The Oil Drum | Whither Oil Prices?

161 comments on Whither Oil Prices?

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MicroHydro on September 15, 2006 - 6:38pm

My issue with all of these price discussion is the units used. Price is expressed as US dollars per barrel. The barrel of oil denominator is a real physical entity present in large but finite quantity. Except for those abiotic oil people who believe that abiotic oil production exceeds a thousand barrels per second, most of us agree that the physical oil reserves in the earth have been depleting since production began. We would also agree that the EROEI of oil production has begun to decline as production has moved to heavier grades, polar oil, and deep water oil. All of these factors make it inevitable that oil will be more highly valued in the next decade. A growing fraction of the goods and services of our civilization will be devoted to oil production.

However, the numerator of the price ratio, the mythical US dollar, has an entirely different nature than a barrel of oil. US dollars are an imaginary invention that largely exist as data bits on computers. Banks have mechanisms for creating dollars at will with essentially infinite $RO$I. JP Morgan just reported a growth of $5.5 trillion in their derivatives in the last quarter. This represents roughly half the GDP of the whole US. The exact value of the derivatives market is unknown, but certainly exceeds hundreds of trillions of dollars. Of note, these electronic dollars can be destroyed as fast as they were created. Likewise last year the Economist reported the OECD homeowners had accrued $30 trillion in home equity gains during the current housing bubble. This is equal to the aggregate GDP of all the OECD nations. This virtual money is also subject to vanishing into thin air.

So looking to predict a future oil price ratio, one must divide an imaginary and highly volatile dollar unit by a physical entity. Good luck with that. However, I agree with the Austrians that central banks exist to inflate the money supply, and they do that more often than not.

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step back on September 15, 2006 - 8:49pm

Excellent, excellent point !

"Dollars" are just a noise that we humans make and that Mother Nature pays no heed to. We can crunch the dollar numbers to any unbounded value we choose. It is not absurd to talk about a googleplex of dollars as reported within the depths of some bank's computer whereas one could not rationally do the same thing for barrels of sweet crude. The physical world is bounded. Human hubris is not.

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Sunspot on September 16, 2006 - 9:28am

My favorite point is: Energy is real, money is fictional.

If printing more money really works, then let's just do this: we'll design a nice, new $1 billion bill. Then we'll print up 6.5 billion of them and give one to every person on the planet. Then everyone will be rich!!

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raymond on September 16, 2006 - 11:23am

the real thing

It is meaningless to say that money is fictional. Are numbers not real?

It would be more accurate to say that that money and energy represent different dimensions, one physical (the world of things, processes and 3 dimensional space), one mental (the world where things and 3d space is represented). These distinct dimensions are not seperate - but they intersect in known and mysterious ways.

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step back on September 16, 2006 - 12:47pm

Money represents a promise.

But then again, humans lie. :-)

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DieOff on September 17, 2006 - 3:13am

Ok... how about a chart of Oil in terms of real value... Gold. It presents an alternative view. Check out a 10 year chart here: Chart of Oil priced in Gold

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Nate Hagens on September 17, 2006 - 2:11pm

One of the points being, since gold has recently sold off more than oil, oil in terms of gold bottomed 10 days ago and is not far from all time highs. Double barreled bad news for those who are long gold and oil. Im still uncertain what peak oil will mean for gold prices - I can see both sides of the argument. Now, chicken prices, that I am sure of.

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Calorie on September 17, 2006 - 9:17pm

Here's one that goes back to 1971:

It's from the Forbes article on Michael Lynch:

http://www.forbes.com/home/forbes/2006/1002/098.html

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Bubba on September 16, 2006 - 9:35am

Although this discussion about near-term pricing is a fun distraction, it has very little to do with Peak Oil. The fact of the matter is that oil production has ceased increasing for over a year now (which Stuart regularly reminds us of), regardless of a continuous and huge run up in prices over the last five years. Prices are going down presently, not because there is more supply, but because demand growth has ceased, and demand for the marginal barrel cannot, at the current point in time, stand a $77 price.

