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Are Oily Characters Behind Crude's Price Move?

by: Investment U August 20, 2008 | about stocks: DBO / OIL / USO    

Investment U

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My last column on crude oil prices certainly generated a number of "interesting" responses.

If you recall, I mentioned that crude oil's pullback from a high of more than $147 a barrel in early July was long overdue. With demand decreasing and supply increasing, oil is doing exactly what you'd expect it to do - drop.

But some readers were angry, calling my analysis off base. And admittedly, it is from time to time. (Caveat emptor.) But not in this case with crude oil prices - and certainly not for the reasons they cited.

For example, one reader was incensed that I claimed oil rose sharply in the first half of the year while demand was actually falling. Not possible, he huffed, and took my editors to task for letting such an outlandish statement get by them.

But maybe my editors weren't asleep in the wine cellar (this time). The Energy Information Agency announced on Tuesday, the day after we published the column, that "U.S. oil demand during the first half of 2008 fell an average of 800,0000 barrels per day compared with the same period a year ago, the biggest drop in 26 years."

The "Bubble Theory" On Crude Oil Prices

This further supports my "bubble theory" of crude oil prices.

The price of oil was actually soaring in the first six months of this year while demand was taking the biggest drop since 1972. How long could we have expected it to last?

  • Prices go up when demand goes down for all sorts of reasons, ranging from supply decreases to market speculation. This particular reader would benefit from fellow Investment U panelist Mark Skousen's new textbook "Economic Logic." (It's all there - and quicker than taking a remedial course in Economics 101.)
  • Other readers swore that the drop in the price of crude oil has nothing to do with market forces and everything to do with the upcoming election.
  • Several claimed that "they" were making it fall until November - and it will go right back up once the election is behind us.

No word, however, on whether "they" is the Bush administration that wants McCain to win or the Democratic Congressional majority that wants Obama to win. Or, for that matter, how our elected officials have the money to influence the $4.78 trillion commodity futures and options markets, where crude oil prices are actually determined. 

(If you have the answers to these questions, please send them along. I promise to run the best of them. And the winner will get a special award, our trophy for "Spending Far Too Much Time on the Internet.")

"Animal Spirits" Driving Crude Oil Prices Higher

As I've been saying for months, it is "animal spirits" - speculation - that drove crude oil prices higher while fundamentals deteriorated.

As long as all trading activity is transparent and prices aren't being manipulated, there's nothing wrong with this. Whether it has all been above board, we're about to find out, as both Congress and the Commodity Futures Trading Commission are investigating some suspicious trading activity.

As The Wall Street Journal reported Friday, "Data emerging on players in the commodity markets show that speculators are a larger piece of the oil market than previously known. The number of futures and options contracts held by traders counted as speculators - those who don't have a commercial need to mitigate the risks of energy prices in their business - rose to 49% of all crude-oil bets outstanding on the New York Mercantile Exchange, up from 38%."

But, under normal circumstances, speculators are a help, not a hindrance. They add liquidity to the market. And when they distort prices - as they occasionally do - it gives us opportunities to sell at inflated prices or buy at unreasonably low prices. What's not to like?

The only investors who get hurt are the ones who buy into the hype - in this case the "peak oil" story - and get trampled when prices revert to the mean, as they always do eventually.

If we don't like this, we can do the smart thing and not play with fire in the futures and options markets. 

Or we can write our congressional representatives. I expect my mailbag this week will tell us which ones…

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This article has 23 comments:

  •  
    Aug 20 07:57 AM
    Great article. I got burned in the tech bubble and learned alot. Got burned again in a gold bubble, learned more. Watched the housing bubble collapse and investing again in housing to re-build. Now making a ton off the oil bubble collapse. (Started shorting oil mid July.) When the price moves due to talking heads and not fundamentals, watch out.
    Reply
  •  
    Aug 20 08:27 AM
    we knew all along that bubble was caused by speculators & hedgie funds.
    > jack
    Reply
  •  
    Aug 20 08:29 AM
    I'm afraid the only bubble here is the one you live in... US demand may have declined but 2008 demand has increased. Supply has increased only slightly this year after 4 years of flat production. The reason for the recent price decline is purely fundamentals. US/Euro demand is weakening, but crucially Chinese demand has weakened in the last 2 months becasue of the build up to the Olympics (wondering where the smog was?) this will change as the factories and the traffic are allowed to restart. $130 this time next month.
    Reply
  •  
    Aug 20 08:50 AM
    I'd like for the author to pursue Aceditor's point regarding US demand versus global demand. In the end, it doesn't matter what US demand is doing, it matters what overall worldwide demand is doing. A counterpoint is that US demand is a large portion of the worldwide demand, but our drop in demand was not that big. But if the US heads into a recession (or deeper into the current recession) it will probably impact other nations as well, dropping their economies and potentially causing their demand to drop as well, only delayed from US drop. Have I firmly sat on the fence on this issue??

