Oil Price Economics the 60 Minutes Way 38 comments
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60 Minutes just ran a comically slanted story on the rise in oil prices. I know that the price of oil is now down by $100 a barrel over the past few months, but that doesn’t seem to matter when you’re in the alarmism business. The 60 Minutes story is wretched, incoherent and it engages in the worst form of scapegoating. It’s hard to believe that this made it to air.
According to 60 Minutes, the surge in oil prices was due to... (wait for it) ...deregulation! Yes, it seems that “hedge funds” (cue Darth Vader’s theme) and “speculators” were buying oil in order to make money. If you just toss around these scare words long enough, people will think it makes sense. Somehow this was all due to deregulation. Of course, oil is traded all over the world, but logic doesn’t play a major role in this story.
Steve Kroft first talked with Dan Gilligan, the president of the Petroleum Marketers Association. Gilligan admitted that the members of his trade group, the people who pay his salary, are the ones responsible and he wouldn’t hear of anyone trying to shift the blame.
Kidding!
"Approximately 60 to 70 percent of the oil contracts in the futures markets are now held by speculative entities. Not by companies that need oil, not by the airlines, not by the oil companies. But by investors that are looking to make money from their speculative positions," Gilligan explained.
Gilligan said these investors don't actually take delivery of the oil. "All they do is buy the paper, and hope that they can sell it for more than they paid for it. Before they have to take delivery."
"They're trying to make money on the market for oil?" Kroft asked."Absolutely," Gilligan replied. "On the volatility that exists in the market. They make it going up and down."
Egad, speculators trying to make money! Next we’ll hear that other people buy things and “sell it for more than they paid for it.” Of course, if you do the opposite for long enough, like GM, you may get a bailout, so maybe “profiting” isn’t a great plan. Next we'll hear that there are oil ETFs so anyone can buy it, not just scary hedge funds.
Asked who was buying this "paper oil," Masters told Kroft, "The California pension fund. Harvard Endowment. Lots of large institutional investors. And, by the way, other investors, hedge funds, Wall Street trading desks were following right behind them, putting money - sovereign wealth funds were putting money in the futures markets as well. So you had all these investors putting money in the futures markets. And that was driving the price up."
So the scandal is that the rise in oil was benefiting schools and retirees. Got it.
Look, speculators don't make an asset go up all buy itself. For any buyer, there also must be a seller. The people who bought oil were taking on the risk, and that later hurt them.
If anyone had any doubts, they were dispelled a few days after that hearing when the price of oil jumped $25 in a single day. That day was Sept. 22.
Michael Greenberger, a former director of trading for the U.S. Commodity Futures Trading Commission, the federal agency that oversees oil futures, says there were no supply disruptions that could have justified such a big increase.
"Did China and India suddenly have gigantic needs for new oil products in a single day? No. Everybody agrees supply-demand could not drive the price up $25, which was a record increase in the price of oil. The price of oil went from somewhere in the 60s to $147 in less than a year. And we were being told, on that run-up, 'It's supply-demand, supply-demand, supply-demand,'" Greenberger said.
The complaint is that oil went from $60 to $147 in less than a year. But now, it’s lower than where it started. Steve doesn't bother to mention that fact which seems pretty important to me. Hey, let’s talk with a wiped out speculator. And that $25 one-day jump came AFTER oil hit its peak. So supply and demand did work after all. What failed was the ability of Mr. Greenberger or anyone else in the government to see it coming. Seems like a good argument against regulation.
"From quarter four of '07 until the second quarter of '08 the EIA, the Energy Information Administration, said that supply went up, worldwide supply went up. And worldwide demand went down. So you have supply going up and demand going down, which generally means the price is going down," Masters told Kroft.
"And this was the period of the spike," Kroft noted.
"This was the period of the spike," Masters agreed. "So you had the largest price increase in history during a time when actual demand was going down and actual supply was going up during the same period. However, the only thing that makes sense that lifted the price was investor demand."
So Steve, a reasonable question would be: “Did you short oil?” Or, did you ever wonder why demand was falling? The answer is simple: Higher prices were impacting demand. The system was working.
