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22 July 2008

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Cieran

Colonel:

For an excellent (and very accessible) overview of the unfortunate role of speculation in modern finance, I'd strongly recommend Nassim Nicolas Taleb's "The Black Swan". His expose of how little so-called finance experts actually know directly supports your thesis here, and in a much larger venue than merely the energy trading markets.

mlaw230

A couple of questions w. comments;

1) There is an enormous distinction between hedging and speculation. It is also very difficult to determine whether the Hedge Fundies (i.e. the speculators) are driving the market because one cannot tell who is who, and anyone who tells you differently is telling you more than they know.

2) Price normally drops midsummer as at that time we have been in the refining of gasoline season since February and the prospects of change over to winter heating fuel is still a ways off. That is gasoline, not crude, but at this time of the year there is no other market for crude so gasoline sets the price.

3) You may well be right that this is a speculation bubble, but speculation usually relates to the greater fool theory of consumerism or amateur investment, and these players are not consumers.

4) Gasoline prices are going to go UP, not down,
regardless of where crude goes for the next 4-6 weeks, it is the only season dealers make any money.

5) Anyone who tells you they know definitively that they understand how petroleum is priced is either a fool or a liar.

6) The price of crude is, in my opinion more likely as high as it is as a hedge against inflation rather than a reaction to ME developments. The oil market is more cynical than that, they know that despots and democrats alike sell oil if they have it. with the dollar dropping like a rock, if you put your dollars in oil you maintain your position regardless of inflation.

WGM

Jonathan House

The assessment of a government task force, for what it is worth.

For Release: July 22, 2008

Interagency Task Force on Commodity Markets Releases Interim Report on Crude Oil

Washington, DC – Today, the Interagency Task Force on Commodity Markets (Task Force or ITF), chaired by the Commodity Futures Trading Commission (CFTC), released a staff report offering a preliminary assessment of fundamental and market factors affecting the crude oil market. The ITF’s Interim Report on Crude Oil studied fundamental supply and demand factors and the roles of various market participants, and it found that fundamental supply and demand factors provide the best explanation for the recent crude oil price increases.

The CFTC formed the Task Force in June 2008 to evaluate developments in commodity markets, in particular investor practices and fundamental supply and demand factors. The Task Force is composed of staff members from the Departments of Agriculture, Energy and the Treasury, the Board of Governors of the Federal Reserve, the Federal Trade Commission, and the Securities and Exchange Commission. Given the importance and timeliness of their research efforts in the crude oil market, the ITF is issuing an interim staff report limited to the crude oil market.

The report itself is not yet available that I can find but the press release can be found at:

http://www.cftc.gov/newsroom/generalpressreleases/2008/pr5520-08.html

JohnH

I'm still of the school that thinks much of the bubble was fueled by speculation about an attack on Iran. As a result, I find the lower prices -- suggesting that odds of an attack have diminished -- to be consoling.

Of course, it still could be the case that the markets are totally manipulated by a handful of market makers, as it could be the case that the former oil executives in the White House played their part in the manipulation by hyping the risk of an attack...

Mad Dogs

Pat,

Can I say how much pleasure I take in your tweaking of the noses of the non-believers? Makes my day! *g*

These are the very same folks who are always welcome in Lost Wages, Nevada.

Cold War Zoomie

I'm not going to declare victory quite yet. My prediction a few weeks ago was $95/bbl by 31 Dec.

I ain't sayin' nothin' to jinx it now!

Murphy never stops listening and watching.

Nicholas Weaver

No, the Economic Fundamentalists look at the huge demand destruction that has occured over the past 6 months (eg, US miles driven down 5%!?! The significant number of SUVs being replaced, to the point where there is a glut on the market), and observe that inelastic supply + inelastic demand can cause prices to drop as sharply as they rise when demand falls.

TomB

Col:

To a great extent I think you're just perceiving the term "fundamentals" differently than others. (Or me at least). You seem to mean the fundamentals in terms of long-term supply and demand. But for those buying and selling in the here and now and for the immediate future, the concerns about war with Iran, the closing of the Straits of Hormuz and etc. are fundamental too.

I don't know that anyone's denying that there's some speculation going on, but as someone said here on an earlier thread, there's gotta be both sellers and buyers in these transactions. So for anyone who believes people are wildly "speculating" by buying future oil at too high a price, then why not belly up to the conviction and get into a fund that's offering to sell it to 'em for less based on the certainty that you'll be able to get it at a lesser price and make a huge killing?

When Shaul Mofaz intimates that it's a near certainty that Israel is going to attack Iran and the price per barrel goes up $7 based on same alone *in one day*, seems to me that's pretty strong evidence that much of the price situation today is that people have simply been similarly reacting to other similar short-term "fundamentals."

