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24 July 2008

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JohnH

Just in time for the presidential elections...

William R. Cumming

Could it be that some were beginning to recognize that oil over $150 barrel might just doom McCain well before November? Just a thought! Also note that subsidizing energy prices took a cut in a number of countries including China and India over last 90 days thus reducing demand. My intelligence is that China stockpiled like crazy before the Olympics (their version of the SPR) to make sure no shortages during the Olympics. Hey who knows but fun to speculate when you have already gone over to driving every OTHER day except in an emergency.

11B40

Just to add a wee bit of fuel to this fire:

http://www.laobserved.com/biz/2008/07/the_mysterious_semgr.php

Given its significance, the oil futures market could use some greater transparency and/or business media could do a better job of reporting. Until then, tidbits like this one will have to do.

Curious

Congress Pursues $80 Oil With Trading Limits, Disclosure Rules

(Bloomberg) -- Congress may outlaw elements of oil futures trading that lawmakers found distorted demand and contributed to the 69 percent surge in prices in the past year.

U.S. legislators are considering limits on the number of oil contracts an investor can hold and may increase disclosure requirements. Speculators such as Goldman Sachs Group Inc. use the practices to bet on price swings, which may drive up prices, though they have no intention of taking delivery of underlying goods, lawmakers say.

http://www.bloomberg.com/apps/news?pid=20601109&sid=aI3KfJ0v2akE&refer=home

heh. They should do like any other sensible country. Nationalized oil companies.

OIL company is a threat to national security. ALWAYS. All of them.

There is no such thing as "free market" in oil industry.

SubKommander Dred

Charlottesville, Virginia
24 July 2008

Sir;
I don't think I understand where you are headed with this. Is it your assertion that the rise in the price of oil over the past several years is not supported by the rise in consumption? As someone who has obsessively followed the price of energy in general and crude oil in particular, there is a distinct pattern of oil climbing in price, then backing down a bit, only to rally and find a new high, from which it descends again. This pattern has occurred pretty consistently over the past several years, certainly since I started paying attention to it in the summer of 2005. As other folks have pointed out, both on this site and others, we live in a world that uses oil in volumes we have not previously seen, and there is some serious concern about the ability of OPEC and others to maintain that output. Indeed, from what I have learned about 'The Oil Situation,' the only thing that will cause a significant and sustained drop in oil price would be a likewise decrease in demand, not just in the U.S. but around the world. And the only way I see that happening is with a global economic meltdown. Now, the way things have been going of late, this certainly could be in our future, but as long as demand continues to grow, especially in China and India, I think this decrease in oil price is a transient thing at best. As for the talking heads on CNBC and others, I stopped paying attention to anything they had to say a long time ago (right about the time we invaded Iraq). If I want to watch clowns perform, I'll wait for the circus to come to town.

SubKommander Dred

LJ

http://www.theoildrum.com/node/4334#more>CFTC Report on High Oil Prices - "Speculation My A$$"

Patrick Lang

All

The CFTC is just another Washington adjunct to the powers that be both in business and politics. Nothing you hear from Washington is ever disinterested. nothing.

Dred

There is a long term need to address the global energy inadequacy.

The short term inflation in prices that we have seen has been driven by investment in barrels of oil as though they were poker chips. pl

11B40

And now comes word of a different trading firm under investigation:

http://biz.yahoo.com/cnnm/080724/072408_cftc.html

And the investigation is being conducted by the CTFC. Without respect to this individual case, would it stretch credulity to assert that, with the incredible amounts of wealth at play in the global oil market that sharpies of all descriptions would be doing their devious best to game this system?

TomB

Curious wrote:

"They should do like any other sensible country. Nationalized oil companies. OIL company is a threat to national security. [sic]."

Ah yes, because the gov't has done such a bang up job on so many things, such as with ... national security and Vietnam and the handling of the Middle East, and with Fannie Mae and Freddie Mac, and with its handling of the budget, and with the looming tsunami of Medicaid and Medicare costs of the Baby Boom generation, and with ....

I guess Francois Furet was wrong and the illusion hasn't entirely passed.

Cheers,


Mad Dogs

I've got to say Colonel, I'm constantly amazed at all the lambs who seem to be able to find any excuse in the world for not believing in wolves.

I read constantly of "experts" who produce 1,000 page tomes that seek to sweep under the rug and sanctify all that is rapacious and ill-serving.

I read the continuing reference to entities naively called "Hedge Funds" as if this would somehow render these folks "innocent and wholesome".

