By Mike Norman
Mike Norman (Norman): Hi everybody, and welcome to HardAssetsInvestor.com. I'm Mike Norman, your host. Today my guest is Dan Dicker, author of the book "Oil's Endless Bid." Dan, thank you very much for coming on the show; I really appreciate it.
Dan Dicker, author, "Oil's Endless Bid" (Dicker): Thanks for having me, Mike.
Norman: You wrote this book; it's fascinating. Basically, what you talk about in this book is that the reason behind the huge run-up in oil prices really has to do with lots of speculation.
I know you're an independent oil trader. In fact, we traded together on the NYMEX years and years ago. It's something that is covered a little bit in the news, but I think for most people − and a lot of them major players in Washington and in the financial industry − their story is it's because of supply and demand. You say that's not true. Why is that?
Dicker: Well, it's not true. In fact, we've overrun all the supply and demand arguments. And they've been overrun with people, not just traders, but also just regular people − in pension plans and other places − trying to get hard assets as opposed to the soft assets that we normally know.
Norman: All right, let's first look at the supply/demand fundamentals as we know them right now. I think global demand for oil is something like 86 million or 87 million barrels a day …
Dicker: Depending on who you talk to; right.
Norman: Output is there, if not greater. I've seen it up maybe around 90 million. If you look at stocks or inventories of oil, here and globally …
Dicker: Here, we're 5 million over the five-year average, and we have been higher. We've been 14 million over the five-year average during the run-up …
Norman: Same thing with gas, right?
Dicker: Exactly. We've got, in fact, our delivery point here for West Texas Intermediate in Cushing, where literally, you cannot fit another barrel; it's overflowing. So, supply is clearly not the issue.
Norman: And if you look at gasoline demand, it's dropped for the last two years.
Dicker: Lower than it's been for the last five years.
Norman: And you have the Saudis now saying they're going to cut back on production because they're seeing demand for their physical …
Dicker: No place for them to put it. And they've said that, by the way, to President Bush in 2008 as well, and the president ignored them that time. So I don't expect the Saudis to be taken seriously this time, either.
Norman: Yet the price keeps going up. What baffles me is that the speculation argument is not really embraced broadly by people. There's some people like you out there talking about it; I've heard others. But a lot of people are still kind of buying this idea that we're running out of oil.
Dicker: Well, it's hard for people intuitively to believe. The arguments for a supply problem are there, and they make intuitive sense to laypeople, for example; we know, and nobody denies it. I wouldn't deny that oil is a limited resource. At some point, it does run out. There's no doubt about that. For people on the streets, that's enough for them to figure on that. Of course, they do see the increase in demand over the last 20 years, and there's no doubt about that. And they put two and two together and they get … well, obviously we're going to get a higher and higher price.
Norman: And you even have a lot of smart people, you had Paul Krugman, the Nobel Laureate economist, who said it can't be speculation because if it was speculation, you would see the storage build up, and you're not seeing that; you know, they'd be holding that somewhere.
Dicker: Correct. He's backed away from that argument, by the way. That was a very, very important column that he did in 2008 where he talked about speculation having nothing to do with the oil market. What he didn't understand at that point, and has come to understand, is that oil has a very strange kind of storage characteristic. You cannot develop storage so quickly that it can accommodate what he thinks are very, very simple kinds of economic rules of thumb. For other markets, he's right. For oil, he happened to not be right.
Norman: And there's also an argument that I've heard that makes a lot of sense, that the storage might be in the ground, in the sense that OPEC is leaving their oil in the ground, and that constitutes a form of storage or hoarding of it.
Dicker: Correct. Above-ground storage is something that's not very flexible. You have a certain amount, and for the most part, it is licensed out for years into the future. This is the kind of thing where you take oil out of the ground and basically, you're taking it out of the ground because you know it's going to be used in a certain period of time. So the storage you have above ground is there only for a short, short, short period.
In the end, if you wanted to actually hoard oil, or store it, or do something like that, you can't really do it above ground. You have to do it, as you say, you have to plan for it, by leaving it in ground.
Norman: Now, for decades, we've had the markets made up of commercial interests: oil producers, users, commercial entities and traditional speculators who were not really price sensitive for the long term. They look to bet either way; to be directionally sensitive, they would bet either way: long or short. But in recent times, we've had the advent of this new class of investors or speculators, these long-only passive investors, you could call them − the pension funds, the endowments. You see this as the big problem, right?
Dicker: That is the start of the big problem. Because in the end − as you know as a trader and I know as a trader − the way to make money as a trader is to drive through as much of what we used to call "dumb money" as possible; that is, money that is price insensitive, money that doesn't have as deep an intellect on the market as you do. And the more we can drive in, the better our profits only can be by trading off of that. Well, that flood of dumb money is coming from passive investors.
