 | Jamais Cascio: Peak Oil vs. Global Warming | The Oil Drum | Peak Oil and Economic Growth: Where Do We Go From Here? |  |
DrumBeat: March 28, 2008
Posted by threadbot on March 28, 2008 - 9:29am
Topic: Miscellaneous
Russian Oil Output to Fall for First Time in a Decade
``Two years ago, we said the growth rate was falling, and we said this was bad for Russia, remember?'' Trutnev said in televised remarks after a government meeting in Moscow today. ``Now we're saying the production rate is falling this year. This is not a bogeyman, unfortunately, this is real,'' Trutnev said, without giving a specific forecast.
Young reporter talks to NYMEX traders about peak oil:
http://www.youtube.com/watch?v=Z_UlFH47YTw
Note the trader stumble on the
finite/infinite question.
Surprising anyone even went on the
record though.
'nuff said.
EDIT: RBM, looks like you beat me to it! I guess that was the highlight of the video. That other kid seemed a little more sensible about it though.
Not to worry - there's enough hydrogen in the universe to power the universe.
/sarcanol
At least for the next several billion years.
You can get a pretty fair picture of how much Wall Street is recognizing peak oil by looking at their call options pricing. There is a math method of calculating an implied probability that oil will be priced at certain levels at certain points in the future by just using the market prices for the option costs. I did this recently for pricing out to 2011:
This looks at how much peak oil theory has been priced in just since 2006, and the answer is none. If there were an increasing amount of peak production probability being priced, the curves would be progressively tilting out as shown by the hypothetical thin red curve that shows higher odds of higher prices by 2011.
The curves are not very sensitive to time frame. You can plot the 4 year numbers for the 2 3/4 year curve and get about the same curve. In fact, you can cut the time frame all the way down to 1 year and plot the mid '05 to mid '06 probabilites and it closely coincides with the 4 year curve shown for Dec '06 to Dec '10.
This noncorrelation with time is also very evident if you just look at the futures contracts tables for any given year for oil. In '06, the table showed $60 something oil (what it was back then) out for as many years as the table would go. Now, with oil at $100, the futures strip shows $90 something oil out as far as the table goes. This apparent cluelessness seems to be only moderated by the fact that the option cost you must pay goes up a little for the farther out calls allowing more volatility risk for the writer of the option.
The general public seems to be wising up to peak oil faster than the MSM or Wall Street. If you'd take a sidewalk poll on the price of oil in 2011, I can't help but think you'd get a higher average answer than the options numbers.
This jives with what the floor traders were saying on the video link above. A couple of floor traders said they expect peak oil th happen in about one hundred years.
Ron Patterson
We should use this incredible ignorance by Wall Street to make some money: That will certainly help our individual peak oil preparations ...
We should use this incredible ignorance by Wall Street to make some mone
This point crops up quite frequently on TOD and I think it somewhat misses the point. The underlying assumption of all such trading is that the counterparty is going to pay up when the losses materialize. This assumes that counterparty risk is negligible - a rather foolhardy assumption IMHO.
What I am saying essentially is that we are in a "tails you lose heads they win" type of situation.
If you would like to see a relatively recent example of this phenomenon check out what happened the last time, 10 years ago, the Hong Kong stock market plummeted.
Yes, and the people who shorted the Hong Kong market made a lot of money.
The counterparty risk is negligible. If you own a future contract, you are automatically leveraged, but if the price moves against you, you are required to come up with more money or the contract is sold. It's not like the markets just trust you to pay up on big losses.
Here is the thing to be aware of when you're considering using investments to help hedge against the difficulties of peak oil.
The peak oil investment decision is essentially a classic gambling decision, and people are hard-wired to make the wrong decision in this situation. There is an entire field of neuroeconomics that has looked into the propensity of people to make the wrong decision in this situation.
What that means is that the correct thing to do is going to be the extremely scary thing. And people will find all kinds of ways to explain this fear to themselves and rationalize making the wrong decision.
In poker tournaments, there is a predominant type of amateur player that I've come to think of as the Scared White Guy. These tend to be well-educated types--doctors, lawyers, accountants, engineers--who are all afraid to take risks and who tend to sit there waiting for "strong cards". They know just enough about the math and odds to be able to talk themselves out of any moves that would actually give them a prayer of winning.
In the current economic situation, these guys are the ones with all their money in T-bills, getting slowly eaten away by inflation as they wait for deflation to bail them out. They are going to believe anyone who tells them it's not safe to invest in oil, or that the recession will bring oil prices down, because the reality is they just don't have the nerve for anything but T-bills no matter what is going to happen. And it's not really their fault: They are making the bad gambling decision their neurons are hard-wired to make.