Masters believes the investor demand for commodities, and oil futures in particular, was created on Wall Street by hedge funds and the big Wall Street investment banks like Morgan Stanley (MS), Goldman Sachs (GS), Barclays (BCS), and J.P. Morgan (JPM), who made billions investing hundreds of billions of dollars of their clients’ money.
"The investment banks facilitated it," Masters said. "You know, they found folks to write papers espousing the benefits of investing in commodities. And then they promoted commodities as a, quote/ unquote, 'asset class.' Like, you could invest in commodities just like you could in stocks or bonds or anything else, like they were suitable for long-term investment."
There's no need to use the phrase "quote/ unquote." Commodities are indeed an asset class. This is fear-mongering masquerading as "quote/ unquote" journalism.
As far as suitable long-term investments go, gold has been holding its own against stocks for a couple years now. And what’s worse, I bet a lot of gold investors never take delivery either.
"Are you saying that companies like Goldman Sachs and Morgan Stanley and Barclays have as much to do with the price of oil going up as Exxon? Or…Shell?" Kroft asked.
"Yes," Gilligan said. "I tease people sometimes that, you know, people say, 'Well, who's the largest oil company in America?' And they'll always say, 'Well, Exxon Mobil or Chevron, or BP.' But I'll say, 'No. Morgan Stanley.'"
Morgan Stanley isn't an oil company in the traditional sense of the word - it doesn't own or control oil wells or refineries, or gas stations. But according to documents filed with the Securities and Exchange Commission, Morgan Stanley is a significant player in the wholesale market through various entities controlled by the corporation.
Anyone see Morgan’s stock lately? I have. I own it.
The Wall Street bank Goldman Sachs also has huge stakes in companies that own a refinery in Coffeyville, Kan., and control 43,000 miles of pipeline and more than 150 storage terminals.
And analysts at both investment banks contributed to the oil frenzy that drove prices to record highs: Goldman's top oil analyst predicted last March that the price of a barrel was going to $200; Morgan Stanley predicted $150 a barrel.
So Goldman drove up an asset that it owned. Do we know if the bank got clobbered once oil plunged?
Asked if there is price manipulation going on, Dan Gilligan told Kroft, "I can't say. And the reason I can't say it, is because nobody knows. Our federal regulators don't have access to the data. They don't know who holds what positions."
"Why don't they know?" Kroft asked.
"Because federal law doesn't give them the jurisdiction to find out," Gilligan said.
So now we have our scoop. Price manipulation might be going on, but we have zero evidence of it. But now we’re going to hear that dark forces are at work.
And in 2000, Congress effectively deregulated the futures market, granting exemptions for complicated derivative investments called oil swaps, as well as electronic trading on private exchanges.
"Who was responsible for deregulating the oil future market?" Kroft asked Michael Greenberger.
"You'd have to say Enron," he replied. "This was something they desperately wanted, and they got."
Just mention Enron and suddenly you have a story. Let's ignore the fact that nearly every commodity was soaring.
"When Enron failed, we learned that Enron, and its conspirators who used their trading engine, were able to drive the price of electricity up, some say, by as much as 300 percent on the West Coast," he added.
"Is the same thing going on right now in the oil business?" Kroft asked.
"Every Enron trader, who knew how to do these manipulations, became the most valuable employee on Wall Street," Greenberger said.
Again, we have zero proof of anything. Just some people made money and some people lost money. Now Kroft has to update the story to account for the gigantic decline in oil, so we now do a quick about-face.
But some of them may now be looking for work. The oil bubble began to deflate early last fall when Congress threatened new regulations and federal agencies announced they were beginning major investigations. It finally popped with the bankruptcy of Lehman Brothers and the near collapse of AIG, who were both heavily invested in the oil markets. With hedge funds and investment houses facing margin calls, the speculators headed for the exits.
"From July 15th until the end of November, roughly $70 billion came out of commodities futures from these index funds," Masters explained. "In fact, gasoline demand went down by roughly five percent over that same period of time. Yet the price of crude oil dropped more than $100 a barrel. It dropped 75 percent."
