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The Fundamental Problem with Oil Prices
Posted by aeberman on May 30, 2011 - 10:10am
This is a guest post by Derik Andreoli, Senior Analyst at Mercator International, LLC
It has been a tumultuous month when it comes to oil and fuel markets. As of the writing of my Oil and Fuel column in the May issue of Logistics Management, which was submitted on the 15th of April, WTI (the crude stream traded on the NYMEX) was at $109.66 per barrel, up 19.8% from $91.55 where it sat at the beginning of the year. Meanwhile, the spot price for Brent Blend, the benchmark crude stream traded on the European Intercontinental Exchange (ICE), had climbed 30.1% from $95.82 on January 3, to $124.63 by the 15th of April. My warning in the May article was that refiners’ costs were better reflected in the price for Brent, and that supply chain and logistics professionals following the WTI price were going to get caught short as the refiner average acquisition cost had diverged from a historical average of $2 to $4 per barrel below the WTI spot price to $4 per barrel above the WTI spot price.
Since the writing of the last column, the prices for a barrel of both WTI and Brent Blend have gone on a roller coaster ride. The spot price for Brent climbed as high as $126.64 by the 2nd of May before falling by nearly 12% over the next three days alone. Meanwhile, the front month WTI futures price reached a peak of $113.93 on April 29 before falling by more than 16% to a low of $95.33 by the 12th of May.
Of course volatility is precisely what should be expected when oil markets are tight, as they have been since the onset of the recovery. Despite living up to expectations, however, the recent volatility has led some to conclude that the prices simply don’t reflect the underlying fundamentals of supply and demand, but such a conclusion is not supported by sober analysis. The precipitous price decline has led others to postulate that the mini-bubble inspired by the shuttering of Libyan production has been popped, and the price of oil has returned to a fair level. Yet others, like ExxonMobil CEO, Rex Tillerson, are all-too-eager to pass the blame of high fuel prices on to Wall Street and the little-understood high-frequency trading of quantitative hedge funds.
Interpreting Market Fundamentals
To a Senate committee, Mr. Tillerson asserted that oil should be $60 to $70 given the fundamentals of supply and demand. As always, context is important, and Mr. Tillerson was testifying before a group of Senators who are aiming to eliminate the significant oil tax breaks that Mr. Tillerson benefits from. The Senators’ basic argument is that the tax breaks made sense when enacted because the price of oil was less than $20 per barrel and the vast majority of new fields were located offshore where production costs exceeded the sale price. The fact that today’s oil prices are now earning the oil majors near record profits strongly suggests that the subsidies are no longer needed.
At any rate, Mr. Tillerson’s reading of the fundamentals differs from mine. The simple fact is that today’s prices reflect the market’s best guess as to what future supply and demand will be. When the market interprets economic and oil production signals as indicative that demand will grow faster than supply, the price of oil is bid up. Through this important process, the market signals to oil producers that additional investments in exploration and production are justified. To consumers, rising prices inspire increased efficiency.
Mr. Tillerson’s reading of today’s fundamentals of supply and demand belie the reality that oil markets will most definitely tighten into the foreseeable future, unless, of course, the world economy falls into another recession and the demand for oil and fuel falls as a consequence.
Mr. Tillerson’s argument also plays to the wrongheaded idea that oil futures traders collectively win when the price of oil increases. To be clear, traders earn profits by correctly guessing the direction that aggregate market sentiment will take the price of oil futures. Traders can turn a significant profit by betting that the price will fall just as easily as they can turn a profit by betting that the price will rise, so long as the market moves in the direction that they bet. Futures traders base their bets on their reading of aggregate market sentiment, and aggregate market sentiment represents the collective, though imperfect, interpretation of news which bears on future oil demand and future oil supply.
Most recent news regarding the supply side of the equation indicates a further tightening of oil and fuel supplies. Rather than taking my word for it, I present below a review and brief interpretation of current events on supply coming from the largest oil producing countries.
Russia and Saudi Oil Production and Consumption
Russia and Saudi Arabia are the world’s largest oil producers. They are also the world’s largest oil exporters, and from the perspective of a net oil importer like the U.S., oil exports matter far more than oil production. On this front, there is a critical difference between Russia and Saudi Arabia. Russia has continued to increase oil exports each and every year. Oil exports from Saudi Arabia, on the other hand, peaked in 2005.
Another important difference is that Russia, like nearly every other oil producing nation, does not claim to have any surplus production capacity. By contrast, Saudi Arabia is one of only four nations to claim that they have the ability to increase production at a moment’s notice. Saudi Arabia is, in fact, the only nation to claim significant surplus production capacity (3.15 million barrels per day), thus Saudi Arabia is the world’s swing producer.
Of course Saudi claims of surplus production capacity are not backed up by transparent and verifiable information, so market observers like me are left to interpret Saudi Arabia’s actions in addition to their words. Along these lines I am discouraged by the Kingdom’s actions. At the end of March, Saudi Arabian oil officials met with Halliburton to discuss plans to boost their oil-directed rig count by roughly 30%. The fact that there exists a strong inverse relationship between the amount of surplus production capacity and oil prices leaves the market observer wondering why on earth Saudi Arabia would make such a large investment to increase production capacity if their claims of having more than 3 million barrels per day of surplus production capacity reflect reality.
With Saudi Arabia already claiming production capacity of 12.5 million barrels per day, why would they look to further increase their production cushion? Do they think the price is too high, and look forward to earning less per barrel of exported oil? Obviously, not. Could it be that they are seeing internal demand climbing, and realize that without significant investment, their production cushion would be quickly eroded? Or could it be that their claim of 12.5 million barrels of capacity in place is, in fact, an overstatement?
According to a Saudi oil official interviewed by Reuters, the investment in new drilling rigs “is not to expand capacity. It’s to sustain current capacity on new fields and old fields that have been bottled up.” (1) This news on its own should be troubling as it infers that the Kingdom is facing significant declines on currently producing fields. Even more troubling is the recent statement by another senior Saudi oil official that the Kingdom “expects oil production to hold steady at an average of 8.7 million barrels per day to 2015.” (2) These statements made in regard to Saudi production call into question the Saudi willingness and ability to increase exports, which is tacitly understood to be the responsibility of the world’s only pivot producer. Moreover, these statements should come as a warning. If the Kingdom holds production flat, exports will decline by the rate of growth of internal demand, and Saudi domestic consumption has been growing at just under 10% per year.
Turning to Russia, I am equally concerned by the news that “Russia decided on Thursday [April 28] to halt premium petrol exports and switch the flow to the home market to fight shortages and a price rise that is coinciding with growing voter discontent.”(3) Interestingly, Vladimir Putin, like Mr. Tillerson, is eager to deny that oil and fuel markets are tight and tightening. Unlike Mr. Tillerson, who defends oil producers and passes the blame onto Wall Street, Mr. Putin relieves political pressure by passing the blame to the oil producers, asserting that, “there is no deficit… this is an issue of collusion.” (4)
At any rate, fuel demand in Russia is climbing faster than the rate of supply, and exports are by default put into jeopardy, just as they are in Saudi Arabia and many other oil exporting nations.
Revenue Requirements of Oil Exporting Nations
But Russia is not alone when it comes to enacting export restrictions. Said the Financial Times on May 10, “Beijing has put strong pressure on its state-owned [oil] companies to halt overseas sales of petrol.” (5) Then on May 13, the Financial Times reported, “Beijing has suspended exports of diesel fuel indefinitely to help meet domestic energy demand ahead of the peak summer season, prompting concerns about knock-on effects across Asia.” (6) In addition to battling inflation, China, like Russia, is facing diesel supply shortages.
China is not alone in an effort to battle inflation in Brazil, leaders there have called on state-owned oil producer, Petrobras, to lower fuel prices by 10 percent. Doing so would of course provide a perverse incentive to Brazilian consumers to increase consumption. Even more importantly, lowering fuel prices would cause further problems for Brazil’s unregulated and privately owned ethanol producers who are already suffering from skyrocketing input prices as they compete with food producers for sugarcane. Perhaps this is why Petrobras was also recently ordered to triple its share of the nation’s ethanol production, and why there have been calls within the nation to begin regulating the sugar and ethanol industries.
Turning north to Venezuela, we learn from the Wall Street Journal that, “the South American nation is swapping out its old system of royalties and will instead charge a higher levy of 80 percent or 90 percent on revenue above $70 and $100 a barrel, respectively.” (7) As investment advisor and energy expert, Jim Hansen, points out, “The taxes will be directed to social programs (read that as buying votes) and not into the poorly performing Venezuelan oil industry. About all this is going to guarantee is continued pressure on declining oil production from Venezuela and continued domestic economic difficulties.” (8)
Given that 80 to 90 percent of revenues will be funneled away from Venezuelan oil producers, it will be difficult for Petroleos de Venezuela to continue investing in new production. And the Venezuelan government is not unique in levying what might be called a ‘political premium’ on top of production costs. According to a study by the Institute of International Finance, a global banker’s trade group, the increase in Saudi federal spending in response to the unrest in the Middle East and North Africa has ensured that Saudi Arabia will need to sell its oil at an average of $88 per barrel in 2011 just to break even. (9) Bearing in mind that Saudi oil, which is both heavy and high in sulfur content, sells at a discount to Brent, it is clear that even Saudi Arabia requires the price to be above $60 to $70.
Of course, Mr. Tillerson, like so many other prognosticators, has a vested interest in passing the blame for higher prices to someone, really anyone, other than themselves. But the reality is that we are all complicit in the rising prices.
The Majority View on Likely Oil Price Developments
All that said, if we were to ask oil industry executives to forecast prices for the remainder of the year, we would get a very different take from Mr. Tillerson’s. This is, in fact, exactly what KPMG did in their annual energy survey, which in April polled 550 financial executives from global energy companies. In contrast to Mr. Tillerson’s claims, the majority of executive see $121-plus oil through the end of the year. To quote Downstream Today, “32 percent think 2011 U.S. crude oil prices will peak between $121 and $130 per barrel. One-third of executives see even higher prices, with 17 percent of those predicting between $131 and $140 per barrel; nine percent between $141 and $150; and six percent expecting crude prices to exceed $151 per barrel before year end.” (10) Either these financial executives are basing their analyses on something other than the fundamentals, or Mr. Tillerson interprets the fundamentals differently than many of his peers.
Unfortunately for those of us in logistics, sober analysis suggests that the supply is likely to tighten through 2011 and beyond. As it does so, the prevailing trends in rising prices and rising price volatility will continue… unless, of course, the trend in rising global demand suddenly reverses - an outcome which is highly unlikely given the subsidies that oil exporting nations provide for domestic consumers.
Given these trends in rising prices and price volatility, it might be time to revisit contingency plans and re-evaluate current sourcing and transportation strategies. While the market is tightening and prices are generally rising, the price impacts are not distributed evenly across modes, nor are they distributed evenly across geographical regions or along the major shipping lanes that connect them. With every challenge comes opportunity.
(1). http://www.reuters.com/article/2011/03/29/us-saudi-libya-idUSTRE72S5RT20...
(2). http://www.platts.com/RSSFeedDetailedNews/RSSFeed/Oil/8812036
(3). http://au.finance.yahoo.com/news/Russia-bans-petrol-exports-afp-38043921...
(4). http://www.ft.com/intl/cms/s/0/9c10cf28-772a-11e0-be6e-00144feabdc0,dwp_...
(5). http://www.ft.com/intl/cms/s/0/7eac6bb0-7b29-11e0-9b06-00144feabdc0.html...
(6). http://www.ft.com/intl/cms/s/0/ad165aa8-7d8e-11e0-b418-00144feabdc0.html...
(7). http://www.businessweek.com/news/2011-04-26/chavez-windfall-tax-to-repla...
(8). http://www.ravennacapitalmanagement.com/mrr/wp-content/uploads/2011/04/T...
(9). http://blogs.wsj.com/economics/2011/03/31/saudi-governments-break-even-o...
(10). http://www.downstreamtoday.com/News/ArticlePrint.aspx?aid=26594
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I'm afraid that this is not quite accurate. Here is what BP shows for Russian net oil exports for 2002 to 2009 (of course, no argument about Saudi Arabia):
2002: 5.1 mbpd (total petroleum liquids)
2003: 5.9
2004: 6.7
2005: 7.0
2006: 7.1
2007: 7.3
2008: 7.1
2009: 7.3
Russian net oil exports increased at 5%/year from 2002 to 2007, but then stagnated, with a decline in 2008 and no change in 2009 net exports, versus 2007 (rounded off to 0.1 mbpd).
My frequent co-author, Samuel Foucher, and I have written extensively about net oil exports for the past five years. Recently, we have been focusing on what I call Available Net Exports (ANE), which I define as Global Net Exports (GNE) less Chndia's combined net oil imports.
Following are what we show for GNE for 2002 to 2009 (oil exporters with net oil exports of 100,000 bpd or more in 2005, which account for 99% plus of global net oil exports).
Note that GNE increased at about 5%/year from 2002 to 2005, and then we had flat to declining GNE. I suspect that this inflection point was quite a shock to oil importing countries, especially developed oil importing countries.
Also shown are Chindia's combined net oil imports. The difference between the two is what I define as ANE.
As you can see, ANE fell from 40.8 mbpd in 2005 to 35.7 mbpd in 2009. A plausible estimate is that ANE could be down to about 27 - 30 mbpd by 2015.
Global Net Oil Exports Less Chindia’s Combined Net Oil Imports = ANE
(BP + Minor EIA data, mbpd) :
2002: 39 - 3.5* = 35.5 (ANE)
2003: 42 - 4.0 = 37.4
2004: 45 - 5.1 = 39.9
2005: 46 - 5.2 = 40.8
2006: 46 - 5.5 = 40.5
2007: 45 - 6.1 = 38.9
2008: 45 - 6.6 = 38.4
2009: 43 - 7.3 = 35.7
2010: 44 - 8 = 36**
*Chindia's combined net oil imports
**Estimated
This table shows the detailed data for 2005 to 2009:
http://i1095.photobucket.com/albums/i475/westexas/Slide3-1.jpg
Two recent articles:
Peak oil versus peak exports
http://www.energybulletin.net/stories/2010-10-18/peak-oil-versus-peak-ex...
Egypt, a classic case of rapid net-export decline and a look at global net exports:
http://www.energybulletin.net/stories/2011-02-21/egypt-classic-case-rapi...
Jeffrey J. Brown
I'm afraid that this is not quite accurate. Here is what BP shows for Russian net oil exports for 2002 to 2009 (of course, no argument about Saudi Arabia):
Russia did increase exports again in 2010 it was 7.4 sorry 7.438 :-)
Where did you get the consumption data?
But even if accurate, which it very well may be, the rate of increase from 2007 to 2010 would be 0.5%/year, versus the 5.0%/year that we saw from 2002 to 2009, with an average post-2007 net export rate of 7.3 mbpd. So again, the key item to focus on is the inflection point--at a 5%/year rate of increase in net exports, Russia's net oil exports in 2010 would have been 8.5 mbpd.
In any case, regarding the (2005) top five net oil exporters, following is my estimate for 2010:
(2005) Top Five Net Exporter Update
I took the EIA data for total petroleum liquids for 2010 and then extrapolated the 2005 to 2009 rate of increase in consumption for Saudi Arabia, Russia, Norway, Iran and the UAE to come up with estimated (2005) top five production of 29.8 mbpd and consumption of about 8.0 mbpd, resulting in estimated 2010 net exports of 21.8 mbpd.
Here are the BP (2005) top five net exports data for 2005 to 2009, and my 2010 estimate:
2005: 23.8 mbpd
2006: 23.6
2007: 22.9
2008: 22.8
2009: 19.3
2010: 21.8*
*Estimated
Note that at the 2002 to 2005 rate of increase in net exports for the top five (6.3%/year), they would have been (net) exporting 32.6 mbpd in 2010, versus the estimated net export rate of 21.8 mbpd. The top five data continue to fall between Sam Foucher's middle case and high case. The wild card continues to be Russia, the only country where the production data are currently falling at the upper limit of Sam's projections.
Sam's most optimistic projection is that by the end of 2014, the (2005) top five will have (net) exported about half of their post-2005 CNE (Cumulative Net Exports).
Westexas
I have gone with the EIA data, which appears to be quite accurate with the likes of china, India and USA.
I didn't realize that the 2010 data were out. It looks like the 8.0 mbpd consumption estimate I used for the top five was accurate, at least based on the EIA data set (I just used 2005 to 2009 rate of increase in consumption).
According to the EIA data
In the last 5 years, of the 40 oil exporting countries, 26 exporters have declined a total of 4.4 mbd.
14 have increased production a total of 3.2 mbd, therefore a net loss of 1.2mbd.
Brazil is now a net exporter of oil and Egypt a net importer.
It is possible that the 14 could reverse the export decline trend for 3/4 years if they all expand their production without any hitch. 4.4 - 3.2 = 1.2. You can see how Iraq could reverse this trend for a few years.