People who understand peak oil should get hedged for it. You can hedge with a big garden in a good location with good water, or you can hedge with financial instruments, but you had better get hedged.
Yesterday, I posted that yesterday was not the time to buy--that we'd want to see a better set-up. There is no change today. If you're not already in, I'd advise you to continue to wait for a better set up.
Moe
The recent spike due to bombing in Iraq indicates to me a nervous tight supply. With this in mind I predict a lot of upward pressure in the couple on months receding the Olympics. I may be completely wrong but I get the impression that the Chinese have been buying cheaper sulfurous crude but when they are "on show" they will want to clean up their act. Maybe somebody in the refining industry could educate us on the differences? Can you simply push sour crude through a refinery not designed for it and suffer the consequences, This also raises the question as to what the global impact of the ever increasing sour/sweet crude split is going to go (in terms of refinery upgrades), sweet crude is declining more rapidly, not plateauing at all
Neven
Loooong time lurker, first time poster. Awesome website, great information, and writers. It is my go-to site for PO.
I remember when I bought my first crude contract back in May 2004. I wanted a Dec 2008 contract, which was $29/bbl, because I was pretty convinced that oil would hit the unheard of price of $80/bbl before Dec 2008. The broker asked why I was getting such a long term contract, and I told him that it would hit $80 because oil production would fail to meet demand. He was flabergasted... "but sir the experts say that oil is going back down to the low 20s, you will just be throwing your money away. I am not going to enter your order, you need to think about this sir". And he hung up.
I should have called back immediately, but I waited until the next day. Now the Dec 2008 contract is $29.50/bbl (asking price). Again he balked, this time I told him to either enter the order or I give me his supervisor. Well, I got my Dec 2008 contract at $29.50... and I still have it, along with another I bought a few months later at $35.50/bbl. Unfortunately, he was fired around the time oil hit $60/bbl, so I couldn't have a followup conversation with him.
Oh yeah, I am an engineer (ChE) who doesn't mind taking risks. However, most of my engineering friends are in mutual funds.
Keep up the great work.
One of the advantages of online brokers like Interactive Brokers (which also does futures) is that you don't have to talk to a person, and thus there's no emotional consideration of what they're thinking. This is especially true for amateurs who feel that the broker (a full-time professional) knows more than they do.
I guess 'scared white guy' labels me pretty well. I started becoming peak oil aware in early 2006, and although I've made a lot of little household changes to mitigate coming problems, I've been very cautious about making changes to my investments (401k & IRA). I am overweight energy, particularly in oil services, but this level of hedge is not really proportionate to my level of confidence that big energy problems are coming soon. I don't really know what's holding me back. I guess it's very hard to pull one's self out of what Kunstler calls the 'consensus trance.'
A question to those who have hedged with a robust Plan B:
It occurred to me that at some point a Plan B will turn into a defacto Plan A if planning for a post-peak world becomes one's primary blueprint. Even if you expect that a near peak is a foregone conclusion, do you then hedge that expectation with a new Plan B in case by some miracle the cornucopians turn out to be right?
As a product of my times, I am a techno-cornucopian at heart but I am preparing for the worst and preparing for the best simultaneously.
As Dickens famously put it,
"It was the best of times and the worst of times."
My first priorities are physical hedges of the basic requirements to not only survive but to thrive in a post-peak environment. I think moe is imparting some excellent observations on financial hedging but as he indicated, financial hedges are only part of an overall hedging strategy. One cannot eat digital money or specie and one must be nimble to escape the just-in-time-collapse of financial structures.
IMO we are entering into terra incognita at the end of an age here.
We have scenarios of what the end-game might look like but
no one can predict the twists and turns of how it will play out.
I am reminded of a sticker a student had plastered on her laptop:
"Blessed are the flexible for they shalt not get bent out of shape"
"It was the best of times. It was the worst of times."
A Tale of two Crises..
I think rather than being hard wired to make the wrong decision most people are trained to do it. it's IMO a form of social conditioning heavily exercised in public schools and religion, the fact that the human species has been so successful tends to suggest (at least to me) that it's not hard wired.
My own experience has been that I knew what decisions to make and would make exactly the wrong one, in a win, lose, draw situation I was losing far too frequently for it to be coincidence.
imo, the other type of guy you can beat in poker is the one who has it all figured out.
