at certain points of the cycle. When there are too many of them, the liquidity they bring becomes excessive, and their bidding process begins to dominate the pricing mechanism. They don’t need to be eliminated, just regulated.

  • avatar
    Kiwi_Mark_in_Aussie

    An interesting article on Peak Oil

    http://www.theregister.co.uk/2008/09/17/richard_pike_rcs_interview/

  • avatar
    Engineer

    No, I wanted to see the economic data that you were using to support what you had been claiming to be an economic argument. I take it from your data-free reply that you’ve abandoned the pretense that you had anything quantitative to support what was supposed to have been a quantitative position.
    As I have stated above: Of course, (much as we engineers hate it) there is no way to calculate a fair price based on the fundamentals. (emphasis added) You are looking for data that does not exist. Conclude from that what you wish. Can’t introduce you to Santa either. That does not mean you win the argument.

    When there are too many of them, the liquidity they bring becomes excessive, and their bidding process begins to dominate the pricing mechanism.
    No, when there are too many of them taking the same position, reality intervenes and they lose their shirts. Without any help from Uncle Sam. Those are the rules of the game. They understand it (for the most part) and still choose to play.

    They don’t need to be eliminated, just regulated.
    What, you’re a nanny state kinda guy?

    I see $104 right now. What do you see?
    The $225/bbl was a prediction. Meaning, not what you see right now. Meaning, we won’t know for some time whether it was prophetic or foolish.

  • avatar
    Pch101

    Of course, (much as we engineers hate it) there is no way to calculate a fair price based on the fundamentals.

    That would substantiate the argument being made in the article — the pricing is being dictated by speculators who have other agendas, such as playing movements of the dollar, rather than oil hedgers who care about the price of oil because they purchase it.

    Those are the rules of the game. They understand it (for the most part) and still choose to play.

    This has absolutely nothing to do with the reality that speculators still are setting prices that are disconnected from supply and demand fundamentals.

    What, you’re a nanny state kinda guy?

    What are you, an advocate of bubbles and stagflation?

  • avatar
    Landcrusher

    If speculators are indeed setting the price with no connection to supply and demand, then why are actual buyers and sellers willing to go along?

    There HAS to be some connection.

  • avatar
    Pch101

    If speculators are indeed setting the price with no connection to supply and demand, then why are actual buyers and sellers willing to go along?

    The hedgers have no choice. The futures markets set the price. If they didn’t, we could just scrap them; if the pricing mechanism was meaningless, the futures market would be window dressing and would serve no purpose.

    The issue is one of making the futures market serve as a reflection of hedgers’ prices. Right now, they aren’t. Usually, oil prices have no connection with the value of the dollar and the financial industry, but lately, they correlate with each other. That’s an indication that the future markets are not serving the function that they normally do, because they are incorporating components into the pricing that have no relationship to the supply and demand for oil itself.

  • avatar
    Alex Rodriguez

    For those of you who still want to cling to the fantasy that the market is controlled by supply and demand…

    I refer you to today’s events. What exactly happened with oil today that would cause futures to rise 25%…in a single day? Did some new demand number come in showing a huge increase? Did a major project get blown up somewhere? Did Iran stop shipments?

    No. No and NO. Money is rushing into commodities by people who have little or no interest in the actual oil. They are just looking a place to make money since the dollar is down and banking is shaky.

    Period. When I hear “peak oil” I reflexively laugh out loud, it is so comical.

    The commodities markets are in serious need of reform. That is the bottom line.

  • avatar
    Landcrusher

    A currency value can not be divorced from the price of a global commodity. There is a relationship by necessity.

    The hedgers do have a choice. They can deal or not. The need for a hedge is itself an input of demand into the system.

    Correlations are interesting, but causation is better. The financial markets are an indicator of future demands for oil. Good economy, high demand and so forth.

    I will agree that historically normal supply and demand relationships have not been the cause of the price swings. I will even agree that speculators may be responsible. However, you aren’t getting closer to a good explanation, in my opinion. If we can’t zero in on the real cause, we aren’t doing any good.