The fact is the exports from the majority of exporting countries is now falling and they will want higher prices to make up the difference.
You are selling coal to Newcastle with your ELM argument. WT is the person who came up with the idea.
Of course, I started focusing on net oil exports because of some of Matt Simmons' early work.
I think that the major contribution that Sam and I made was to quantify "Net Export Math," especially the following point--given an ongoing production decline in an oil exporting country, unless they cut their consumption at the same rate as, or at a rate faster than, the rate of decline in production, then the net export decline rate will exceed the production decline rate, and the net export decline rate will accelerate with time. I think that this has to be one of the most obvious mathematical observations ever made, yet at the same time, it is probably the most overlooked major factor that is adversely impacting and will continue to adversely impact the global industrial economy.
WHT
Yes I do know that, I have been looking at the export land model in reverse, IE countries that are increasing production and exports. This is necessary in order to see what export decline rates we may see in the future taking political factors into consideration. Such as Nigeria, Angola, Iraq etc.
It is called looking at all the facts, you should try it sometime.
You ought to look at the math behind ELM, The Prequel; it's pretty interesting.
Let's assume that "Export Land" peaked in 2000.
From 1990 to 2010, oil consumption increased at 2.5%/year.
From 1990 to 2000, oil production increased at 5%/year, peaking in 2000, and from 2000 to 2010, oil production fell at 5%/year.
From 1990 to 2000, net oil exports increased at 8.7%/year. Note that the rate of increase in net oil exports, 8.7%/year, exceeded the 5%/year rate of increase in production from 1990 to 2000.
From 2000 to 2008, net oil exports declined at 27%/year (hitting zero in 2009). Note that the eight year rate of decline in net oil exports, 27%/year, exceeded the rate of decline in production (and of course, the year over year net export decline rate accelerated over the decline period).
We see a somewhat similar pattern in real world data. Global Net Exports* rose at 5.1%/year from 2002 to 2005, faster than the 4.6%/year rate of increase in exporting country production, and then stagnated in 2006, and began falling in 2007.
So, from the point of view of oil importing countries, supplies seem abundant, rising at a rapid clip--until we hit a combined production peak or plateau in the exporting countries, and then everything changes.
*Countries with net oil exports of 100,000 bpd or more in 2005 (BP + minor EIA data).
Incidentally, BP shows that Brazil is still a net oil importer (as of 2009), while the EIA shows them as a net oil exporter. I assume that the difference is that the EIA counts biofuels, while BP focuses solely on petroleum production and consumption.
Westexas
Yes the maths is frightening, all these countries want to become richer and will therefore use more and more of their production.
It is no surprise that Saudi Arabia struggles to increase exports when they are burning over 800,000 barrels per day to make electricity, what a waste, it must be the most expensive electricity in the world.
http://www.tradingeconomics.com/saudi-arabia/electricity-production-from...
http://blog.thomsonreuters.com/index.php/graphic-of-the-day-electricity-...
That's over twice what I calc for KSA, using the same data source as your links, which don't give kb/d figures for power generation.
KLR
I have seen these sorts of figures before, perhaps their power plants are inefficient?
http://www.eia.gov/cabs/Saudi_Arabia/Full.html
"Contributing to this growth is rising direct burn of crude oil for power generation, which reaches 1 million bbl/d during summer months"
UK is 60 million and uses 1.6mbd, Saudi population is 28 million, I cannot imagine them using more oil than 1.6 million for cars etc. Burning 800,000 to 1mbd in power stations does sound about right.
Interesting, thanks. Didn't know the EIA had chimed in. By converting kwh to bbl I got 415 kb/d for 2006. Picture that sliced out of this:
Thus ca. 1/4? So they'd be at 600 kb/d now? But I've occasionally caught other blurbs about power taking up ca. 1 mb/d, too, the CEO of one of their major contractors building out gen infrastructure, for instance.
Saudis would be very much advised to give diversification a try - they'd completely rule for solar thermal. And for whatever reason they just can't exploit their NG resources. Just suggesting they strive for efficiency will get a big laugh.
Another venture with some promise is the development of a local Gulf grid, which would trim consumption somewhat. Big part of that went online last year, it didn't keep demand from rising YOY, but only ca. 50 kb/d, instead of 2008/2009's staggering ca. 400 kb/d.
KLR
From Debbie's Article Saudi commissioned 11,000MW in 2010 alone and the Gulf demand is growing by around 10% per year.
According to this article, Riyadh alone consumes 800,000 per day.
Hawaii too - apparently 78% of its electricity generated by burning crude oil -- 16.4cents/hour in 2001 according to http://archives.starbulletin.com/2001/06/10/news/story3.html
Still "over 75%" in 2009 according to EIA - http://www.eia.gov/state/state-energy-profiles.cfm?sid=HI
KSA electricity should be cheaper than Hawaii's due to little transporting of oil...
I wonder if that is part of the discrepancy that was discussed between the EIA and JODI?
NAOM
I use total liquids numbers, this is because butane and propane are being used more and more as fuel for cars and trucks.
http://www.drivelpg.co.uk/
http://www.drivelpg.co.uk/about_lpg.php
So to exclude them does not make sense on a practical level.
Also the EIA data gives figures of consumption of total petroleum liquids, so Brazil currently produces more total liquids than it uses.
EIA gives a separate page for production of biofuels, which is not included in petroleum products.
http://www.eia.gov/cfapps/ipdbproject/IEDIndex3.cfm?tid=79&pid=79&aid=1
I believe that both the EIA and BP count NGL's as part of total petroleum liquids.
Note that there is a large discrepancy between the EIA data and BP regarding Brazil.
First, here is what the EIA and BP show for Saudi Arabia for 2009:
EIA:
TOS: 9.8 mbpd
TPL: 9.8
Consumption: 2.4
BP:
TPL: 9.7 mbpd
Consumption: 2.4
And here is what the EIA and BP show for Brazil for 2009:
EIA:
TOS: 2.6 mbpd
TPL: 2.5
Consumption: 2.5
BP:
TPL: 2.0 mbpd
Consumption: 2.4
TOS = Total Oil Supply (which the EIA says includes other liquids, which I assume means ethanol)
TPL = Total Petroleum Liquids
Can anyone account for the 0.5 mbpd difference between the EIA and BP regarding total petroleum liquids?
Edit:
Figured it out. The TPL category for the EIA has an "other liquids" component. If you add the EIA C+C number to the EIA NGL's number, you get 2.0 mbpd for Brazil in 2009, which is exactly what BP shows. Therefore, it seems to me that if we focus solely on petroleum liquids, and don't count biofuels, Brazil is still a net oil importer of petroleum liquids, based on both EIA and BP data sets.
If we look at the EIA data for C+C+NGL's production for Brazil, and what the EIA shows for consumption, we get the following:
2009: 2.0 - 2.5 = 0.5 mbpd net imports
2010: 2.1 - 2.6 = 0.5 mbpd net imports
Brazil to the rescue?
If we extrapolate the 2004 to 2009 rate of decline in Brazil's consumption to production ratio (130% in 2004 to 118% in 2009, BP), Brazil would approach zero net oil imports around 2018.
http://www.eia.gov/emeu/ipsr/appc.html
westexas
Thanks for that.
Spot on. In my experience of watching the oil markets, you are exactly correct that the price is determined by the balance between supply and demand.
The U.S. has also interfered itself in the free markets with massive subsidies for oil companies ($600 billion in the military budget alone) and lesser subsidies for ethanol producers. The true cost of producing oil has yet to be passed to the consumer through taxation but when it does then we could see a significant drop in demand unless we have strong economic and wage growth.
Some of my thoughts:
http://www.aspousa.org/index.php/2011/05/us-oil-gas-industry-shoots-itse...
US Oil & Gas Industry Shoots Itself in the Foot
What I find amazing is that even though the oil industry has the target on its back, when most critics, pundits and politicians take their pot shots at energy subsidies they hit ethanol. This despite it is the oil industry that pockets the blenders credit that supposedly only benefits ethanol.
The madness continues when corn farmers are then accused of pocketing the subsidy which is at least two pockets removed from their own.
How the blenders credit subsidy which clearly is in oil industry pockets jumps out and into the pockets of ethanol producers and then into the pockets of corn farmers is not clear.
It would seem to me that the oil industy collects it, keeps it and that is reflected in oil company profits. The benefits that go to ethanol distillers and farmers are a bonus similar to the bonus consumers receive when oil subsides are given to oil companies.
But few claim that consumers receive oil subsidies. Obviously, they do not since they pay the world price for oil whether it is subsidized or not.
It seems to me that those who pocket the subsidy have in fact collected it. Others in their business relationships may benefit or not but can not be accused of collecting the subsidy.
The weird thing is that in the case of the ethanol blenders credit, the subsidy collector is held not to have received it by critics. Those who did not receive it are held to have collected it.
Such is the power of media spin...or politics, it appears.
Strangely, Tillerson is right.
Exxon buys much more oil than it produces (it produces about 2 mbpd of crude + NGL and worldwide refines over 5 mbpd)) so it has to pay for those oil price increases.
Speculators are parasites on the world energy system.
Oil futures markets/casinos should be closed.
I agree.
Clearly a fundamental paradigm change has occured in the past decade - marginal cost is increasing for oil and other natural resources as depletion catches up to/outpaces technology. So upward prices are due to biophysical reasons 'in general'. However speculation adds a significant 'tax' to economies due to the billions of paper trading of oil and other commodities that exchange for no economic purpose other than digital transfers. If only hedgers and producers were allowed to trade basic commodities I would guess prices would be ~30% lower - yes - the fundamental rising cost-due-to-depletion story would still exist, but it wouldnt be quite so sharp as it is now, and lower prices might buy policymakers more time to mitigate the financial storm thats coming. Also, as I wrote about after Amaranth blow up and again after Hurricane Ike, extremely LOW prices, due to the speculator pendulum swinging the other way, hamstring policymakers in the other direction - giving incorrect signals on future resource scarcity. Its the swings that are killer.
In essence, 'speculators' are to blame and not to blame for high oil prices depending how wide a lens you use. The real issue is free money from central banks not put to productive long term use - those middlemen following legal, acceptable environmental cues to amass more digits are 'speculators', but speculation only exists because of the free money and government policies. I should hasten to point out that if speculation in oil and commodities were outlawed it wouldn't solve our energy/financial problem, but probably buy a bit more time and divert circular resources into something more productive.
We are heading towards more nationalization - and fast. I suspect (and in this case would support) coming restrictions on who can trade key commodities. Those that think this would disrupt the 'free market' are kidding themselves. (as in..free market hasn't existed in long time)
This is a mystery to me. Under such a regime, how would it be mathematically possible to hedge anything (unless of course one defines "hedger" broadly enough to keep essentially the current regime)? If, say, Southwest Airlines wanted to hedge next April's fuel price, who could they possibly go to? I suppose in theoretical principle they could go to a supplier, but there must be strong reasons (liquidity?) why hedgers have historically gone to the futures markets.
Then, there's that 30% number. Where did that come from? It's only a blog comment, so SWAG is fair enough. But SWAG based on approximately what? And if, a big if, prices got dropped 30% (for long enough to cover a runup to a US election, which usually seems to be the point; but no one would notice the transience of the effect until after the fact), would that not tell everyone, OK, problem solved, go back to bed and enjoy some sleep?
There seems to be an awful lot of wanting to Have It Both Ways (and then some) on all sides of this speculator issue. But is there anything much to see except, perhaps, juvenile campus-Marxist outrage that somewhere, someone might be making some money. [Someone other than a ballplayer, that is, since by some magic rich ballplayers don't seem the least bit disturbing to even the angriest levelers. Indeed, even The Progressive now has a columnist who regularly apologizes eloquently for astronomical ballplayer salaries.]
I rarely agree with PaulS (and let's just ignore that last paragraph rant--interesting to hear, though, that he is a regular reader of The Progressive!!), but if things work as they are supposed to, aren't 'speculators' there to make the market more responsive to longer term realities.
If someone understands that there will be less oil available in the future, and makes money by betting on that, what is wrong with that? And if that raises the price of oil, isn't that appropriate? Isn't oil--a commodity that is gone for ever once it is burned and that packs the labor of 200-300 days of manual work into a gallon--vastly UNDER-priced?
I don't see any indication that low oil prices have or will spur countries to start undertaking the necessary measures to adjust to an oil depleted world. They should be raising prices through taxes and using those taxes to both off set the impacts on the poorest and prepping society for a post oil world.
But the US at least is apparently completely incapable of doing such simple and obvious things.
I have no great love for speculators, but really, to the extent that they are having any effect on raising oil prices, isn't this exactly how the market should work? Isn't this exactly the signal the market should be sending to consumers--this is a commodity that is going to be in increasingly scarce supply from now on?
The Filter Bubble... Going by this mainstream review, author Pariser surely has at least part of a point - if everyone reads or views only what they violently agree with, to the complete exclusion of all else, we're in no little trouble. Not that anyone need go nuts immersing themselves in disagreement, just not to keep it completely airtight. To see the bubble effect in its full glory, simply skim the comments thread on any significant story on any mainstream-media or widely-read blog site, and weep.
The problem with blaming speculators is that so far no one has ever explained how this is possible. Every long contract bought must be, at some point, sold. If buying a contract causes an uptick in the price of oil then selling that contract will cause a corresponding down-tick in the market.
Even is buying oil in bulk, when it is cheap, causes prices to go up, that oil must eventually be dumped back on the market. That will push prices down. The only thing that can be said of this type of "speculator" that is the kind that deals with the physical product, is that they remove volatility from the market. That is they push prices up when they are low and push prices down when they are high.
So no, speculators are not responsible for 30 percent of the price of oil. Speculators are not responsible for 1 percent of the price of oil. Supply and demand is responsible for the price of oil. Of course as I stated elsewhere, news also affects the price of oil. If a revolution breaks out in a major oil producing nation that news will push up the price of oil, both the futures and the spot price. If if is perceived that oil, or wheat, or pork bellies, will be far scarcer next week than right now, this will affect the price, both spot and futures right now. That is just common sense.
But for years I have been begging these folks who say speculators are pushing up the price of oil to explain how this is possible? Of course they say buying contracts push the futures price up. But what happens when they sell that contract? That pushes the price right back down again. Anyway to date not one of them has come forward to explain how this is possible. How buying contracts can push the price up without the selling of that same contract not pushing them right back down again. But I am waiting... and waiting... and waiting...
And of course no one has even come close to explaining why in this land of speculators, Wall Street and the USA, oil is the cheapest in the world. Not one of these folks who blame speculators has even tried to explain that one. Are US speculators keeping prices down? Now that is a poser ain't it!
Ron P.
I am equally bewildered. Are they saying that speculators are buying contracts and never selling them?
dohboi - I'm pretty sure you know this but for others: the futures contracts represent options to buy/sell a certain amount of oil on a certain date at a certain price. And the amount of oil that the volume of these options represents is 99X more than the existing daily global production. IOW not one bbl out of 100 represents oil that actually exists. That alone should be an indication of how futures speculators can't control the market
I've made this simplistic point before. Only two parties control the price of a commodity: the folks that buy it and the folks that sell it. Oil is selling at its current price because the folks who are buying it are willing to pay that price. And they aren't buying it on speculation...they are buying it to refine and sell the products at a profit. The vast majority of oil flowing through the system is not being hoarded...its working inventory needed to keep the process in motion. And the sellers don't accept a price one cent lower than they are willing to sell for...while they desire to sell oil and generate income they are not obligated to do so. If the KSA wanted to sell every bbl of oil they can produce for $70/bbl they can chose o do so at any time. And they can restrict those purchases to the refiners. Thus no reseller could up the price. Again, it's their oil...they can make the rules any way they want. So, if they do have that excess capacity they claim and really do want oil prices lower in order to slow down alt developments AS THEY CLAIM, then they can post the reduced price tomorrow morning and make it happen.
And if they don’t post the lower price tomorrow and flood the market with cheaper oil (exactly like they chose to do in 1986) then it’s because they really don’t want cheaper oil prices. Or they don’t have the excess production capacity they claim. All IMHO, of course
The main issue with futures, or any other kind of derivative is, that it by definition is two sided. You can't buy a crude contract unless somebody else sells something they don't have.
Futures trading is fundamentally different from say stock trading where there are a certain number of shares which exist and that's it. In futures trading the contracts are created through transactions. The initial quantity outstanding is zero. After somebody does a trade and buys a contract somebody else is short a contract, netting to zero.
When there are a million contracts long there are also a million contracts short.
No matter how you slice in futures trading the sum of all longs and all shorts is zero.
Zero....zero....zero....zero.
Rgds
WeekendPeak
As long as the speculators (a) don't constitute a large % of the market and (b) derivatives are not mainly bought with borrowed money (margin), then you have a point. Unfortunately, as the Mortgage Bubble and the prior stock market bubble proved so painfully, this is not always the case. Speculation can --and often does-- have a very significant impact on the price of many commodities, and of course markets are not always perfectly efficient at pricing risk That said, I agree that speculators have become convenient scapegoats for P.O. deniers.