I.e., lots of this is just terminological inexactitude with people talking past one another.

(And as a short-term "fundamentalist" and seeing that the price was up to $147 p/bbl and then fell, I think my prior prediction of the price maxing out at $150 per barrel and then falling is doing as good if not better than any long-term fundies' predictions, no?)

Cheers

Lysander

"My hat's off to all of you who can continue to believe that fundamentals and trivial news can explain the oil futures markets' action in the last couple of weeks. it takes real discipline to maintain that kind of position in the face of reality."

Colonel, you must admit the same could have been said about the oil bears as the price moved from 100 to 140 plus. As I recall that was/is all blamed on 'speculators' who apparently had faith the house of Saud wasn't going to drown them in their positions.

Oil is and always will be a volatile commodity. Katrina shot the price up to 70 and within 6-8 weeks it was back down to under 50, only to rise again. There was a similar jump and fall following the Lebanon war and in the beginning of 2007. Price drops of 30-35% made many think the oil bubble had passed. And yet always it rebounded with each new high higher than the last one.

Oil could continue to sell off. Panic selling is part of commodities trading. But I'm willing to bet that we will see the 140's and higher again this year.

Thanx,
Lysander

Andy

Well, back in this thread I predicted oil would be around $95-100 a barrel at the end of the year. I continue to think that prediction will not be too far off the mark.

Colonel, sadly you never gave us your prediction in that thread which leaves us unable to either praise or tease you come January!

Old Bogus

I agree with WGM's analysis. The WH is the cause of high oil prices from printing money like the Inflation Stimulus checks. Until the oil markets switch to Euros.

Patrick Lang

Andy

OK. I think we will see $80/barrel sometime before 1 January, 2008. pl

otiwa ogede

"the absence of major news can push the market down — just as incremental supply concerns previously drove prices sharply higher."

What does this refer to? What "major news" is absent? What "incremental supply concerns" drove prices higher?

The much publicized news of US-Iran engagement has little to do with the drop in oil price? I think not.

the price of crude didn't rise because it was just worth more to produce or ship it, and speculators do not operate in a vacuum.

Got A Watch

It is now politically correct to sell oil. But no market stands still for long.

So one day (probably within a few months) all the money now exiting the oil sector will rotate back to it, and the price will soar once more.

We are just one geo-political event or Gulf storm from that event.

Duncan Kinder

Meanwhile, back in Nigeria, the insurgency group, MEND, has threatened, "To prove that we are not a part of this deal, the Chanomi creek pipeline and other major pipelines will be destroyed within the next 30 days".

Apparently MEND was responding to reports that the Nigerian National Petroleum Corporation had paid twelve million dollars in protection money to gangs in the Niger Delta.

MEND stated that, to prove that it was not part of this protection racket, it would conduct these attacks.

The Niger Delta has been the site of militant attacks on oil facilities which have reduced Nigeria's output by about 25 percent.

Fred

"This is more of the long exit from the market by the hedge funds" ... who have performed magnificently in the 'creative destruction' of thousands of jobs while enriching themselves. This was achieved by the absence of accurate information and complete lack of regulation or oversight. I doubt that the EU or any other combination of nations on the receiving end of this type of economic warfare will sit still for another episode so that some immensely rich hedge fund owners and managers can fatten their wallets one more time by wielding their financial power in the 'free trade' marketplace.

zanzibar

Earlier on when some of the threads on oil began I mentioned that oil markets were in contango and that historically they correlated well with subsequent drops. It looks like that correlation held even this time.

Now on to the debate on speculation here's my cynics view:

- oil up: bad
- corn up: bad
- soybeans up: bad
- stocks up: good
- CDS up: good
- CDO squared up: good

On the way up speculators were blamed for the high price of oil. As Fannie & Freddie stock were hammered as their balance sheets showed insolvency speculators were once again blamed for short selling. And SEC chairman Cox who was completely absent while Fannie & Freddie were cooking the books and speculating on mortgage backed securities suddenly felt he had to regulate short sellers. While Hank Paulson was demanding nothing less than a blank check from the taxpayer to bailout Fannie & Freddie bond holders, equity holders and of course corporate executives who created the insolvency problem in the first place. When speculation in credit provided billion dollar bonuses for Wall Street and a "free" ATM to home speculators - Chairman Greenspan and Ben Bernanke and all the regulators could not see the bubble and believed that their role was to make the aftermath less painful. Now they can magically see the hand of speculators when another market rises rapidly beyond immediate supply & demand.

So what should one infer?