    Moving forward there are two possibilities. Either we have confidence we know what went wrong, or we don’t. If we do have confidence, then we can likely arrive at positive reforms. If we don’t have confidence, then we need to tread lightly and keep working at it until we do. Otherwise, the reform will simply cause a later problem which is likely to be worse than the present one.

  • avatar
    DearS

    I do not believe in supply and demand controlling anything. Because I can charge what ever I want for what I own, no matter supply and demand.

    Supply and Demand are not in of themselves in control of anything but they do exist. Just like emotions, they do not control our choices, but they tell who we are.

    Its funny how these folk have so much power over our lives path. I’m a little worried, but I have more faith then ever in my path. People often need to go through hardships before they grow up, set boundaries and assert themselves. Its tragic and sad for people to experience pain though. There is a lot we can do, but people need to see that for themselves. I think things are going to get much better and interesting in the future, but its going to take a much different substance of character to get there. Profits do not equal happiness, losing them or going through hell to keep them may just be what America needs to overcome the addiction to money, status and prestige. I know its worked for me.

  • avatar
    Pch101

    A currency value can not be divorced from the price of a global commodity.

    Typically, there is no relationship, and the dollar is usually stable enough that its fluctuations become irrelevant.

    As Mr. Montgomery addresses in the article, there has been a relationship as of late that is atypical.

    The hedgers do have a choice. They can deal or not.

    Over the medium term, they do. In the short run, they do not. Airlines still have to fly, otherwise they fail. Refiners still have to refine, otherwise they have to pay for refining capacity that produces no revenue. Consumers need time to recognize the problem and adjust. They need time to adjust, but like an aircraft carrier trying to make a turn at sea, they cannot do it on a dime.

    Moving forward there are two possibilities. Either we have confidence we know what went wrong, or we don’t.

    We know from the price parabola and the dramatic increase in open interests held by speculators exactly what was wrong. A viable solution would be to require higher margins from non-hedgers in the market, so that they have more skin in the game and less available capital to invest. But since the CFTC likes to pretend that everything is just peachy, it’s going to take some effort to get this to happen.

  • avatar
    Alex Rodriguez

    “A viable solution would be to require higher margins from non-hedgers in the market, so that they have more skin in the game and less available capital to invest. “

    Ding! Ding! Ding! Ding! We have a winner.

  • avatar

    Terrible timing, eh, William?

    Though it should be stated that the 20% surge in prices today is due to people moving their money around, and not due to demand outstripping supply.

    Demand is nosediving as people are reducing their driving and the economy is grinding to a halt – and that brings the price of oil down.
    Anyone who knows anything about extracting oil now that “Drill now!” is not going to solve anything — at least for a number of years.

    With the plummeting value of the dollar, the next hairpin bend in the road facing the US is whether major oil producers will continue to accept the dollar as payment. And that’s worth thinking about.

  • avatar
    Landcrusher

    PCH,

    One more shot, but I am about done.

    Yes, the fluctuations in the dollar have usually made little difference. That has changed, not because of oil speculators, but because of confidence in the dollar.

    Airlines have to fly, but they do not HAVE to hedge. They choose to. The whole business model of the large airlines is screwed up, but they can’t seem to change. This makes them a bad example for anything that demands rational choices.

    Refiners will, at some point, stop refining. They may play at a small loss, but they aren’t as stupid as airlines.

    I will not buy your idea that supply and demand are completely divorced. Sorry. At some point, they matter. I believe the problem is that supply is near demand, price is inelastic in the short term, the commodity is still cheap, and the dollar is going whacko.

    One person in the pool makes a lot less waves than fifty. There is just too much going on. You won’t find the answer by simply nullifying economic theory.

  • avatar
    Pch101

    That has changed, not because of oil speculators, but because of confidence in the dollar.

    Agreed. The value of the dollar correlates roughly with the US budget deficit and world confidence in US stability. In that sense, the oil price is symptomatic of the underlying weak, now unstable currency in which it is denominated.

