The Oil Drum | DrumBeat: June 5, 2006

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The Interloafer on June 5, 2006 - 9:07am

Is Condoleezza Rice aware of the basics of supply-and-demand?

Yesterday, in response to Iran's talking about decreasing its oil production, she said:

"We shouldn't place too much emphasis on a threat of this kind," Rice said on "Fox News Sunday," referring to comments today by Ayatollah Ali Khamenei, Iran's supreme leader. "I think something like 80 percent of Iran's budget comes from oil revenue, and so obviously it would be a very serious problem for Iran if oil were disrupted."

In the 1979 oil crisis, a response to the Iranian revolution, oil supply decreased by only 4%, but the price more than doubled from $15.85 to $39.50. So I'd say Iran would be a perfectly rational actor to curb supply, or even just talk about doing so. They could get more money and produce less oil. In fact, they'd be fools not to do that (unless they're afraid of U.S. military intervention, which is perhaps the real point of Rice's comments).

I'm actually surprised that a lot of oil exporting countries don't voluntarily reduce production in order to "save some for later" when prices are inevitably a lot higher.

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tate423 on June 5, 2006 - 9:28am

And I keep hearing how intelligent she is. I guess she missed the Econ courses.

I was reading John Mauldin's letter and noticed an interesting snippet.

So when the poor jobs report came in today, the bond market immediately moved huge on the news, as the assumption is "How can the Fed raise rates with a slowing job market, not to mention all the other problems noted above?" Ten-year interest rates dropped to 4.99%. The yield curve once again starts to flatten.

http://www.frontlinethoughts.com/pdf/mwo060206.pdf

To point out how we're stuck with a no win situation:

The bond market has decided that the rate cuts won't happen. They have repriced bonds accordingly and the yield curve has flattened back out from inversion.
With Paulson as the new Trez Sec., he has stated he wants to vigoursly defend the dollar.

Ok, so who wins? Is the bond market right and FED is stopping, or does Paulson get with Bernanke (yeah right) and demand to defend the dollar in the face of mounting inflation? Oh yeh, inflation is the number one enemy of the Fed, according to policy.

I think the bond markets are premature. The Fed has no choice but to raise rates.

Here's a snippet of a rant about new Treasury Sec. Paulson & his environmental record.

In Thursday's Wall Street Journal, columnist David Wessel raised some interesting points when he wrote, "...given [Paulson's] record in using Goldman's power and money toward environmental ends, he just might use his clout to push the administration toward dealing with climate change or even - don't mention it before the elections - considering an energy tax."

If you want the whole thing check out:
http://www.townhall.com/opinion/columns/JonathonBurns/2006/06/03/199811.html

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LevinK on June 5, 2006 - 9:40am

The Fed has no choice but to raise rates.

Absolutely. The dollar has been on such pressure recently that I am quite worried what may follow if the FED decides to pause. Hope I'm not wrong...

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smekhovo on June 5, 2006 - 10:07am

If Bernanke pauses now, it's a major humiliation for him in the macho world of central bankers. Like a prizefighter squaring up to his opponent at the start of a bout, then running away and diving back outside the ropes.

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tate423 on June 5, 2006 - 10:33am

Great analogy! Not to mention he testified to the Senate that he would vigorously fight inflation. Efficient markets are not real, they exist in a classroom.

Look at this article about the love of full service gasoline and the FIGHT to keep it LAW!

http://www.chicagotribune.com/business/chi-0606050179jun05,1,2029021.story?coll=chi-business-hed& ;ctrack=1&cset=true

Here's how it's framed:

None of the states offering self-service seems to have fallen prey to the perils that the New Jersey law associates with pumping one's own gas. These range from "the fire hazards directly associated with dispensing fuel" to "exposure to toxic gasoline fumes" to "the fact that customers who leave their vehicles . . . face significant inconveniences and dangers, including the risks of crime and fall-related personal injury."

I thought these were a thing of the past!

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LevinK on June 5, 2006 - 11:24am

Or maybe this is exactly what the FED wants us to think, while in the meantime is happy with inflating the internal debt and with the weak dollar. Personally I don't believe so, but I'd rather not put all my chips on a single square.