William R. Cumming

Business Week reports over $2Trillion in hedge fund monies that are unreported and unregulated! Wonder how much of that dabbles in oil? And today the Congress approved raising the US Debt Ceiling another $1Trillion. So it goes! Look for Paulson begging for authority (which he says he will not use) to bail out FNMA and FHLMC to go unheeded until after Labor day. This will cause stresses and strains because Russian, China, Japan, and Saudi's have huge bond holdings and are very very interested to know if these entities really are backed by US Govt. If they are then huge new trillions of debt ceiling will be necessary and actually debt of US will increase dramatically with treasuries crowding out stock (equity and bond)sales. Oil may be the least of our (US) problems by November. And of course if this scenario plays out President Bush will get full credit for bankrupting the USA both financially and otherwise. His place in history now is controlled by the financial markets in the second half of 2008 not 2001-2003 events. Look for a riveting post-Labor day session of Congress. Also look for a slug of recess appointments.

TomB

zanzibar, you stated that SEC chair Cox was "completely absent" in this Fannie Mae/Freddie Mac thing. But with all due respect this blaming of Bush here (by proxy) seems to me—like a number of other things—to be nothing but getting suckered by others into a "blame everything on Bush" thing. (Not to mention that I think it's just plain flat maybe even 180-degree wrong here.)

Just late last year the SEC nailed Freddie Mac with lawsuit that netted a $50 million dollar settlement for earnings mismanagement. And in 2006 the SEC sued and won a $400 million settlement from Fannie Mae for fraud.

And if you look at their history, I think you'll find that if anyone it's been Republicans and very possibly even Bush's admin itself that was rather constantly agitating for requring stronger capitalization from Fannie and Freddie, stonger oversight ability over them and etc., etc. And it was the Dems especially who ran interference for the two concerns, especially in at least one instance Chuck Schumer using the usual Dem. line about how the Republicans were "attacking" the ability of people to get home mortgages and other such "boob-bait for Bubba" crap.

And both Fannie and Freddie have been known as being kind of cushy, Dem out-of-office holding tanks, with Clinton's big buddy Franklin Raines having been put in charge of Fannie and then resigning in 2004 after SEC and regulatory investigators said that under him earnings were overstated to the tune of some $6 billion and that this allowed him and some other top execs to pocket as personal income some $50 million or so. (Although in his settlement Raines alone paid some paltry lesser amount still in the millions I think.)

So now people are blaming *Bush* for happening to be in the hostage seat when the chickens come home to roost for Fannie and Freddie and the Dems? Isn't it clear that the fundamental problem here is with the insanely skimpy capitalization requirements that *Congress* lays down for Fannie and Freddie rather than any lack of regulation? So what's the SEC supposed to have done about that? And are people *really* arguing that Bush *shouldn't* stand behind Fannie and Freddie given what this could very reasonably mean to the economy?

I don't like Bush one whit, but don't people realize that they are being played for boobs by others who are responsible for all kinds of things by letting that dislike blame Bush for everything under the sun?

Cheers,

zanzibar

TomB

All good and accurate points.

I was focusing on Cox in that here he is making a big deal about shorts when the broker/dealers are the biggest players in the naked short game. He was notably absent when they were playing the game earlier and making money at someone else's expense. But when the tables got turned here he is swooping into action.

He is however actively participating in a large number of accounting gimmicks being perpetrated by the banks and broker/dealers to inflate their earnings and asset values right now. Enron redux! Take for example Wells Fargo - they have now taken the period from when a home equity loan is classified as delinquent from 120 days to 180 days so their Q2 chargeoffs were reduced and voila increased earnings. Another common accounting scheme is to move Level 2 assets to Level 3 again with the express purpose of not having to take writedowns and increase reported earnings. This is directly defrauding investors, preventing the clearing of assets and ultimately leading to larger taxpayer bailouts. Where is Cox today in investigating the malfeasance of corporate executives who walked with billions of dollars of bonuses based on questionable financial performance?

Now in all fairness if you have read my posts on these topics in several previous threads I have been railing against the Clinton administration and in particular Bob Rubin, Alan Greenspan and Franklin Raines. How under the guise of "free markets" and the wonders of capitalism they repealed Glass-Steagall and stopped enforcing existing regulations that allowed all this leveraged speculation and gross abuse of shareholder capital and now ultimately taxpayers are on the hook.