Harm, you are comparing the Mortgage bubble with the oil futures market? They are not even remotely related. The Mortgage bubble was caused by people buying the actual product, houses, with liars loans then flipping them for a profit... hopefully. However because the price of homes, for over a decade, went up over twice as fast as inflation, that could not be sustained. When home prices started to drop the liars could no longer pay on their loans so the market collapsed.
And what stock market bubble? We are within 200 S&P points from the peak back in 2007 so if that was a bubble then we are almost back to that same bubble point. But that was by no way a bubble. Stocks were actually fairly priced in 2007 but then the economy collapsed. Earnings plummeted. The price of equities plummeted right along with earnings as they should. No bubble there, just fundamentals.
If you have an argument that futures speculators are causing the price of oil to rise, then make that argument. But don't try to make it by using examples that are not even remotely related to the futures market.
Futures speculators never actually purchase the actual product. They simply bet on which way the spot price will move. And just as many are betting that the price will fall as are betting that it will rise. Their bets can not, and does not, affect the actual supply and demand of the physical product. So what is your argument?
Ron P.
Thanks for jumping on that one.
Rgds
WP
ron what is the right price for oil? the $100 its at now? or the $30 it was at 2 years ago? Speculators make it possible to see those 2 extremes in very short order (and I expect now that govt stimulus is over/declining we will see sub $70 by year end). Of course on any given day the price is due to supply and demand, but the amplitude of prices over several years is due to huge leveraged positions from non-producers/users- not just on oil but on cotton, coffee, corn etc. Oil just happens to impact everything so people pay attention to it. (And oil is not the cheapest in the world here - what about Venezuela)
No that is not the right price for oil. It is the right price around Cushing Oklahoma and surrounding area but not for the rest of the world. The right price for Tapis is just over $121 a barrel. The right price for Brent is about $115 a barrel. The right price for Louisiana sweet, down here on the Gulf Coast is $116 a barrel, Alaska North Slope is about $112.5 and Bonny Light is $118.3 a barrel.
Well no it never got quite that low, but close. The economy collapsed and the world oil price collapsed. But the price in the USA dropped further than anywhere else in the world. Speculators just went along for the ride and most of them lost a bundle of money. But in the land of the speculators oil was cheaper... even then.
Now come on Nate, you know better than that. The stimulus in the US has nothing to do with the world price of oil. If the world economy collapses it could go even lower. (The last recession was worldwide you know, or very nearly so.) But if the economy stays strong, or get stronger, the price will go even higher. It's all about supply and demand Nate, but world supply and demand, not US supply and demand.
Venezuela's light oil is much higher than WTI. Their very heavy oil is priced accordingly. I really don't know what they are getting for that. Gasoline in Venezuela is much cheaper because it is subsidized by the government. That has absolutely nothing to do with the price Venezuela charges for exports however.
And as I said above, I have been waiting for someone to explain how speculators raise the price of oil when they buy contracts but never cause the price to drop when they sell that contract. And I am still waiting... and waiting... and waiting...
Wourld Crude Oil Spot Prices
Ron P.
As noted down the thread, average annual US spot crude oil prices--which I think give us the best indication of fundamental supply & demand factors--have not been down to $30 since 2002.
Annual post-2005 oil prices have so far all exceeded the $57 level that we saw in 2005, and it appears that five of the six years since 2005, through 2011, will have shown year over year increases in oil prices.
Speculation can drive up the price of oil by driving up demand in two ways. Speculation is a vehicle for potentially limitless amounts of paper money to flood the demand side of the equation. But it's like a ponzi scheme. New money must keep flowing into the oil market to keep the price going up. I think we may have had something like that when oil went to $144. As long as there is an ever increasing flow of cheap money into a commodity, the price will rise, put simply. It was no different with the housing bubble, even if that had some more complications.
The only other way for speculators to drive up the price of oil is to take delivery and hoard oil. We saw this after oil crashed to $35 a barrel. Tankers everywhere put a bottom on the price of oil. Even in a global recession oil never returned to it's 1990s level.
So we get higher prices through speculation only thru a) ponzi scheme (i.e. constantly increasing inflows of cash) or b) physical hoarding.
It is quite obvious that you haven't a clue as to what you are talking about. Whether speculators trade one contract or one million contracts they do not demand even one single barrel of oil. A futures contract is a bet on what the price of oil will be sometime in the future. Only a very tiny fraction of one percent of contracts ever result in delivery. And the vast majority of oil traded on the world markets is not traded on any commodities exchange. Speculation in the futures market does not create any demand for oil whatsoever.
There are hedgers, or even very rich speculators who, when oil was in strong containgo, actually buy the physical product and sell futures contracts equal to the amount of their purchase. But it is always a wash. That is they buy the product and sell the futures, then after the time of their contracts expire they sell the product and buy back their futures. They lock in the containgo difference. But it is always a wash. Any amount they moved prices up when they bought the oil, then they move prices down when they sell the oil. And when they buy the oil they sell the futures and vice versa. There is no way that this scheme could possibly push up the price of oil. But such speculators only hold a very tiny fraction of the oil traded over the period of their contracts. Not enough to make any difference even if it was not a wash both ways... But it is.
Anyway no one ever does this unless oil is in strong containgo. Only then can hedgers lock in a profit by actually buying the physical product and selling a futures contract on that oil. But there is hardly any containgo on WTI right now. Not nearly enough to pay the storage fees let alone enough to make up the difference in what they could get investing that money in government bonds. So no one is trying that scheme right now.
Again, it is impossible for speculation to do anything but cause very short term swings in the futures market, swings that last from a few minutes to a day or so at most.
Ron P.
I disagree. A flood of money buying in the futures market will push up the futures price. The spot price may then respond by following the futures market. As long as people feel there is someone else that will pay a higher price, bubbles can form. People can roll over contracts into future months. The market makers will move spot price to a location which causes as many people as possible to have their futures contracts expire worthless.
There is clearly a limit to how far oil can advance past the hypothetical 'true' market price but commodity bubbles can form even with commodities like oil that are eventually delivered. There are far more paper barrels traded than real barrels that exist. There is no 1 to 1 correlation between paper barrels and real barrels.
I think you are right, in principle. But, for how long can such a bubble exist?
You talk about the (long) speculators possibility to roll the contracts forward. Yes they can, however, at that time there must be a buyer. Thus, all speculators (short or long) must leave the game before expiration. Those left would be those who actually will buy (take delivery) or sell (deliver) physical oil. When the time limit for speculators, whether long or short, is up the price will be set by those who actually want to trade in the physical product.
As time closes in on the point where speculators have to leave the game that means the price will close in on where actual market participants decides. If this leads to a decline in the front contract this will affect also the forward curve. At least I would beleive it must work this way.
If so it is doubtful that speculators can move the price for any longer period.
IMHO
Not unless it is your desire to take delivery or make delivery if you are on the short side. No one can ever be forced to take or make delivery of the physical product. Even if you are holding an open contract at expiration, you can still settle for cash. It happens all the time. Some people just forget to close their contracts, or they get sick or die or something like that. And they put up only about 5 to 8 percent margin. Most speculators do not have the money to take physical delivery. One contract today would take over $100,000 dollars to take delivery. And all the storage and other things would have to be taken care of.
And even if you are a hedger and desire to take delivery, you may still be forced to settle in cash. That is because there must be a corresponding short who wishes to make delivery. At expiration all shorts that wish to make delivery are matched with all longs that wish to take delivery. There will be some on one side or the other that cannot be matched. Those people must settle in cash.
Ron P.
Ron,
Thanx for the information. I thought, that if you really wanted to, e.g. sell oil, you could always sit out and when the time comes execute such a right according to the futures contract you entered into.
Of course I understand that there are (must be) mechanisms to avoid having any party to actually deliver or take physical oil if not desired, even if you, as e.g. a buyer, according to the contract could be called upon to take delivery. However, I would have thought that if you put yourself in this situation/predicament there would be some cost or "penalty" involved.
However, when I read your comment it appears that you could actually just as well choose to settle the contract in cash instead of closing it.
That I think, would weaken the argument against speculators having the power to drive the futures price. The more decoupled the futures market becomes from the “real” physical market the bigger the risk must reasonably get. The fact that there always must be just as many buys as sells does not in any way preclude bubble forming. If speculators dominate the trade (even at expiration) it is just a matter of what they (the speculators) agree on as the correct price at termination.
You wrote before: “Every long contract bought must be, at some point, sold.” (Or, as I thought, be fulfilled by the actual transfer of oil.) Now, you actually tell me it isn’t so. One, the (long) speculator, could actually sit the time out and settle in cash. That is they do not have to sell the contract.
As to news: It is not news themselves that cause price swings, but the perception of the consequences of the news. Now speculators may have completely incorrect perceptions of what the future has in store as regard the demand supply situation in the same way as they may misinterpret single items of news. If they dominate the trade (even at expiration) I would think that should constitute a basis for possible bubble formation. If only “real” buyers and sellers remain at expiration the situation would be different.
You write: “The core overlooked issue in this instance is that speculators are not purchasing any product, they are only placing a bet. One guy is betting prices will go up and one other guy is betting prices will go down. The question is which one has the most effect on the market? Which of the push-pull is having the most effect? The truth is neither is affecting the price of the actual product because neither is buying or selling any product whatsoever. “
If those actually buying and selling pay the same price as those who settle in cash it seems they must affected by the cash-price, i.e. the speculators. That is if the settlement price is dominated by cash transactions.
No, no penalty is involved, you only pay commissions and suffer any loss or benefit from any gain in the contract. Many brokers insist that their clients must take a cash settlement. There is just too much involved in the delivery process. They just don't want that headache.
Not exactly. The contract is indeed closed or sold if you will, at the close on expiration day. Those wishing to take or make delivery must notify the clearing house of their intentions. Then these people must make their own arrangements to take or make delivery. Storage space must be obtained and delivery cost, if any, paid. It is a real mess and that is why very few people do it.
You must understand that hedgers do not necessarily need to take or make delivery. In fact the vast majority of hedgers never take or make delivery via the futures market. They settle in cash. If a hedger is long and the price goes up, they use the profits from their trade to offset the higher price. Or if the price goes down then the cheaper price of oil will offset their losses. All they are trying to do is guarantee a price that they can make a profit.
I don't fully understand what you are trying to say. The settlement price is the average price of all contracts sold at the close. If you will notice the settled price is often well off the price of the last trade. The clearing house simply matches all longs and shorts not closed, or marked to sell "at the close" and that average price is the closing price. And yes the settling price is dominated by cash settled transactions. It must be since only a tiny fraction of one percent of all futures contracts actually result in delivery of the physical product.
Ron P.
I am well aware of the principle idea behind hedging as you describe it.
But to my understanding there is a technical difference between selling (a long contract) before expiry (and book the profit or loss) or allowing it to expire and settle in cash. And I believe this difference will have an effect on how the exchange works, how the contracts are traded.
If the second option is standard procedure then I can’t understand how you can say that: “Every long contract bought must be, at some point, sold.” (I took it you meant if the holder was a speculator. ) If you’re a speculator and settle in cash, then obviously you don’t have to sell. Selling and settling is not the same thing. Or do you mean they are?
Yes, but this price might very well be different if all those who doesn’t want to touch the physical stuff have to close their positions (buy or sell) before a certain date or if they can just as well await expiry and settle in cash. Obviously there will be an immense difference in trading patterns.
And, yes, my broker does not allow delivery either. I think, that means he/she/it will close my contracts before that could happen if I would forget.
No, they are the same thing, long or short. Of course one tries to settle, (sell or buy), before expiration because the market at the close can get very hectic.
Again, there is no such thing as automatic delivery. It can never happen just because you or even your broker forgot to close. But if you read the exchange rules they do not make that clear. But here are the settlement rules for TAS. (Trade At Settlement). That means all who do not settle physical.
Light Sweet Crude Oil (WTI) Futures and Options
Now is that clear as mud? Anyway that is what they are saying will happen if you just let your contract expire. That is the price you get. I have read this thing over several times and it still don't make any sense. I never ran into any such problems when I was a broker back in 86. But then I was a broker only for six months.
On the ICE the rules for both WTI and Brent are much easier to understand. That is because the ICE is cash only settlement.
ICE WTI Futures
ICE Brent Futures
Ron P.
Ron,
Thanks for the information. Obviously my understanding of how these markets work was far from complete. And most certainly still is.
On the other hand my strong belief that speculators do not to any significant degree move the markets has been rocked by this new view of how the markets work ;-).
For every dollar buying paper barrels in the futures market there is a dollar selling a contract in the futures market. Any flood of money on the long side must be matched with a corresponding flood of money on the short side. Speculators never just flood the market for no reason. If there is a rush to go long and a rush to buy back shorts then there is always a reason. That reason is there is some news. There is always news that pushes the price up or down. Nothing ever happens without a reason.
Any news that causes a the futures prices to spike up will also cause the spot price to spike at the same time. But even if there are wild intraday swings in the futures market that does not mean that there are wild intraday swings in the spot market.
I don't think you understand this process. You cannot just rollover any futures contract without entering the market with a sell order for your current contract and another buy order for the next month's contract. If you are long the current month and you wish to roll forward then you must sell your current long position. That sell, if there are enough of them, will cause the same downward pressure on the expiring contract price as buying it caused upward pressure. Also you must settle your expiring contract, either take your profits or pay for your losses. And the new contract you are buying into will require bring your margin up to the opening margin rate, not the maintenance margin rate.
If a commodity bubble exist it exist for a reason. If there is there is a panic caused by some news, true or false it will affect the spot market. The futures market does not cause the bubble, the news caused bubble and it had to affect the spot market also. The futures market does not cause bubbles, news causes bubbles. And if that news proves true then the spot price will remain high... or low, whichever way the news pushed the price.
Ron P.
Ron,
You might want to read Matt Taibbi's "Griftopia". It has a really interesting section on commodities... and funds trading them. Speculawyer is right... once you have significantly more paper barrels in markets than real oil, traders with significant computer power and significant capital can manipulate them.
Do you remember when Goldman-Sachs decided to change the ratio of components in it's big commodity index fund? They reduced the weighting of gasoline. Do you think they front-ran that decision?
The fact is that since the index funds trade billions, the folks who decide the (index) weights make the rules. I imagine they front-run every tweak they make.
Will
Speculawyer is dead wrong. "Once you have significantly more paper barrels in the market?" Once! You always have significantly more paper barrels in the market than real oil. Today, open interest for NYMEX Light Crude Oil, all contracts, is just under 1.5 million contracts. That is contracts for 1.5 billion barrels of oil. By the end of the day, over one third of them will have changed hands. That means contracts for over 500 million barrels of will have changed hands just today. I have seen days where over one million contracts traded.
Now how much money would a trader need to "manipulate" this market? Right now the margin requirement for one NYMEX contract is $6,750. That means if you traded just 100 of those over half a million contracts that will be traded today, you would need $675,000. Over two thirds of a million dollars. And trading 100 contracts would not make a blip on the NYMEX. You would need to trade several thousand contracts to cause any effect in the market. About 10,000 contracts might make a blip if you placed the order all at once. That would require over 67 million dollars in margin money.
Then just as soon as you placed your order, and forced the price up a few cents, meaning that most of your orders would have been executed at a higher price, then the price would likely collapse again costing you a bundle.
NO, no one has that kind of money to and especially no one has that kind of money to lose. And they would stand at least a 50 percent chance of losing money.
Goldman Sachs decision to change the weighting of their portfolio would have affected the market but a few seconds when they placed the orders. Did anyone front run and make a few bets before that. Well even if they did they would have not made much money. Also it would be very easy for the SEC to figure out if someone was front running. And they would go to jail! I really doubt seriously that anyone at Goldman Sachs, or any other fund management group, is doing that.
Also commodity funds almost always play both sides of the market. They are short just as often as they are long. And these funds are often public funds. That is anyone can buy into them or sell out their share of them. Or they are made up of groups of investors. Hell, I used to sell shares in these funds way back in 86. They are based on computer algorithms that when back tested always made money. But when they would run them in real time they lost money just as often as they made money.
The idea that funds always make money is the funniest thing I have ever heard. They don't and they don't manipulate the market.
Ron P.
Ron,
What's the status of weather related hedging financial instruments? I wonder if people would argue that betting on weather changes the outcome?
Ron,
You don't get it. Read Taibbi. Don't assume you know the score. What you know was probably relevant 20 years ago.
The rules have changed. Index funds are not about individual contracts. You do not help this forum by insisting that speculation has little bearing on price. If we have 20 times more money in oil futures today than 6 years ago... it matters. It matters that most of the oil is bought by entities that will never take physical delivery. It matters that hedgers have been replaced by indexed funds that buy and sell futures.
The "invisible hand" notion clearing of markets is no longer true. It does not matter how long it took the market to adjust to Goldman's re-weighting of a major index fund. Whether it took 20 seconds, 20 minutes, or 2 days... the fact is that hundreds of millions of dollars shifted. And it had nothing to do with supply and demand. It had to do with whether Goldman wanted to play with gasoline.