    The US dollar strengthening is a big driver of the the drop in oil, just as it was a big driver in the rise of oil. The dollar has strengthened but there are many who believe that this is window dressing and the real foundational problems in our banking system, our money printing, the FED's inability to lower rates to stave off the recession and the outright lieing done by our government regarding inflation all point to a financial disaster. Will the dollar maintain the strengthening it has recently enjoyed should Lehman and/or another major bank go under?
    Reply
  •  
    Aug 20 09:10 AM
    Acreditor is right. Supply and demand determine oil prices, which will soon skyrocket.

    According to energy investment banker Matthew Simmons and most independent analysts, global oil production is now declining, from 74 million barrels per day to 60 million barrels per day by 2015. During the same time demand will increase 14%.

    This is equivalent to a 33% drop in 7 years. No one can reverse this trend, nor can we conserve our way out of this catastrophe. Because the demand for oil is so high, it will always be higher than production; thus the depletion rate will continue until all recoverable oil is extracted.

    Alternatives will not even begin to fill the gap. And most alternatives yield electric power, but we need liquid fuels for tractors/combines, 18 wheel trucks, trains, ships, and mining equipment.

    We are facing the collapse of the highways that depend on diesel trucks for maintenance of bridges, cleaning culverts to avoid road washouts, snow plowing, roadbed and surface repair. When the highways fail, so will the power grid, as highways carry the parts, transformers, steel for pylons, and high tension cables, all from far away. With the highways out, there will be no food coming in from "outside," and without the power grid virtually nothing works, including home heating, pumping of gasoline and diesel, airports, communications, and automated systems.


    Reply
  •  
    Aug 20 09:31 AM
    Obviously according to the articles analysis oil and gas supplies are infinite, and geology is unimportant.
    We are not going to 'run out' of oil or gas, but new supplies are increasingly expensive and flow rates low - oil may cost around $80/barrel to extract now, as against $5/barrel for the early, large fields.
    In addition to this, the sour oil which is left needs sweetening with substantial amounts of natural gas.
    Increased prices won't lead to greatly largere amounts of oil any more than increased prices for buffalo hides led to increased supply after too many had been shot.
    Reply
  •  
    Aug 20 09:48 AM
    I think you are right on about oil and pricing, I am sick of the traders forcing the prices up for no good reason. I hope they all loose thier shirts!
    Reply
  •  
    Aug 20 09:52 AM
    I already wrote my Congressman and Senators and sent them Professor Michael Greenberger's report ( in case they did not see Greenberger's testimony on June 3, 2008 to the US Senate Committee). I have had responses from all three. They plan to pass legislation so that I don't have to pay $4.00 a facking gallon for home heating oil.

    Prior to June 3rd, the public was being told there is no speculation going on in the futures markets. We were being lied to.

    This time, the GD speculators have distorted the economy, stupid.

    Go To:

    www.stopoilspeculation.../

    if you are not a speculator and want to see lower oil prices.

    If I sound angry...I AM.
    Reply
  •  
    Aug 20 10:45 AM
    I want a Lamborghini fo $30,000. Who is pushing the price to $200,000? I am going to write to my congressman to legislate the price of Lamborghinis down to $30,000. After all, I am an American and I have a birthright to have anything I want for a price that I want to pay. Also, I don't want to mine the ore for the Lambo in the US because I want a pristine environment. And I am mad as hell!
    Reply
  •  
    Aug 20 10:52 AM
    Guys - quit being so short sighted...the pricing bubble is speculator driven...go back and read teh GS' GSCI "Investing and Trading in teh GSCI"...they clearly have coaxed huge mnonies inot the comodity arenas that shouldnt be there - and they trumpted the price of oil into the stratosphere to support the promises they have made in these offerings...quit being so blind as to the realities... world supply has been and continues to be aheada of world demand by 1 mmbd or more...and will continue to be there - in 3 to 5 years ann lot of new oil will hit the market and gas refineing capacity goes up significantly by the end of this year as foreign refineris come on line...do you guys not know how gas we ship overseas?
    Oil should never have crossed the $85 mark this year...and would not have if GS, MS JPM BB and the Bush/iran/Putin juggernaut had not wanted it to do see...
    Pls. wake up.
    GT
    Reply
  •  
    Aug 20 10:56 AM
    Sorry for the mis types - AND BY THE WAY - where is this statistic of Matt Simmons that says that world daily oil production is 74 mbpd. That is roughly 10 to 11 mbpd short of demand - this number has been batted around for some time and is just plain wrong - see the IEA and the EIA, etc. If we were running that much of a shortage, we would be seeing major lines at the gas stations and oil at $300 - wake up!
    GT
    Reply
  •  
    Aug 20 10:57 AM
    if oil's so scarce or cheap...why no M&A?
    Reply
  •  
    Aug 20 11:48 AM
    The 74 million barrels/day is just crude oil. The bigger number everyone talks about (roughly 86) is crude plus other petroleum production. You can draw your own conclusions about the value of citing just the crude oil number when it's not all that matter, even on just the supply side.
    Reply
  •  
    Aug 20 11:52 AM
    Hey DownOnMyLuck,

    You made my day with your comment!!!