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BrentCrude on June 5, 2006 - 11:54am

Can someone explain the relationship between the money supply and interest rates.

Can you pretend to fight inflation with higher interest rates whilst secretly printing lots of inflationary dollars (now M3 is not being published) ?

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BrianT on June 5, 2006 - 11:58am

Yep. There are methods but if you discuss them people accuse you of being a conspiracy nut. There are lots of books written on this subject. A recent theory is this is why they are bringing Paulson on board. Listen to the financialsense broadcast from Sat.Good luck with your research.

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tate423 on June 5, 2006 - 12:41pm

First about not putting all your chips on one square....if you make your living in the financial markets, that's what you get paid to do. No balls...no blue chips. So buck up.

When the MSM says interest rates are going up it's really the federal funds rate, or the rate that banks charge each other to loan funds deposited at the federal reserve. This is a paper transaction in most cases, but can be stemmed from a cash crunch which would require the cash to be deposited to actual banks.

What the FED does is they do not "set" the rate, it is determined by Supply & demand, but for money. They know they can control the SUPPLY of money. They can print more(more on that in a sec) or they can take money out of circulation. When they raise rates they are suppose to be taking cash out of the system. This ine effect reduces the supply of money and therefore the new "price" of money is the new FF rate. That rate sets many other prime rates etc.

I think this is BS, because it's far easier to set a rate by telling everyone it costs 25bp more today, than yesterday. They don't need to reduce anything, but instead charge more. I say this because you bring up M3 which is the broadest measure of money.

I have no confidence in the Fed's compilation of banking system "net" repurchase agreement positions, and that it generally excludes Wall Street "repos" makes this quite worthwhile number worthless. There are also issues with "eurodollar deposits." Additionally, any broad measure of "money-like" instruments today must at the minimum include CP [commercial paper], some ABS [asset backed securities] and should include some "structured products." [derivatives?]

What all this means is that the Fed can "print" money in ingenous ways that may or may not inflate the monetary base. Basically M3 includes all the games that the finance community has come up with to make money on something.

Pulled from Wiki: According to the last published data from 16 March, 2005, M3 has been growing at an annual rate of over 8.22%. As of 16th March 2006 M3 was $10'336.3 billion. One year earlier, on 14th March 2005 the M3 was $9'550.5 billion.

CPI & GDP are easy numbers to alter and they've done that quite well. M3 isn't nearly as easy to fudge. One last note about M3 from http://www.capitalspectator.com/archives/2005/11/does_m3_matter.html

Superficially, at least, it looks a bit suspicious when the Fed says it'll soon bury a series of money supply numbers that contradicts the central bank's public relations effort to convince the world that it's squeezing the monetary system and thereby taking a hawkish view on fighting any and all future inflation. Of course, as Cosgrove observed, the Fed has relatively lesser influence on M3 vs. M2, or certainly the monetary base. Nonetheless, the Fed's only explanation for the planned demise for M3 boils down to sparse interest in the series and the allure of saving money by discontinuing its publication. The former is a reasonable, but ultimately unpersuasive point. After all, the Fed publishes a massive amount of data, and much of it is obscure for all but a few economics geeks. As for the bit about saving money, well, that one just rings hollow from the outset. How much could the termination of M3 save the Fed? Measured against its annual budget, it's barely a rounding error, if that.

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TechGuy on June 5, 2006 - 7:00pm

>Pulled from Wiki: According to the last published data from 16 March, 2005, M3 has been growing at an annual rate of over 8.22%. As of 16th March 2006 M3 was $10'336.3 billion. One year earlier, on 14th March 2005 the M3 was $9'550.5 billion.

The expansion is largely caused by the Huge trade deficits. Virtually all major US trading partners have High USD reserves. Some of the foriegn trade surpluses are reinvested in US bonds (Treasury, CP, and Mortgage Debt) which has prevented bond rates from rising significantly.

>What all this means is that the Fed can "print" money in ingenous ways that may or may not inflate the monetary base.

I doubt the Fed is Printing money to manipulate the economy, not when there there are Asian countries dumping goods and providing easy credit for them. I suspect that the reason that the Fed has decided not to publish M3 (Its still calculated by the Fed, just not released) is related to the surging trade imbalances which presents a systemic risk. In the past, large trade imbalances always end in a financial crisis.