Taibbi will explain why the SEC is doing NOTHING. And why no one is in jail. Read him.
Will, Index funds, the really big ones, are all about the S&P 500 and have nothing to do with oil. There are commodity index funds and oil ETFs. These funds buy but a tiny amount of futures traded.
The invisible hand has nothing to do with futures or the clearing of futures. You are really confused.
Again, oil is not bought by speculators. That is the one thing you guys simply cannot get through your head. And you have not explained how two people placing a bet on the future price of oil can actually affect the physical product. You still seem to think they are buying and selling oil. That is totally absurd.
I went to Amazon.com and used their "search inside this book" function. Crude oil is mentioned three times and never in the context of the futures market.
Will, it is quite obvious that you haven't a clue as to what you are talking about. You seem to think that "index funds" actually buy and sell oil. No, even commodity funds do not buy or sell oil and not even ETFs.
You do not help this forum by insisting that betting on the future price of oil can actually control the price of oil. But if you can explain exactly how I will listen. I am waiting... and waiting... and waiting...
Ron P.
Ron,
Once again you present us with a skewed and conditionally reduced perspective. So you searched for "crude oil".
Your search criteria are irrelevant to Taibbi's work. He doesn't think in terms of "crude oil". He is writing about the manipulation of finished petroleum products (and derivatives, etc). And he's discussing the financial and regulatory changes in those markets.
You do not have to wait and wait and wait. READ TAIBBI's book. Learn something new. When oil spiked to $147 in 2008, there were NO PHYSICAL SHORTAGES. Inventories were normal. What I read here in the Oil Drum is centered on production rates. Physical inventories are usually ignored, as is trading volume, Forex, etc...
You are dead wrong in your assertions about how oil is trading. The rules changed significantly when Goldman thru it's commodity subsidiary: J. Aron and Co, petitioned SEC for hedging status. The other big banks followed immediately. The market was redefined. It is no longer a relationship between oil production and consumption. If you continue with that assertion, you are wrong. When $$$ do X, Y, or Z traders move into futures commodities, they could not do that 15 years ago.
Do not assume that because I disagree with you that I am
uneducated, ignorant, or just plain stupid. It might be that you need to get over the "invisible hand" nonsense that economists love and get down to understanding oligipoly issues. That is the situation. If you think Goldman Sachs is a price taker, as opposed to price setter, you are foolish.
All of the above does not mean I disagree with you on peak issues. I think 2005-2006 was it for conventional crude. I think Saudi is past peak, etc...
There is never a physical shortage of oil if oil is priced according to supply and demand. When oil hit $147 the economy was booming. Then the crash in the economy, then the crash in oil prices.
Right now Brent is trading at $115.63 and most of the rest of the world is trading somewhere around that figure. That price assures that there is no physical shortage because enough demand, at that price, is killed until the supply is adequate. The same principle applied when oil was $147.
Why do some people think that a physical shortage must go with high prices. Give me a break!
I really can't believe anyone would make such a statement as that. Demand will always equal production as long as price is the arbitrator. The price is what prevents gluts and shortages. If there is a glut the price falls until demand (consumption) equals production. And if there were a shortage then the price will rise until demand equals production. There is never a shortage or glut as long as price is allowed to be the arbitrator. Shortages and gluts exist only in the presence of price fixing or rationing. If you have neither then you will have neither a shortage or glut.
If there was no relation between production and consumption then there would be a huge glut of oil at $115 where oil is right now. Production would outstrip demand. But there is enough demand that all the $115 oil is being consumed. Of course there are stocks, there always have been stocks and there always will be stocks. Stocks are what prevents a crisis. They keep a smooth supply of oil flowing.
I am not an advocate of any "invisible hand". The market is never 100 percent efficient. There must be regulations. I am a Democrat, not a "no regulation Republican". There is no invisible hand that tells OPEC how much oil to produce. No invisible hand will replace crude oil on the downslope of peak oil. There will eventually be the mother of all market crashes and no invisible hand will save us. And it is not any invisible hand that sets the price of oil. It is supply and demand, nothing more. And as supply declines the price will rise until a recession knocks it down again like it did the last time. We will have steps of recovery and recessions all the way down.
No invisible hand will be there to save us.
Ron P.
I suppose that the Goldman conspiracy goes back several decades. Note the charts showing the annual oil price versus Texas production peak and annual oil price versus North Sea peak down the thread.
As noted elsewhere, why must people construct elaborate conspiracy theories, when we have a simple explanation of oil prices having to generally* increase to bring overall demand in line with a slowly falling supply of global net oil exports? And the key item to focus on is the 2005 inflection point. At the 2002 to 2005 rate of increase in global net oil exports, we would have been at about 59 mbpd in 2010, versus a probable 2010 global net export figure of around 44 mbpd.
But to cite a common example of irrational belief, a lot of people believe that the world is a few thousand years old, so I guess people will believe what they want to believe.
*Annual oil prices have so far all exceeded the $57 level that we saw in 2005, with four of the past five years showing year over year increases in annual oil prices (US spot).
West...
I am not suggesting a conspiracy. I am suggesting that like wheat, corn, copper, and other commodities, oil futures react to things other than production.
If the SEC went back to the old rules about energy commodity hedgers and speculators, and the big banks were compelled to exit the energy markets, we would see trading volume shift downward dramatically. It has nothing to do with crude production. When J Aron got the ball rolling, oil was what? $10/barrel? Did New York banks own 40% (exact figure escapes me) of Cushing storage?
I have little doubt that we are past conventional peak. I have little doubt that Chinese and Indian demand is stressing global supplies. But... I also have little doubt that Goldman, Morgan-Stanley, Citi, etc. built oil trading desks to lose money exactly half of the time. They have injected billions of $$$ into these markets and they are not doing it to break-even.
These are the banks whose earnings were largely derived from financing the real-estate market. Well... that market sucks today. It's in the toilet. So, how are these same banks reporting record earnings? What's the new game?
Enron never died. It simply metatastized.
Are you saying that New York banks own 40 percent of the oil stored at Cushing? Are you serious? You cannot make such a claim without backing it up with some reference. But you seem to be short with references. Oil companies, producers and refiners, own the oil at Cushing. And they move the oil as soon as they can because it cost money to rent storage space.
And who is J Aron. Well that was a commodities firm that dealt in gold and coffee futures that was taken over by Goldman Sachs back in 1981. But that has nothing to do with whether or not speculators control the price of oil. You are just name dropping.
Will, you make a lot of claims that you simply cannot back up. You claim that Goldman and others make massive amounts of money from trading oil futures, or front running their recommendations to clients, but for this is we just have your word, your conspiracy theory. You have not one ounce of proof.
And this is why you say that speculators are responsible for the high price of oil, or that Goldman Sachs is responsible. This is sheer nonsense. If WTI were the highest oil in the world you might have an argument, or at least some circumstantial evidence to support such an argument. But WTI Light Sweet Crude at the Cushing Hub is the cheapest oil in the world? The very cheapest oil in the world! How does this square with your claim that traders manipulating the WTI NYMEX price is responsible for the high price of oil?
Ron P.
Ron,
This isn't dissertation defense. I'm not gonna provide ten footnotes per assertion. That's academia. And your crying wolf: "you make a lot of claims"... "I'm waiting"... "it's conspiracy" isn't going to intimidate me.
I suggested twice... that you read Taibbi's book: "Griftopia". In it he explains better than anyone I have read how the hedge funds, the sovereign wealth funds, and the money center banks are plundering the markets.
Start around page 144 of Taibbi's book, if you will. Or perhaps you can Google up Mike Master's congressional testimony. Or Fadel Gheits commentaries. It's out there Ron. And it's not what you're telling the this forum. Finance guys under oath are telling Congress a different story.
J. Aron is not name dropping. It is central to the story. It is where the SEC and our government decided to rewrite the book on commodities investing. It is the beginning of huge capital flows into what had been specialty markets for industrial brokers. But you don't know this, because you searched Taibbi's book for "crude oil".
As for Cushing. Get real. If you were going to run a market wouldn't you choose one that was small, that had restricted supply and delivery channels, and, most important: was cheaper than all others? Cushing has great margins... oh well.
I'm tired, it's late. You're good with your Saudi analysis. You are great with your carrying capacity thinking. You really should read Taibbi. He's bright, and he's painting an interesting picture. It changed my view. I think he is right.
Will, "read this book" is not an argument. If you do not realize that then you are really in bad shape.
Small? Cushing is the largest crude futures exchange in the world! There is no restrict supply at Cushing and until just a few years a go there was no restricted delivery. That is there was no bottleneck because all the oil traded could be easily delivered. And the biggest, and silliest, claim of all is that it was the cheapest. No, until about three years ago WTI traded at a premium to Brent, a two to three dollar premium. And all this was while your silly book was being written.
But all that is beside the point. The point is that it is NOW the cheapest oil in the world. It was not the cheapest oil but one of the highest back when oil was so high and everyone claimed that WTI was swinging the price up of all the rest of the oil in the world. But that was all proven wrong just three years ago when WTI began to slide below Brent and all the other benchmarks and spot markets. Now people can no longer make that very stupid claim.
Look, I saw "Too Big To Fail" and every crooked thing they say about Goldman Sachs is likely true. They are crooked as a snake. That does not mean they control the price of world oil via the NYMEX. Regardless of how crooked they are they still cannot do the impossible.
I read several reviews of Graftopia and non of them said Tabbit made any such claims. I doubt that he did because he probably has more sense than that. No one, except you Will, to my knowledge, has ever made such a claim. I think you just made that up, claiming it was in his book. That is called "The fallacy of appeal to authority". Except worse, because your authority never even made that claim.
Ron P.
OK Ron... you win. Don't read Taibbi's book. Read reviews instead. Call it a silly book. Call it the fallacy of appeal to authority. It's easier to do that when you won't read it.
I never said Goldman controlled the global price of oil via NYMEX. It's OK though, I know you either thought I said that, or thought I believed it. I do not. But like a lot of your arguing, you project arbitrarily and not necessarily with intention of understanding what has been said.
I think the central issue is that you, West Texas, and a few others have decided that the price of oil commodities can only reflect the production/demand basis. I used to believe that. I did. Because geology will trump all, just not necessarily in the time frame we'd like.
In a parallel universe, there were people who believed that the real-estate market was priced on fundamentals. We don't read about them so much these days, but they still deny deflation in the housing and commercial real-estate market. These people narrowed the transaction market to buyers matched with sellers. Much like you do for oil. They ignored the securitization of mortgages. They ignored the selling of credit default swaps against the mortgage securities. They ignored the consequences of using CDS's to avoid capital reserves. They kept their view simple by avoiding all of the evidence that mortgages as contracts had fundamentally changed: not between buyers and sellers, but between institutions and central banks.
I am saying that similar things are happening in the commodities markets for energy. When Fund A is leveraged long on gasoline and buying swaps to deflect that liability, a lot more is at play.
I do hope you decide to read Griftopia. It's a remarkable book. Not perfect, but prescient.
What you and I are disagreeing on is not geological, it is market mechanics.
Will, like several others you keep trying to bring some other type of market into this discussion. As if the real estate market has anything to do with the price of oil. It does not. However everything, including real estate, always comes back to the fundamentals. For two hundred years home prices kept pace with the rate of inflation, no more no less. Then about ten to twelve years ago home prices started to rise at about twice the rate of inflation. That could not last and finally home prices fell like a rock, back to where the rate of inflation said they should be. They finally came back to reflect the fundamentals. Once they settle out you can expect home prices to rise, or fall if that be the case, at about the same rate of inflation.
The oil market however is not even remotely related to the real estate market. Oil is a commodity used primarily as a transportation fuel by everyone in the world. What leverage Fund A has in New York has nothing to do with the price of jet fuel in Singapore.
The big mistake you guys make, and by you guys I mean all those people who believe speculators are responsible for the high price of oil, but your mistake is believing that Speculators or trading houses like Goldman Sachs can really control the price of jet fuel in Singapore, or diesel in Belgrade, or even crude oil at the port of Ras Tanura in Saudi Arabia. If you truly knew how silly that idea really is I think you would, very red faced and embarrassingly, withdraw that suggestion.
Ron P.
Ron,
I've bookmarked this thread.
When it becomes obvious that the difference between x volume (1990) and 25x volume (2011) has affected oil prices, we might have some insight on the kerosene on Singapore and diesel in Belgrade.
It's hard for me to divorce volume from price.
I think the most significant issue you do not factor is leverage. Leverage allows price to rise faster.
Me too! The price definitely affects volume. That has been my argument all along. The higher the price the less the volume. That is the higher the price the less the volume of oil that is sold.
In the USA in 2005 the average price of oil was $50 a barrel. That year the US imported 12,549 barrels of crude oil per day (net) and produced 5,178 barrels of oil per day for a total of 17,727 barrels of crude consumed. So far in 2011 the average price of oil has been in the high $90s, almost double, and so far this year we have imported 8,865 barrels of crude oil per day and we produced 5,512 bp/d for a total of 14,337 barrels per day.
Meaning that we have consumed 3,350 barrels less (volume) per day in 2011 than we did in 2005. The reason ,quite obviously, was the price. Because the price was higher the volume purchased by the people was much less.
You simply cannot divorce volume from price! That is high school economics. Errr and they had no leverage except for those who bought gasoline with a credit card. But I don't think that had a lot to do with the rise in price.
Table 3.1 Petroleum Overview
Ron P.
Well, perhaps we are coming to some common ground...
Taibbi says on page 144:
From July 2003 to July 2008, the amount of money invested in commodity indices rose from $13,000,000,000 to $317,000,000,000––a factor of 25 in the space of less than five years. By an amazing coincidence, the prices of all 25 commodities listed on the S&P GSCI and the Dow–AIG indices rose sharply during that time. Not some of them, not all of them on the aggregate, but all of them individually and in total as well. The average price increase was 200%. None of these commodities saw a price decrease. What an extraordinarily lucky time for investors!
In around Wall Street, there was no doubt what was going on. Everyone knew that the reason the price of commodities was rising had to do with all the new investor inflows into the market. Citigroup in April 2008 called it a “Tidal Wave of Fund Flow". Greenwich Associates a month later: “the entry of new financial or speculative investors into global commodities markets is fueling a dramatic run-up in prices.”
And the top oil analyst at Goldman Sachs quietly conceded, in May 2008, that “without question the increased funds flow into commodities has boosted prices.”
One thing we know for sure is that price increases had nothing to do with supply or demand. In fact, oil supply was at an all-time high and demand was actually falling. In April 2008 the secretary-general of OPEC, a Libyan named Abdalla el Badri, said flatly that “oil supply to the market is enough and high oil prices are not due to a shortage of crude.” The US Energy Information Administration (EIA) agreed: its data showed that worldwide oil supply rose from 85.3 million barrels a day to 85.6 million from the first quarter to the second of that year, and the world oil demand dropped from 86.4 million barrels a day to 85.2 million.
Ron... I think we have to divide demand into 2 categories:
Investor Demand and Physical Demand.
Investor demand increases with an upward price trend. Physical demand decreases with an upward price trend.
Will, you haven't learned one thing from this whole discussion. You surely must have flunked 10th grade economics. Price increases decreases demand, it cannot possibly be otherwise unless you are talking about insulin or something like that.
Demand from China and India increased, that drove up prices. Higher prices caused a decrease in demand in places where demand was elastic. And all this time net oil exports were declining. By 2009 they were down three million barrels per day from 2005.
Lower supply automatically meant higher prices and decreased demand. Supply and demand is always arbitrated by price. Supply, demand and price are inexorably tied together.
If you cannot understand that simple fact then all further argument is futile.
Ron P.
Geeze Ron, I guess I wasted all that money on an MBA from a top tier school decades ago. ;-)
You have to read a bit more carefully. Of course price increases cause "physical demand" to decrease. And I have not suggested otherwise.
What I am suggesting, read my comment again, is that demand might be broken into 2 classes:
1) physical demand from users (industrial, consumers, etc)
2) investment demand from funds and speculators.
I suggest, read my comment again, that physical demand will decrease when prices rise.
I suggest that investment demand will increase if investors are following what they believe to be a trend.
A buyer for use (case 1) hates rising prices. A buyer seeking appreciation (case 2) desires rising prices.
Taibbi is reporting huge increases in investment demand. This category of demand is increasing as prices increase i.e.: The number of futures contracts is increasing. The physical demand, however, what we use, is decreasing. This is an important distinction. It is also true that China's and India's physical demand for barrels has grown much more slowly than Wall Street's demand on paper. Think carefully about that.
I think you need to read for understanding, rather than read for argumentation.
It is also true that China's and India's physical demand for barrels has grown much more slowly than Wall Street's demand on paper. Think carefully about that.