Asked how he explains that, Masters said, "By looking at investors, that's the only way you can explain it."
Yes, it’s the only way. Just as it is all the time.
The last sentence is the worst. I can’t believe a professional journalist said these words:
The regulatory lapses in the commodities market that many believe fomented the rampant speculation in oil have still not been addressed, although the incoming Obama administration has promised to do so.
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This article has 38 comments:
I just wish I had been smart enough to short oil when I took most of my money out in July.
I like oil price to be LOW and lower. So if we don't buy oil contract/ETF/Equity when it's going up then peoples can not manipulate.
If you dont know how prices get manipulated by these investment banks and their analysts then you missed the nineties or didn't trade then. Call Henry Blodgett, he will explain. The only difference is that the commodities exchange has looser margin and short requirements so it was easier to run these up, like gold..And dont forget 40 to 1 leverage. Yes Wall Street has their fingerprints all over this one.
> jack
Not one of their pundits mentioned the elephant in the room, the fact that people buy commodities when they fear their government is printing so much money that they'd rather own physical assets than paper. Oil rocketed skywards as the fed began to slash rates and came down to earth when it looked like the economy is so weak that inflation was not an immediate concern.
crudeoiltrader.blogspo...
If my investment strategies increases your cost of living by 10%, but when you retire I can bump up your retirment pay by 7%, who benefits? Other than the people who work at CalPERs who were involved in the trades and increased their own bonuses?
NB. CalPERs can be substitued with any number of pensions funds, investment banks, etc.
What we're seeing here is too much money chasing too few deals. This will not end with oil, and like oil, the government will only be reacting after the damage is done and the money has been made.
So why did oil go over $140. The obvious answer is supply and demand. No one can deny that China and India, growing at over 10% annually, added greatly to world demand. No on can deny that it takes years for the supply side to react to high prices, due to the enormous capital expenditures required to develop oil producing properties.
And why did oil go back to $40. Again, simple. 1) That new supply came to market, 2) high prices caused substitution and economization and reduced demand, and, 3) RECESSION!
In the short term, oil is a highly price inelastic commodity, which makes oil prices potentially highly volatile. Too bad Steve Kroft, and others, never did any Economics 101 before they ventured onto the networks to demonstrate their public ignorance.
That's besides the point. The point is whether speculators articificially drove up the price of oil and created a bubble that ultimately hurt everyone and greased our skid into recession.
The fact that your rant doesn't make mention of the Enron Loophole that made this insanity possible is telling.
I am so sick of the blame game we have all been playing for every event that occurs. The media just loves to start the ball rolling with idiotic programs like this 60 Minutes program.
Speculation is what makes a market. Some argue it was the dam*ed speculators that drove up the price.... Well, if that is true, then it was the same speculators that have driven the price down to the wonderful (for some) low price we are seeing at present.
The media has become so very powerful. It can manipulate the masses to follow whatever agenda it wants to follow.
While you are certainly right to support the concept that speculation plays an important role in the market process perhaps it would be good to back up and look at the bigger picture.
There are important differences between the Commodity Futures markets and the equity markets. The Commodity Futures market is a price discovery market where buyers and seller of commodities exchange their views on market conditions by executing financial commitments in an effort to determine the supply and demand clearing price. The equity markets are for raising long-term investment capital and serve a completely different function than the futures markets.
The argument is being make that institutions who manage long-term investment capital such a pension funds and endowments have lost the distinction between the function of these markets in their effort to generate short-term gains. In the process, due to their financial size, they have distorted the normal price discovery that takes place in the Commodity Futures market to the detriment of both producers and users of many commodities. In their effort to secure above normal returns for institutions of their size they found ways around the normal and established practices of position size limits and then moved their trading off of the exchange in order to avoid reporting and to obscure their activities.
At this point, no one is saying speculation does not play a role in the markets. The legitimate question revolves around the issue of institutions responsible for long-term investments directing their capital to short-term price discover markets thereby distorting the price discovery process. The argument is they should limit their long-term investments to the equity markets that are more suitable for their large investment capital. It is a basic and fundamental suitability argument.