The argument today is that if the GSEs and banks and broker/dealers are not bailed out by taxpayers the financial system will collapse. I don't buy for a minute that if share holders and bond holders of Bear Stearns, JP Morgan or Fannie and Freddie are not bailed out that we will have any sort of collapse. If we have to nationalize the mortgage market lets be straight and do it clean. If we do it then there's no reason why Bill Gross and the Chinese and Japanese and Russian sovereign wealth funds who are all sophisticated investors who were receiving an extra coupon on Fannie debt should not get a haircut and why shareholders shouldn't get zero. This pretension that we have a private system backstopped by taxpayers or else its Armageddon is the problem. That is what is being promoted by Paulson, Bernanke, Barney Frank and Chris Dodd as part of the Housing Bill. If the maxim is "too big to fail" then why allow these institutions to get too big in the first place and threaten the system due to unsupervised and in Greenspan's case cheerleading of leveraged speculation. Let's just have a nationalized mortgage and banking system and then we would not have to pay these guys millions of dollars in salaries. Then of course let's also get off the high horse of American capitalism!

Please note my biggest peeve is the kleptocratic crony capitalism that we have seen under both Democratic and Republican administrations and Congresses. This has directly lead to one set of rules for us plebes and another set for the well connected "oligarchs". And why our constitution now is best suited for a museum show piece.

As you can see I am waiting for the second coming of a Mr. Jefferson!

zanzibar

TomB

Where is the outrage? No people on the streets. No popular campaigns to break the incumbent protection racket.

Why no outrage?

The Fannie Mae Gang

mlaw230

A couple of points here too:

1) Fannie and Freddie are not natural creations of capitalism in the first place. The were created and intended to be a thumb on the scale of the mortgage market to encourage home ownership Low capital etc... was a problem of long standing but BECAUSE they were seen as being backstopped by the treasury, it didn't make sense to shorten them up.

2) These are not "subprime loans" these are, by definition, prime loans. That alone should put the lie to the idea that this is a crisis of overly optimistic homeowners, or that this crisis is anywhere near a bottom.

3) The risk here isn't to the stock holders, I suggest that they really don't matter. What is at risk is foreign investment that currently props up our debt and as long as it continues to flow, prevents run away inflation.

4) Neither a bailout of Fannie and freddie nor the Governments proposed "bailout" will actually bailout homeowners. In my view they have grossly underestimated the effect of this crisis because the consumer has nowhere to go, tighter credit is going to make homeownership and/or refis very difiuclt and wages are not there to work them out of this crisis.

5) Inflation as bad as it may be could offer some relief on the housing front, but only if it takes hold in real wages, and with globalization I just do not see it.

TomB

zanzibar wrote:

"TomB

All good and accurate points...."

As are yours. Esp. your previously made ones about the Glass-Steagal Act and etc., which now that you mention it I *did* see you make and just plumb forgot. Sorry. No partisan you by a long shot.

And I'm just as ... depressed about the lack of outrage as you are. Again it all seems to come back to me at least to this ... partisanship racket the parties got going where they both profit by same in distracting people with it from rightfully holding all of 'em responsible—as they are—for working together to as great a degree as possible.

Not gonna change soon that's for sure, just gonna be the usual same old same old. Obama will win I think, for a couple of years people will be all excited as if things are really gonna change, and then the letdown. (With the ME policy too essentially I'd bet.)

I dunno if you've seen but on other threads a few of us have kicked around a bunch of different ideas as to what the hell would best reform things, with me climbing on board the terms limits idea.

But, you know, I wonder if maybe an even better thing would be to just have national elections every four years for every single congressman and the Prez instead of this infernal staggered thing we got going. Reinforce the idea that they're all in the same boat and we can hold 'em all responsible collectively.

In any event, loved the "kleptocratic crony capitalism" description and wish it would catch on.

Cheers,

shepherd

Is anyone able to point me to the mechanism by which futures market speculation has an effect on spot market pricing? By my understanding, unless hedge funds are actually buying the oil and stowing it somewhere, I don't get how they're affecting the spot price by making futures bets. It's vaguely analogous to saying that I can affect the outcome of the Packers game by placing huge bets on tit. By doing so, I may affect the line, but not the game. I've heard there may be workarounds to this, and I'm curious what they are...

Jon T.

A guess at why no true and substantive (with teeth) Progressive Movement as yet: addiction to Professional sports, starting with viewing and following them, addiction to absorbing information from media without considering its source, intent, or effect on one's mind, and other, umm, "preoccupations". I am in no ways now suggesting a Straussian sinisteria provoking that state. It is just what it is.

Video games, IM, Facebook and the like dominate a lot of the youth in our high schools. Not all. A lot though.

Certainly not those who two months ago were high school seniors I've been seeing during BEAST Barracks at the USMA this the last few weeks.

Thus, right now, no foment, no massing of power at tipping points. As yet, that is, as yet. At least not in classically recognizable ways. Maybe the young people have something cooking somewhere inside their LinkedIn world.

A Manhattan Project for A Sustainable Economy and Self Reliant Energy Source IS POSSIBLE. It is. We can if we choose. We have to harness the power and creativity of our people. Somehow.

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