The fundamental difference is that China and India's demand is real. They are actually taking the oil and burning it. Wall Street's demand is just paper. They are not taking delivery, they are just speculating on the price. The latter doesn't have much effect on the global price, the former certainly does because they are physically taking the oil away from other consuming countries, such as the US, and outbidding them in the process (using US dollars, by the way).
As others have noted, WTI is somewhat exempt from this process because it can't be physically delivered to China, and as a result its price is lower.
Rocky,
I agree that China's demand and India's demand are real.
What Taibbi says on page 144 of his book "Griftopia" is:
From July 2003 to July 2008, the amount of money invested in commodity indices rose from $13,000,000,000 to $317,000,000,000.
In your world... if one company bids on an oil or gas lease, is the price typically higher or lower than if many companies bid?
What might happen to lease prices if Wall Street started bidding on them, in addition to oil and gas producers bidding on them? Would those lease prices go up?
If bidders are motivated by trend-lines... as prices go up, demand for contracts goes up. As I said earlier, a Wall Street buyer seeks appreciation. They will buy more, not less, if they perceive price is rising, whereas an industrial user will seek substitutes.
Here's an interesting snip from the WSJ in 2007, talking about financial firms leasing oil storage in Cushing:
Storing oil became big business. Tank owners and companies that leased storage, including Wall Street giants such as Morgan Stanley, turned sizeable profits simply by sitting on tanks of oil. They would buy oil for immediate delivery and stick it in their storage tanks, then sell contracts for future delivery at a higher price. When delivery dates neared, they closed out existing contracts and sold new ones for future delivery of the same oil. The oil never budged. The maneuver was known as the oil-storage trade.
link is here:
http://online.wsj.com/article/SB119162309507450611.html
There's a good bit of coverage on Wall Street's storage leases and arbitrage, if you poke around.
And just as much money was invested on the short side as was invested on the long side. What is so spectacular about that?
You should have posted the paragraph preceding that one.
I have tried Will, to explain "contango" to you before but you still don't seem to understand it. Contango is when oil for further out contracts, four to six months out, is priced well above the near term contract. Anyone with enough money, can make money by buying oil now and selling contracts for future delivery. It was common knowledge that this was happening and there was a lot of discussion on Drumbeat about this practice. How could you have missed it? This did not drive the price of oil up. In fact it caused the price difference, or contango, to beome less by buying cheap oil and selling expensive oil, thereby closing the gap somewhat.
Did you think this some big exposé? Boy are you fooled.
Ron P.
No Ron... I've been reading here for about 5 years. I get the contango thing. I get shorts, longs.
I didn't think there was some expose in that piece. I don't think there's a conspiracy, yada- yada-
I don't know why you keep ascribing thoughts to me that I have not expressed, but you do. As Vonnegut says: so it goes.
The reason I posted that link upthread was to indicate that Wall Street leases a good deal of Cushing storage. Which I had mentioned about 4 posts back. The holders of record are typically distribution businesses, but Wall Street leases the storage. You knocked it 4 posts ago. So it goes.
I notice you've chosen not to address my question to Rocky.
To wit: if one firm bids on a lease or if multiple firms bid on a lease... which scenario leads to higher lease prices.
I followed this with a hypothetical: what if Wall Street decided to make a market in oil/gas leases? What if instead of the usual players, a whole crowd of rich investors participated in a hedge fund that speculated in oil/gas leases?
Do you think the additional participants change the demand for, and therefore the prices of the leaseholds?
My sense is yes. Leasehold prices would rise.
Now... Rockman, (not Rockymtnguy who is in this subthread), Rockman, keeps saying that his firm's investment hurdle is $75/barrel. Do they do that because they are fundamentally conservative? or that they fear significant demand destruction? OR... is $75 their read on the fundamentals if Wall Street takes a powder, leaves the table, and stops running billions of dollars of cash in and out of oil.
Perhaps Rockman will tell us.
I think you're missing the essential point that all those millions of barrels of oil sitting in storage in Cushing are forcing the price of oil down rather than up. The reason the tanks are full is that there are too many sellers and not enough buyers for it. If there was excess demand they would be nearly empty. As it is, sellers are will to accept a price about $15/bbl lower than Brent prices just to get it off their hands.
They only make money storing it if the price goes up, and in recent weeks the price has been flat to down. In general, refineries like to keep their inventory as low as possible, mainly because it costs money to store oil and they have to pay interest on the money they borrowed to buy it.
No, the real problem is increasing demand from China and other developing countries, and the failure of OPEC and other producers to keep up with that demand. What happens in US oil markets has become more or less irrelevant to world prices.
In your world... if one company bids on an oil or gas lease, is the price typically higher or lower than if many companies bid?
What might happen to lease prices if Wall Street started bidding on them, in addition to oil and gas producers bidding on them? Would those lease prices go up?
Petroleum leases are probably a bad example because leases are not fungible. Leases are different from each other, are not moveable, are not interchangeable, and are not easily traded (if only because the lessors can put all kinds of covenants into them). The price is determined to a certain extent by the number of bidders, but the number of bidders depends on what the geologists think is there, and the price can jump drastically if the landowners catch on to what the companies think is there. If an oil company is taking a lease from another oil company, the price is apt to be higher than if they are taking it from John Q. Dirtfarmer, regardless of the number of bidders. It's all about relative knowledge.
Leasing petroleum properties more resembles a high-stakes poker game in which all the players base their bids on what they think is in each other's hands, and they are all cheating by talking among themselves and trying to sneak peeks at each others cards. It's an industry in which the competition taps your phones and watches your drilling rigs from the bushes with binoculars. If the Wall Street boys got into this game, I think the oil industry insiders would take them to the cleaners. Mind you, the mortgage business got to be that way, too.
To add to Rocky's point that every lease is different it must also be added that Wall Street does not "bid" on oil. They place bets on whether the price will go up or down. And if leases were fungible, which they are not of course, but in this case speculators would place bets on whether the lease price would go up or down. One speculator would bet on up and another would bet on down. But neither would have any interest in taking the lease himself.
It would not affect the lease price one way or the other because the actual bidders on the lease would have no interest in which way the speculators were betting or whom the betters were.
Ron P.
Will, you clearly stated: "One thing we know for sure is that price increases had nothing to do with supply or demand." That is wrong WRONG WRONG, I don't care what you are talking about. The "price" we are talking about is the price of a barrel of oil, is it not? And it has everything to do with supply and demand.
Will of course it it true that the price of oil has nothing to do with the supply and demand of futures contracts. If that is what you meant then you should have stated that. There is simply no limit to the amount futures contracts. The supply is infinite. No one in their right mind would claim that the price of a barrel of oil is tied to the supply and demand of futures contracts.
The demand for investment contracts has absolutely nothing to do with the demand for crude oil! Any fool knows that. Any increase in investment demand, for paper contracts, is totally beside the point. It has nothing to do with the supply, demand or the price of oil.
So what the hell is your argument? I think you need to clarify your argument before you start talking about the demand for investment contracts and assuming, incorrectly, that they have something to do with the demand for crude oil. You simply cannot seem to get it through your head that these are two totally separate things.
Will, we are talking about the price of oil, the supply of oil and the demand for oil and do speculators affect any of these three things. That is the subject of discussion. I say no, or not for more than a day or so anyway. Any long term trend in the price of oil dependent upon the supply and demand of oil. That is the argument. If you had something else in mind then you are arguing with the wrong person.
Ron P.
Speculawyer, thanks for some sanity.
The core overlooked issue is that basically ANY purchase of a product beyond ones use/needs is speculation. These people aren't making money on the trade per se, but on a price differential expected in the future. This makes prices rise artifically (to some extent) and history shows that markets where people go because they expect to have higher prices in the future, get higher prices in the future (until they don't). The 'premium' above marginal cost (~$85-$90) sets the market up for a pendulum that will eventually (always) swing too far in opposite direction (2008-9, 2011-12). Futures markets themselves aren't 'bad', but in the context of a money supply itself untethered from natural resources it adds amplitude and volatility that is costly in both directions. Quite simply, everything above marginal cost is 'speculative' which is where I got the 30% number (we had $120 oil and marginal cost is $90).
Fast forward to QE^N where commodity prices, due to expected inflation and free money are $150 or so. Futures then function as a wealth distribution device further destabilizing the system.... (in effect, while buying time to develop some mitigation plans for global supply chains etc, I would rather $90 oil headwind for society than $120)
As noted up the thread, at the 2002 to 2005 rate of increase in net exports for the 2005 top five (6.3%/year), they would have been (net) exporting 32.6 mbpd in 2010, versus the estimated 2010 net export rate of 21.8 mbpd (and versus 23.8 mbpd in 2005). And total global net exports are showing a similar pattern, at least through 2009.
It seems to me that the simple explanation is that annual US oil prices have so far all exceeded the $57 annual price that we saw in 2005 because a higher oil price was necessary to balance demand against declining global net oil exports.
you are missing the point Jeff. Im not arguing that higher oil prices are due to speculators. I am aware of peak oil, extraction limits, net exports etc. If marginal barrel costs $90 to extract that is the main thing we need to know (versus $10 a decade ago). Widen your boundaries a bit. All Im saying is that speculation, coupled with free money, ZIRP, Quantitative Shenanigans at the end of a paradigm, etc. will send incorrect, costly signals. I.e. without any speculators involved at all we would still have a quadrupling in oil prices last decade. Its just a) the extra 20 or 30% makes a difference and b) when prices crash it will send the wrong signal.
In any case, my premise is that once conventional production peaks in a given country (and there are no political reasons, e.g., Iran & Iraq), there may not be a realistic oil price that will keep conventional production on an upward slope. The Texas and North Sea case histories, with C+C production on the horizontal axes and annual oil prices on the vertical axes:
The core overlooked issue in this instance is that speculators are not purchasing any product, they are only placing a bet. One guy is betting prices will go up and one other guy is betting prices will go down. The question is which one has the most effect on the market? Which of the push-pull is having the most effect? The truth is neither is affecting the price of the actual product because neither is buying or selling any product whatsoever.
I do not understand this reasoning at all. I take the margin cost to be what it cost to produce the last barrel of oil. That is if the price were not that high then that barrel would not be produced. Well, not for very long anyway. But that has nothing to do with how many barrels of oil the world actually needs. If the world demands 75 million barrels of crude oil each day but only 73 is produced then the price will rise until demand is only 73 million barrels per day. It does not matter, in this instance if the marginal cost of oil is only $90, the scarcity of oil drives up the price until demand equals the lower supply, the marginal cost notwithstanding.
Ron P.
Ron - let me add a wider perspective - outside of what speculators add to costs of real goods.
10 years ago I quit my wall st job. All of my friends - the best and brightest of University of Chicago and other schools are still in the grind - have orders of magnitude more (paper) wealth than I do, and are still on the treadmill, some short, some long, all taking commission, and not producing anything for our country. If basic goods (like oil and corn) didn't have speculators, at the margin those people would perform productive tasks, perhaps invention, or farming, or education, for society. I don't have numbers but the % of people employed in the "FIRE" sector of economy (Finance, Insurance, Real Estate) is near all time highs - much of it is just spinning digits back and forth.
Let me give a tangential but related true life example. 2 friends of mine - one with MBA and one with PhD in Neuroscience played, until recently alot of online poker. Both are very smart - IQ 140+, socially astute and good people (one male one female). They were both winning poker players and played between 20-60 hours per week online until the USA made online poker playing illegal 2 months ago. I don't know for sure but would guess that one of them made about $2 k per month and the other $5k per month playing poker - a fraction of what they could have made from real jobs. Now, when talking to them, they have their lives back, because the rules changed. They work in gardens, work out more, spend more time with families and are working on various projects - things they never would have done had poker not been made illegal. They didn't have the strength to give up poker on their own but when the government made it impossible for them to play, they had to change where their energies were focused. (I would guess that only 5% of poker players made their living off of it - another 15% made some smallish dollars and the other 80% were between small and serious losers). If pure speculation were made illegal, something similar would happen to some of our best and brightest minds in the country. And don't give me the 'speculators are needed to provide liquidity' - the entire liquidity is provided courtesy of FED right now.
In any case - something to consider. We are sending the wrong environmental cues, en masse...
Nate, you realize that the argument you are making now has nothing to do with the previous thread which was are speculators responsible for the high price of oil? But now that you have changed the thread to something totally unrelated to that argument, I will put in my two cents worth.
There are very few speculators who make a living speculating. In fact I would guess there are almost none because none of them are that good. Some make a few bucks but most lose money in the long run. Speculators have other jobs where they make lots of money. They must make lots of money because otherwise they could not afford to be speculators.
Of course there are professional money managers, brokers and such. I was once a broker myself albeit it was only for about six months. And of course you were once in the business yourself but left. I left because a stockbroker is nothing more than a salesman. I had to cold call people who would rather I would just leave them alone. So I did. I just wasn't a very good salesman. I hated the job.
Anyway if speculating was made illegal nothing much would change except a few people would have more money to spend on their families, and their adult toys. Brokers would have a little less business but they would still have a business. Stocks and bonds would still keep them in business.
I think you are wrong about the Fed being the sole provider of liquidity. I really have no idea where you are coming from with that. The Fed does not buy or sell commodities. The Federal Government does, but not the Fed, that is the Federal Reserve System. So I really have no idea what you are talking about there.
And I don't see the futures market as sending any cues to the environment. Sure the environment is a mess but you are the first one I've ever known who blamed it on speculators.
Ron P.
Oil is an oligopoly industry. A firm does not tend to price at marginal cost in an oligopoly. Because the marginal revenue curve lies below the demand curve, an oligopolist (similar to a monopolist in this case) will produce at the point where marginal cost = marginal revenue. But price is set by the demand curve--at a point well above marginal cost.
Over the long run, price does tend to follow fluctuations in marginal cost, but the price tends to remain well above marginal cost.
Because oil is highly price inelastic (both for supply and demand), small shifts in the demand or supply curves can have very great impact on prices. These price inelasticities account for the great volatility in oil prices. As Ron says, you cannot blame speculators for most of the price volatility of oil and oil products.
It seems that most people don't realize what Ron has been consistently pointing out, i.e., that the bullish and bearish bets on oil prices offset each other. An interesting article in today's WSJ that points out the disastrous effect that the low WTI oil price has had on airlines hedging efforts (based on WTI)--they are much more exposed to rising global fuel prices.
http://online.wsj.com/article/SB1000142405270230456310457635581248880280...
Oil Hub's Sway on Prices Slips
Cushing, Okla., has been the center of the oil market for decades, housing millions of barrels of the light, sweet crude that make up the world's most actively traded oil contract. But that contract isn't what it used to be.
If WTI looses relevance as a benchmark price, as indicated by your link, the trade in such contracts will diminish and those profiting from the trade itself will take huge losses. However, if these are the same guys as those profiting from the trade in the alternative contracts it possibly would not matter much. Swings and roundabouts as we say where I live.
Otherwise the losers on this transition should be hard-pressed to do something about it.
And that is already happening. Brent trading is on the upswing versus WTI trading.
The WTI/Brent spread is effectively giving north america a fairly significant fuel cost subsidy versus the rest of the world.
Rgds
WeekendPeak
Elm, it seems that a lot of people believe there are some folks, hedge funds or whomever, that make consistent profits in the futures market. Nothing could be further from the truth. The best any trader or fund can hope to do is have profits above losses. Some funds open up with a group of investors and lose money almost from the start. After the fund is depleted to about 25 percent of its original investment, it closes down and returns the remains to the investors.
Some funds are more successful. They have very smart managers that manage to keep profits slightly above losses... most of the time. But even these guys often have long losing streaks.
Just as I write, on CNBC comes this announced that Goldman Sachs lost 98 percent of a 1.3 billion dollar fund. Found this with the aid of Google.News.
Goldman Sachs Was Really Sorry It Lost 98 Percent of Libya’s $1.3 Billion Investment
The money was lost over a period of two years by placing losing bets on the futures and Forex markets. This is not really big news because most funds lose money, whether managed by Goldman Sachs or some other really big name funds manager.
Ron P.
For all - Don, to go along with your fine points I'm a little confused by folks wondering if WTI will lose relevance. To an operator selling Angolan oil to a German refinery WTI has no relevance...and never has. OTOH Brent has never had any relence for any of the oil I've ever sold in Texas. And if you're buying WTI future contracts Brent also has no relevance. After all the discussion I think some folks still are confused. Very little US oil, including a lot of WTI, isn't sold exactly at the WTI price benchmark. There are almost always price adjustments....some small...some very large.
Ron,
My native language is not english and maybe my wording was not clear as to what I meant. When I wrote "those profiting from the trade itself" I meant those that benifit from the trading - without taking any position at all. That is the exchange (NYMEX I believe) and banks/commissioners etc.
What's the difference between "make consistent profits" and "have profits above losses"?
Oh, sorry for the misunderstanding. Of course the exchange and brokers will suffer from diminished trading. But I don't think WTI will suffer all that much from diminished trading. They will do okay.
You can have profits above losses this week only, or this month only. But if you are consistent then you do it almost every week of every month. However no one is that good in my opinion. A few have profits above losses at the end of the year, a very few.