Jack
Truly, it doesn't take a Wharton MBA -- or even Steve Kroft's Syracuse BA in journalism -- to understand that prices of all essential consumer goods (food, housing, fuel) commodities were being jacked by speculators during the exact period when interest rates were being kept artifically low by Mr. Greenspan. And, that those same prices all plummeted when a big piece of that speculative pie, housing, turned out to be the first to turn elastic (i.e., turns out people will move in with their parents to escape a bad-deal mortgage faster than they'll stop eating or stop driving to work and the store) when interest rates began climbing again and threatening the leveraged towers they'd built.
Housing also fell fastest and hardest because it was super-jacked with CDS plays and other leverage schemes, but once those deals went south, you knew that a box of Corn Flakes would be down from $7 to $4 not long afterward.
It's equally clear that there's a lot more involved than SUV mileage and demand from China and India when you realize that the number and average size of energy-related hedge funds more than quadrupled between 2001 and 2006, when doesn't include similar plays among sovereign wealth funds and commodity broker-dealers.
The true scandal is the fact that those oil-desk traders will move from Enron to Morgan Stanley and now somewhere else for the signing bonus and the chance to inflate the next commodity bubble.
Some of them undoubtedly must have had relatives for whom $4 gasoline was a true crisis. Did they share their trading profits with those relatives? Not likely.
Which merely provides more circumstantial evidence that, yes, speculation really WAS manipulating the price of oil. Yes, the major players were shorting the market, hence the monumental and likely criminal rise-and-fall of the price/barrel. Thank you inadvertantly proving 60 Minutes' point.
"Hey, let’s talk with a wiped out speculator."
Yes, let's. Because of course the fact that lots of little guys got left holding the bag automatically means that Goldman didn't make billions by shorting their positions after it talked the market up...
"Or, did you ever wonder why demand was falling? The answer is simple: Higher prices were impacting demand. The system was working."
Consider China's imports of diesel during the spike... China's imports of diesel through the end of Nov. were up 800% y/y. At the peak in July the Chinese imported 970,000 tonnes of diesel, 4,850% more than the same month in '07. The barrel conversion is a little more than 7 bbls/metric ton. Using diesel is material in that it has a multiplier effect close to 3x due to its processing conversion rate. Roughly 30% of a bbl of crude is processed into some form of diesel.
The real one way buying/demand by China in the diesel market alone was enough to skew the price of a bbl of oil in a tight market. Not surprising Chinese diesel imports have fallen from the high of 970,000 tonnes in July to just 40,000 tonnes in Nov. Put another way, that's a decline of nearly 700,000 bbl/day of oil equivalent in July to just 9,300 bbl/day of oil equivalent in Nov.
The world runs on oil, its the cheapest and most efficient store of energy, making crude a global commodity used to fuel economic growth.
And on or about the middle of July (08) when there was heat aspplied and speculation dried up the price started down.
Those of you that have the ability to check these things, I have a question. Did the massive shorting of Bank stocks start about mid July also. About the same time all the money was coming out of Oil speculation?
The amount of gasoline that can be stored is very limited.
Gasoline is still a minor part of refining. Oil companies really do only make a small profit margin on gasoline as the CEOs told Congress.
Most of 2008, they lost money. Oil went up 100% and gasoline only 37%.
Have you considered the impact speculation had on the price of Tulips in 17th century Holland? The 'quant' on 60 Minutes called it right. If the recession began 4Q07 and Oil demand fell while supply increased the law of demand/supply says the price goes down. The time lag in price decline from July to recent is a matter of financial engineering to de-lever speculators before the 'market' understood what was happening. The Wall Street centered financial sector is the source of the current credit crisis and the speculative (artificial) rise in Oil prices over the past year.
Rank speculation, and legitimate inflation hedging, coupled with "fear" of rising energy prices and supply/demand /consumption issues ARE an integral part of any sharp run up in oil prices, and I base my energy investments , IN PART, on these beliefs.
Those who buy into the claims of the article are encouraged to wear them in good health, but include me OUT, thank you.