The Feds biggest mistake was to lower short term rates to 1%, which kicked off the housing bubble, which will only end in suffering. The Fed failed to enact laws to prevent excessive bad loans (ie low income borrowers using ARMs, insufficient background checks, insufficient regulation with credit swaps, etc) that might have dampened the hardship Americans will face in the future.

One item of interest that may signal bad times ahead is the large number of Fed banking officials resigning and few replacements can be found to fill the vacant positions.

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tate423 on June 6, 2006 - 1:57pm

>The expansion is largely caused by the Huge trade deficits. Virtually all major US trading partners have High USD reserves. Some of the foriegn trade surpluses are reinvested in US bonds (Treasury, CP, and Mortgage Debt) which has prevented bond rates from rising significantly.

While this may have been true a long time ago, please read some more on this.

The surprise here is that China and Japan are doing what they said they would do, even selling off some of their holdings. If Japan and China are not buying the government debt, who is buying? The little islands of the Caribbean stand out. Obviously, they are not wealthy nations with the wherewithal to by such quantities for their own natives who are harvesting coconuts. They are acting on behalf of investors from other nations who are passing money through the banks of the Caribbean to make their purchases. Unfortunately, the US Treasury is unable to capture the true source of this money since they only know the first party of their transactions. The most cynical observers offer a theory that the US government itself might be behind these off shore operations to prop up the dollar. They have no evidence, and we are unlikely to ever know.

http://www.safehaven.com/article-3097.htm

If you want the whole story look at this website. It's got plenty of graphs to back this data up.

>Fed has decided not to publish M3 (Its still calculated by the Fed, just not released)

Really? So when the Fed said it was ending the release of the M3 data, what was their reasoning? I could have swore they said something like, "the costs to prepare the data does not justify the information it provides." M2 is sufficient according to them, however M2 data does not include repurchase agreements. What don't you understand about liquidity? It doesn't take bills being "printed." Money is created everywhere through various financial instruments. There are securities for sale that base their value on an underlying security. There are securities of those securities.

So if this is the reasoning and now you're telling me they are still data mining. While I would agree that this could go on, if we agree that it is going on, itt would be proof that the FED is lying. Who cares what they are doing THEN. Do you trust a private bank (proxy for gov't) that lies to the American Public?

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TechGuy on June 6, 2006 - 6:51pm

>While this may have been true a long time ago, please read some more on this.

China is still accululating dollar reserves. Back in Jan 2006, China held about $800 Billion, Today its approaching on $900 Billion.

Below is an
http://216.109.125.130/search/cache?ei=UTF-8&fr=ush1-finance&p=China+Reserves&u=www.chin ability.com/Reserves.htm&w=china+reserves&d=Y7bpOzmtM4Pv&icp=1&.intl=us

>The surprise here is that China and Japan are doing what they said they would do, even selling off some of their holdings. If Japan and China are not buying the government debt, who is buying?

China diversifaction was from US treasuries into the US mortgage debt market. If I recall correctly 1/3 to 1/2 of all new mortgage debt after 2003 is held by China. This is why the mortgage rates didn't rise in step with treasuries.

>I could have swore they said something like, "the costs to prepare the data does not justify the information it provides."

The cost for public consumption was the issue. However. All large financial institutions are still required to collect and provide the data to the Fed. Perhaps the data isn't been used to calculate an "M3" figure, its still used by the fed. I suspect that the reason for discontinuing publication is hide how fast the money supply is growing and prevent it from spooking the bond markets.

>Unfortunately, the US Treasury is unable to capture the true source of this money since they only know the first party of their transactions.

The source is mostly large hedge funds, using carry trades to make money. The Caribbean are relatively small. If I recall correctly, back in early 2005 it was about $70 billion, where as Japan had over $550 Billion and China was somewhere between $300 and $400 Billion in Treasury withholdings. If the gov't wanted to secretly expand the money supply, why bother using a front? They could just buy and hold treasuries with out any paper trail. Why would the gov't bother expanding the treasury bond market by creating new debt. Why not just fictiously deposit funds in electronic banking accounts instead of raising funds through the treasury market?