After all, one might besmirch their character to call them what they really are; namely "Speculators".

How interesting that these benign and freedom-loving "Hedge Funds" never seem to take delivery of what they buy.

How interesting that these ethical and upstanding corporate citizens always seem to "buy low and sell high".

How interesting that these wondrous zealots of the "free market" always seem to be against investigation of their activities, against regulation of the markets they manipulate, against any light being focused on their double-dealings.

Yes, the world consists of nothing but fluffy, cute lil' ol' lambs who are just doing their part to keep our hedges well trimmed.

And I've got some oceanfront property in Phoenix to sell. Interested sheep folks can just email me their credit card numbers, PIN information for their bank accounts, their Social Security Numbers, and the deed to their homes.

I'll get right back to them with all the glorious details about enjoying their new oceanfront sunsets on the beaches of Phoenix.

Jonathan House

A propos the government task force report you write: "The CFTC is just another Washington adjunct to the powers that be both in business and politics. Nothing you hear from Washington is ever disinterested. nothing."

I believe you have pointed out that while it is wise to 'consider the source' the arguments and data from even the most suspect sources should be evaluated.

With that in mind, below is a pertinent excerpt from the report. I wonder if there are any specific assertions in this excerpt which should provoke skepticism?

... "The imbalance between scarce supply and growing demand, and expectations that this imbalance will persist in the future, have led to upward pressure on oil prices and greater market reactions to any actual or perceived disruptions in available supply. Under such tight market conditions, it is often the case that only large price increases can re-establish equilibrium between supply and demand. Consequently, large or rapid movements in oil prices are not inconsistent with the fundamentals of supply and demand; such price movements, by themselves, do not indicate that prices have become divorced from fundamentals. Moreover, if speculative positions, rather than fundamentals, were pushing prices upward, then inventories would be expected to rise. To date, there is no evidence of such an accumulation; in fact, known inventory levels actually have declined.

Analysis of Crude Oil Futures Markets

Activity in crude oil futures and options contracts has been increasing since 2004. During that period, the number of contracts outstanding (known as “open interest”) has more than tripled, and the number of traders has almost doubled. The fastest growth in open interest has been recorded among non-commercial traders – often called “speculators” – holding spread positions combining long positions in one month with short positions in another month. Thus, while the long positions of non-commercial traders have increased, the short positions of non-commercial traders also have increased. Additionally, although the net long positions of non-commercial traders have increased somewhat since 2004 – which some market observers have hypothesized has pushed prices up – the proportion of those positions has been relatively constant as a share of open interest over the last few years, undercutting that hypothesis.

Much of the attention related to participants in futures markets has focused on the role of commodity index investment funds and the commodity swap dealers that often act as their intermediaries. During the period studied, January 2003 through June 2008, pension funds and other investors have increasingly used index funds as vehicles to participate in commodity markets. Some observers have suggested that this rapid inflow of investments through index funds has been a cause of oil price increases. The CFTC has issued Special Calls for data about this activity, but only partial responses have been received as of the date of publication of this interim report. An analysis of the data from these Special Calls will be made available in September.

The data currently at hand – which incorporates non-public surveillance information – includes positions held by commodity swap dealers. Commodity swap dealers offer institutional investors contracts whose returns are linked to a variety of commodity indices. Broadly speaking, after netting their index fund clients’ positions against the positions of their other clients, these dealers use futures contracts to hedge the risk remaining from this business. Thus, the activity of commodity index participants should become evident in the position changes of commodity swap dealers.

Non-public CFTC trading data shows that commodity swap dealers have held roughly balanced long and short positions in the crude oil markets over the last year and actually held a net short position over the first five months of 2008 – that is, swap dealers’ futures positions would have benefited more from price decreases than from price increases like the ones experienced in the last few months. Moreover, any upward price pressure exerted by the long positions of swap dealers’ commodity index clients has largely been offset by the short positions of the dealers’ other clients.

The Task Force’s preliminary analysis also suggests that changes in the positions of swap dealers and non-commercial traders most often followed price changes. This result does not support the hypothesis that the activity of these groups is driving prices higher. The Task Force has found that the activity of market participants often described as “speculators” has not resulted in systematic changes in price over the last five and a half years. On the contrary, most speculative traders typically alter their positions following price changes, suggesting that they are responding to new information – just as one would expect in an efficiently operating market. In particular, the positions of hedge funds appear to have moved inversely with the preceding price changes, suggesting instead that their positions might have provided a buffer against volatility-inducing shocks.

psc

Would not oil sky rocket once again if an Israeli or Iranian politician makes a threatening statement?