    Airlines have to fly, but they do not HAVE to hedge.

    If they wish to manage their costs, they really do need to. However, they have been reducing their hedging during recent months, because they cannot afford it at the current prices and because locking in the high prices of earlier this year made no sense for them — if forced to pay those prices over the long run, they would fail, anyway, hedges or not, because they cannot survive in a world of $140 oil.

    I will not buy your idea that supply and demand are completely divorced.

    That isn’t my point. The issue here is that the equilibrium price of oil investments is higher than that of the equilibrium price of oil as a good to be used.

    This is akin to the dot-com bubble, in which investors happily paid many times more for the stock of a company than a fundamentals-based approach would indicate was warranted. As long as there was a greater fool, this made perfect sense — the seller could profit. Eventually, the fools run away from the market, but until they do, the prices go well above what they ordinarily would be.

  • avatar
    William C Montgomery

    Terrible timing, eh, William?

    Not at all. The instability of the last few days is exactly what I was afraid of when I composed this article. To wit: “It’s going to get worse before things start to get better.”

    Though it should be stated that the 20% surge in prices today is due to people moving their money around, and not due to demand outstripping supply.

    Demand is nosediving as people are reducing their driving and the economy is grinding to a halt – and that brings the price of oil down.

    And today the prices are falling again. These wild swings are illustrative of a market in chaos. Investors don’t know what to do and have no confidence in the economy. These motions have little to do with supply and demand. This is PANIC.

    Anyone who knows anything about extracting oil now that “Drill now!” is not going to solve anything — at least for a number of years.

    I made that point in my last article on this subject. However, it is terribly short sighted (i.e. asinine, irresponsible) to leave exploration and drilling prohibitions in place. If we don’t, fifteen years from now when we need those reserves, we’ll be fifteen years away from being able to tap them. Just as if these restrictions had been removed fifteen years ago, we might have access to those reserves today, making the country less vulnerable to market spikes or foreign supply disruptions (i.e. not invulnerable, but better able to cushion international market pressures).

    Furthermore, it must be noted that the last time many of the protected coastal areas were surveyed was 30-40 years ago using now antiquated techniques. Many of the geological surveys predate the use of computers, let alone 3D modeling. Oil companies are far better equipped to locate oil and gas reserves than ever before. In a sense, we really don’t have an accurate picture of the potential of those reserves. If nothing else, we need to open up those restricted areas to exploration efforts so that the nation (and the world) can make informed decisions about how to proceed.

    With the plummeting value of the dollar, the next hairpin bend in the road facing the US is whether major oil producers will continue to accept the dollar as payment. And that’s worth thinking about.

    The current bailout scheme threatens to severely weaken the US dollar, which will result in higher oil prices for Americans. You might be right. If the US dollar falls hard enough the market might adopt the Euro as the standard currency for valuing oil. However, US recessions tend to have a domino effect on other markets, especially big foreign trading partners like the European Union. If we all go down together there will be no point in changing currencies.

  • avatar
    reclusive_in_nature

    Haven’t read all the coments here yet, but I’ve already spotted one socialist “solution”. Sad how commies come out of the woodwork when times get hard. Sadder still, is the amount of people who will subscribe to their solutions.

  • avatar
    DearS

    Its about balance I believe. Folks have not been keeping their balance emotionally becuase they have been looking at money as the answer to happiness for a lot of things. Now they panic and feel afraid when what they put their well-being on emotionally is no longer there, its normal its human. Still its out of balance to just put unrealistic on money. Their capacity for denial just got a challenge. The feds capacity for denying the truth is also being challenged. So is America and just about everybody. The economy is also morphing with all these players acting in a new way. Well no one can make anyone else do something unless they put a gun to an investers head. We need observe, try to go in the direction we think is best and show up for life. We do not know what is going to happen, thats on a need to know basis. Like Cassandra and her curse.

  • avatar
    Alex Rodriguez

    If I’m reading Reclusive In Nature right, I’m guessing Theodore Roosevelt would qualify as a “Commie” since he fought monopolies, trusts, and fought to institute oversight in the financial markets.

