How Institutions Manipulate the Price of Oil 20 comments
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A recent article shows the chart to the left which demonstrates the correlation between crude oil prices and the size of the passive long-only institutional investor.
This is a topic that I’ve been harping on ever since last year, as a barrel went for $135: What is really going on with the price of crude oil?
It also confirms the previous chart showing the stampede of hedge funds and other large speculators to the long side of oil. Back then I couldn’t prove what was going on but the inflation adjusted price of oil certainly looked like a bubble.
There wouldn’t be a problem of course if these powerful market participants were taking both or either sides in legitimate speculation or hedging. But there is a problem for everyone, including these same institutions, when they pile into only one side, continuously going long the crude oil futures.
According to the article:
Passive investors increased their crude-oil holdings to the equivalent of more than 600 million barrels in June, up more than 30% from the end of last year…
So what is going on? How can these behemoth institutional players treat the crude oil market like their very own ponzi scheme? Last year the effects on the world economy were devastating. Wealthy economies stalled into a recession and poor economies were thrown into chaos as staple food prices soared.
Isn’t there a regulation to prevent the manipulative “walking up” of prices in commodities? Yes, yes there is. Or more accurately there was.
Matt Taibbi’s scorching article on Goldman Sachs (GS) in the most recent edition of Rolling Stone magazine explains. There was a 1936 government regulation which had successfully stopped this type of shenanigan. In effect it did not allow large speculators to lean on any commodity market and crowd out real producers and consumers. Until 1991. That’s when Goldman Sachs’ (GS) commodities subsidiary, J. Aron, request an exemption based on the flimsiest justification.
Amazingly enough it got it. And over the years the CFTC handed out 14 other similar exemptions. Goldman and its ilk were busy with a few other schemes and it wasn’t for a while that they started to really take advantage of the loophole they had gained. What followed was nothing short of astonishing. For example:
Between 2003 and 2008, the amount of speculative money in commodities grew from $13 billion to $317 billion, an increase of 2,300 percent.
What makes this even more astonishing is that last year’s oil spike (or bubble) happened when the world was awash in oil supply and faced a drastically reduced oil demand!
…according to the US Energy Information Administration,the world oil supply rose from 85.24 million barrels a day to 85.72 million. Over the same period, world oil demand dropped from 86.82 million barrels a day to 86.07 million.
By the summer of 2008, in fact, commodities speculators had bought and stockpiled enough oil futures to fill 1.1 billion barrels of crude, which meant that speculators owned more future oil on paper than there was real, physical oil stored in all of the country’s commercial storage tanks and the Strategic Petroleum Reserve combined.
This whole bear market has been a massive lesson in the validity and value of smart government regulations. As Ritholtz counts off in his book “Bailout Nation”, over a number of years and even decades, the threads of regulation where one by one removed. As the regulatory framework deteriorated in tatters, things started to go wrong.
Of course, as you may recall, that explanation was not the one offered when we were in the thick of things last year. The old and tired theory of “Peak Oil” was on everyone’s lips and many actually believed it.
The problem with that is, in the market when something is obvious to everyone, it is obviously false. And as I’ve said before many times, while no one disputes that the supply of oil is finite, it is a non-sequitur to posit that as this resource is exhausted, the price of oil will spike.
If you believe otherwise, then get into your time machine, go back to the 1800’s and corner the whale blubber market.
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This article has 20 comments:
Excellent work, and thanks for your fine efforts.
"What makes this even more astonishing is that last year’s oil spike (or bubble) happened when the world was awash in oil supply and faced a drastically reduced oil demand!"
-"…according to the US Energy Information Administration,the world oil supply rose from 85.24 million barrels a day to 85.72 million. Over the same period, world oil demand dropped from 86.82 million barrels a day to 86.07 million." -
Although supply rose - a little - and demand dropped - a little - it looks to me as though the demand was still some 350,000 barrels a day greater than the supply at that point, despite the massive price hikes. That doesn't seem to be very convincing evidence that this was all a bubble caused by excessive speculation, and I think it takes precedence over the other evidence that the "speculators" were betting long and that there was a massive influx of futures contracts, which in fact exceeded the actual quantity of oil in reserves.
In fact, it would seem to buttress the opinion editorial in Energy Current (excerpted below) that the price spike was a result of:
Peak oil, not speculation
www.energycurrent.com/...
"After many years of solid growth, oil production plateaued in October 2004. Regardless of the price level, the oil supply simply stopped responding, and from then on, the world had to make do with broadly flat supplies. Ordinarily, the expansion of the world's economy would be accompanied by increased energy consumption and an inelastic oil supply might have been expected to hinder economic development. It didn't. In the four years to mid-2008, the world economy expanded by 18 percent. The global economy boomed, even without new oil.
However, this came at a price. In the absence of oil supply growth, demand accommodation was required. This was achieved by secular prices rises averaging 25 percent per annum from 2003 to the end of 2007. In other words, the price of oil went up, and this constrained consumption by causing the marginal consumer to drop out of the market. This proved a workable solution for a time, but the global economy could not sustain 25 percent annual price increases indefinitely, and by the second half 2007, the situation was becoming critical. Consumption was being maintained by continuing draws on inventories averaging 1.4 mbpd, and virtually every producer, with the possible exception of the Saudis, was running flat out. By early 2008, even the Saudis were throwing the kitchen sink at the market - all to no avail. On paper, it looked like a peak oil nightmare.