Ron P.
Wouldn't higher prices (that you claim are the result of speculation) buy us more time? Higher prices promotes conservation and development of alternatives, after all.
I suppose that there is always some comfort in shooting the messenger, but note that the wascally speculators have been at it for quite some time.
Here is a chart of annual US spot crude oil prices:
http://www.eia.doe.gov/dnav/pet/hist_chart/RWTCa.jpg
And here are the annual spot crude oil prices and year over year exponential rates of change:
1998: $14 (-41%/year)
1999: $19 (+31%/year)
2000: $30 (+46%/year)
2001: $26 (-14%/year)
2002: $26 (0)
2003: $31 (+18%/year)
2004: $42 (+30%/year)
2005: $57 (+31%/year)
2006: $66 (+15%/year)
2007: $72 (+9%/year)
2008: $100 (+33%/year)
2009: $62 (-49%/year)
2010: $79 (+24%/year)
We have nine years showing positive year over year rates of change, and the median is +24%/year, within a range from +9%/year to +46%/year. Assuming that 2011 does show a year over year increase over 2010, based on these numbers, we would expect to see an average annual price for 2011 between $86 and $125, with a median expectation of about $100, which is the approximate average to date for 2011.
We have seen three year over year price declines, in the above data set. As I have previously noted, each successive year over year decline fell to a price level which was about twice the level reached during the previous year over year decline. If this pattern holds, the next year over year decline would bring us down to the $120 range (average annual).
Maybe so, but I think in a short period of time the lower price would mean lower supply (quantity supplied) and higher demand (quantity demanded).
So does shutting down the speculators really do anything except redistribute the costs and benefits? If one believes in a near term peak, it's a yawner. Or let's get rid of the speculation and tax oil/gasoline instead.
When all so knowledgeable politicians brought in a law to prevent short selling of banks, it had the effect of increasing the fall of bank stocks. Do you know why?
The price of oil is determined by supply and demand, the problem is supply and demand are very tight and it is this that is causing higher volatility.
Of the 40 oil exporting countries only 14 have increased exports in the last 5 years, that number was over double that up to 1996.
Traders trade reality, it is a pity politicians do not.
I think you meant short selling by banks. But I know of no such law. I googled it and came up empty. Perhaps you can post a link.
The term "short selling" is used in equities but not the futures market. You can sell stock you do not own. That is "short selling". Naked short selling means you sell stock you do not own and you do not borrow the stock from any broker. There has always been a law against that but it was seldom enforced. There has been talk that the SEC is cracking down, enforcing that law. Perhaps, perhaps not.
Banks also use that term in real estate, but not commodities. When a bank agrees to sell a home using a short sale process, it is agreeing to accept less than the mortgage balance owed by the current owner. There is no law against that however.
The term "short" is used in the futures market but it is not called "short selling". Every contract has two sides, the long side and the short side. Every open contract involves two parties, the party who is long and the party who is short. But the party who is short is never referred to as a "short seller".
Edit: Perhaps you did mean short selling of banks. Still there is no such law. The SEC, not congress, did pass a rule in July of 2008 that prevented the short selling of 19 financial companies for 30 days. SEC's lame short-selling move means bank stocks will be overvalued This happened during the "Too Big to Fail" crisis. It was to prevent short sellers from driving bank prices down, making the crisis worse.
Ron P.
Edit: Perhaps you did mean short selling of banks. Still there is no such law. The SEC, not congress, did pass a rule in July of 2008 that prevented the short selling of 19 financial companies for 30 days. SEC's lame short-selling move means bank stocks will be overvalued This happened during the "Too Big to Fail" crisis. It was to prevent short sellers from driving bank prices down, making the crisis worse.
Ron P.
Yes that's the bit I was referring to, it did not work, why?
companies like IG index were shorting bank stock but even after the rule bank stock still fell a long way.
http://www.forbes.com/2008/10/01/sec-short-ban-biz-wall-cx_lm_1001bizsec...
rule or law the term is the same if you are not allowed to do something, look it up in dictionary
Jaz, what you said was: When all so knowledgeable politicians brought in a law to prevent short selling of banks, it had the effect of increasing the fall of bank stocks.
You specifically said politicians brought in a law. Neither of these two things happened. Politicians are elected officials. The SEC members are not elected and they cannot make law. And this rule likely prevented further fall in the few 19 financial companies that it affected. True they did fall after the rule was in place but they would have likely fallen further had the rule not been in effect. The link I posted complains that the rule caused the bank stocks to be overvalued!
The sun rises every morning after the cock crows. Some people, observing this, assumes that the cock crowing causes the sun to rise. Some people observing that bank stocks continued to fall after a short selling ban was placed assumed that the ban caused the fall. Those folks are just as smart as those who assumed that the cock crowing caused the sun to rise.
Think about it. The idea that something not happening, short selling of bank stocks, actually caused something to happen, the stocks fell even faster, is truly absurd. Selling of bank stocks could indeed cause them to fall faster but not selling them could hardly have that effect.
Ron P.
Darwinian
Please note the words GOVERNMENT
The government last night stunned the City when it banned short-selling of bank shares by speculators, hours after a pledge by Gordon Brown to tackle the deepening global credit crunch with a "clean-up" of the financial markets.
http://www.guardian.co.uk/business/2008/sep/18/banking.creditcrunch
People see government statements like this as a warning that something serious is wrong and it makes matters worse.
http://www.telegraph.co.uk/finance/markets/7742134/Markets-crash-as-Germ...
"Billions of pounds were wiped off the value of shares as the main European indices on Wednesday dropped on the back of large-scale selling by institutions shocked and spooked by Germany's actions."
When the government in the UK said there is plenty of fuel and no need to panic buy everyone dashed to fill their cars up.
Many years ago there was a sugar shortage and the government said "Ministry of Agriculture stresses that there is no immediate crisis".. the shelves were empty in two days.
http://www.guardian.co.uk/theguardian/2010/jul/09/archive-rationing-suga...
Shall I go on? Your cockerel analogy is simplistic and totally lacks any understanding of the psychology of people and how they react.
Jaz, I do not follow what the UK does or does not do. It does appear that when the European Union banned short sales of its debt banks it caused a lot of anger and the market reacted negatively. But the not selling of the European debt and the not selling of shares of banks could not possibly have a direct negative effect on those shares. However mob anger at government actions can cause almost anything to happen. But according to the article what happened was to the entire market, not necessarily to those shares that were not sold short.
Do you understand that short selling is exactly the same as selling except you must borrow the stock you sell. In other words short selling the stock of any bank is exactly the same thing as selling the stock of that bank. The only difference is you borrowed the stock you sold. Do you understand that? If not then all further comment is useless.
However I will assume that you do understand that selling short is just selling, nothing more. Now you must explain how not selling could cause the price of the stock to collapse.
Also your comments on sugar and fuel were very interesting. Thanks. But of course this has absolutely nothing to do with not short selling bank shares.
But I think we can agree on one thing. Banning short selling is not a good idea, just as banning market speculation is not a good idea. If a bank's shares are due to fall, banning short selling can only slow the decent, not prevent it.
Ron P.
I agree on all points, but I must add one small thing
It is possible for banning short selling to increase the decent in the price of a stock.
Not due to market demand or fundemental resaons, but due to market fear.
Most institutional traders make money on the way up and the way down. So if you are a fund manager and you are holding 100000 shares of XYZ stock you bought at Y price and now the price is higher by X, you can lock in that profit by selling XYZ. So after its sold, what now?? The trader knows the price is doing down, he made his money, he wants to get in on the action on the price move down, he wants to short. Like I said this is just pure market speculation and feasr driven behavior. But if large trading houses want to short a sector and cannot due to a regulation, what does Joe Six-Pack do when he hears Jim Cramer crying about all these institutional investors who desperately want to short the banking sector. They look at there little portfolio with e-trade and see they own 1000 shares of a bank stock. So you might.....might....get a bump from the little guys playing into the market fear that a sector is dropping. The (the smaller investor) like to follow the bug guys and if the feds narrow the market liquidity by preventing the larger houses to trade wihtin a sector....
Maybe....
But that's all I got and it's pretty thin...
Maybe with selling call options and such....buying up naked puts...i dunno..
PooBah
Jaz, I do not follow what the UK does or does not do.
Darwinian, sorry to say it is kind of obvious.
Anyway my first point is correct Governments have passed rules to ban short selling of bank stocks.
My second point I have also proved, governments have caused major market panic when they interfer in this way, when the government passed the rule on Saturday bank shares fell even faster on Monday then they did the previous week.
http://www.dailymail.co.uk/money/article-1060110/Close-trade-report-Lond...
My third point was you do not understand the psychology of what is going on, it is not logical, it is a herd reaction of fear, fear is not logical.
jaz 3 darwinian 0 :-)
Not quite. Collectively oil traders neither win nor lose because collectively (longs+short) positions are zero and therefore profits and losses equal zero.
To clarify/reinforce what Darwinian said a couple of comments ago: In futures and options trading the sum of all longs and all shorts is zero. The only way one party can buy (go long) is if a different party sells (goes short). Therefore in aggregate speculators do not make or lose money when prices move. Individual traders will win or lose, but in total the Profit/Loss is zero.
The situation in physical buying/selling is similar albeit with a delay. If a person charters a VLCC and buys oil to fill it it may increase the price somewhat. However, eventually that oil is sold and it stands to reason that oil would come down by that same amount.
It is really difficult to see how speculators can increase (or decrease for that matter) prices. What they likely are doing is introducing more volatility, and one can argue that increased volatility increases oil prices because it increases the hurdle rate required for new projects.
Rgds
WeekendPeak
Great post WeekendPeak. However I think the jury is still out on whether speculators increase volatility. The volatility in the futures market is not always reflected in the spot market. The spot market is far more sluggish than the futures market. The futures price may shoot up and down during the day but if you knew what the average contract price was doing during that time I would bet you would not find any such volatility. And by contract price I don't mean futures contracts, but actual contracts to buy and sell oil.
Anyway it is a well known fact that the thinner the market the higher the volatility. Therefore it could be argued that the more speculators you have the lower the volatility is likely to be.
However it is my opinion that looking at what the futures market is doing is a poor gauge of what the spot market is doing.
Ron P.
So isn't the fundamental problem with oil prices is that it is just a proxy for some other more fundamental measures that we can't really observe?
Prices can be a combination of current supply and demand, anticipated changes in supply and demand, and of the current rate of change -- the slope or derivative of demand or supply.
To top this off, it is impossible to have a universal model for price, since if one existed, then you could use that to make money, but if everyone used this model, no one could take advantage of it. This boils down to the category of game theory known as the zero-sum game. A zero-sum game is exactly what you are describing with speculation.
I think that one of the issues is that what we commoners see as oil prices are really paper barrel prices. At which price Aramco sells a specific cargo with specific charateristics to Valero we'll never know. As more than 99% of crude futures don't result in a physical exchange it stands to reason that you can have significant deviations between paper prices and actual transactions for significant periods of time. See where Canadian crude trades - hint - at a 25-40 dollar discount to WTI. That has a large effect both on the particular incentives for Canadian Syncrude producers as well as Valero.
Speculation is not quite a zero sum game. First of all, there are transaction costs. Secondly, if speculation introduces additional volatility in a market one would expect that the behavior of participants in those markets will change.
Rgds
WP
THE ROLE OF WTI AS A CRUDE OIL BENCHMARK has an extensive description of the history and oil infrastructure supporting the pipeline and refining business around Cushing.
Note that is is a study available from and sponsored by the CME.
Page 14, "Managed money net open interest positions on NYMEX and WTI prices" of the presentation Global oil market outlook shows a tight correlation between the managed money net open interest and the WTI price.
Thanks for the links - I think I read the second one a couple of months ago. Although there is a correlation over a very specific time period the fact of the matter still is that the only way for say a a commodity index fund to be long crude is for somebody else to be short. A number of years ago I ran correlations between open interest and WTI (when WTI still meant something) and the correlation was less than 0.3. My guess is that the timeperiod they chose to run their correlations specific period leads me to believe that this specific period was chosed to make a point rather than actually find out facts. For example, run a 24 month rolling correlation between open interest in WTI and prices. You'll find that it runs somewhere between -.7 and +.9. So pick your poison.
Net open interest (longs+shorts) is zero, no matter how you slice it.
Rgds
WeekendPeak
I'm with Darwinian 100 percent in his argument that speculators are not responsible in any serious way for the price of oil;his agrument meshes perfectly with theory as I learned it in Econ back in the dark ages.
Another way to look at this problem is to simply ( he also touched on this point but did not elaborate it fully) to look at who is buying and selling actual product.
Now why should we believe that any large oil producer, either an independent or a nationalized company, would allow a bunch of SPECULATORS to get between THEM and thier CUSTOMERS and rake off huge unearned profits?
Saying this is so is equivalent to saying that the people who are smart enough to TO BE IN CONTROL of the oil industry are DUMB enough to be made out fools by a bunch of slick talking brokers.
I would remind the reader that the owners/ managers of major chains of retail stores, refineries, oil fields, and other such large cap businesses not only have proven track records AS MANAGERS but also that they are easily able to afford to buy any sort of professional expertise at or above( if necessary) the going market rate.
Does anyone here really think that the management team that runs WalMart or any other giant retailer allows a bunch of middle men to get between them and thier suppliers, be the product gasoline or toilet paper, and rake of a fat percentage while they struggle mightily to turn a buck by selling the actual product?
Now IF we were to define the ACTUAL physical PLAYERS in the markets as "speculators" , so that the "speculators" and the "players/operators" are mostly one and the same, well then-the speculator argument holds water in that case.
In that case guys such as Rockman, who goes out and actually drills wells, etc, could be called a speculator.He has after all made it clear that he is in the business to make money and obviously makes more when the prices go up.He wants to own oil in the ground that can be sold at a fat profit, now or later.
The folks who own the big tank farms where gasoline is stored up ahead for the summer season want to buy cheap and sell high wiothout a doubt-or at least collect the maximum possible rent from leasing thier facilities to other folks who actually OWN PHYSICAL OIL.Why should they allow somebody else to rake in the coin by renting out thier tanks too cheaply?
If they own the product, what is to stop them from dealing directly with refiners, just as they deal directly with trucking companies, etc?
Now I myself have been really and truly speculating, if you want to call it that, in diesel for years- in a VERY modest way-by buying it when ever it seems cheap and burning it later.
Right now I am using off road diesel fuel bought at $ 2.35/us gallon in bulk iirc three years ago.
I made a genuine speculators bet- an unhedged bet-that fuel would be going up-and won .If it had crashed to fifty cents a gallon I would have lost my butt on that transaction.
So long as average prices keep on rising over time, I will continue to do very well as a nickel and dime "speculator".
Ron is dead right-if I were buying diesel now-and pretty soon I will have to restock-I would be contributing to current demand and helping push prices up.But in actuality , I helped HOLD PRICES UP when I bought, and am helping hold prices down NOW by using my remaining speculators hoard of a few hundred gallons.
My recollection is that the time period is constrained because "managed money open interest" was not broken out from "non-commercial open interest" until recent years.
Figure III-6 of the first report shows the net open interest for non-commercial parties. It is generally long, which must mean that commercial parties must be generally short.
Presumably this is sellers of actual oil, priced referencing the WTI but not necessarily delivered via Cushing, who are locking in prices on future deliveries?
The only delivery point for WTI is Cushing, but the number of bbls delivered are a fraction of a percent of paper barrels traded - pretty much irrelevant in terms of setting the global price of oil
Rgds
WeekendPeak
It looks like that only about 700 kbpd flow through Cushing, so that is about 5% of US usage.
However, it is my understanding that much more oil is priced based off the price of the WTI contracts. That is, a contract between producer and user will specify that the oil will be bought for the WTI price plus and offset for grade plus an offset for distance from Cushing. Such a contract is not a CME contract, but is only a contract between the seller and the buyer.
Such contracts cover a lot more oil in the Midwest, MidContinent and Gulf than flows through Cushing, while oil delivered to East and West coast buyers may be priced relative to Brent or Asian markets.
Therefore, if you are seller or buyer of oil not delivered through Cushing, but priced relative to WTI, you can still sell or buy WTI contracts on the CME to lock in future prices and hedge your risk with respect to price changes between when the contract is written and when the oil is to be delivered.
OTOH, for example, if the producer is unhedged, it is in the producers interest to deliver oil to other points than Cushing in order to reduce supply at Cushing and to help drive up the WTI reference price. Conversely, if the buyer is unhedged, it is in the interest of the buyer to take delivery from other sources than Cushing to increase the stocks there and drive the prices down.
WTI as a benchmark is determined by the API gravity and sulphur content of the crude. The price of any specific oil can be at a discount or premium to WTI. A 42 gravity with a .3 sulphur will sell at a premium to WTI and a 36 API gravity with .6 sulphur will trade at a discount to WTI.