Peak oil is about production capacity, and production capacity is extremely insensitive to short term pricing. The Gulf of Mexico Lower Tertiary Play will not start producing oil before 2009 if oil is $35/bbl or $135/bbl. The same is true for almost all of the projects on Chris Skrebowski's Mega-projects list. Most of those projects were justified on oil forecasts considerably less than $40/bbl and they will go forward in all cases, absent a worldwide economic contraction.

To be honest, most of the major oil companies would be happy for oil to move back to $50/bbl (or even $40/bbl) and stay there. Such a scenario takes them out of the political spotlight, it puts downward pressure on the cost of services and supplies, and it takes power and money out of the holders of the resources (governments of nation states) and puts it back in the hands of those who have the capability to extract the resource.

Sometimes it seems that we are watching the daily fluctuations of temperature in NYC and trying to make statements about global warming.

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Halfin on September 16, 2006 - 12:39pm

Oil production and oil consumption are inherently equal, to within a couple percent. So when you say oil production has not increased, you can just as easily interpret that as that oil consumption has not increased. And that's not so hard to understand, in view of what you describe, "a continuous and huge run up in prices over the last five years".

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westexas on September 16, 2006 - 12:59pm

An interesting note regarding consumption

http://www.forbes.com/business/feeds/afx/2006/09/15/afx3019146.html

BEIJING (XFN-ASIA) - China imported 95.8 mln tons of crude oil in the first eight months, up 15.3 pct year-on-year, with 11.82 mln tons in August alone, the General Administration of Customs said in a statement.

The imports of oil products rose 25.7 pct year-on-year to 25.75 mln tons from January to August, with 3.78 mln tons in August.

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gtjeffers on September 17, 2006 - 9:49am

Excellant point about the marginal barrel unable to command $77 at the moment. In this post, we are discussing current oil trading prices, not Peak Oil. Prices today reflect the desire of market particpants - not environmentalists, doomsters, politicians...

I have worked on Wall Street for nearly 20 years. A former boss once said:
"a - fill in the blank with stock, bond, commodity - will keep going up till it stops going up, and it will keep going down until it stops going down". And "they always go up farther than you thought possible, and down farther than you thought possible". If do not trade for a living, this statements might seem simplistically obvious. When you have a great deal of money on the line... they can eat a hole in your stomach.

At the moment the short term trend is down, even though we had a couple of days of pause. As a trader, I would not reach for the falling knife, so i must believe that prices are headed lower. Prognosticating a price point of the bottom? Ha! These are always made by economists who do not a penny of their own money in the game.

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Don in Colorado on September 18, 2006 - 2:27am

I don't know how you guys do this kind of thing for a living. It's insane.

All these people who put their life saving into speculative houses over the last couple of years. Reading the headlines today must be a nightmare for them.

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gtjeffers on September 18, 2006 - 9:07pm

Can anyone tell me why I keep reading posts that Oil prices are down becasue of
"massive imports"? I reviewed the import data (for the U.S.) at the EIA website and the "massive imports" are actually down, year oover year for the first 6 months of 2006 from 2005. If I am missing something please let me know. Any help would be appreciated

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Jack on September 19, 2006 - 5:33am

Where are you reading that? Oil prices can't, even in theory, be down because of massive imports. Gasoline prices could, in theory, be down because of massive imports of oil, but as you noted that is not the case. Oil prices could be down because of massive exports, but that is not the case either.

My feeling is that oil prices are down on a combination of expectations of lower demand (partially because of lower economic growth expectations) and reduction in the role of financial intermediaries/risk premium. Could all change soon, who knows.

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gtjeffers on September 19, 2006 - 6:03am

Thanks for the reply.