Jonathan House

Dear Mad Dogs,

I don't think hedge funds or speculators are "innocent and wholesome" - in fact I tend to think of them as greed incarnate or worse.

Likewise I would be happy to label as "speculation" everything that takes place on futures markets (although for some purposes it is useful to distinguish some futures market activity as "hedging" as opposed to "speculating").

There are a number of questions that remain. E.g. can activity on the futures market affect the price on the spot market and if so how and to what extent? In this respect, is oil different from e.g. gold, in that all that is bought on the spot market in a given month is consumed in (more or less) that same month or the next.

Curious

Ah yes, because the gov't has done such a bang up job on so many things, such as with ...
Posted by:TomB | 24 July 2008 at 01:16 PM

actually the main point will be "not doing a bang up job". That the government will not optimize oil exploration for profit but to seek biggest political return if not national interest.


The so called oil company efficiency is actually pretty nasty. Yes they maybe good at extracting oil, but they also get to manipulate laws, bribing, putting their giant profit elsewhere but inside domestic investment, etc, etc. They create government inefficiency. They undermined policy. (notice how all oil rich states are at the bottom of ranking in all social indicators. Texas, mississippi, Louisiana.)

Where do you think exxon $40B annual profit goes? Not paying 'Public Radio Opera' and 'Green children education fund' that's for sure. Majority is handled by investment bankers. China, housing, that sort of thing. And we know how efficient that money is being used.


Norway, China, Malaysia, Saudi, Russia are all government controlled oil companies. (they stop screwing around and destabilizing the country once they are under government control)

One of these days, an oil company is going to stage a coup supported by foreign power. Hell they already control all think-tank and owned all DC politicians.

Fred

A prior post asked how futures affect the commodity price.
Here's two quick sources:
http://en.wikipedia.org/wiki/Futures_contract

The classic finance text:
Fundamentals of Financial Management
Edition: 11
Author(s): Brigham, Eugene F.
ISBN10: 0324319800
ISBN13: 9780324319804

Available online

shepherd

Mr. House,

Thanks for the analysis. If the money flowing into oil index funds is actually hedged by long and short positions in the futures market, that should have little or no effect on the price of oil. All the traders are doing is trying to match the spot price--in which they can't invest--by laying money over and under on the futures market. Their interest in laying such bets is convergence, not moving the price of oil.

I don't think, however, gold is a good market to compare with oil, because it is possible to buy the yellow stuff and stash it away, unlike oil. Perhaps a market like iron, where there is no futures trading, is a better place to look. Iron prices have also dramatically risen over the last few years without the benefit of "speculators."

J

Colonel,

http://money.cnn.com/2008/07/24/markets/cftc/index.htm?eref=rss_topstories

Government uncovers oil price manipulation

Mark  Logan

Mr. House,

How would one suspect?

Look at this paragraph:

"Much of the attention related to participants in futures markets has focused on the role of commodity index investment funds and the commodity swap dealers that often act as their intermediaries. During the period studied, January 2003 through June 2008, pension funds and other investors have increasingly used index funds as vehicles to participate in commodity markets. Some observers have suggested that this rapid inflow of investments through index funds has been a cause of oil price increases. The CFTC has issued Special Calls for data about this activity, but only partial responses have been received as of the date of publication of this interim report. An analysis of the data from these Special Calls will be made available in September."

It doesn't answer the question. Pretended ingnorance or real, it should raise an eyebrow. It's their job to know.

Jonathan House

Fred,

I have not yet consulted the text book but I have re-read the Wikipedia article you cite. As I read it there is nothing to suggest that futures contracts affect the spot price, rather it is clear that spot price is what is central to the futures price.

All,

Would someone tell me what is wrong with the following analogy:

Consider the sports bet on the total number of points that will be scored in the Super Bowl. No mater how much “speculative capital” flows into the market for that wager – no matter how much money is bet - it does not affect the number of points that will be scored. (Excluding illegal stuff like point shaving.) In the same way, no matter how much is bet on the September 2008 price of WTI crude oil, it will not affect, at least not directly, the price of the September 2008 spot market. This is hardly surprising since the amount bet “long” on any given price is precisely equal to the amount bet “short”. Only by holding crude oil off the market – i.e. putting in reserve or “hoarding” – can one directly affect the supply of crude available to purchasers in September 2008.