This assumes that counterparty risk is negligible - a rather foolhardy assumption IMHO.
I had read somewhere that fear of counterparty default (e.g. by Bear Stearns as a NYMEX clearing member) was a factor in the recent commodities meltdown. So I agree - the risk (real or imagined) does exist. And these futures contracts are, after all, just derivatives for the ordinary investor.
theautomaticearth has a link to an article about the credit default swaps bought by Wall Street banks being worthless because the other party didn't have the money to pay up.
It's my understanding (based on reading Taleb's "Black Swan," not on any deeper expertise) that option pricing is still derived largely from application of the Black-Scholes formula, which basically just uses a "normal" distribution for price movements and then calculates the probability that the price will move to the strike price by the expiration date. This method completely ignores trends, and tends (as Taleb argues) to dramatically underestimate actual rare but extreme price movements. The baseline assumption via Black-Scholes is that the future price of any commodity will be the same as the present price, impacted only by the probability of "normal" price volatility over the time period in question. Correct me if I'm wrong here.
Two notes of interest:
1. I purchased some 2010 and 2011 calls a few years ago, but have been trying to purchase more 2011 and 2015 calls recently (e.g. CLZ15100C, December 2015 call at a strike price of $100/barrel). No takers. I'm not entirely sure what to make of it--the markets report some volume on these options, but no one seems to want to sell me one or two, even when I offer a premium of as much as 20% the last traded price :( Anyone with actual pit trading experience that can shed light on this? I had no problems buying similarly long-dated options in similar quantities in 2005.
2. There are "interesting" tax consequences of buying non-equity (e.g. oil) call options: you are taxed on your capital gain mark-to-market at the end of each year, regardless of whether you've sold the option or not, at a 60% long-term capital gains, 40% short-term capital gains rate, regardless of how long you've held the option. So if your option has made money this year, you have to pay taxes on that capital gain, even though you haven't sold the option yet and don't have the money in hand. I'm NOT a CPA, so do NOT take my word on this, but I have been told that this is what I.R.C. Section 1256 says. Just a heads up.
Jeff, this is a formula that a lot of traders use to determine the "fair price" of an option. By using this formula they can determine when an option is either overpriced or underpriced. However option prices are not "set" by any formula. The price of any option is determined by what traders are willing to pay. That is the "bid-ask" price.
You are trying to buy calls by placing limit orders and getting no takers. This is not unusual in very thinly traded markets as far out options usually are. But if you placed a market order your order would get filled in minutes. But of course it would be filled at a price far above what you might be willing to pay.
In 2005 far fewer people were aware of peak oil and most really expected the price of oil to fall in the coming years. Now that the cat is out of the bag you will have a lot harder time buying those far distant out of the money options. And because so many more people are now expecting the long term price of oil to rise this has driven up the price of those far distant out of the money options.
Ron Patterson
Yeah, I seem to have no effective way (without more direct access to the pits than I have) to communicate how much of a premium I'd be willing to take. That or I'm just not offering enough of a premium to compensate for not buying a larger block of options. Do you know, when a limit order is placed, if the pit trader receiving the order routing sees merely a buy that then won't execute above a certain level, if they see the limit and you're just hoping that they won't be greedy and always execute exactly at the limit, or something else? I have, in the past, had limit orders on NYMEX CL execute at prices below my limit, so that seems possible, but I don't know the mechanism. Either way, I'm not willing to place a market order and gamble that I won't get burned!
Your view of the Section 1256 treatment of futures options (and futures) is correct. I have worked in the accounting department of a major Wall Street trader and I am familiar with these rules.
Section 1256 also applies to broad based exchange trade contracts on stocks, such as the S & P index funds, and not surprisingly exchange traded funds based upon futures such as USO for oil.
The disadvangtage of reporting gains/losses yearly is somewhat offset by the favorable partial (40%) capital gains treatment - even if you hold the futures contract/option/ETF less than one year.
There is also a special loss carryback rule if (and only if) you had a Section 1256 gain in an earlier year. So if you report an unrealized gain one year, and a similar loss the next, they could offset each other - resulting in no tax effect.
There is also a special loss carryback rule if (and only if) you had a Section 1256 gain in an earlier year. So if you report an unrealized gain one year, and a similar loss the next, they could offset each other - resulting in no tax effect.
Would the investor have to file an amended return in that case for the prior year?
I just want to clarify for people that they will not be paying 60% of their profits in taxes!