Of course world Oil prices should not be down because of US imorts, unless of course, the tanker inventory world wide can't find a home... but that is the line coming from a number of Oil market analysts and advisors... US inventories have only 3 components (when you lump crude, distillate, and gasoline together) domestic production, imports, and consumption. Production is down, imorts are down, consumption is... down? Must be if inventories are up year over year

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Francois on September 15, 2006 - 8:52pm

Some of those trillions of derivatives have been built up by JP Morgan entering the natural gas market in late 2005. They were never a player before, but the day after they started trading the market, natural gas entered a steep decline from $17 to it's current price around $6.00.

It is my contention that in the same way, the other primary trading banks (Goldman Sachs, etc),are holding similarly massive derivative positions in the gold and oil markets on behalf of the Federal Reserve System, and can move the daily price at will by buying / selling these instruments. The idea that the oil markets are too big to be controlled in this way does not hold if you look at the size of these derivative positions (Trillions!!).

Remember that these markets are decoupled from the physical commodities, since for the most part the traders dont actually take possession of the physical - they just take their profit and move on to the next trade. There is a lot more oil trading in derivatives than there is actual oil existing in the world. The same with gold. Once the paper trades outweigh the physical trades 10 to 1, the price decouples from the actual physical demand / supply, and voila.

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Agric on September 15, 2006 - 9:59pm

I completely agree that Fed proxies using free Fed virtual money are holding manipulative positions in stocks, commodities and their derivatives. And rather well they seem to be doing their job so far. There were signs they intervened on Nymex oil in the immediate wake of Katrina, possibly to get some friends out of nasty short holes.

Also agree that the markets are decoupled from reality (there is a case for saying that many derivative markets are decoupled from fiction, too).

I have a complaint about $ bills: they are too small and not sufficiently absorbent for the role they are being prepared for: toilet paper.

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john milton on September 15, 2006 - 10:25pm

At least you folks still have a $1 bill, up here in Canada we are going to be stick trying to use the $1 coin,a.k.a. the loonie, now thats impractical!

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elwoodelmore on September 16, 2006 - 2:57am

what is the loonie made from ? what metal ? if the loonie were made of silver for example they would hold their value against worldwide fiat currency

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john milton on September 16, 2006 - 7:20am

The loonie is a Nickel base with bronze plating

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Pitt the Elder on September 16, 2006 - 10:16pm

Nah - you just use 'em like you use the shells. That does mean you need three, though.

(Don't tell me you don't know how to use the shells?...)

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MicroHydro on September 15, 2006 - 10:31pm

Francois - agree, in fact the strategic manipulation is in plain site:

stop reporting M3
declare that companies working in partnership with the government can keep secret books
put a Goldman Sachs guy in charge of the treasury
stop reporting committment of traders

VOILA! The US government can print money and give it to their strategic trading partners to be used in manipulating the market. NOW PERFECTLY LEGAL! If the traders lose several billion, no problem, just print more money. Market manipulation for political purposes is the goal, not trading profits. It works until a foreign power declares the practice to be bullshit. Then the US dollar becomes nonconvertible, like the Zimbabwe dollar.

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Nagorak on September 15, 2006 - 11:05pm

One little thing: in the real world usually there's some middle ground between "everything's fine" and total collapse. The dollar will weaken if we keep printing too many dollars, but it's unlikely we'd go straight from business as usual to a total collapse. It could happen if China and Japan suddenly decided to dump all their dollar holdings, but it's pretty unlikely.

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Yosemite Sam on September 16, 2006 - 1:15pm

You couldn't be suggesting that the decline of the price of oil might be coupled with the impending US elections? I shocked! Shocked!!

Serioiusly, I have wondered and after reading your post, I am really wondering now.

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Samsara on September 16, 2006 - 11:22pm

"3 put a Goldman Sachs guy in charge of the treasury
"

Correction;

3 put a Goldman Sachs guy in charge of the treasury AGAIN.

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Halfin on September 16, 2006 - 12:44am

Financial markets cannot be completely separated from physical markets. In the case of oil futures, the front month oil price must converge to the spot price. And the spot price is set by supply and demand that month. Other months can't diverge too much from the front month. So even though only a small percentage of contracts end up being delivered, they set the prices for the whole system.