    Ya know, when Peak Oil really hits, these "mad as hell" types are going to be in tizzy when they can't get on the phone to call their congressperson, can't get on the Internet, can't even watch TV or listen to the radio to find out happened. It will all come to pass after the last power blackout. People should Google: peak oil impacts -- in order to see what lies ahead.
    Reply
  •  
    Aug 20 11:57 AM
    Help!

    We need Congressional intervention to drive out the SPECULATORS who are causing the price of oil to fall.

    Where are the Liberals when when we NEED them. Oh, on vacation, you say, on their private jets promoting their loser book tours?

    Well, guess what, guys? We're going to send them on vacation PERMANENTLY in a couple of months!
    Reply
  •  
    Aug 20 11:59 AM
    To the deluded of which there are obviously no shortage. Ok oil demand in the U.S. was down by 800K per day. So what our economy especially the construction biz was decimated. Some are conserving great! But guess what according to the EIA our petroleum inventories are down by 50 million barrels during the last year. So inspite of less demand our inventories still declined by around 5%. H-m-m-m price goes up, demand goes down and inventories still decline to levels well below what are considered average. That's the bigger picture, supply is not increasing and high prices are rationing demand. That's the way its supposed to work. No lines in the U.S. well that's due to the higer price rationing the demand. Look a bit harder around the world and you will find that lots of developing and 3rd world country consumers have been priced out out of the market due to those high prices. Translation high prices are here to stay because that rations demand. The other factor most refuse to examine is that the countries exporting crude are getting richer by the day and as a result they increase there consumption lowering the supply for the rest of us. Just yesterday Russia (2nd largest exporter) announced their exports are down around 5.3% vs. last year while their production was flat.
    In regards to Simmons he is talking about crude oil, the other 11 mbpd is made up of ethanol, Natural gas liquids, Refining gains etc. Light sweet crude the mothers milk is in decline, and the other heavy sour, and tarsands take a lot more energy to refine thus less NET energy to count. If you really want your emotions and ignorance guide your opinions so be it. But really ignorance is no excuse. Delusion is a short term fantasy soon to be destroyed. Get the facts and get ahead of the curve.
    Reply
  •  
    Aug 20 12:03 PM
    And that's right!

    It MUST be Big Oil behind falling oil prices. See, this is only a pre-election ruse to lose money and get the Liberals re-elected.

    I look for $60 oil and $2 gasoline again by election day myself.

    Give me a break!
    Reply
  •  
    Aug 20 01:54 PM
    a lid will be kept on oil prices by bush/cheney & their houston millionaire oil friends until after nov.4 at which time the not-so-free-for-all will begin anew.
    > jack
    Reply
  •  
    Aug 20 03:52 PM
    Clifford Wirth: Please stop cluttering comment sections of every oil related article out there with your canned comments. I cannot tell you how many times I have read your identicle posts promoting your website. Could the reason you want people to google "peak oil impacts" be that your website is at the top of the list?
    Reply
  •  
    Aug 20 09:54 PM
    US demand is not the sole driver in a global market, GLOBAL demand is. And global demand is forecasted to go down due to the deepening recession, which is expected to last well into 2009, if not far beyond.

    In terms of the speculation boogeyman, Cheney, Bodman, IEA, EIA, and even the Commodity Futures Trading Commission (CFTC) says that speculation did not drive the oil price rise.

    www.cftc.gov/stellent/.../@newsroom/documents/f...

    "The Task Force’s preliminary assessment is that current oil prices and the increase in oil prices between January 2003 and June 2008 are largely due to fundamental supply and demand factors...the Task Force’s preliminary analysis to date does not support the proposition that speculative activity has systematically driven changes in oil prices."
    Reply
  •  
    Aug 21 04:16 AM
    skyemoor- You are right about speculation, it cannot be blamed for the rising prices as more down bets were placed than up bets, when the prices were rising. You are WRONG about demand though, the IEA forecast global demand to grow 0.9% this year, 1.1% next year, most of the demand grow coming from countries that subsidise gas.
    Reply
  •  
    Aug 24 10:28 PM
    aceditor, how recent are those forecasts (please provide links)?

    If more than a month old, they are OBE.

    US and Global Economies Slipping in Unison
    Reply
  •  
    Aug 24 10:29 PM
    www.nytimes.com/2008/0...

    (apparently, one cannot use html embedded linking on this site)
    Reply
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