Here's how the taxes on your profits work:
60% x 15% (maximum long-term capital gains tax rate) = 9%
40% x 35% (maximum short-term capital gains tax rate--your own rate may be lower, depending on your income) = 14%
Net maximum 60/40 blended tax rate = 23% (no matter how long you actually hold a position)
All commodities futures based investments (ETFs, specialty mutual funds, options) get the 60/40 tax treatment mark-to-market at the end of each tax year if you haven't sold it. It's an outrageous act of greed by the IRS, but at least they are nice enough to treat 60% of your profit as long term at the lower tax rate.
The new ETNs (exchange traded notes) are actually debt notes, not funds with forced distributions each year, and can be held for years with no tax due untill you sell them or the debt obligation reaches maturity, usually 15 or 30 years. This gives you full blown compounding. But ETNs are merely promises by the issuer to pay you what the underlying commodities are worth upon demand. If they default, your investment is worthless. So these days you must be very carefull who the issuer is. They are haggling over whether ETNs will keep their tax-exempt status. They may be forced to do a distribution thing like the funds even though they are notes if the mutual fund industry has their way (they don't like the tax-free competition threat that ETNs present).
This all applies just to commodities. Things like currency are taxed differently.
It's actually the result of an overzealous and overbroad attempt to close a tax loophole that was being aggressively marketed many years ago whereby individuals would take simultaneous positions in a market at a near and a distant expiry date and essentially be able to perpetually declare a short-term loss and a long-term gain, thereby offsetting their tax liability while effectively shifting the date they'd need to pay their tax perpetually into the future. Again, I'm not the most knowledgeable in this area, others can probably explain exactly how this loophole worked and how 1256 closed it, but that was (as I understand it) the impetus.
Yes, I think there was some slickery going on by traders that was fixed by some political slickery back in the mid '80s. As Green Trader Tax tells it:
Above I said that my comments about relative tax advantages applied to commodities, not stocks, currencies, etc. Actually the capital gain distribution part applies to all things other than commodity futures. If a fund has holdings in futures contracts that expire (are bought and sold) each month, that investment is all taxable short term capital gain by Section 1256 and is tabulated mark-to-market each year. The 60/40 thing was something of a compromise for longterm fund holders.
I am a novice: I learned just enough to do what I wanted to do, and that was to buy long-term naked crude call options with 5% of my savings, which I decided to risk, while moving most risk out of the rest of my savings as well as I could.
My wife has been exasperated at the fact that despite the fact I haven't sold them, we owe a lot of taxes since they're worth a lot more than they were. Not so exasperated she wishes I hadn't done it, though.
I decided to pay an actual agent since I found a place which had kind of a 'flat fee' to get in and out of each trade, and I wanted someone to answer my questions... since my strategy was "buy and hold", the per-option fees was less of an issue for me, since the volume would be low.
Back last year, the options prices were darn cheap, though hard to get more than a couple years out. And there's the "theoretical" value of them, and then there's what someone is actually willing to sell you. Like last year, my agent could only get 'ask' quotes from a single trader named "Brutus" who wasn't always there or in the mood to deal with one or two contracts at a time. That underscored the silly-human nature of how these things actually play out in the NYMEX pits. I also got a couple of 2011 calls filled at below the theoretical value, my agent guessed it was because "they got tired of hearing you wanted just two and filled it to make it go away".
I'm currently trying to get some options for 2012 and 2013, even though the prices are pretty high for 100 calls now.... and I have been unable to snag any. My agent notes that "the guys who sold the naked calls last year got hammered". So I've hung out some GTC orders at a price I'd be willing to pay, and that's that.
I really like the fact that with options you never risk more than you have on the table. Still, I have toyed with the idea of getting a future or two, to be able to get into the 2012-2015 timeframe. I dunno that I'd be willing to buy farther out than that.
I think crude options are still a great play.... it's like being able to invest directly in human ignorance & arrogance while shorting the dollar, and bidding up the prices can't do any harm to send "conserve" signals, either.
YMMV
Time to cash out.
Good song for you:
EJECTION , by Robert Calvert, ex- Hawkwind.
From Capt. Lockheed and the Starfighters:
Ejection :-0
There's only one course of action
left for me to take
I've tried every switch selection
that might control this state
I think for my protection
I'd better make it straight
into EJECTION
better tell base - EJECTION
that I think it's a case - for EJECTION
protect my face
EJECTION
The screen's projection
tell's me I'm too late
to make a course correction
I'm about to meet my fate
no time for reflection
I'd better make it straight
into EJECTION
bust through the sky - EJECTION
the air rushing by - EJECTION
it's a case of goodbye - EJECTION
I'm too fast to die
EJECTION
When a ship meets with destruction
the captain stays to drown
but no tin contraption
is going to drag me down
my reference intersection
tells me that I'm bound
for EJECTION
eight times my weight - EJECTION
abandon this crate - EJECTION
only one move to make - EJECTION
I've got to escape
EJECTION
:-0
PS - I forgot.
