Do Lawmakers Really Understand the Energy Markets? 20 comments
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Last week, the U.S. Federal Trade Commission [FTC] issued new rules to prevent oil market manipulation, greatly boosting the agency's enforcement clout. The FTC will now coordinate its efforts with the Commodity Futures Trading Commission to police the physicals and futures markets.
Among other things, the FTC's new rules prohibit oil market participants from making misleading statements or intentionally omitting information that could affect prices.
In her advocacy for the tougher regulations, Sen. Maria Cantwell (D-Wash.), a member of the Senate's Energy and Natural Resources Committee, said this year's hike in oil prices raised questions about manipulation of the markets.
"Oil supplies are near 20-year highs," she said in a written statement, "and demand for oil is at a 10-year low -- so why have gasoline prices gone up a dollar a gallon since the beginning of the year?"
Why, indeed?
If we gauge the oil supply as the commercially available domestic stockpile outside the Strategic Petroleum Reserve, the senator's got a point. According to the U.S. Energy Information Administration, when Cantwell's statement was published, the U.S. oil supply stood at 349.5 million barrels. Twenty years before, 334.5 million barrels were available.
Gasoline prices, too, have risen this year, although when measured by unleaded gasoline futures, it's more like an 80-cent rise than a buck.
However, Cantwell has left behind a lot of context by pitting the crude oil supply against gasoline prices.
First, there's the trend in our domestic oil supply, represented by the dashed black line in the chart below. When you derive the trend line mathematically, smoothing out the choppiness, you see that our domestic supply is actually getting smaller.
The black solid line represents week-by-week oil inventories. The most recent peak was in May, when our domestic stocks topped 375.3 million barrels, the highest level since the summer of 1990, when we had 391.9 million on hand.
Spot crude averaged a price of just under $52/barrel in May. With oil supplies down some 26 million barrels by late July, though, the price of oil has risen nearly $20 a barrel.
Inventory Vs. Futures Spreads
Directly comparing today's oil price to supply over the longer term, however, ignores the effects of inflation. We've seen inflation's impact on oil prices in "A Picture's Worth A Thousand Word (Or Dollars)." When oil supplies peaked in summer 1990, crude was nearly $21 a barrel. Inflating the 1990 price by the Consumer Price Index makes the oil worth 34 simoleans in 2009 dollars. Inflation accounts for 42% of the apparent price rise since oil's last supply peak.
And the rest? Well, we can determine the legitimacy of oil prices by looking at the futures curve. When we're well-supplied with oil, contracts calling for later delivery are priced higher than the spot market; this price relationship is often called "contango." In May, for example, spot West Texas Intermediate [WTI] traded through NYMEX at $53.50 a barrel. A contract three months forward traded $3.58 higher at $56.78. The price differential mostly represents the expenses associated with carrying the oil cargo (storage, insurance and interest) until delivery.
Technically though, contango represents that part of the price premium in excess of carrying costs. On May 1, the per-barrel cost for financing, storing and insuring a WTI cargo was $1.68 a barrel. That means the excess carry or contango was $1.90 a barrel - incentive enough for savvy traders to buy, store and redeliver through futures. Contango balloons when the market's awash in oil, either because of overproduction or slack demand.
But the crude oil market isn't always flush with supply. At times, in fact, there's too little oil to meet demand. In such times, it's common to see the futures term structure invert. Nearby futures then trade above the price of distant deliveries; in other words, deferred delivery contracts sell at a discount to nearbys. This condition is known as "backwardation."
In June 2008, the WTI market slid into contango after spending nearly a year in backwardation. When the market's inverted, or backwards, the premium in the front months reflects bidders' desire for immediate, rather than later, deliveries. Everybody wants their oil now, so there's no carry in a backwardated market. The inversion is an indication of tight current supplies.
Think back now. Oil was being bought hand over fist in 2007 and early 2008, right?
Oil's flip to contango in June 2008 presaged the post-Independence Day plummet that took prices down $111 a barrel by year's end. Fully a month before crude tumbled from its nosebleed heights, the market was signaling a slackening in demand, and the prospect of a supply overhang.
If you look back over the past two decades, the crude oil market's vacillations between contango and backwardation line up pretty well with oil inventories. As inventories build (demand wanes), a carrying charge market develops. When the thirst for oil remains unslaked, the market tends to invert.
We're in a contango market now, meaning we have more oil than we need. But the contango's not huge by any means. Back in January, the carry trade could have earned you more than $14 a barrel; now, you'll clear just $2.