Of course, consumers were responding. From 2005, the EU and Japan began to shed consumption and, from late 2007, US consumption also began to decline as the US consumer sought to escape high oil prices. Notwithstanding, developed economy consumers were not abandoning the market as fast as Chinese consumers were entering it, and prices continued to rise. In early 2008, prices took off and some argue that speculation took over. Still, as inventories continued to fall until May 2008 and all the oil producers were running at full output, the case for market manipulation at that time is hard to make. Indeed, the market was in backwardation most of this time. In backwardation, futures prices are lower than spot prices, the equivalent of the market saying, "Well, prices are high now, but they'll be lower later." The market - those very speculators - believed that oil was over-priced but was continually surprised as demand kept pushing up prices.
Prices did ultimately fall, but not because the supply situation eased, nor because speculators fled the market, and not because inventories were released. Prices fell because the global economy collapsed."
Yes, in too many respects we live in a gangster state, and the fate of the typical citizen is up for grabs. So, where do we go from here? Not encouraging to say the least.
How does speculation explain the 350,000 Barrel/day shortfall? 350,000barrels x $140/barrel = $49Million/day that for some reason nobody took advantage of.
The only reason that makes sense is that in 2007, the worlds peak oil production was 85.72 million barrels a day.
As to JeffDB above, there was more oil last spring than there was demand. Prices, having started up in late 2007, had already cut into demand. There was a great hoarding by the oil players to fill up their storage facilities all through the spring as the prices where rising, cutting into demand. It just took about 5 months before the surplus started to show up. Of course, the ginned up Gov. Sachs and JPM Squawk Talk on CNBC was keeping the myth going...
So, how do you square with the reality?
So explain to me why production didnt increase to take advantage of the "fake" demand (and make millions a day off of ole Bush).
Even if what you say is true, (and I wont argue it - hell you are probably right) you still have not answered the supply side question.
Just so you know, what I call Peak Oil means Peak Oil Production. I dont differentiate between geological, political, logistical, economic or any other limit to oil production. There is however an effective world-wide limit to oil production, and I believe it has been reached.
The world can not produce more than approx 86million barrels of oil a day.
On the bright side, at least the world became cleaner with lesser cars and more people with "greener" lifestyle. A better cleaner future Earth.
However, the point that price is not a proxy for availability remains valid. The fact that the run up to last year's price spike began in earnest when the credit crunch hit and culminated coincidentally with the bursting of the greatest financial bubble in history, when even the criminanciers were flailing around wildly, tells me that $150 was not the result of orderly price discovery in a transparent market.
On the other hand, the idea that oil would drop down to 30 bucks and we could all live happily ever after, if only GS and their henchmen would only go away, is simply nuts. $30 is less than the cost of production for a great deal of existing oil supply, let alone the (wholly inadequate, by the way) forthcoming supplies from deep water, polar and unconventional.
There are plenty of signs pointing to a physical supply crunch in the 2013-2016 timeframe, even allowing for the recession to be deeper and longer than most expect. If it happens, oil could spike to $120 or to $300 - who knows? The price itself will be decided by a whole range of factors, from the state of the dollar to geopolitics to our old friend manipulation.
The way things are going, the price may not even be in dollars.
The fact is we hit peak oil production last May-July and unlikely to ever hit that again. Why is we are discovering only 1bbl for every 4bbls we use. Think about that. And the faster one pumps, the less one gets.
The Saudi's are almost out of sweet crude and likely Iraq is now has the largest reserves, much of it sweet our refineries need.
Of course there is too much money and it goes from real estate to oil, etc as each bubble bursts and now going back into oil.
Expect it to after a pause to go up until it causes another economic downturn which will keep happening until we become independent of oil in about 10 yrs by switching to EV's and NG.
Sadly the repubs seem to keep us on oil which will only keep our economy in taters and our enemies rich.
The only way out of this is putting the true cost of oil, all the balance of payments, tax breaks, depletion allowances, Persian Gulf military, Iraq, Afghanistan oil wars cost in it. Then nothing else would need to be done, we could get a big tax cut and help switching to other energy sources, eff, conservation.
The $1T/yr savings from those costs and no longer importing oil will create millions of new jobs from construction retro fitting buildings to EV's. Plug in Hyrids, NG semi conversions, biomass to fuel units, high speed trains, etc.
What we need to do is more than clear, the only thing is will the repubs, some dems get us on that path. Or we make our enemies rich and us broke. Call your congress person on Monday.
www.prisonplanet.com/r...
And Mike Morgan just one a court victory against them. I could not believe the extent of questionable behavior about GS. You can spend a lot of time at this website. Mike Taibbi says GS tried to "carpet bomb" Mike Morgan with litigation. Mike won.
www.goldmansachs666.com/
As far as peak oil. Recently I read:
1) Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy by Matthew R. Simmons. He makes a compelling case that OPEC seriously exaggerates both reserves and spare capacity. He also goes into non-OPEC areas.
2) Game Over by Dr Stephen Leeb. He expands the topic to address a wide range of commodities.
So while I fully agree GS antics should be investigated. Unfortunately, I also conclude too much of Washington politics is in bed with them. However, I see this as GS exploiting an increasing scarcity of virtually all commodities. I encourage everyone to read both books. It has changed my outlook on investing to focus on commodities and those that produce them. That said, if the market corrects (as I expect), USD should be one hiding place, which will slam commodities. I intend to build positions if that unfolds.
or maybe there was but it went away LOL