On April 2, 2012, the Brent July futures contract closed at $125 and West Texas Intermediate registered $105, while the recent prices of $98 and $83 respectively have no resemblance to yesterday's perceptions. But not much has changed since then, economically and geopolitically speaking. Europe is still a mess, China is limping along and hiding it, and the U.S. economy is moving at a snail's pace. From a risk perspective, Iran is still defiant and continuing to pursue its nuclear ambitions, while Israel may still take action if all else fails. In addition, the Keystone pipeline is still a pipe dream, with Warren Buffet being the winner through BNSF.
With modest expansion, railroads can handle all new oil produced in western Canada through 2030, according to an analysis of the Keystone proposal by the U.S. State Department. "Whatever people bring to us, we're ready to haul," Krista York-Wooley, a spokeswoman for Burlington Northern, a unit of Buffett's Omaha, Nebraska-based Berkshire Hathaway Inc. (NYSE:BRK.A), said in an interview. If Keystone XL "doesn't happen, we're here to haul."
While U.S. crude inventories have been increasing and gasoline consumption shrinking, a price decline of 21% and 23% for Brent and WTI respectively in only eight weeks is hardly justifiable, and begs the question as to what the overall bet was truly about.
But before we move on, the talk about speculators has abated, and no mention of that ill defined group is being printed. I shall remind everyone, only because we tend to forget the news as recently as yesterday, mostly due to the overwhelming flow of information, that in April President Obama put forth his plan to crack down on oil market manipulation, as outlined in his remarks.
We can't afford a situation where speculators artificially manipulate markets by buying up oil, creating the perception of a shortage, and driving prices higher - only to flip the oil for a quick profit.
If that is the case, I whole heartedly agree, but the facts aren't there, and one cannot start charging oil traders, mutual funds, hedge funds and ETFs in a broad sense without hard evidence. But speculators can also create the perception of abundance and profit equally, although that is never a problem. Then again the call to suppress oil speculators is not unique to this administration.
Bart Chilton, a CFTC commissioner, was nominated by President Bush and confirmed by the U. S. Senate in 2007. In 2009, he was re-nominated by President Obama and reconfirmed by the Senate. Mr. Chilton delivered a speech on February 24, 2012, that addressed the impact of speculators on oil prices.
A Goldman Sachs study last year stated that each million barrels of net speculative length in the markets adds as much as 8 to 10 cents to the price of a barrel of crude oil. As of February 23, 2012, the CFTC Commitment of Traders Report showed that "managed money" held net positions in NYMEX crude oil contracts equivalent to 233.9 million barrels. Using the Goldman Sachs research figure, and multiplying 10 cents times 233.9 million would mean that, theoretically, there's a "speculative premium" of as much as $23.39 a barrel in the price of NYMEX crude oil.
The point is that all of us, in varying degrees and through our investments, contribute to high oil prices, and speculation is not the exclusive domain of the people in the trading pits. And even when someone or a company is the subject of an investigation, the length of time that it takes to prosecute hardly resolves the present price pressures. A recent case highlights the point, while it took five years to get a verdict. The paltry fine when compared to the daily trading of the WTI contract that accounts for over $2 billion on margin requirements alone, is hardly evidence of widespread manipulation.
Federal Court Orders $14 Million in Fines and Disgorgement Stemming from CFTC Charges against Optiver and Others for Manipulation of NYMEX Crude Oil, Heating Oil, and Gasoline Futures Contracts and Making False Statements.
There are three main reasons behind the expectation of high oil prices: supply disruption, global economic recovery, and dollar devaluation. The geopolitically induced potential risk of disruption is still in play, and the true impact on prices is now highly questionable. But there's still that other supply issue, and Citigroup (NYSE:C) weighed in with a report (pdf) in February: "Resurging North American Oil Production and the Death of the Peak Oil Hypothesis."
From an economic recovery perspective, and setting the U.S. and Europe aside, it wasn't long ago that China was viewed as the insatiable oil consumer with an economy immune to global shocks, and that has proven to be false. Although oil consumption is still growing, "China's net crude oil imports are expected to rise 5.9% this year, the slowest growth rate since 2006," according to China National Petroleum Corp. Furthermore, Russia, Brazil and India are scrambling to keep their economic engines from sputtering.
Thus the devaluation of the dollar is the ultimate bet, and if anybody is aiding and abetting the speculative play is the Federal Reserve Board, and I am not sure how that "speculator" can be contained, from a political perspective, that is.
And if the often mentioned demise of the dollar is driving some to expect oil to rise to the sky, I shall advance that if the "fiat" currency party is to end, as some expect, the dollar will be the one piece of paper to close the door and turn out the lights. By then oil will be heavily discounted looking to attract buyers that will be in the nearby forest gathering wood and hunting rabbits.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.