Since the year 2000, when it was made illegal by the Commodity Futures Modernization Act, we've had a flood from basically zero in 2003, to over $350 billion today. Now, in an oil market, that is very, very sensitive to money, because it's actually pretty tiny when you think about it. Three-hundred and fifty billion dollars is an enormous amount, an enormous flood of buying, nothing but buying.
And the point is that commodities are not like stocks. You cannot just have one side of the trade. Somewhere, you've got to find a seller for everybody who wants to buy. In stocks, you don't, but in commodities, you do. So that flood of just buying has sort of emptied out all of the sellers in the room. And what you get is a price that inevitably goes higher, and a lot higher.
Norman: But what do you make of the argument that the other guys say: "Well, they never actually take deliveries, so they buy the futures contracts, but then they have to sell them again"? There's this constant rollover … which I guess the people who say it's not a speculative element would say that they are really a neutral factor.
Dicker: Right. The point is that the cash market − where people actually have to go out and buy physical oil − has become based over the last five, six, seven years on what's going on in the futures market. It used to be, prior to 2000 and when I first came down on the floor in the '80s, that in fact the futures market would take all of its cues on where it was going by what was trading in the physical market, in the cash markets. That's lopped around entirely.
Norman: The tail wagging the dog, in a sense.
Dicker: Exactly. The tail has wagged the dog now for 15 years, even before the CFMA. So in the end, all of that money flooding into the futures market has the end result of boosting what in fact is being paid for on the cash market. And that continues to recirculate itself as money flows in, and then, again, rolls over to the next month, and rolls over to the next month, and in fact, never comes out. All of that buying stays in the market forever, in essence, because people want to be long oil for as long as they want …
Norman: Because they view it as an asset class. And they need to own it on that basis. They're not price sensitive. It doesn't matter to them where the price is. They want to have it …
Dicker: And in fact, they don't have any metrics. Part of the point I make in the book is that oil doesn't have the kind of metrics that stocks do. Stocks have a PE, they have a certain amount of inventory, they have sales, they have a growth potential, they have new markets to go into. Oil − we have no idea what a barrel of oil is really worth.
The way that the markets used to work is that you used to get all the buyers and sellers in a room, and they would sort of decide together what a barrel of oil is worth. But there are really no metrics to decide what it's worth. In fact, the metrics and the price are being set by all of these players, which are now all buyers.
Norman: All right, let's talk a little bit about the Dodd-Frank Act, which attempted to impose position limits and deal with this aspect of speculation. But now it looks like Dodd-Frank has become somewhat toothless – maybe pressure from the financial industry itself. Now they're talking about 2012, when anything − if anything − is going to happen. How do you see, from a regulatory standpoint, if any, that it will have some impact on the market?
Dicker: Well, I wasn't very hopeful about Dodd-Frank actually having a big impact when it was written in July of last year. And as I've seen the process kind of play out, I've gotten a little more hopeless about it, because what has happened …
Dicker: Yeah, hopeless about it. Because what has happened is in fact, that in very good faith, the CFTC has taken Dodd-Frank − which is kind of an outline on what to do in oil − and they've found 30 separate rule-making areas that they need to write rules in. And every time they've written a rule, they've opened it up for comments. Now, every time they've written a rule that's been opened up for comments, they've been buried, inundated by all of the traders who just want to keep the status quo. Pimco, Blackstone …
Norman: … Goldman Sachs, Morgan Stanley.
Dicker: … Goldman Sachs, Morgan Stanley, Vitol, the old Marc Rich, Glencore, the FIA, SIFMA, and they've got all the money. They've thrown at them every lawyer, the best lawyers in Washington to go make arguments for them. They buried them with paperwork.
Norman: I heard Gary Gensler recently at a conference I was at talk about that very issue, that they maybe have 20 comments in favor of keeping it the way it is for every one comment from the public saying, "Hey, this is bad. We're getting hurt about this."
Dicker: Right, and they've been buried. So, in the end, their ability to write a rule under the avalanche of all of this anti-commentary has basically stopped them in their tracks. Like you say, on position limits, they're not even going to look at it for another year. They're not even bothering to even try.
Norman: So to sum it up, how do you see all this playing out over the next several years?
Dicker: Well, the mechanism is clearly busted and it's overrun by financial players. And if it's not, it has nothing to do with real supply and demand issues, then it has to do with financial events that really move the price of oil. Then only a financial event − as we saw in 2009 with the fall of Lehman Brothers − can remove some of the money that's driving the prices here.
Now, I hesitate to think what the next financial event is that will puncture the bubble that's going on in oil now, but is it on the level of a Lehman failure? I certainly hope not. But that seems to be the pattern that we're setting us up for.
Norman: It could be something catastrophic.
Dicker: It could be something bad.
Norman: Excellent book. Dan Dicker, thank you very much. The book's titled "Oil's Endless Bid." That's it for now, folks, see you next time. This is Mike Norman; take care. Bye bye.