Put another way, a futures contract obligates the holder to buy or sell the commodity at that price at a particular future time. Big financial interests may be able to temporarily shift the futures price away from what the spot price will be, but that just puts them on the hook to pay the difference when the contract closes.

This means that any such manipulation is basically an offer to give money away. If you're convinced that futures prices are artificially being held down, here's your chance to get rich. You can invest a few thousand in an options contract and make many times your investment. Reinvest your winnings and in a few years, you can be sitting on millions.

Basically what you're saying, when you adopt this conspiracy theory, is that these companies are willing to give away their wealth to anyone who sees the truth of what they are doing. If whatever secret, hidden information gets out that clued you into the true situation, then everybody would want a cut of this money fountain. So this kind of manipulation can only work as long as most people are not aware that it is happening. It must be well hidden and well disguised. But then, how did you find out about it?

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Agric on September 16, 2006 - 6:07am

Generally I agree with you Halfin: it is difficult to manipulate large, freely traded, commodity markets without it being obvious. However, the gold and silver markets have been manipulated for years - they are small enough to make it feasible. There were also hints that in the immediate wake of Katerina, in the first hours and days after oil peaked above $70, there was purposeful action to bid down the price, possibly partly to protect a major player or two who held expensively large short positions. Job done on that occasion, I'd say, but normally the oil and energy markets are too big for more than an attempted nudge in the 'right' direction to work, and there are plenty of media pundits that get wheeled out to do the job much cheaper.

Just the awareness that virtually unlimited pockets could be used to 'protect' certain markets from too sudden moves in the 'wrong' direction skews the ways traders bet on markets. That's the beauty of the PPT (plunge protection team) 99% of the time just the knowledge of its very existence is all that is needed, only very rarely is real intervention required.

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seanarama on September 16, 2006 - 8:28am

I don't believe there's a plunge protection team for stocks -- that market is just too big. However, if you had, say, about $7 billion to $8 billion to play with, you could push the oil markets around if you wanted to. The questions we must ponder include: Are there funds that have that kind of money? Certainly, especially if it was a coordinated move. The next question is: What would they hope to gain?

You could posit that funds that see it in their best interests to push oil prices higher most of the time (because that raises the value of the much-larger positions they hold in oil company shares, by increasing the value of those companies' oil reserves), could choose to push prices lower right before the November elections, hoping it will help out the Republicans. Republicans tend to be more eager to pass the sort of corporate welfare that can make fund managers rich beyond the dreams of avarice.

This theory can't be proven of course, unless one of the big funds goes bankrupt and we suddenly get access to their emails, as happened with Enron so it can only remain a theory. It may be paranoid, but it's not tin-foil hat territory, not when you have a long history including ...

During Calfornia's energy crisis, allegations that Enron was gaming the market were scoffed at. Those charges, as we all well know, later turned out to be true. The Federal Energy Commission went on to hire Enron's lawyer, a woman who scribbled this note to her client: "Answer questions, say nothing. Answer questions, finger others." Enron invested a few million in George W. Bush and reaped billions in return. Nice business!
Senator Ted Stevens, the Republican head of the Senate Energy and Commerce Committee refused to require energy company CEOs to testify under oath last year -- thus freeing them up to lie. Why did they want to lie about Dick Cheney's Energy task force, do you think?
The Department of Energy asking the National Petroleum Council to investigate Peak Oil claims, and NPC is headed up by former ExxonMobil CEO "Don't Rock the Boat" Lee Raymond to run the investigation. You know -- that same Exxon that says Peak Oil is not a problem. And yes, Lee Raymond was one of the oil CEOs who lied to the Senate.

I could go on, but there's only so much time. All this doesn't mean there aren't real economic reasons for oil prices to go up and down -- but there could be other forces at work as well. I don't know that the oil markets are being manipulated ... I just suspect it.