Yes, oil's higher than it was in the winter, but part of that move is seasonal. Oil and gasoline prices tend to decline in the winter as refinery and driving demands weaken. After winter maintenance is completed, refinery capacity increases. Input and product prices tend to rise, peaking with the summer driving season's finale around Labor Day. It's typical for gasoline prices to be higher at midyear. More importantly, today's gasoline prices have little connection to crude oil inventories two decades ago.
I'm not saying that there hasn't been manipulation, but I wonder just how well lawmakers like Sen. Cantwell understand the markets' seasonal and demand influences.
For now, while we're not awash with oil, our deck shoes are at least sticky with it.
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This article has 20 comments:
Who is to blame here? I'm not sure, but as far as I can tell the courses given in energy economics at most universities are absolutely terrible, and those advisors, assistents, experts etc are too dumb or lazy to read forums like this one where they can learn a few things.
The global economy was nearly at a trough at that time. While its not strong now, it is less weak. I think common sense would dictate some rise in price off such an extraordinarily weak demand for energy.
For some good reading on this subject check out this site.
Global Research.
www.globalresearch.ca/...
Also read more about it at this site:
losangeles.injuryboard...
It must be refined and the Dems haven't allowed for the building of any additional refineries in 20 years.
Lawmakers look in the mirror. Yes, the problem is YOU.
www.opensecrets.org/in...
I believe that the level of care and concern within the political arena will always coincide with the next election cycle.
On Aug 13 12:23 PM Moon Kil Woong wrote:
> Lawmakers don't understand much at all. I find it ironic they opposed
> regulation when oil was at $140 but not now when oil traded below
> $60. I don't think they are looking out for your best interest so
> expect pump prices to rise regardless of what a barrel of oil costs.
> Most of your cost is in processing anyway.
And if no oil users are bidding up futures contracts, how can contango exist? Supply would be withheld in the short term until spot prices rose to futures prices. And if there's good profit for speculators to carry excess inventories during contango, why wouldn't suppliers carry their own excess inventories and cash in on the profit? You can't just turn oil production on and off, but if there's money to be made by creating your own storage capacity then why shouldn't suppliers do it themselves?
In a free market "excess inventories" is a signal to cut production. That's how all those companies reported rising profits this year: they laid off staff and cut production in the face of a declining demand market. If they had kept flooding the market with more product than could be sold at present prices, they would have found themselves engaging in fire sales to clear their excess inventories. But if speculators enter this market with 'liquidity', which means money to buy and hold the products that consumers will not buy today but which they will need in the future, speculators can hold prices up at levels which market conditions do not support. Instead of consumers getting bargains from excess inventories, speculators get profits and consumers pay full price.
Speculation distorts market prices and distorts supply and demand signals. Speculation is "noise", not information. Would the housing bubble have climbed so high if real estate speculators, who had no intention of ever living in or renting out the houses they were having built, had not added hugely to demand? Real estate speculators 'added liquidity' to the housing market and inflated prices to spectacular bubble levels that put housing out of affordable reach of most people.
"The market", which is real people who want a house to live in or to rent out, would have been able to inflate that high. 'Exotic' mortgages, whose 'affordability' could only be based on the expectation of ever rising real estate prices which enabled homebuyers to essentially be speculators and sell the house at a higher price because they could never afford the IPT payments on a $500k house, would never have seemed viable without all the speculators 'adding liquidity' into the housing market.
Speculation 'financializes' supply and demand markets, utterly distorting the prices that suppliers and users rely on to plan for their future business decisions. These are supposed to be commodities markets, not financial markets. Demand is created not on any need or intention to keep and use the product, but only to make a monetary profit form buying and selling it.
If future prices are higher than present prices that is a signal for suppliers to increase output to cash in, and it is a signal to end users to try to cut their use of that product in order to save money. Oil demand is price inelastic in the short term because we have to fill our tank to go to work regardless of the price, and refineries need continuous supply in order to avoid very costly shutdowns and restarts. But we saw last year how demand can decline with high oil prices in the medium term as people adjust their circumstances to the new reality.
Speculation adds nothing useful to this equation. If speculators can make money in futures markets, the only way this is possible is by inducing producers to supply too much at low prices, and inducing buyers to pay higher prices than the excess supply justifies. Suppliers make less profits and consumers pay higher prices.
We do this in service of the virtuous speculators, who add $1 million of liquidity on the front end of their trade then take out $2 million on the back end, with a net cost to the real commodities market of $1 million. I'm all in favor of making money. But I object to elbowing your way in between buyers and sellers and stealing their money.
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