At one time the pipeline companies segregated the crude to maximize the higher grade crude oil. Now everyone is blending to get the 39.6 and .5 sulphur. This used to be a firing offense in the pipeline business.
Now everyone wants to bump against the sulphur line. Heavy grade NMX mixed with high gravity sweet condensate allow the pipeline companies to buy lower cost low and high gravity (which trade at a discount) and mix it to make pipeline WTI to pump to Cushing.
Same with blending the Canadian to push to the gulf coast.
Whenever that starts up!
A fascinating overview, but this sentence caught me off guard:
"These statements made in regard to Saudi production call into question the Saudi willingness and ability to increase exports, which is tacitly understood to be the responsibility of the world’s only pivot producer."
When was this "tacit understanding" arrived at? Are the Saudi's in on the understanding, or is this an understanding the consuming (i.e., the wealthy modern developed nations) have arrived at somewhat on their own?
The Saudi's must be VERY concerned about demand destruction: The U.S. economy is still in a limping recovery at best, there is great concern that China may very well be overbuilt and due for a correction...and Europe? I know this is controversial to say, but there is now grave concern as to whether the European Community can survive in anything like its current form, and whether the European community nations can hope for any real economic growth. European energy demand is a very large question mark for the coming half decade at least.
I know that such things as hybrid gas electric cars are often scoffed at here, but they really are now on a very rapid development slope, and are now being incorporated into the automotive mix at an increasing rate (if the economy were healthier, the efficiency gain would be even faster). The Saudi's and other major oil producing nations must be very careful: They see developments around the world, and know that if the price of oil does drop in the next half decade, they could be caught with billions of dollars of sunk cost that would be very difficult to recover. The Saudi's are between a rock and a hard place: If the oil price keeps going up, the move toward greater efficiency would move even faster, destroying demand. If they overproduce and drive the price down, they fuel waste (both internal and external) which they are then expected ("tacitly") to attempt to supply. And they have the normal national costs (placating Saudi citizens, especialy given the "Arab spring" going on all around them). I do not envy their position.
RC
ThatsItImout
Renewables produce a ridiculously small proportion of our energy production and once they are producing they become hard baked into the system hydro is a good example and very few of them are a substitute for oil. the only thing which will effect the price of oil in the long run apart from depression is to find a substitute for oil in the transport sector and energy efficiency. I would expect that they have at least a decade before they have to worry. The problem for the developed countries is to build out this base. Let me give you a good example Let us say that we develop a battery that is cheap and has a high energy density, that makes electric cars competitive with petrol powered cars. Let us then say that the only way that we can supply the electicity for those cars is using PV cells. America produces only 0.1% of its electricity from PV panels, then let us say that America has a crash program for the installation of those cells, let us say that it doubles the intallation every year,in 4 years time America will still only be producing 1.6% of its electricity from PV panels. It is only during the next 4 years that expotential growth really kicks in rising to 25% when it would really have an effect on the market. This means that renewable s are a long term solution, not a short term.
In many ways the Saudis are between a rock and a hard place. However much the Saudis would like to reduce the price of oil to keep renewable s uneconomic such a policy would be self defeating as they need more and more income for handouts too there burgeoning population that is apart from the 4 billion they are virtually giving Egypt to keep it afloat before it goes bankrupt and the money that they are giving Pakistan for a couple of division of the Pakistani army and a couple of Atomic weapons
http://www.defence.pk/forums/strategic-geopolitical-issues/86523-two-pak...
http://www.islamtimes.org/vdcev78p.jh8neik1bj.html
non of which comes cheap. Pressure on the Saudi budget will force them to try and keep the price of oil high. It has been estimated that the Saudies need a price of $88 dollars a barrel just to balance there budget. The inability of renewable s to quickly scale up will give the Saudis a breathing space and the rest of the oil producers in the middle east but once they kick in there economies will be dog meat.
This might be an interesting read by the way.
http://canadafreepress.com/index.php/article/37029
deep regards
Yorkshire Miner
That is why I propose my alternative.
http://snipurl.com/27xcpq
If Mr. Murphy makes only a minimal appearance, and we apply the same effort to electrifying railroads as we do to boiling more tar out of more sand, we can electrify 35,000 miles of mainline track (@80% of ton-miles) in 7 years.
With more double track, rail over rail bridges and intermodal terminals, we can transfer most of the truck freight to electrified rail. Up to 2 million b/day saved in less than a decade.
And then if the USA duplicates French tram building (adjusted for population & workweek), we could have 4,000 miles of light rail either finished or under construction in 4 years and 6,000 miles completed in 10 years.
And expanding bicycle infrastructure can be done faster than that.
Best Hopes,
Alan
...or about one whole inch per capita, or a single-use mode reaching about 1/660 of the extent of the four million multi-use miles of streets and roads. Yeah, that framing is a little silly, but it emphasizes how you'd need a tremendous number of capita jammed into very little space for them collectively to have enough inches of light rail to get anyone anywhere, and then only as long as they don't need to take much of anything with them. Or actually what it really emphasizes is that the tram lines would primarily constitute a massive subsidy to people so affluent that they can afford astronomical downtown rents - really, much like the Paris Metro, which reaches very few of the ordinary folks stuck in les banlieues.
It follows that the tricky problem would be making the "voting case" (so to speak; parallel to "business case") for such a thing. Perhaps it has theoretical or philosophical merits, but when we get down to brass tacks, why should or would 95% of the population vote to subsidize the other 5% in that manner?
Wrong calculation.
One needs to look at the catchment area for the line. In the EU, the walk-up catchment area is 500 m on each side - a swath (or series of dots) a km wide.
In the USA, it is assumed that 100% will walk 1/4th mile to a stop, and 0% a half mile.
Bicycling (especially in an oil supply emergency) dramatically increases these ranges. Small (fuel efficient) buses can also serve as feeders.
I will link to a map of the trams of Mulhouse, pop 110,900 in a remote corner of France. First line opened in 2006, latest expansion December 2010. More coming.
This is a fundamental shift away from the car alone for most of "Small Town" France.
http://upload.wikimedia.org/wikipedia/commons/9/9f/Reseau_tram-train_mul...
58 km from memory. The grey arrows indicate future expansion possibilities.
I have looked at detailed maps of Mulhouse and there is an area east of Port Juene Europe that is not well served by the tram lines, just buses. But it appears that a majority of the citizens in this smallish French town can avail themselves of oil free transportation to the significant destinations of the town. The minority that cannot will shrink with the expansions.
Actually, the expansions (and two existing lines) reach beyond the city limits into the metropolitan area (pop 280,000 from memory). I not know why one area close to the town center is ignored.
Best Hopes for Mulhouse,
Alan
Grenoble, pop about 250,000 has an even more impressive set of new tram lines.
Today
http://en.wikipedia.org/wiki/File:Tramway_de_Grenoble.svg
Future plans for Grenoble
http://upload.wikimedia.org/wikipedia/en/5/50/Grenoble-tram-future.jpg
Click the magnifying glass and this map shows the street grid.
Well, I did say the calculation was a bit silly, but maybe only a bit.
Looking at that Mulhouse diagram, and Google Maps, and Wikipedia, those lines serve a metro area of about 280,000 people. At a WAG, maybe 1/4 of the built-up area, if that much, is within walking distance of a stop. So the chances of two random points both being within walking distance would be maybe 1 in 16. Now, that may be better than most US metro areas of that size, but a fundamental shift away from the car? Maybe not.
And the population density for Mulhouse itself is 12900 per square mile. That's just shy of half the density of New York City proper; we haven't got a lot of places that dense, and most or all would already be served and not need any of the 6000 miles of lines. Milwaukee, WI, say, has six times Mulhouse's population in the city proper but it's only 6300 per square mile. Madison, WI, has twice Mulhouse's population, has only 3000. No amount of wishful thinking will make the USA into France anytime soon, if ever.
So, at 6300 to the square mile and a 0.4-mile walking distance to approximate the US radii you gave, a stop serves 0.5 square mile, 3150 people at the Milwaukee density. With the stops 0.8 miles apart (although they often tend to be a bit closer) and 6000 miles of lines, we can serve 7500 stops, or 23 million people. Total pop. 311 million, so we're asking 92.6% to gift the other 7.4% with quasi-free rides. But even many of the 23 million will find that the local line won't take them where they need to go, or let them carry what they need to bring along. So even many of them will also be donors, not beneficiaries. My original WAG of 95% donors seems reasonable.*
Regardless, what I'm still not seeing here is any "political case" that 92+ percent of voters should donate to the other 8- percent - especially since the 8- percent will typically be those who can afford sky-high urban housing costs, i.e. the more affluent. Absent a persuasive "political case", it's perhaps unsurprising that every time we delve into this, the conversation wanders off to France or some other faraway place. By the same token it's unsurprising that the current Congress seems to be cutting this sort of stuff. And by the same token again, it's unsurprising that Congress's response actually matters, i.e. that states and/or localities don't see it as valuable enough simply to do it on their own.
* One key piece of info I'm not finding is a cumulative-histogram or table showing what proportion of the US population lives above what density. For all I know, 6000 miles of tram lines installed on sensible routes in the densest now-unserved places might only reach 10 million.
Your analysis assumes that all "built-up" areas are uniform.
There are office buildings, factories, schools and other prime destination places served. And some residential areas are denser than others (see apartment buildings).
And then there is Transit Orientated Development. People move to the rail. Rail creates increased ridership. Post-peak Oil, this impact should be magnified and accelerated.
A reasonable goal is to have 1/3rd of Americans in low oil consumption TOD islands within two decades.
I stand by my statement that a majority of the citizens of Mulhouse can use the tram. The first two lines had a daily ridership of 47,500 in 2008, just two years after opening. New data since the December 2010 openings is not available.
Add the grey arrow extensions, and more of the metro area will be served. Daily ridership above 100,000 with an expanded system and an oil shortfall certainly seems possible.
Funding, btw, is from a payroll tax on firms with more than 10 employees.
The faraway and foreign places of Toronto, Vancouver and Calgary all have excellent transit systems.
The faraway and foreign places of Toronto, Vancouver and Calgary all have excellent transit systems.
The faraway and foreign places of Toronto, Vancouver and Calgary have more transit ridership per capita than major US cities such as Washington, San Francisco, Boston and Chicago, and far, far more than Los Angeles. The only US city with more ridership than the five largest Canadian cities is New York.
Public Transport in Major North American Metropolitan Areas
A couple of surprises on the list. Montreal is almost = to Toronto (I knew they had a good subway and commuter rail system, but still). Winnipeg and Halifax did better than I expected.
Alan
Montreal is quite compact compared to Toronto, and has lavished less money on its road system, which is probably why its residents use transit as much as they do. Winnipeg is quite compact, too, and has a very good bus system. Halifax is compact, and its transit ridership probably benefits from the fact that its population is less affluent than most other Canadian cities.
increase exports, which is tacitly understood to be the responsibility of the world’s only pivot producer."
When was this "tacit understanding" arrived at?
The Saudi Aramco motto is "Energy to the World".
Numerous quotes for the past declare the Saudi responsibility to meet world oil demand. That is why they keep X millions/day off-line, just in case (supposedly).
I would call it explicit, rather than tacit.
Alan
Okay, well then I am now comforted. As long as the Saudi's are holding the bag for having to supply all the waste I can come up with, I am in the market for a Rolls, or a Porsche, or a private plane even...after all, the Saudi's have the obligation to provide the fuel, what do I have to worry about? :-)
Morgan Stanley released a new report on the supposed 'renaissance' of American oil industry.
Here's an interesting graph that they have of forecasting U.S. oil shale production:
I know some people would automatically reject this, but the major banks have recently stated that oil is going to hit very, very high levels in the near term and they are openly talking about tightening supplies, including Morgan Stanley, so I think it's worth considering that some people may be underestimating shale. I think that we won't be able to avoid an oil shock, but it may not be the end of the world, mass famine, die-off etc etc as some here are thinking. Especially if demand is depressed again in the near term.
And it's also important that China also has huge oil shale reserves and are already well into the process of producing from these.
Nontheless, we probably have to wait at least 5-10 years before the full effect starts to show from oil shale.
Naturally, I'm not saying, 'forget Peak Oil', this is still an issue and it remains to be seen if these forecasts can become viable(and even if they will, will they help?). Nontheless, it's an interesting report and it deserves to be taken seriously and be discussed.
This site in particular have had some very doomerish forecasts that have all turned out to be wrong(ace's 2008 comes to mind, Foucher's older forecasts too). So critical discussion is not exactly a bad thing in this context, whether you agree or disagree with Morgan Stanley.
It is BAU propaganda such as this that keeps the oil price artificially low. Supposedly there are plenty of alternatives around the corner, so no need to worry or deal with reality.
We will only know the performance of the oil shale extraction by 2016. Today it is mostly guessing based on non-existent data. Reminds me of the rosy tar sands production claims. Canada was supposed to be producing 5 million barrels per day by 2020. But this number keeps shrinking as the years go by. Now the target is 3 million bpd.
L -Thanks for the chart. Very revealing how the bankers absorb the info. First, I'll be the first to make the rather picky point that the chart doesn't represent "oil shale" production as the oil patch and many others understand it. I'm pretty you know the distinction. But do the bankers? I'm sure they read the report offering billions of bbls of oil "resources" in the "oil shale" reservoirs which have yet to produce a bbl of commercial production. The formations on the chart represent fractured shale reservoirs...not "oil shales" which as most on TOD know contain kerogen and not oil.
I'll only jump on one trend since I'm more familiar with then the others. The Eagle Ford shale trend is booming like no other I've seen in decades. Just the cost for new leases is mind boggling: $10,000+/acre for leases that could have been had for $150/acre just a few years ago. So a 40 acre drilling unit could cost well above $500,000 if you're late to the party. Drill and completion costs are on the order $4 -7 million. Initial production rates are 300 - 1,200 bopd.
Now for the not so good news. As typical of all fractured reservoirs the initial production rate is not very indicative of the URR. I've talked to operators who have seen rates drop up to 80% in just 4 months. It's still too early to be very definitive but the general scuttle butt is a 60 -80% decline rate per year should be expected. I'll avoid the math model and just point out the obvious: those EF wells coming on line in 2012 will be contributing very little if any of that 600,000 bopd the chart shows for 2016. That doesn't prove the expectation is wrong but it does show that any sustained high rate of EF oil production will require a continuous and very aggressive drilling effort. And that may be possible given the many millions of potentially productive acres there are in the trend. But just like the shale gas plays such trends as the EF are totally dependent upon the public companies and the demand of Wall Street that those companies must show y-o-y reserve growth. My company has no interest in the EF...not profitable enough. We don't have a stock to push so our sole incentive is rate of return. And we do much better drilling 17,000' deep wells for rather small NG reservoirs even at current low prices.
So just as the SG plays helped boost our NG reserve base AS LONG AS NG PRICES STAYED HIGH, the fractured shale reservoirs may have a similar effect as long as oil prices stay high enough. So there's the rub: while the bankers might anticipate a good bit of future oil production from such plays it also requires the belief that oil prices will stay high enough to support those efforts. Considering the decline of existing oil rates many forecast it doesn't seem as though these plays will flood the market with excess capacity. OTOH that's what many thought about NG coming from the SG plays until the recession knocked down NG consumption and destroyed much of the price support for those plays. So there's the irony IMHO: these new oil plays can add to our resource base but only at prices that hinder the economy. They may help delay some of the worst aspects of PO but not one of the basic problems IMHO: sustained high oil prices.
A lot of people seem to assume that will have infinitely expanding supply of rigs, personnel and related infrastructure.
Don't we ? :-P
Just write a check and they will magically appear.
Alan
Alan - And even when you get the equipment you still need a hand who knows what he's doing. Two weeks ago I had a very well known company that runs test equipment on one of my locations. Their test hand had 30 years experience...with Texaco...AS AN ACCOUNTANT. Had the test all screwed up. Even my owner's wife who was visiting the location that day knew something was wrong. Needless to say I don't plan to use them again. OTOH there's another service company on my "Hell will freeze over before I use them again" list. And I still used them a month ago because no other company was available. So I could just sit there and pay $60,000/day for the rig while I waited for another company or call them.
Always the same when there's a boom: prices goes up, availability gets tough, quality goes down and more hands get hurt/killed.
Fascinating information: thanks.
Leiten says: "I think that we won't be able to avoid an oil shock, but it may not be the end of the world, mass famine, die-off etc etc as some here are thinking. Especially if demand is depressed again in the near term."
And R says: "So just as the SG plays helped boost our NG reserve base AS LONG AS NG PRICES STAYED HIGH, the fractured shale reservoirs may have a similar effect as long as oil prices stay high enough."
So, it seems to me that if demand is depressed, by what - economic slump caused by too-high energy prices - then we may be able to continue as now as long as the price is just high enough to make the shale economic? This is a very delicate economic balance and the bankers projection seems to be indifferent to it, just indicating expected expansion; period. I see an economy getting more and more stressed with ever greater numbers of people falling off the economic merry go round as the energy price creeps ever higher, no matter how it is produced. Never do the realists contributing here seem to expect burgeoning energy supplies, merely a reshuffling of deckchairs, yet this energy growth is what economists expect and our economy demands.
