10 Notes on the Crude Oil Fixation
In different economic eras, different things attract the attention of the media, investors, politicians, etc. Today a leading attention grabber would be crude oil, and the energy complex. It is a honeypot for conspiracy theorists and unscrupulous politicians (not quite an oxymoron).
1) Fuel is subsidized across much of the world, particularly in countries where there is a large state owned oil company. Current high prices are making it difficult to maintain those subsidies, so countries like Egypt and Indonesia are reducing subsidies. Yet subsidies are not being eliminated everywhere yet.
2) Speculators — perhaps they need a new name, and a branding campaign. Risk bearers, maybe. I don’t know. But discouraging speculation by raising margin requirements will not necessarily decrease the cost of crude — those who are short crude also face margin requirements.
Now, many commodities have no futures contracts. On average their prices have increased more than those that have futures contracts recently. That indicates to me that those that have futures contracts are not in a bubble.
Some look at the dollar change in prices and think that speculation must be high. Bespoke does a good job in breaking it down into percentage terms, which indicates that the oil market has been more volatile more than half a dozen times in the past.
Do speculators include the ordinary schmoes like you and me who use ETFs? I’ve used currency and stock and bond index ETFs, but not commodities so far. Amazing how the trading interest on commodities has grown through ETFs — here’s another good chart from Bespoke.
As I have commented before, I think the run-up in the price of oil is fundamental, not manipulation. Ignore the futures, and just look at spot prices — it is hard to affect where the real buyers and sellers trade in a global commodity. If prices get too high, like the last move of OPEC in the 1979, where they overshot, and supply eventually overwhelmed their too high price.
3) We could be in overshoot mode now; it’s hard to tell. As I have said before, sustained high prices are necessary to create the investment in alternative technologies that save energy and produce energy more cheaply. I don’t think that it will happen quickly though… in the early 80s, oil prices edged down, and then came down rapidly in the mid-80s. It took a while for the new supply to be developed, and for conserving technologies to be created and deployed.
If you want a current example, think of the new big oil field found off the coast of Brazil. It will be three years or so until we see new production there. Another example is that it is hard to ramp up additional production from existing fields. If you try to force more oil out more rapidly than is prudent, you can destroy the long-term viability of the oil fields.
4) But, there are dissenting voices, whether wishful ones like this one from a Japanese Vice Minister, or this article from Fortune which is more nuanced. His arguments sound like mine, but on a faster timetable, with less consideration for future depletion. This article from the Dallas Fed is similar; though it says that it will be difficult for oil to stay over $100/barrel in 2008 dollars, they have a ten-year horizon on that forecast. Hey, even I think that oil will drop below $100/barrel within 10 years.
5) Now, there is demand destruction. We are already seeing it in the UK. We are not seeing it in China, yet. Part of the difference has to do with China subsidizing gasoline, which blunts the market effect.
From this article, within a year gasoline demand is pretty inflexible with respect to price. Beyond one year, people adjust their behavior.
And, it is worth noting that OPEC thinks demand in the US and globally is shrinking. They are probably right, though the effect on price is problematic, because many oil producers can’t produce what they used to — Mexico, Venezuela, Indonesia…
6) Now, this article indicates that changes in demand for oil have been more significant than changes in supply. Whether that will be true in the future remains to be seen, but as the rest of the world gets better off, they will demand more energy. A wealthy life is energy-intensive.
7) Inventories are light compared to average, but I’m not sure that is as big of a factor as many indicate. At the edges when inventory is close to capacity, or when it is close to running out, that has a big impact, but in the middle zone, the impact should be modest.
When I read this summary of a speech by Donald Kohn, I concluded a few things:
- The Fed is stuck.
- Because the Fed is stuck, it will let things drift for a while.
- A certain amount of idealism is waning inside the Fed, with a creeping suspicion that they aren’t wizards, but only sorcerer’s apprentices.