    Reclusive. If I’m reading your comment wrong, let me know.

  • avatar
    DearS

    I was just thinking, if inflation goes up fast, what is keeping people from switching to Euros and leaving the dollar behind?

  • avatar
    joeaverage

    I read something early this year that said alot of the South American and Mexican drug dealers had switched to the Euro. Whether that means they had reduced confidence in the dollar or they we doing business with more Europeans I don’t know. Just thought it was interesting. Maybe Euros are easier to “launder”.

    While the news is focused on Wall Street and Congress I’m still waiting for somebody to define what the current situation means to our state and local governments – that is, how this is going to affect us on a local level.

    I still haven’t heard an explanation that makes me want the gov’t to bail these nitwits out. First you have the consumer who has over extended themselves. They had the full terms of the debt they were signing on to right there in front of them. Let them live with the situation they had made for themselves. I suppose there will be alot of McMansions and shiny new cars going up for auction but maybe we’ll have the second coming of the depression era mentality – save – save – save – save money. No debt when possible. I think while the folks making a living off of debt interest might get left out in the cold the economy as a whole would be healthier. Less trade in paper, more trade in substance.

    As for Wall Street… I was disappointed over the past few days with finding a series of articles from various sources trying to make a partisan issue out of this. Authors trying to say the left or the right was responsible for the current woes. One article explained that when legislation was pushed through Congress to regulate Freddie and Fannie the Democrats opposed it so this problem must be there doing. I would have thought the intelligent people who author our news media would try to look beyond petty arguments like this. Both sides are responsible for this problem. On one hand you’ve got people who ought to regulate these guys so they don’t get too far out of hand. On the other hand we’ve got greedy folks doing everything they can to make another dollar off of trading paper.

    Too many people responsible for this – the banker making a living from high interest APR loans. The consumer who is reaching beyond their means to take on more debt or because they walked away when the going got rough or because they did not make the sacrifices necessary to have a better financial footing (forgo the shiny new car or the cellphone with the $60 a month fee, or the too often trips to the mall to buy name brand stuff).

    In the end we’ll all be paying for this for some time through higher taxes or lower value of the dollar causing prices to rise here. Of course McCain still says he wants to lower taxes but with all of the spending how can they expect to make the budget work? Bailouts, Iraq, and Afghanistan. All pretty expensive stuff.

    I say let’s let the economy recover without the bailouts and let Wall Street take the punches and bruises. We’ll all be poorer for a while but in the end we’ll as a nation be wiser.

  • avatar
    Landcrusher

    Joe,

    I think you have pretty much described what lots of American’s are thinking about this deal. Many are more partisan on one side or the other, but in the end they feel similarly.

    These financial wizards had better get out some charts and start explaining what they want $7B for, and fast.

    If we could simply buy up mortgages at 25 cents on the dollar and save the day, then I might support that. So long as we don’t somehow get stuck with all the bad ones. But after all this, I still don’t understand what you really own when you get one of these bonds. I also don’t know if that’s REALLY what they want to do with the money.

    I also don’t know what would happen if the SEC changed the rules so that these companies could simply value those bonds at .25 of face value. Would that swing their books into positive territory? Is that more realistic than zero?

    I would be happy to buy a few mortgages. I would consider it an excellent investment, and so would many others. Unfortunately, Wall Street and Uncle Sam built a model that kept guys like me out of the market because we don’t control tens of millions of dollars. It was corporate socialism which seems to be a bipartisan issue on Capitol Hill because the right votes for corporate and the left votes for socialism.

  • avatar
    Pch101

    I say let’s let the economy recover without the bailouts and let Wall Street take the punches and bruises.

    I really don’t want to live through a depression just because it sounds like a form of street justice to avoid the bailouts.

    The economy is going to suffer, no matter what. The question is how much you want to suffer. The bailouts are unappealing, but are nonetheless the least painful of the available options. The chemotherapy is going to suck, but the alternative is death.