>What don't you understand about liquidity? It doesn't take bills being "printed." Money is created everywhere through various financial instruments. There are securities for sale that base their value on an underlying security. There are securities of those securities.

I think your missing the point. The money supply is expanding just fine with all of the various capital inputs. For instance, we have the $600+ billion trade deficit, Easy credit fueled by the housing bubble and comsumer debt growth, bond carry trades, Federal deficit spending and so on. With all these sources of input capital there is no need for secret gov't transactions to further inflate the money supply. All the fed needed to do is drop the rates by ~550 bps to kick it off. If they wanted to accelerate it further, they just need to lower the rates again.

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steverino on June 5, 2006 - 1:38pm

this isn't some theory...this is exactly what the fed has been doing for quite some time...looking like fierce inflation fighters with interest rate increases (of course, after lowering short term rates to a ridiculous 1%), then inflating money supply by 10% plus...and that was before they did away with M3! ...and all the time blathering about core rates being 2%...what bullshit! ....discounting those volatile food and energy costs!...oh! we can't include them!...they're volatile!

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tate423 on June 5, 2006 - 2:30pm

The Fed has started to prepare everyone....

http://www.breitbart.com/news/2006/06/05/D8I27DP80.html

Fed policy-makers pay close attention to "core" inflation figures to get a better sense of how prices of lots of other goods and services are behaving. As these core measures have marched higher, economists have worried that surging energy prices are feeding into higher price tags for more and more items.
Although consumers, who account for two-thirds of all economic activity, are showing signs of moderating their buying appetite, businesses on the other hand are spending and investing at a robust clip, Bernanke noted.

So we know they are targeting inflation. So there should be a 25bp increase. In addition for those of you who wonder why things "on paper" seem great, it's due to massive corporate profits (in fact the largest ever) and they are spending a lot of it. This funnels through the economy and is keeping things afloat on paper.

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rlaws on June 5, 2006 - 9:41am

Funny, but when I first read he had a worrying 'environmental record', I immediately visualised him authorising the manufacturing and dumping of some kind of toxic waste into American rivers...

Quite surprised at the reality though, I hope he achieves the position within the administration.

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tate423 on June 5, 2006 - 10:55am

Here's a scary thought...

Third, the concentration of power is starting to look unhealthy. A clan of former senior Goldman staffers is now in a position to help steer the dollar, the euro and the pound. There needn't be anything sinister about that -- though financial conspiracy theorists could have a field day with some of the connections. The issue is that they are likely to have a uniform set of preconceptions and prejudices. In any area of endeavor, it is healthy to have a wide diversity of views. Global monetary policy is no exception.

http://quote.bloomberg.com/apps/news?pid=10000039&refer=columnist_lynn&sid=aGS6lvr8ipiw

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GreyZone on June 5, 2006 - 5:24pm

"And I keep hearing how intelligent she is. I guess she missed the Econ courses."

I think you misunderstand. She knows perfectly well what the situation is. Instead she is counting on the vast majority of players in the global markets not knowing and accepting her statements at face value. This is yet another form of "jawboning" - where she is trying to make the case that Iran cannot impact the global economy badly. She's doing this to reduce the scare factor that Iran has at its convenience, and help jawbone down the price of oil (and other commodities as well). Unfortunately, and I am sure she knows this, if Iran calls her bluff and cut production for one month by 10%, there'd be immediate and visible reaction.

What's interesting is that she appears to believe that Iran values its current income greater than the leverage that playing off that income provides. I am not at all convinced that this is a valid analysis but I am also not the Secretary of State.

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BrianT on June 5, 2006 - 9:40am

Hugo has been trying to convince them to do this. The rest of them might be concerned about the US military might (just a guess).

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LevinK on June 5, 2006 - 9:50am

Only a handful of producers are so large that cutting back may affect prices to such extent that they could win.

What is often overlooked is that if you cut production prices indeed rise and in the short term you can reap some profits. In the longer run the market adapts one way or the other (and there is always some way, see Cuba). So, if you decide to ramp up production in the longer run prices will fall and you lose. So, what is your incentitive to cut production then? You lose reputation, your immediate cash flow decreases you scare off customers etc etc. For what? A little more profits for some time and then nothing again. What producers are interested in are stable profits in the long run. Especially considering that most of them have huge investments to repay or are government organisations.

