Thursday, November 13

oil pricing

At the present price of around $57 per barrel the oil price has fallen quicker than I would have anticipated which is due maybe to futures traders activities, or perhaps more likely to be a combination of weaker demand and speculative trading in oils non transparent traders market. A trader need only put down a very small amount and borrow the rest to create the highly leveraged position which can help either drive prices up or down.

I don’t believe speculators serve any useful purpose other than to profit by manipulating a market at the expense of normal supply and demand principles. In turn this makes sensible investment decisions virtually impossible which is much more damaging than most folk realize. I think we need to clamp down on these jokers instead of just blaming oil producer nations for high prices that may have nothing to do with them. Bear in mind also the current oil price is 60% below its long term inflation adjusted price.

In so far as the speculation is concerned I think even the hardest headed economists can no longer be in denial, they must now all freely admit to the huge price distortions that have permeated markets for some considerable time. The speculators had the added advantage that many were lulled into a false sense of certainty about the inevitability or rising oil prices. Many advocating the ‘peak oil theory’ confirmed authoritatively we had reached the so called tipping point (falling supply could no longer satisfy existing demand) so it was virtually impossible for prices to diminish. Well so much for the immeadiacey of that theory; it looks like the price has fallen by 67%. The speculators also knew that we don’t have the information about the worlds known reserves as most producer countries refuse to divulge them. We don’t even know what the stockpiles of oil are applicable except in the USA. Even so, personally, I think oil will increase in a few years.

But before investors are asked to fork out their hard earned money into alternative energy enterprises by way of direct investment in shares or governments concede substantial subsidies for consumer to pay higher utility costs for government funded alternatives they also need to make sensible estimates about the long term price of oil. Make a wrong guess and it will bankrupt many investments whose prospectuses are reliant on false assumptions or severely disadvantage consumers in some countries should oil be so much cheaper than what was estimated. Anyone betting on $35 a barrel?

A long time ago Allan Greenspan argued very strongly to congress against any form of regulation of derivatives trading for the relatively newly formed but growing insurance derivatives called credit default swaps. Hence the market for these insurance based derivitives were never transparent nor was it regulated.

If there is one golden rule that has since been learnt about markets during the current unprecedented turmoil it is the critical need for transparency and regulation in all markets, including oil.

Simply put the need to know what’s going on so as you give yourself the opportunity to intervene, (as undoubtedly you will need to do) and have needed to do in all of the so called free markets from time in memorial.


Cart said...

“Many advocating the ‘peak oil theory’ confirmed authoritatively we had reached the so called tipping point” I guess I’m leery of any sort of conspiracy theory, into which category peak oil loosely fits. While I subscribe to the “There Are More Things in Heaven and Earth, Horatio” school, that is balanced with a desire for evidence. The only evidence we have is of new fields being discovered (or possibly just revealed) and fields lasting far beyond projected capacities.
Sadly oil supply and demand seems to work on the sort of artificial constructs you allude to, as does the development of efficient alternatives. We need, somehow, to urn the incredibly gifted imaginations of the finance market players to more socially productive pursuits.

Seraphine said...

speculators serve a useful function. they assume the rish many others don't wish to carry. especially in commodities such as oil, airlines (as an example) will lock in a price for oil as a hedge against rising costs, at a price they (hopefully) can turn a profit. somebody else assumes the risk of price volatility from the airline. as such, speculation does a useful service to society.

lindsaylobe said...

Hi Cart & Sera – thanks for your comments.

I do think there is a legitimate key role for banks and insurance companies in mitigating and facilitating world trade, to reduce risk as distinct to pure speculation in the futures commodities market.

Let me explain further.

Speculators do take large risks in the hope of making quick enormous gains for themselves.

Speculators are risk-takers; but the huge escalation in oil prices (given the benefit of”Harry Hindsight”) confirms, without doubt that speculation has been massively excessive.

Its true most commodities are bought and sold on the basis of a specific future price, as producers (if they want to reduce risks) need not fear disadvantageous from future price movements.

An Airline can purchase its future fuel and hence avoid future price hikes by hedging in that manner without the need for any speculation on its part.

Many Airlines do this -did this, as was case with our national carrier Qantas, which was able operate successfully on the basis of secured lower fuel prices than many other Airlines who had not bothered to hedge in similar manner. That was the case until such time as the “hedges” implicit in the future contract expired.

Hence there is a logic and legitimacy in hedging, which is not speculation as such.

That market between producers and buyers is more of type of insurance but bear in mind it is always directly linked to the actual physical delivery of the product or commodity to the buyer.

On the other hand the futures market for commodities is not linked to physical deliveries. You have the so called recently created 'paper barrel of oil' which has driven up the price of oil. There was a very strong correlation between the growth in this paper market and the corresponding rise in oil prices. Thus
'Paper Oil' became the new hedging instrument for the weakening dollar and for known rising inflation as I attempted to explain in my previous post. Thus oil went from a commodity whose price was "hedged" legitimately to reduce risk, to a new paper asset class (a paper barrel of oil) which was added to the portfolios of speculative investors. You even had terms such as the Japanese housewife’s foreward carry trade investment in the paper price of a barrel of oil. That is how all the leveraging began.

What caused oil’s precipitous fall was not reducing demand but the unwinding of these highly leveraged positions when the bubble burst. For every legitimate hedge there were 2 or maybe 3 speculative ones in the newly formed paper commodities market.

Best wishes

Zee said...

Come up with some snappy lyrics Lindsay, I have a song contest in the works... (something to take my headache away from oil prices and bail-outs...)

Progressive Traditionalist said...

Hello, Lindsay.
Thank you for that explanation.
Certain things are becoming more clear now.

Much like Cart, I am by nature resistant to various forms of Chicken Littlism; although there are other reasons it would be desirable to move our consumption away from petroleum.

This paper barrel of oil that you speak of is included in M3 money in the Federal Reserve's reports.
As I remember it, the rate of inflation of M3 money was running in the low 20's. And this at the time when the M1 money supply was held even.
They stopped reporting that in March, I believe of '06.
It looks for all the world like the Fed saw the bubble coming and acted in collusion.

Pondering this, and I believe that M3 is best understood as 'credit,' ie future claims on assets.

Wondering if Greenspan ever read Animal Farm...
What an idiot.

gfid said...

i think at the base of all of this is a fundamental belief in the minds of the world's business people that exponential growth is the earmark of successful business. this is neither healthy, realistic, nor sustainable, and there is always a price to pay for it, both in real life and in the artificial world of the stock market. no business can use natural resources, labor and energy at these rates without pillaging the environment human and animal populations, and power sources in its immediate vicinity. the typical pattern of the big biz that turns out these kinds of profits is to suck everything it can out of an area, then move on, leaving behind a desolate natural landscape that will take generations to recover, and a populace now addicted to its financial stream, also in need of a 12 step recovery program. the basic greedy premise that we can get something for nothing, and hope someone else will pay the bills applies as much to the stock market as to actual industry.

Gary said...

YEs, we need that golden rule because there is another one that says: "Those who can get greedy in the short term, will."

Although even the traders are shocked by this I'm sure.

Summer coming?

lindsaylobe said...

Hi PT, GF & Gary
Thanks for your fruitful thoughts .......always look forward to hearing your point of view!
Best wishes