Shepherd,

I agree completely with your comments about gold vs. oil. Would you agree with the following? Except for a small amount that is “consumed”, once mined gold is automatically put in a “reserve” or “hoarded” and available for the next spot market, and the next and the next. The oil produced each month is effectively 100% consumed and no longer available for the spot market. So unless there is a change in the amount actual oil (not future contracts) held in reserve, speculators in the future market are not affecting the spot price.

Mr. Logan,

The report does not appeal to ignorance of the relevant facts on most points. On the question of Special Calls, September does not seem to be too long to wait. Given the rest of what they detail, it does not push up my eyebrows.

Jonathan

J

mr. house,

'speculators' is nothing more than a pc term for a 'bookie'. and you are correct in saying they are not a 'wholesome creature'.

Twit

TomB:

The whole problem with Freddie and Fannie was that they were not nationalized, but were still guaranteed by the USG. If tax money and political capital is being spent on similarly protecting oil companies and their profits, then why not just socialize the benefits? Reducto ad absurdum, by demanding REAL socialism, it shatters the illusion that the market is in control. The oil speculation bubble is just another example of our current gamed system - not truly free market and not truly socialist - but just enough of each to benefit those that 'get it' (and are lucky enough to be in a position to exploit it). Which is, after all, not so different from the way that Soviet society functioned.

The following from the Financial Times seems relevant:
http://blogs.ft.com/maverecon/2008/07/time-for-comrade-paulson-the-pull-the-plug-on-the-fannie-and-freddie-charade/

So let’s call a spade a bloody shovel: nationalise Freddie Mac and Fannie Mae. They should never have been privatised in the first place. Cost the exercise. Increase taxes or cut other public spending to finance the exercise. But stop pretending. Stop lying about the financial viability of institutions designed to hand out subsidies to favoured constituencies. These GSEs were designed to make losses. They are expected to make losses. If they don’t make losses they are not serving their political purpose.

So I call on Secretary Paulson, Chairman Bernanke and Director Lockhart to drop the market-friendly fig-leaf. Be a socialist and proud of it. Come out of the red closet. The Soviet Union may have collapsed, but the cause of socialism is alive and well in the USA. Granted, the US version of socialism is imperfect thus far. The federal authorities have mainly intervened to socialise the losses in the financial sector while allowing the profits to continue to be drained off into selected private pockets. But that is bound to be an oversight. It surely cannot be the intention of such committed Marxists to target taxpayer-funded largesse solely at the very rich and at a few favoured, electorally sensitive constituencies. Fannie and Freddie are, or will be, safe in the hands of comrades Paulson, Bernanke and Lockhart.

TomB

In response to a post of mine Curious wrote:

"actually the main point will be 'not doing a bang up job.' That the government will not optimize oil exploration for profit but to seek biggest political return if not national interest."

Exactly right; "to seek the biggest political return." So they'll end up exploring not where it's most likely they'll find oil, but instead in this or that ridiculous area to create some jobs, or not in this or that great area because of protests, or to buy off some Senator's vote, or to put their dough not into the likeliest new technologies for oil extraction but instead into this or that one to satisfy this or that political fad of the day, or to pump dough into this or that tech center in this or that Senator's state, and on and on and on.

Here's government: One of the first guys we sent to Iraq to rebuild its health-care/public health system after we invaded was a guy named James Haveman. And you know what this U.S. government guy thought was the most important thing to start with was? In this country with a typhus epidemic starting and with little or no electricity and therefore little or no running water or refrigeration in nice steamy Baghdad? An anti-smoking campaign....

That's government.

So without competition (given that what you are calling for is all the oil companies to be nationalized), and then without even the profit motive anymore that comes from shareholders demanding profitability, the government will do things *more* efficiently?

It's an illusion, Curious. Even if the politicians and bureaucrats were angels it'd still be an illusion. And they aren't. After all, look at the books they're *already* keeping in the way of the federal budget: Every dime of this Iraq thing, for instance, "off" budget merely so they can pretend things aren't as bad as they are. Social security, utterly fraudulently sold as a "trust fund" or "lockbox," with the receipts it's receiving now and that it will desperately need in the future when the Baby Boomers start to retire being spent like water right now ... on bridges to nowhere and Lawrence Welk museums. Fannie and Freddie, allowed to either put the entire economy in the risk of a meltdown or to add some $500 trillion to the federal debt....

Why do you think that when it comes to running an oil business suddenly they'd suddenly become ethical virgins again?

And as to those profits of Exxon and etc., you bet I think they are being more efficiently spent than the gov't would. They're being reinvested in new technologies and oil field acquisitions, and going into private people's pockets, where it's reinvested and saved and spent by its owners far more smartly than the gov't spends the taxpayer's money.