The stern faced estate agent lady came round today to value our family home.
Hereabouts in Aberdeenshire: not yet in nose dive. In England, you can kiss 30% of your YOY Equity goodbye.
Hereabouts (her words!):
''roughly at peak, a kind of a plateau, if priced right, will sell''.
We are looking to cash out and get mortgage free by downsizing and right now, we think we have just enough equity to achieve this objective.
But it will be tight.
Plan may work.
But to dither for two months may kill all hopes.
Have fun on TOD.
Will be busy for a while.
Painting rooms in a pleasant neutral shade for prospective buyers...
Magnolia...
Dorme Bien.
PPS:
YOY Equity?
Means:
''Why oh why didnt we sell last year''....
pppsss:
http://www.youtube.com/watch?v=Jd0CbIwRd1Q
Not ejection , I'm afraid, but from the Calvert / Hawkwind album.
Nighty - night.
This is incorrect.
Options are not based on themselves as a standalone instrument, but based on the matching underlying futures. Since 2006, long dated futures contracts have skyrocketed, 80%, which indeed shows that peak oil has been, at least partially priced in. The 'probability' you refer to is just implied volatility matched with the futures strip - it has nothing at all to do with option traders - options are just a different risk profile way of expressing a view of the future.
Redo your analysis incorporating the change in futures strips and you'll have a clearer answer. But what you'll find is that volatility has gone up (based in part on ACTUAL volatility going up and expected volatility increasing due to more people in CERA camp and more people in Simmons/TOD camp - meaning less people in the middle...e.g. market realizes we could have big move in EITHER direction), and price has gone up. At any time if you give me an average implied volatility and a futures price, I can tell you what the options will trade for - it is not related to peoples expectation of peak.
If more people believed that peak oil was a reality, you would expect to see distant contracts in steep contango compared to the typical backwardation we've had in recent years (front months higher than back months). And in fact this is exactly what has happened. We are almost flat out to 2016 in prices, meaning THE MARKET DOESN'T EXPECT THESE HIGH PRICES TO BE SHORTLIVED. In 2006, long dated futures were $20 under spot, which was about 35%. That 35% discount has all but disappeared.
It will be very interesting as we reach and pass peak oil what happens to futures. Because, via arbitrage, long dated futures can't get too much higher than current futures - otherwise people would just buy the current and store it - which is why many hedge funds have taken out physical storage space for oil -the worlds limited private oil storage capacity will limit how large of contango the oil market can have.
“FELM” (Food Export Land Model) in Action:
I think that we are going to increasingly see bilateral trade between food and energy exporters. It's not a good time to be both a major food and a major energy importer.
From Drudge:
Financial Times: Jump in rice price fuels fears of unrest
By Javier Blas in London and Daniel Ten Kate in Bangkok
Published: March 27 2008 18:30 | Last updated: March 28 2008 09:06
Perhaps we should compile a list of countries that have imposed export bans on rice and other edible commodities?
I predicted some time ago that the world financial crisis brought on by PO would cause a rise of nationalist sentiment and probably trade barriers (protectionisim). The 'globalist movement' cannot co-exist with nationalisim. My predictions were met with some derision. Nah Nah Na Nah Nah. :) Trade barriers are at times leading indicators of wars.
Indian rice export ban to hit Bangladesh imports - traders
http://in.reuters.com/article/businessNews/idINIndia-32379220080309
Cambodian PM bans rice exports to halt spiralling costs
http://groups.google.com/group/soc.culture.cambodia/browse_thread/thread...
I bought rice yesterday.
No, not contracts.
I took possession of the physical commodity.
Too bad brown rice does not store as well as well as white.
Local Retail
Indian Basmati: $.60/lb
Texas Long Grain White: $.32/lb
California Organic short grain brown: $.88/lb
Back in 2002 I bought a very large quantity of organic brown rice. I'm still using rice from that stock, and it both cooks and tastes fine to me. Now maybe if I tasted it side-by-side with fresh rice I'd be able to tell the difference. But it is more than good enough for the apocalypse. Based on that experience, I recently bought another large quantity of organic brown rice, which I've stashed in air tight bags in my baseme