  • avatar
    William C Montgomery

    Too many people responsible for this – the banker making a living from high interest APR loans. The consumer who is reaching beyond their means to take on more debt…

    You forgot the politicians (from both parties) pandering for votes by promising and delivering affordable home loans to people who can’t afford them. This has never been an issue of inadequate regulatory oversight – in their wisdom, the political leadership of our country fully intended for these loans to be made. The bankers you mention would not have made the high risk loans if Freddie and Fannie, under legislative mandate, weren’t buying them (a bi-partisan bill passed through a Republican congress and signed into law by a Democratic president). And the loans wouldn’t have proliferated if the Federal Reserve Bank weren’t holding interest rates extremely low in order to stimulate the economy, in part via new home construction. Funny how the congress and administration (current and former) are deathly silent about their leadership in inciting this financial meltdown…

  • avatar
    joeaverage

    And ANYBODY running for election is talking about lowering taxes with the way the gov’t is spending? Are they nuts?

    Hey, let’s send out another round of gov’t checks. It’s only money…

    How about getting the gov’t ledgers balanced???

  • avatar
    blindfaith

    There is a lot of oil out there and it is in Canada and the US

    http://www.heavyoilinfo.com/

    From the article:

    The International Energy Agency (IEA) estimated there are 7 trillion bbl of non-conventional oil, including heavy oil, bitumen, oil sands, and oil shale. Technically recoverable quantities vary from 1 trillion to 3 trillion bbl, the IEA reported.

    IEA’s World Energy Outlook forecasts significant growth in heavy oil and bitumen production, particularly from Canadian oil sands. Heavy oil resources are concentrated in Canada, with 2.5 trillion bbl, and Venezuela, with 1.5 trillion
    bbl.

    Production and processing costs have fallen significantly

  • avatar
    tankd0g

    Don’t hold your breath on those lower gas prices. The refining monopoly is still in place even if world markets have taken a dump.

  • avatar
    Landcrusher

    Some monopoly, people do it in their garages for themselves.

    At best it would be an oligopoly, but if so, it’s a REALLY benign one because refining margins have been just silly low.

    You would think they were charging prices for gasoline like they do water. Sheesh.

  • avatar
    jl1280

    Drill baby drill! And just when does that insignificant amount of oil actually get to the local pump? Is that 2020 or 2025? I could run my SUV on the hot air of the “drill baby drill” crowd.

  • avatar
    Landcrusher

    jl1280,

    Actually, we could be getting some oil in some prohibited areas in months, others in a few years, but yes, it will likely take 6 to 8 years to really get large volume out of some of the now prohibited areas.

    Still, it’s about as certain an investment as we can make. Failing to do it only means the situation will be worse in 6 to 8 years.

    OTOH, we could gamble on the hopes that we come up with a better solution. There is no faster plan available. NONE. All the other plans, except nukes are much greater unknowns.

    All the other plans will take lots of fossil fuels to actually develop as well. Nukes, windmills, hydro, bio and solar all take large amounts of energy to exploit. Green energy grows like a tree. It takes a long time to grow it.

    So yes, drill, drill, drill. We need the oil to bridge us over to whatever we can figure out is the best substitute.

    Unless you have a plan that we can go with today?

  • avatar
    Engineer

    Dog,
    What are you talking about? US refiners have recently been taking it on the chin, as oil prices have gone up, but demand for refined products (mostly gasoline) has been going down. These guys are hurting, as a study of the “crack spread” (basically how much money refiners make) shows.

  • avatar
    tankd0g

    Come on guys, you can’t seriously still be parroting the company line that refiners are hurting. When Bush took office the 5 major oil companies in the USA moved to take a controlling share of the refining business. The FTC was going to move to stop this obviously monopolistic move and Bush told them to back off. So I’m sorry if this is news to you, but the high prices at the pump, the prices that seem to be completely divorced from the falling market price of oil, they represent a huge markup. Probably the highest in the history of gasoline refining in the USA.