The "Enron loophole" exempts most over-the-counter energy trades and trading on electronic energy commodity markets from government regulation.
[1] The "loophole" is so-called as it was drafted by Enron Corporation lobbyists working with U.S. Senator Phil Gramm to create a deregulated market for their experimental "Enron On-line" initiative.
[2]The "loophole" was enacted in sections § 2(h)(3) and (g) of the Commodity Exchange Act, 7 U.S.C. as a result of the Commodity Futures Modernization Act of 2000, signed by U.S. president Bill Clinton on December 21, 2000.
[1] It allowed for the creation, for U.S. exchanges, of a new kind of derivative security, the single-stock future, which had been prohibited since 1982 under the Shad-Johnson Accord, a jurisdictional pact between John S. R. Shad, then chairman of the U.S. Securities and Exchange Commission, and Phil Johnson, then chairman of the Commodity Futures Trading Commission.
In September 2007, Senator Carl Levin (D-MI) introduced Senate Bill S. 2058 specifically to close the "Enron Loophole" This bill was later attached to H.R. 6124, the Food, Conservation, and Energy Act of 2008, also known as "The 2008 Farm Bill." President George W. Bush vetoed the bill, but was overridden by both the House and Senate, and on June 18, 2008 the bill was enacted into law.
Wendy Gramm, Senator Phil Gramm's wife, coincidentally was the former chairman of the Commodity Futures Trading Commission. After leaving the CFTC, she took a seat on Enron's board of directors.
[3]On June 22, 2008, U.S. Senator Barack Obama proposed the repeal of the "Enron loophole" as a means to curb speculation on skyrocketing oil prices
For anyone curious about the Enron Loophole, as I was.
Once again it raises as many questions as it answers.
Did Phil and Wendy file separately or together?
Why do we know more about Sarah Palin's portfolio
than we do about Phil and Wendy's?
And why is Barak trying to repeal something that has already been repealed?
Or does "closed" have a different meaning than "repealed"?
Anyone care to weigh in on the effects of supply and demand vs speculation on the price at the pump?
Speculation added 20 to 30 cents.
Supply and demand added $2.10 to $2.20.
I'm speculating.
they'll keep on doing the same thing, though, until some one organizes and boycotts them.
The American Oil Cartel, with representatives such as Phil Gramm , have done more to hinder and block a viable and effective "Energy Policy" in this country than anyone else I have read or know about.
It has damaged us far more than anyone can uncover or prove, but it is nonetheless there and doing its dirty work on an ongoing basis.
While I may disagree with you about the relative effects of speculation and inflation hedging, , I nevertheless applaud you on your investigative work and its posting. I am grateful, and many thanks, I hope to read your posts in the future.
On Jan 13 12:33 AM Allen Phatimer wrote:
> That was really weak argument on your part, and I am a bit surprised
> that so many share your sentiment but not surprised that not a one
> of you can or do deal with the facts as you make the case that speculation
> wasn't a key factor in oil going parabolic, and crashing. The facts
> are so clear that this shouldn't be a controversial issue. You do
> a serious dis-service to folks that don't know any better and come
> here to gain a little insight. Hopefully, people don't take your
> word for it (or mine for that matter) and go see the segment themselves.
> I just submitted an article meant to gently pants you and your friends
> and hopefully help to shed a ray of light on the truth. Somebody
> had to do it.
......."I believe that oil prices ( at 150 a barrel) are the result of supply and demand.".... and on and on it went..."I believe that oil prices are a result of supply and demand." Once again before congress and these experts deny that they crapped their pants and then the expert pundits back them up, "It s just supply and demand." But something is smelly. It's deja vous, and once again all the expert pundits in the Biz and their friends have convinced us that," smoking is a choice," "it's free will," while they wink at their buddies, smug in knowing that there won't be a smoking gun. ........But all I know is, when oil prices fall that far, that fast, something is very smelly and that means one thing.....somebody crapped their pants!
On Jan 12 04:20 AM M. Weinstein, SA Editor wrote:
> A brilliant fisking, Eddy - even if you had stopped with the GM mention.