9) It has been a long term theme of mine that the oil that is easiest to refine would get relatively more scarce. This article from Naked Capitalism is another demonstration of that. And, for those who want a stock pick, that favors Valero (VLO), which can refine the heavy and sour crudes.
10) A large part of the US current account deficit is the increase in the price of crude oil. Eventually, the decline in the US Dollar will stimulate exports, but for a while, the J-curve effect remains in place, and the Dollar takes a beating. That beating isn’t happening at this instant, but it has gotten hit over the past several years. I’m not sure that this recent rise is the reversal, but there will come a time when the current account normalizes. Hopefully other nations will liberalize trade; that would do it in its own.
Disclosure: Long VLO; market weight in energy stocks.
Related Articles
|
Trading Center
Hedge Fund Jobs
Job Seekers: Search jobs by category, get job alerts by email or live feed, apply online See full list of jobs »
Employers: See all recruitment options, get applications online or by email Post a job »
This article has 15 comments:
- theinvestingspeculator
- 133 Comments
My Website
Jun 16 09:58 AMtheinvestingspeculator...
- longoil
- 116 Comments
Jun 16 10:08 AMExcellent article. You bring up many good points.
I have the following remarks.
On point 2), prices were not corrected by the fact they were too high (indeed they were, 16 times increase between 1973 & 1981), Correction occured because of the new OECD production (North Sea, Cantarell and Prudhoe bay) that came online in the early 1980's flooding the market with 10 mbbl/day of new supplies, at a time when the world using 50 to 55 mbbls per day)
On point 9) I agree fully the world is running of sweet and easy to find oil. I believe heavy oil refiners like Valero will lose their advantage because of two key reasons: 1) The $5 to $10 discount between sweet and heavy oil will disappear as sweet crude supplies dry up completely 2) Many other refiners are upgrading their facilities for heavy oil as sweet crude becomes more scarce and Valero will lose its competitive edge.
- zenalgorithm
- 158 Comments
Jun 16 10:11 AM- junkyarddog
- 62 Comments
Jun 16 10:15 AMHas demand for oil increased over 600% since 2001 like oil prices did? Weak dollar: has the dollar lost that much value to justify these high prices? Even after losing over 30% in value since 2003, oil went higher much disproportionally to the dollar.
I'm not arguing either way, every one already has their own opinion. But to say that contracts "help" stabilize somehow the price of oil and this is not a speculative market -- as in my very simple 2 examples above -- is ground breaking theory. I just wish the author would elaborate more and make a case for that.
- chistletoe
- 42 Comments
Jun 16 10:17 AMMethinks that all the stuff about "speculators"... in the media is coming from the human nature to want to blame someone else (anyone else) before having to alter one's own behavior. However, a pretty good case can be made that more and more people are "hoarding",
and it might be good to start using that word instead.
- Al Fin
- 6 Comments
My Website
Jun 16 10:36 AMYou forgot to mention the political prevention of new oil refinery expansion by Sierra Club and the State of California AG Jerry Brown.
Peak oil doobies say there's an oil shortage, but what they mean is there's a shortage of light sweet crude. Not the same thing. If the politicos and enviros let the refineries expand to refine the glut of heavier more sour crude, the "fundamentals&quo... would change pretty quickly.
- JWG460
- 12 Comments
Jun 16 10:45 AMYou meant "not quite redundant" of course...
Politicians, even those still encumbered by the odd scruple, may be morons but they are not oxymorons.
- anaconda
- 36 Comments
Jun 16 11:09 AM1. Showing a demonstrated capacity to increase oil production would do a lot to flatten the market.
2. showing a capacity to swing into balance both U.S. trade and budget deficits would help flatten the market.
3. Two above, and Fed tools, showing capacity to maintain the value of the Dollar on international currency markets.
4. Showing the United States, in particular, has the 'political will' to explore and produce oil from the most promising locations, wherever those locations are.
Publicize the ultra-deepwater, deep-drilling oil plays like Carioca off the coast of Brazil. These type finds are the future of oil. Offshore is the future of the oil exploration and production.