Simply put, cutting back as a market strategy is not an option for anybody.

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jkissing on June 5, 2006 - 10:58am

Cutting back to defend prices is opec's raison d'etre. They are happy to produce all they can at today's prices, but this cartel is by far the most successful in history, with only the internal squabble in 1998 (when they overproduced and oil dropped to 10) as a blot on their record.

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LevinK on June 5, 2006 - 11:18am

I think the reason for OPEC to exist is not "cutting back" per se but defneding the common interests of the oil producers.

At these prices cutting back is clearly not in their interests, and they are behaving much as expected - pumping as much as they could and urging everyone in the cartel to do the same thing.

OPEC is shivering at the thought it may cause a oil-price induced recession accompanied with a world-wide effort of conservation and mitigation. They will do all they can to keep business as usual goining on. In this situation if a member country chooses to back-off without a reason it will be considered a traitor and will have the whole cartel (and the whole world actually) against it.

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alan on June 5, 2006 - 12:34pm

The addiction works both ways. We may be 'addicted to oil' but you could also say the rulers of the OPEC nations are addicted to oil money.

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Darwinian on June 5, 2006 - 10:01am

I'm actually surprised that a lot of oil exporting countries don't voluntarily reduce production in order to "save some for later" when prices are inevitably a lot higher.

Interloafer you make a very good point. M. King Hubbard was fond of making that exact same point:

Were we a rational society, a virtue of which we have rarely
been accused, we would husband our oil and gas resources.
- M. King Hubbard

I have tried to make that point many times before. When many exporting countries realize that we have actually reached peak oil, they will do exactly that. Countries like Mexico, Russia and all other countries that use a lot of oil for domestic purposes will start to husband their oil, saving it for themselves. I fully expect them to dramatically cut back on oil exports when they realize their oil is in decline right along with the rest of the world. They would be damn fools not to do this.

This will greatly exacerbate the peak oil problem. It will make the decline much steeper than previously estimated, at least for all importing nations. All gradual decline scenarios are actually based on everything being business as usual. But in a world of obviously declining oil resources it will not be business as usual anywhere on this planet.

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Sunspot on June 5, 2006 - 10:17am

I remember seeing an announcement out of Russia, probably a year ago now, that they would stop exporting ALL energy resources by 2010. We should send Europe a few extra sweaters...

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Donal on June 5, 2006 - 10:49am

M. King Hubbert Hub - bert (not as in Old Mother Hubbard).

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fallout on June 5, 2006 - 11:14am

"OPEC linchpin Saudi Arabia said it cut output to 9.1 million barrels a day in April due to a drop in refinery demand, not a desire to lower stock levels, the Wall Street Journal quoted Oil Minister Ali al-Naimi as saying."

from the last paragraph of this WaPo article:
http://www.washingtonpost.com/wp-dyn/content/article/2006/06/05/AR2006060500233.html

Frankly, I'm skeptical of the stated 'reason' for the output cuts. They may be at or passing peak output and are about to pay the high price of excessive water injection, and are starting to realize it.

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lastchance on June 5, 2006 - 11:23am

My first post here at TOD.

I also believe that when Nations and States realize fully that Oil Production and Discoveries have reached their "Peak", then they will begin to slow down or halt exports. It would be self-destructive not to pursue such a Policy.

I am old enough to remember the Arab "Oil Embargo" and when Leaders in such States such as Texas and Oklahoma publically commented that they were under "no obligation" to export their oil to other States. This did result in some grumblings from DC. I just don't recall what was said exactly.

As an aside, I do enjoy TOB and especially the scientific and possible societal change comments. However, I think some of the political comments should be in another Forum. I personally hold both Parties of the Duopoly responsible for the lack of preparation and for being reactive instead of proactive. There is more than enough blame to be shared by our past and present National Leadership.

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jokuhl on June 5, 2006 - 1:20pm

'some of the political comments should be in another Forum..'

You might be right, but the question of politics in this issue is hard to separate even from the technical science of oil acquisition, of natural-resource economics, or the inevitable relationship between oil and war, especially since the energy predicament hinges so intimately between all of the above and Politics, which is all about Power and Resource management, in the long run. In fact, more than it just being 'hard' to separate, I think it is unrealistic to separate them .. sounds like our 'Age of Reason' desire to evaluate phenomena each in their own petri dishes.