Plus, even if the gov't were comprised of angels, there's just too many decisions to be made for any centralized system to even try to make. Where to drill, what technologies to pursue, where to explore, how to even *price* their product given that they have no competition....

Let the self-interested greedy wolves devote themselves to it in the hope of striking it big. Let 'em swarm those problems like hungry rats. And just like we're seeing now with this oil bubble collapsing apparently, some are gonna turn out to lose their shirts and some are gonna win. And so are we from the fruits of their competition unless you wanna just cut off our noses to spite the winners' faces.

It's an illusion, Curious. A very appealing one that seems to make sense on its face. So appealing it captivated about half of mankind for over 100 years. But it's an illusion.

Cheers


Lee

Colonel,

I would be extremely cautious about reading the tea leaves of this price drop and inferring the price was pure fevered speculation.

For the Olympics, China has mandated that half of the three million cars in Beijing remain off the road each day, and is mandating that hundreds of factories shut down. All this so that the air be "free" and clear of its choking pollution as the Olympic guests arrive.

It remains to be seen if Beijing mandates more factory shut downs from cities 'upwind'.

Too, tight Olympic security measures have restricted transportation around Beijing of late, slowing what remains of Greater Beijing's production capacity.

My point is, I see the current oil price drop coinciding with the "virtual shut down" of Greater Metropolitan Beijing with it's cars and factories. China's oil demand has decreased in the short term.

But what will happen after the Olympics, and the Chinese factory juggernaut comes back on line?

On top of this, we have the contraction of the American economy due to high energy and commodity prices. Our own demand for oil has decreased.

We must wait and see.
After the Olympics, let us once again peer into the bottom of the cup.

shepherd

Mr. House,

You wrote: "Would you agree with the following? Except for a small amount that is “consumed”, once mined gold is automatically put in a “reserve” or “hoarded” and available for the next spot market, and the next and the next. The oil produced each month is effectively 100% consumed and no longer available for the spot market. So unless there is a change in the amount actual oil (not future contracts) held in reserve, speculators in the future market are not affecting the spot price."

I'd definitely agree. I think there's a layman's notion that if you pour dumb money into a market, it must go up. True enough in some markets. A good example of this is the increase in P/E ratios on the S&P 500 since the explosion in popularity of index funds. But if we're talking futures markets...well, that's just not the same thing.

What I'm missing in this discussion is a "how." Everyone seems to be assuming that the market is being manipulated, and speculators are making a killing, but what I'd like to know is the mechanism by which they're doing it. I can explain to you how mortgage securities were manipulated, I can explain how Lehman's stock has come under pressure, I can explain how Enron drove up the price of electricity in California. What I don't understand is how speculators are influencing the price of oil through futures markets. Perhaps there is a way this can be done, but I don't know what it is.

Curious

Exactly right; "to seek the biggest political return." So they'll end up exploring not where it's most likely they'll find oil, but instead in this or that ridiculous area to create some jobs, or not in this or that great area because of protests, or to buy off some Senator's vote, or to put their dough not into the likeliest new technologies for oil extraction but instead into this or that one to satisfy this or that political fad of the day, or to pump dough into this or that tech center in this or that Senator's state, and on and on and on.
Posted by: TomB | 25 July 2008 at 02:00 AM

Right so what's the problem? Maybe slightly less efficient, but they still have to find oil unless they want a fuel riot right?

Also note: our so called efficient oil industry/market economy is giving us extremely unstable and high oil price. And this situation will happen again now that everybody know how the system at large can be manipulated. Russia, China, europe, midle east all know what button to push to put out of control US policy in check.

"Let the self-interested greedy wolves devote themselves to it in the hope of striking it big."

actually, all the big guys ends up gobbling each other then only less than 3 players left and they all form market monopoly. That's how free market work. Every single one of market class. That's the mathematical model say if there is free market.

Everything will end up a monopoly in truly "free market". (so you observe, train, airplane, shipping, car manufacturer, airplane industry, etc etc)

and they all own congress. But oil industry is a different class of monopoly.

And that my friend is what you have in so called "free market" that you are thinking.

But don't believe me. wait until a single giant oil company finally doing a coup. (I'll be around to say 'I told you so')

It happens EVERYWHERE. That's why all oil rich states are so screwed up and have stunted development. Efficient investment is what corrupt politics is about. It's cheaper and far more profitable to bribe and change the law than real investment in human resource development.

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