Check out Oil Is Mastery, which focusses on the ultra-deepwater, deep-drilling sector of the oil industry.
"Peak" oil is a load of Bull -- oil isn't about to "Peak". Oil Is Mastery proves it.
- longoil
- 116 Comments
Jun 16 11:18 AMThe falling US dollar is only partially responsible for rising oil prices.
During 2002 to 2008 oil prices prices went up 6 times in US dollars.
During the same period oil prices went 3 up times in Euros.
I used 2002 as the starting point because the Euro and USD were at par back then.
Peak Oil is real !!!
I suggest you read Hubbert, Campbell, Deffeyes, Hirsch, and Simmons.
- iThinkBig
- 751 Comments
My Website
Jun 16 06:43 PM- flow5
- 338 Comments
Jun 17 01:00 PMAs for the J-curve, I don't think it applies to the U.S., esp. since 85. If it did work then the 30% decline in the trade-weighted exchange value of the U.S. dollar since 2000 would have substantially narrowed the current account deficit.
Paul Craig Roberts tells the real story: "A quarter century ago US oil imports accounted for the US trade deficit. The concerns expressed over the years about "energy dependence" accustomed Americans to think of trade problems only in terms of oil. The desire to gain "energy independence" has led to such foolish policies as subsidies for ethanol, the main effect of which is to drive up food prices and further ravage the poor.
Today oil imports comprise a small part of the US trade deficit. During the decades when Americans were fixated on "the energy deficit," the US became three to four times more dependent on foreign made manufactures. America's trade deficit in manufactured goods, including advanced technology products, dwarfs the US energy deficit."
- flow5
- 338 Comments
Jun 17 01:05 PM- anaconda
- 36 Comments
Jun 18 02:55 AMLong oil, your argument proves my point -- oil rose more in Dollars than Euros because the Dollar fell in relation to the Euro.
Longoil the guys you mention are a bunch of hacks, shilling for "Peak" oil. I've read their stuff -- a lot of it is outright garbage. And since you're invested in oil - long, I must presume you're a shill too, for your own interest.
Continental shelf and margin oil deposits -- they're huge and virtually untapped, in other words, "scoreboard baby!"
Sorry Flow5, while manufactured goods is a large part of the trade deficit, with the cost of oil this high, that part of the trade deficit is 400 billion, roughly half the total. And Paul Craig Roberts agrees with me -- I read his latest column.
You are right about cost and quality -- as far as it goes, but America needs a "better deal." It makes no sense to have American goods taxed twice: Once in this country and once on the dock in China, while Chinese goods are rebated their VAT for products exported to America and not taxed, here.
In other words, Chinese products imported to America aren't taxed at all. That's not just a bad deal, that's a "Raw Deal."
America can get a better deal, so China will respect us in the morning -- right now they don't -- we're cheap and easy like a Five Dollar whore.
iThinkBig, no the smucks in Washington are getting the message -- the citizens are marching with pitch forks and torches to the Capital.
That sends a "Big Message." By the time the elections roles around even Democrats will be singing a different tune on offshore drilling.
Their political skins are on the line -- that gets their attention.
So, there you have it, all the world's wisdom in a nutshell. Ha Ha.
- YogiG
- 39 Comments
Jun 18 10:35 PMWon't matter how much oil we drill or the Saudis pump, untill these new, enormous maverick stock funds get out the commodity futures markets, there is going to be TOO MUCH MOENY Chasing OIL and the other commodities and we will see nothing but outrageous prices!!
YG
- YogiG
- 39 Comments
Jun 18 10:35 PMWon't matter how much oil we drill or the Saudis pump, untill these new, enormous maverick stock funds get out the commodity futures markets, there is going to be TOO MUCH MOENY Chasing OIL and the other commodities and we will see nothing but outrageous prices!!
More by David Merkel
Articles on related themes
Editors' Picks
Economy
Oil Price
Specialty ETFs