Great posts by the way, and thanks.
U - Pretty much how I see it also: a very tender balance. And as such potentially very unstable. Which is why the above ground/political factors may play a bigger role in PO than the geology/drill rates/decline rates IMHO.
That looks like the front half of the bell shaped curve. Back half would be down to 2008 levels by 2024. Just a hiccup. I'm sure WHT could do a better technical job of that, I'm just throwing a standard eyeball at it and make no apologies for inaccuracy.
NAOM
More MS graphs: The Future Of The American Oil Industry. But they're nothing exciting - oil rigs and US prod is up a titch. Yergin gushes about how this will add another Kuwait or Venezuela, so prepare for invasion/assassination attemps, Texans. And look forward to indoor skiing.
Lower 48 production:
As can be seen the late 70s price spike was good for a nice 6 year long run on the treadmill. Gains in last two years that MS are crowing about were also courtesy of UDW in the GOM; slowdown that and subtract out losses to 2015 in PADD V from the shale oil promised above and what do you have left?
How about "oil shale" = kerogen, and "shale oil" = Bakken etc.? Easy to get confused about what's being discussed here.
It seems to me that as long as the cost of filling up the tractor with shale-sourced diesel is less than the cost of hiring horses and day laborers to do the equivalent work, we will continue to be better off than our Mesopotamian ancestors.
How much better off, exactly, seems an open question.
I have serious doubts, Bakken reaching 500 kbpd assumes oil at $200:
https://www.dmr.nd.gov/oilgas/presentations/ActivityandProjectionsWillis...
see page 16.
So define a dollar. My personal approach is to track oil versus gold, which has resulted in a general 10:1 ratio long term. Currently I see oil as historically priced at $150 so $100 is an historical bargain and indicative of oversupply.
Does the price of oil determine the price of gold? Dunno. All I Do know is that you can't print oil or gold. And until fairly recent history at least a fiction was maintained that paper currency [or digidollars] were convertable.
In gold terms, wages have taken a huge haircut unless you're in the upper echelon of earners whose multiples of basic wages have been recently lamented. I posit that in fact upper income earners have not seen a significant rise in absolute income but the general wage earner has been given a 70% cut. Unfortunately, real estate prices tracked gold and oil for a while until that didn't work out so well.
Things look so different when you stop paying too much attention to the slipping fiction of the printed dollar having other than notional value. The Euro seems a lame and late to the party attempt to cash in on trading paper for oil - of which the Eurozone has none to speak of. It doesn't matter whether WE believe our IOU's are good, only if our suppliers do.
Of course it could be argued that both oil and gold are in a bubble, but I see that as a negative bubble or implosion for paper would be reserve currencies. Track available barrels in ground versus dollars in circulation and see what I mean. What were we to expect?
Yeah missing from this whole discussion is that price discovery has, for a variety of complicated reasons, been completely compromised.
Importantly, though, peak oil reveals the Fed's bluff. A higher oil price, itself now reflective of impaired supply (independent of credit expansion induced demand), is debt deflationary. Bernanke cannot print without simultaneously crashing the real economy.
Unless, of course, the real economy gets off oil, severing the relationship. Fat chance! The global economy runs on oil, not dollars.
Bernanke won't fold, so I'm long gold.
Very informative article by Derek: bottom line is that fundamentals are opaque. Nobody know what nobody knows, a very large topic (value/utility) that is beyond a comment.
As for speculating, the basic premise of the arguments are correct but a large part is missing: the bubble mechanism and the effect of margin.
All markets in the world today whether stocks, bonds, commodities or futures are margin markets, that is, what is bought and sold on these markets is margin, the putative 'goods' being traded are simply 'tokens' or instruments by which margin is obtained.
While any particular good is useful in its own right, margin is useful in all rights. With sufficient margin, every good can be had. The goods/margin relationship is self- amplifying because the good is the collateral for the margin and the increase in value of one increases the value of the other.
The commondity markets are leveraged over 90% more or less: for some participants the 10% can also be margined so that a) extremely large positions can be made and b) small gains allow great profits. Margin is self- reinforcing.
If someone buys July WTI for $113, what they buy is $50 worth of oil (its amortized cost of extraction), the exchange fees, the carry or storage costs, the difference between the 'carry' and the cost of a risk- free investment such as 3 month Treasury ... the remainder of the price is 'value' or cost of the margin. The futures price (or stock price or house price or gold price) is the credit- value of the good, the cost of the credit being priced into it.
Houses are expensive because the 'value' of leverage provided by the mortgage needed to buy a house is embedded within the house price. Take away mortgages and the cost of the house would be what its intended user could pay with cash savings only: its 'rent'- or 'down- payment' value. Without credit, houses would cost 10% of the current price. The same is true of crude, without available credit/margin, the price of crude would be what people could afford from the cash flow spun off from the burning of the fuel, minus housing, dressing and eating expenses.
Since most folks don't gain anything from wasting fuel but some fleeting 'entertainment' effects, the price of fuel would decline below what it would costs to extract and refine it.
Arbitrage makes the credit price of the futures (margin) contract becomes the spot price of the physical good. Buying the physical in a margin market also requires margin.
Hence all the 'QE' talk and the effect of 'Fed credit' on markets by commodities' analysts ... even though finance itself, not the Fed, is creating the margin.
When a contract is bought or sold, the effect of the transactions by themselves -- the buying then the selling, the change in the float -- tends to be symmetrical. What changes the price over time is the effect of margin on the spread between the price asked for a good offered for sale and the bid made.
Margin effects the bid as it enables it. While the buyer generally must have margin, no margin is required to sell. The only exception is when there is a deterioration in a buyer's collateral position: he faces a 'margin call' and becomes an 'instant' unwilling seller.
The higher the price, the greater the collateral value and the greater the ability of bidders to access more margin in a virtuous cycle. It is this margin- propelled cycle that pushes prices and creates bubbles. Once started, everyone with margin piles on pushing the price higher still.
When there are many persons seeking to buy, the ability of the exchange to create contracts means there will always be an offer/ask at any given bid. In other words, if a trader wants to buy 100 contracts of March 2012 WTI @ $115 sellers will be found to 'offer' @ $115.25. If the bidder does not accept the price he won't be filled at all or only partially. He has a choice to up his bid and find more sellers, if there are none and the bid is above the market the exchange will create the contracts @ that new price.
Over time -- perhaps minutes -- organic offers/sellers are found.
When demand for contracts exceeds the organic supply, there will be more longs than there are shorts: the exchange (and its banker) will then become the 'short'. This occurs as the price is continually bid higher, the organic sellers are all bought out.
When this happens there are different levels of risk for each side. The long has credit/margin cost risk as well as the price risk that accompanies a squeeze. The short has the risk of an unhedged open position that -- if large enough -- can bankrupt the short in a squeeze in another market. These different risks are purely asymmetric. A rise in short term interest rates will make margin too costly (Hunt brothers) while the same rate rise makes shorting less costly b/c borrowing contracts to sell costs less than risk- free margin.
A highly leveraged market can have only one or two large longs (Hunt Brothers, silver) and one giant short (J.P.Morgan- Chase, silver). In any event, the ability of longs to gain margin determines the bid: the longs by accumulating their positions accumulate margin @ the same time.
Eventually, the price is bid to the point where margin becomes too costly and the bubble collapses. There is nothing to support bids, prices must fall to a level that margin -- or cash flow -- can support. Once the bubble reaches the peak, the market roles of bid and offer reverse. The single 'offer' created by the longs on the way up becomes the one-and-only 'bid'. The 'New Bid on the Block' has does not bid b/c he or she is short ...
The squeeze is on!
Sans bids, the price plummets. The Hunt brothers lost all their money as the banks on the other side of their massive long positions would not buy the Hunts' contracts and the Hunts could not meet margin calls. The Hunts' margin was shrinking too fast (and the Federal Reserve at the time decided to teach the audacious silver speculators a lesson.)
The same thing happened w/ real estate- and mortgage debt bubbles. High petroleum prices forced short- term interest rates so high the banks could not afford to borrow to fund day-to-day operations. Mortgage market makers required short- term repo money from the 'shadow banking system' (black market) to service longer-term debt. Once short term funds vanished, there was nothing for the banks to support their margin- inflated debts. Entities at the center of the repo- mortgage derivatives' (margin) markets -- Fannie and Freddie, AIG and Lehman Brothers -- failed.
As a squeeze takes hold, margin evaporates and longs are 'sold out' by their brokers. The bid- offer spread widens and becomes the measure of longs' loss. These losses can be catastrophic. The availability of margin propels bids on the way up and its absence on the way down prevents bids from appearing.
Besides intra- market margin there are derivatives: EFTs and options on futures that allow margin in these tertiary markets to 'arbitrage' prices upward. Producers can 'lease' their physical product for the purpose of creating 'phantom' bids to manipulate the futures price, which is a tactic that has been seen for awhile on the precious metals markets.
Search 'Chris Cook' here and you can find some highly informative articles about manipulation/speculation in the futures markets.
Keep in mind that all successful futures traders -- and there are many -- profit by the arbitrage between markets. The larger players can arb massive positions and exploit imbalances that they themselves create as a consequence of their making the positions using margin.
The increase in marginal value enables the end-user to actually consume the goods he bids for. Credit makes the world go around ... until it cannot any more. What happens next is the suckers who believe in a god- given right to waste 'cheap fuel' pay more than they can afford for the margin, being bankrupted by the 'purchasing' process. This is America, the world, the OECD and its wannabes; our crisis!
Couldn't happen to a nicer bunch of rapacious jackasses ...
Great post Steve, I'm going to save this and go through it very carefully. As you say, no one really knows fundamentals in this leveraged margin game. Last month it seems JP Morgan backed off on their massive naked silver shorts to allow the price to rise to $50, which stimulated weak speculative longs to pile. Then JPM piled their shorts back on while the CME successively raised margin requirements 5 times over a week or so. This planned take down crashed the supposed "bubble" in silver (even though the shorts have no metal backing them), bought them some more time to keep the gold / silver ponzi scheme going a little longer. As to the fundamentals of how much real silver there is left, who knows, but it doesn't look good.
Null, there are obviously a few things you do not understand about the futures market. But first let me say that when some commodity is very thinly traded, such as silver, it is possible for the futures market to cause sudden and dramatic swings in the market. Crude oil currently has over 12 times the open interest, (contracts) as silver. But sudden swings caused by the futures traders are usually very short lived. However if someone is actually buying massive amounts of the physical product, as the Hunt Brothers did, the swing could last quite a long time. Only changes in the availability of the physical product can cause long term price swings or trends.
The term "naked shorting" is sometimes used in commodities but this betrays the fact that all shorts are always naked unless you are hedging, just as longs are always naked unless you are hedging. Hedging is guaranteeing yourself a fair price for the physical commodity that you plan to sell or buy in the future.
In the commodities market one is either short or long. And for every long contract there is a corresponding short contract. It cannot possibly be otherwise. JP Morgan held a massive short position in silver. Remember that someone had to hold the corresponding long positions because for every short there must be a corresponding long. JP Morgan went short silver because they thought the price was too high and would fall. If that had happened they could then unloaded their shorts at a profit. That did not happen however.
The opposite happened, silver started to rise and JP Morgan began to panic. They rushed in to buy back their short positions. This did not, as you put it, allow the price to rise it actually caused the price to rise. This meant that as JP Morgan unloaded their short positions the price rose and they had to pay a whole lot more to close their shorts as the price rose.
This means that JP Morgan lost a bundle in this scheme. This was not a planned take down, it just worked out that way. They would much rather have made a bundle than lost a bundle. But that is just what happens in the commodities market sometimes.
Also shorts, unless you are hedging, have the exact same backing as longs, none. Shorting is nothing more than placing a bet that the price will fall. Going long is the opposite, placing a bet that the price will rise. Only a tiny fraction of one percent of all commodity traders are actual hedgers. Well, that is the case in oil anyway, other commodities may have a slightly higher percentage of hedgers... but only slightly.
Short Covering, Not Speculative Buying, Led to Silver's Parabolic Rise
Ron P.
Thanks for your response Darwinian. I understand that for every short there must be a long. It is a zero sum game. That is why the silver price "spike" happened. JPM covered its shorts and since it is the only significant player shorting this market (which is also illegal, since they hold too high a position), prices rose, and quickly. There was no one left to short. They did this because there is very little silver left in the world and in order to discourage more traders from taking delivery on the metal, and to keep the average PM accumulator from accumulating more metal (which would cause a default), they had to create the illusion of a bursting bubble and oversupply (even though the greatest bubble in history, the bond bubble, continues on despite every single US government bond in existence being completely and utterly worthless, worth about $0.00000000 based on fundamentals). This fabricated bubble burst was done for the purpose of destroying confidence in silver investors. So while JPM lost a bundle on the price rise, they then subsequently piled on more shorts near its peak at $50, when they coordinated with the CME and its onslaught of margin hikes. So they probably made most of that back on the other side of the fabricated bubble. But they are being shoveled billions from the Fed anyways, as its right hand man (or in the case of Blythe, woman) to eternally suppress PM prices. They can't let silver price rise to its true value because then gold would follow, and they have to keep gold suppressed, because it is the opposite of paper money. If gold suddenly went to $2500 because silver suddenly went to $300, well that would spook the system and the whole ponzi scheme that we call our monetary system would be over. Investors would scramble for the physical metal they thought was held in the phony GLD and SLV ETF's, and realize that there was none, and then that would be the end of money.
And it was my understanding that when you place a bet on a future price (long or short), you have to supposedly borrow some of that thing you are betting on, and how much you borrow is what the margin requirement is all about. But since JPM doesn't do this (illegally), it can create perpetual shorts and suppress silver prices to well below what would be the case if there was actual metal backing those shorts.
http://kingworldnews.com/kingworldnews/Broadcast/Entries/2010/3/30_Andre...
https://marketforceanalysis.com/articles/latest_article_081310.html
http://www.bullionbullscanada.com/index.php?option=com_content&view=arti...
No, that is simply not the case. You do not have to borrow anything, you simply have to put up margin money. That margin money is a guarantee that you can cover any losses. If the price goes up and you are short, or if it goes down and you are long, you may be forced to put up more money or your position will be sold out.
I don't know what the margin requirement for silver is right now but here is what they were last month:
COMEX Increases Silver Margin Requirements for Third Time in Past Week
What this means is that last month, when silver was trading at about $46 an ounce you had to put up $16,200 margin for one contract of 5000 ounces of silver or about $230,000 worth of silver. And if you were long and silver started to fall, it would eat into your margin money. Once it, your margin money, dropped below $12,000 you had to deposit enough to bring it back up to that figure or you would be sold out of your position. That initial margin was, at the time, about 7 percent of the value of 5000 ounces of silver.
But now silver is back down to about $36.20 an ounce so I guess the margin requirement has probably dropped a little since then.
I disagree with you on why anyone did this. No one did this this is just how things worked out. A lot of people lost a lot of money when prices fell and this included some very large funds.
You are under the wrong impression if you think funds, or anyone else who buys or sells futures contracts actually control any silver. They do cause wild short term swings in the market but silver and gold or whatever always come back to the fundamentals after the swings have run their course. If they actually buy and sell real silver bullion they may cause some real fundamental changes in the market.
The Hunt brothers did. They bought real silver bullion and also bought futures contracts. They lost their shirts in this crazy attempt to control the price of silver. Since then no one, to my knowledge, has had little enough sense to actually try to set the price of silver, or gold, via the futures market. It is dangerous enough as is without trying crazy schemes like that.
But NO, people who trade any commodity, be it gold, silver, pork bellies or oil, are not required to borrow any of the actual product to trade the futures. They simply need to deposit the cash in their margin account. This money is held by your broker to prevent the brokerage house from losing money if your position starts to tank.
Ron P.
Good post. One mathematical inaccuracy that I would like to nitpick on:
According to net export math, this statement is not necessarily true. The extra barrels used to satisfy internal demand growth, expressed as a fractional increase of internal demand, would not necessarily be the same fraction of the previous period's exports.
If 50% of production goes to exports and 50% goes to internal demand, then with flat production, the percentage growth rate of internal demand could (briefly) equal the percentage decline rate of exports.
However, if internal demand already appropriates 90% of production (say "P=100"), then a 10% increase in internal demand (i.e. from "90" to "99") would result in a 90% decline in export volume in the following period (from "10" to "1").
The same math works vice versa where the consumption / production fraction is still below 50%, such as Saudi Arabia. Currently, their internal demand growth is higher in absolute terms than the decline rate of the net exports.
This math, where net export decline rates start slow and then gather pace at an accelerating rate, makes the impact of net export peak and decline all the more "sudden" to the average uninformed person and therefore all the more insidious.
And note that all of the above was based on an assumption of flat production... if you redo the math to also account for declining production, the high percentage declines in net exports hit sooner and harder.