I do agree that both parties, AND we normal citizens all bear some responsibility for our situation, but the grain of salt there has to be that those who have been trying to move the ball forward on energy, conservation, fuel efficiency, etc.. they get tarred along with their opposition by the broad brush of 'nobody has moved this forward', because they've been pushing in the right direction, but againt vested interests pushing back the other way.. ie Exxon hiring scientists specifically to refute Climate Change arguments, etc, not to 'find what they find'.. Granted, those who push one way or another don't fall precisely on party lines.. closely but not exactly..

Maybe if we hedged and called it 'Political SCIENCE', it would be more palatable..

Welcome aboard!

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Glenn on June 5, 2006 - 3:58pm

I see all of these topics of science, politics, psychology, sociology, economics as deeply intertwined. We can't all just sit in an ivory tower and just talk about energy EROEI ratios without considering the political feasibility or consumer acceptance of technology. We also shouldn't BS about political intrigue that's not related to energy issues.

We should talk about the intersection of all these issues.

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Leanan on June 5, 2006 - 4:01pm

I agree. In the end, politics is about the allocation of resources. It's a big part of the peak oil issue, if not the biggest.

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tate423 on June 5, 2006 - 4:07pm

It's funny you say allocation of resources, but isn't that a defining principle of economics? Scarcity and the allocation of resources is all econ is about. However Politics is simply who has the power to change the allocation. Nevermind...I'll go back in my tower.

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Leanan on June 5, 2006 - 4:14pm

Economics is certainly on-topic here as well.

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jeffvail on June 5, 2006 - 11:27am

I think it is partially a political time-horizon issue. Many producing countries, the top politicians need to create results that ensure their continued election NOW, even if sacrifice today would make much rational sense. Many of the Middle-Eastern potentates, however, are semi-insulated from this. But even Saudi Arabia, with their increasing demographic problems and recent stock market tumble, has to balance the rationality of near-term cuts with the danger of near term revolution (or at least the increase in support for al-Qa'ida in the kingdom).

Austerity measures of all types--though often the most rational course of action, and particularly important to the Peak Oil issue--are fundamentally incompatible with the short-term cycles of modern politics. At least partly because of our miserable general education in fields like economics. What a different world this would be if politicians could put out TV ads that say: Sure, life is a bit tougher today, but look at what I've done for the yield curve...

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ThatsItImout on June 5, 2006 - 1:02pm

Interloafer, you said,
"I'm actually surprised that a lot of oil exporting countries don't voluntarily reduce production in order to "save some for later" when prices are inevitably a lot higher"

Because they need the money NOW. To use an old Southernism, saving it for later don't put no taters on the plate!

Saudi Arabia has a growing population that has gotten more and more used to living well, and bills to pay. Matthew Simmons has done a great job of pointing out that Saudi internal energy consuption has actually put them on a year to year problem with natural gas supply (!!!), Astounding!

Iran has a massive youth population that will soon want to start living better.
Many reports have shown the Iranian "disaffected" youth, engaged in sex and ecstasy parties, they are becoming notorious as the beatnics of the Middle East...the reason Iran needs the bomb is because soon, that will be the only power the Iranian government will have...brute force, internal and external.

Dubai and Qatar are on building and spending binges that are astounding...behind China, Dubai is the construction capital of the world!

Wait "for later" to sell oil? The oil exporting countries can't afford to. They are married to the "expansion" boom just like the rest of us. (by the way, this is why conservation and efficiency could be such a HUGE TOOL. If we could bring down consumption even a percent or two, the alarm bells in the Middle East would be deafening!)

Condi Rice blows it on a lot of things, but this time, the facts are with her.

Roger Conner known to you as ThatsItImout

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The Interloafer on June 5, 2006 - 6:33pm

Roger, excellent points and I appreciate the descriptions of the binds these countries are in. But my vastly oversimplified reading of history is that they could reduce output by 4% and watch as prices double. So they'd produce less but receive more for it (not just more per barrel but more overall). Doesn't that seem like a no-brainer? I guess they tend to think more highly of energy alternatives than I do.

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