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Agric on September 16, 2006 - 9:38am

The PPT exists, the question is: Does it intervene?
http://en.wikipedia.org/wiki/Plunge_Protection_Team

I think this 41 page PDF from Sprott Asset Management answers that question:
http://sprott.com/pdf/pressrelease/TheVisibleHand.pdf

"Given the available information, we do not believe there can be any doubt that the U.S. government has intervened to support the stock market. Too much credible information
exists to deny this. ... These markets have been interfered with on numerous occasions."

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Dan Dare on September 16, 2006 - 8:59am

Halfin, I absolutely agree with this. The markets are much harder to manipulate than most people imagine. If markets were so easy to control, how come so many governments have had to be bailed out by the IMF over the years?

Generally it's much easier to influence a market by massaging information, so as to influence others to take a position. And even then it has to be done infrequently. Like in poker. If you always bluff then people learn to expect it.

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Dan Dare on September 16, 2006 - 9:05am

And the other thing is how often the market successfuly anticipates the actions of the Fed. As revealed in the futures markets.

This shows that they are both reacting to the same publicly available information. And in reality the Fed often does exactly what the market expects it to do, either because it agrees with the market, or because it isn't willing to risk defying the market.

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mw on September 16, 2006 - 9:20am

I'm not going to comment on fiat currency or the illusionary nature of our money. Suffice it to say that it is the system we have today, and today's rules and limitations are built around that system.

However, the system is not without some usefulness in the here and now. The price of oil, or any widely traded, highly visible commodity or financial instrument, is in part a reflection of the average emotion and broad understanding among a world of players. Clearly some players have more input (bigger pockets) than others, in this group-think we call market pricing, for all that, the price is a useful reflection of what the world thinks.

Speaking about the price of oil, the intraday chart on Friday is a possible reversal day; doesn't mean oil is headed right back up, but it may try to stage an attempt at a rally. Whether that holds and a series of higher highs and higher lows is established (a change in trend from down to up) is for the future to determine.

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fireangel on September 16, 2006 - 2:57pm

Completely disagree. It would show up in the COT report. The amount you talk off would be really really large. Currently the net position of all comercials in the market is a short position of about 20,000 contracts. Thats 20 million barrels total. If you think contracts from now till 2012 total ( yes that position is the total for all contracts) can be doctored with 20 million barrels or less than 1/4th of one days use than all of you are crazy.

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gtjeffers on September 17, 2006 - 10:01am

Come on guys... JFK is not shacked up with Marylyn being entertained by Elvis... Do you really think guys competing on Wall Street cooperate with each other? It has been my experience that they would be just as willing to eat each other, medium rare, over a fire in a garbage can on 10th Ave...

It is true that derivitive securities whip the underlying commodity in one of the few true cases of the tail wagging the dog... but this is not down in concert. Goldman is at war with Morgan, who is under attack from Bear Stearns, etc ... for every buyer of ANY security, there is a seller... only one of them gets to be right. There is no altruism in ths industry... no self respecting Wall streeter would take a bullet for another!

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fleam on September 15, 2006 - 10:44pm

MicroHydro do you realize if most Amurrikans were required to sit down and read your post until they understood it, their heads would explode?

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elwoodelmore on September 16, 2006 - 3:01am

playing eddie arnorld's lonesome cattle call achieved the same result in "mars attack"

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Seadragon on September 16, 2006 - 10:01am

They cannot...read I mean, and so what? Who needs reading, after all.

http://msnbc.msn.com/id/14823087/

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super390 on September 16, 2006 - 10:47pm

My God, it's "only neccessary that the leaders know how to read"? In his wildest dreams Hitler would not have tried to run something that offensive on the German people. This guy is finally telling us what Bush has always meant by "democracy" - the masses are not supposed to have the tools to govern themselves unless they're "entrepreneurial" enough to actually run a business.

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DIYer on September 16, 2006 - 8:27am

Of note, these electronic dollars can be destroyed as fast as they were created.

Isn't there some quantum currency theory in which virtual dollars and virtual antidollars are continuously created and destroyed at a furious pace as part of the fabric of the economic universe?

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