    There is no longer competition among refiners in the United States, the wholesale price is set as high as it will go, they tried $4 a gallon gas for a while and saw a decline in consumption, that is the ONLY reason prices have fallen at all. They need to keep price in the sweet spot that generates maximum profit for the least number of gallons refined.

    As if that weren’t enough, these major oil companies that own the refineries, they don’t pay market price for the oil. They are the ones pulling it out of the ground, piping it directly to their own refineries. The same oil they were pulling out of the ground and selling for $40-50 a barrel a few years ago at a hefty profit, it still costs them the same amount today as it did then (aside from an increased percentage paid to the state/country it comes from), but they are wholesaling the gas for twice as much as they were. That is why independent refiners are as good as dead, how can they possibly compete? And so the monopoly becomes impenetrable.

    Don’t take the word of oil company CEOs as they sit there in front of congress with a smirk on their face, they are so full of BS it should be marketed as an alternative fuel.

  • avatar
    Landcrusher

    Tankdog,

    I don’t take CEO’s words for anything. I do listen to lower level employees who are in the know.

    How can you claim that the price of gasoline is so excessive? Exxon made 10% profit for Pete’s sake. If you told most American CEO’s that their profit margin was going to be 10% in their next good year, they would sell their own stock and retire before the news got out.

  • avatar
    tankd0g

    Oh here we go with Exxon’s mythical 10% profit which manages to never change despite wild swings in every aspect of the market. Has Enron taught you nothing about creative accounting? You hit the nail on the head when you say no CEO in their position would accept a 10% profit, think about what you just said.

  • avatar
    Landcrusher

    Ya, I learned from Enron not to believe ridiculous profit claims.

    Are you saying that Exxon’s numbers are phony? Do they not correlate with their competitors? Is your theory that they all collude on what to put on the books each year? Where is all the profit going after all?

  • avatar
    tankd0g

    Among large oil companies there is no real competition, so there are really no competitors to Exxon. They all play the same game by the same self made rules and don’t screw each other over. Their numbers are not phony, they are simply shaped to tell the story they want to tell you. If a CEO takes home $500 million dollars through various shady money laundering technics within the company this year for example, that’s an expense on the books, not profit. “Oh look it costs us $500 million more dollars to operate this year.” he tells the share holders as he gets on a plane to his newly purchased island in the south pacific.

    You also must keep in mind that many of these companies are huge broken up into many different parts, in different tax (or no tax) jurisdictions and operating under different nation’s laws. They can show you one side of the business losing money when it’s actually losing it to another part of the same company.

    It’s no accident that oil tripled in price since Bush took office and it’s not due to the Chinese, Indians or hurricane Ike. When oil took a $50/barrel dump in a couple weeks, the jig was up. A half billion Chinese didn’t die during that time frame, India didn’t get nuked but a couple hurricanes DID hit. The manipulation of prices is plain to see, these bubbles and busts are going to continue several times a year from now on, making some people millions of dollars on each rise and fall while the best the peasants can hope for is that the economy doesn’t improve to the point to allow the price of gas to go up to $5/gal and beyond and still sell in sufficient quantity to maximize profit for the oil companies.

  • avatar
    Landcrusher

    It’s an interesting theory, TD.

  • avatar
    Engineer

    So, Dog, let me see if I got this straight: it’s not the speculators, it’s manipulation by (the US) Big Oil. So why is it that everytime Congress investigates they find nothing? After several years? Don’t say it’s by criminal means: not even the mafia can keep things closed that long.

    You also oversimplify things. I agree, those oil companies that do both pumping and refining make enough profit on the pumping part to subsidize the refining part. The problem is those companies (like Valero) that do only refining.

    As this guys puts it: If there’s a pretty good case that speculation [or collusion for that matter] is driving up prices, then why aren’t pure refiners like Valero screaming? I imagine Valero has a pretty savvy staff of analysts studying this issue, and oil markets in general, to death. It’s their business, after all.

    If Valero thought that something was wrong with the market, and they’re buying on the order of $140 billion worth of crude annually, and their share price is dropping, and they had a 1Q2008 ROS of 0.5%… why aren’t we hearing more from them? [Pch????]

    This suggests to me that the world’s largest buyers of crude are saying “It’s the market price; it’s not artificially high.” (emphasis added)

  • avatar
    Pch101

    If oil companies could really control oil prices in any meaningful way, I have my doubts that we would have had $15 oil for as long as we did.

    The refining side of the business gets hurt with high prices, because it thrives when retail consumption is high, but high prices lead to reduced consumption. Accordingly, their crack spreads (profit margins) decline, which obviously isn’t so good for business. Oil companies may like the higher prices, but the pure refiners get hurt.

  • avatar
    tankd0g

    Why do I even waste my time, if you can’t see the difference between oil prices and gasoline prices I can’t really help you.

    Some pretty hard core ignorance here if you think the speculators control the price of oil. How do speculators drive the price of oil up? They buy futures based on what the OIL COMPANIES say they are going to do in the future. Who do you think is in control here, the guy buying next months contracts or the BP CEO that told him to in a news release stating that for some bullshit reason we’re projecting an X% increase in consumption and also cutting back production X amount?

    Why doesn’t congress find any wrong doing? Maybe because no laws are being broken? Did you know that your government spying on your telephone conversations used to be against the law too? Not any more. Welcome to the neo-con wet dream.

  • avatar
    tankd0g

    Pch101 : $15 oil? Wtf are you talking about? When during the Bush administration was oil $15 a barrel?

  • avatar
    Pch101

    $15 oil? Wtf are you talking about?

    Oil traded between $15-25/bbl until about five years ago. It was this price for a couple of decades.

    If the oil companies were as good at price fixing as you claim, then it is astonishing that they accepted such low prices for so long. The conspiracy managers within the firm were obviously sleeping on the job.

    How do speculators drive the price of oil up?

    I believe that I and many others in the business media have explained this.

    Traders don’t care what they pay, just so long as they can trade out of their positions at a price that yields a profit. Hedgers do care, because they ultimately have to pay it to fuel their planes, etc., but traders are fairly indifferent.

    Just as traders and speculators can drive up the price of dot.com stocks, so they can with commodities and common stock. We’ve seen this happen time and time again, so the reality of this phenomenon shouldn’t be a mystery.

    Here’s an economic tidbit to everyone reading this — when you see sharp increases in the price of anything, the full amount of that increase is probably temporary and unsustainable.

    In normal supply-demand situations, long-term price changes are generally gradual, not sudden. When these drastic increases happen, they are typically doomed to deflate because the market will eventually correct itself. I would not expect there to be $15 oil again, as the fundamentals no longer warrant it, but the $150 threshold was clearly something that only a trader could love, and even they couldn’t love it enough to keep there.

  • avatar
    tankd0g

    PCH101: Oil companies didn’t accept anything, they were not in a position control the price in the 1990s. The 1990s are the darkest time in history as far as oil companies are concerned, they saw their profits strangled by Clinton era oversight that kept them from doing what they are doing now. I’m not going to say it again, the consolidated their monopoly AFTER Bush took office. AFTER he removed price controls, AFTER he told the FTC to stop looking at them.

    http://www.wtrg.com/oil_graphs/oilprice1970.gif

    You don’t find that graph the least bit fishy?

  • avatar
    tankd0g

    Pch101: By the way, the $150/barrel price that traders loved, well only traders who bought in when it was low loved that. It does nobody any good if the price is stable. It will be $150 again soon, you can bet on it, and it will be the oil companies themselves that trigger it, NOT the traders.


Back to TopLeave a Reply

You must be logged in to post a comment.

Subscribe without commenting

Recent Comments

New Car Research

Get a Free Dealer Quote

Staff

  • Authors

  • Brendan McAleer, Canada
  • Marcelo De Vasconcellos, Brazil
  • Matthias Gasnier, Australia
  • Tycho de Feyter, China
  • W. Christian 'Mental' Ward, Abu Dhabi
  • Mark Stevenson, Canada
  • Faisal Ali Khan, India