That Crazy Day in Oil

A perfect storm of events combined to drive oil prices to new highs last Friday. First the numbers, for our cave-bound fans. Oil opened at $128.20, climbed to a record $139.12 all-time high during the day and closed at $138.54 for a record close. That's an 8% jump in just 5 1/2 hours. It was one of those "if only I'd had a crystal ball" days.f

To everyone without that crystal ball, the big jump in oil prices was a scary thing to wake up to with their Saturday morning coffee and newspaper, and even the newspapers seemed a bit confused on where to begin. Here's a recap on some of the competing theories.

Behind The Numbers

First of all, the dollar is weak and getting weaker. The chart below is how the dollar has been shaping up to the euro for the past few months. Not exactly a pretty picture.

Since crude oil is priced in dollars, the price of crude rises in direct relationship to the dollar's decline. Think about it this way, those countries which produce the oil, and the companies in them, have to be able to pay their workers and their bills in local currency, so they have to raise their dollar prices just to stay even. Dollar down = dollar-priced commodities tend to rise.

But we're big believers in simple supply-and-demand charts, so let's look at the supply-shock theory.

First, there are rumors in Nigeria of a strike against Chevron. Not only would it affect existing production, but Chevron is scheduled to bring on-line an additional 250,000 barrels per day on June 15. Even though demand has actually finally started easing in some parts of the world, losing 250K a day of new capacity still matters. Any new capacity that comes on-line will get used, and threats to supply, even rumors of threats, carry weight. Heck, 250K barrels is a quarter of what Senator Schumer is demanding of OPEC.

More disturbing though, is a remark by Israel's deputy minister and transportation minister Shaul Mofaz. In an interview published in an Israeli newspaper and quoted in a Reuters article, he states, "If Iran continues with its programme for developing nuclear weapons, we will attack it. The sanctions are ineffective." Of course, the government was quick to refute Mr. Mofaz's statements, but the damage to oil prices was done.

Evil Speculators

The big enemy in the current debate is definitely that most inscrutable of villains, the speculator, or even the lowly investor who is buying the occasional commodity ETF in their 401(k).

Every pundit, myself included, has discussed the issue of speculation before. But this isn't like the tech bubble, where everyone and their Aunt Mildred was picking stock and investing. Investing in futures is a sophisticated activity, and there are many barriers to entry (margin requirements, portals to trade, etc.). So if the craziness in the oil market was really the result of rogue futures traders, you'd expect it to show up in the volume. But here's the volume of crude oil [CL] contracts traded on NYMEX in the last year:

We see lots of volatility in the daily volume, and yes, it's a line with a definite upward slope. But there's no cataclysmic rise here. In fact, based on numbers available right at the close, there appeared to be around 2,000 fewer contracts traded than on the day before, and 9,000 fewer than the previous Friday.

The chart below is deceiving because it is a chart for July 2008 crude oil, and many investors didn't start trading it until recent weeks; hence the apparent increase in trading volume. But even still, when oil was hitting its highs, the volume dropped off a bit.

Does this "prove" anything? Not really. But it does show a stark contrast to what's typically seen in the equity markets, where crazy price moves almost always coincide with crazy jumps in volume. This is not everyone's grandma deciding to bet big in oil, and as anyone who knows the ETF market will tell you, if everyone decides to go buy a commodity index on a given day, this does not translate directly into the price of the futures contract.

The true test will be to watch what crude price and volume do in the first few days of this week - perhaps there's a time delay we're just not picking up.

Where To Now?

At this rate, it doesn't take a rocket scientist (or Boone Pickens) to call for oil at $140, or even $150. And that's what we're seeing from most pundits - and even some of the producers themselves. Reuters ran a story on Sunday with the following quote:

"I forecast that by the end of summer the price of oil will reach $150 per barrel," Mohammad Ali Khatibi was quoted as saying by Iran's state broadcaster, referring to the summer in the northern hemisphere.

He's an important one to listen to because he is Iran's OPEC representative. With Iran producing the fourth-largest amount of oil, this information could be viewed in a couple of ways - as a projection influenced by the status of the U.S. dollar and market in general, or as a threat or promise.

Ain't geopolitics grand?

The best call is likely to stay focused on supply and demand - these remain the cast iron posts to which commodities prices must ultimately be hitched. And as I said last week - I don't think the signs there are pointing to "lower" anytime soon - at least not Dallas-Fed-$60-oil lower.

Comments

[econtakes:]

The article was well written...In essence it delivers part of what the future might hold if the analytics convince me in a few months. We are approaching a turning point, somewhat differrent than a "bubble" as there is a lot weighing on this election year from all observers in the world. The U.S.... is in a way on stage right now.

The ECOBGURU

2008 Jun 11 09:19 AM

[nyteowl:]

Curious, you neglect to mention that further in the article that Khatibi mentioned a ten dollar increase in one day isn't in his words 'stable'.

No mention of the 14 VLCC's that Iran currently has off of Kargh Island,full of oil they can't seem to get rid of.20 million barrels PER VLCC if you were wondering.

Nor any mention of Goldman or the other investment houses being exempted from CFTC regulations requiring traders to show 90% of their business being energy related, like airlines, utilities and trucking companies.

Isn't it odd that when the largest trader of NYMEX crude futures, Goldamn says $150 oil, every one acts as if it is an edict from on high?

Ulterior motive anyone? Conflict of interest?

Investment banks have no business trading in crude or any other energy futures.

Funny how we're paying more for NatGas in June than we were in January isn't it?

2008 Jun 11 10:24 AM

[svkoho:]

Good posting and the above comments are also thought provoking. The world is well supplied with sour heavy crude.Until enough refineries are finished to process the crap we will be seeing what we have seen for a while. Sour heavy oil isn't a traded commodity on the Nymex, at least not yet.I do not see a serious downside to increasing margin requirements on the NYMEX but unless it's changed world wide, folks will just move to London or the ME to do their trades.Volatility will continue.

2008 Jun 11 11:23 AM

[jjason:]

This article is not only deceptive, it is wrong. The author is contradicted by the following authors:

1. Phil Davis who clearly explains what "paper oil" is. For those of you who do not understand the fraud involved in "paper oil", read Phil's article. ( on SeekingAlpha )

2. Professor Michael Greenberger who wrote a report titled " Energy Market Manipulation and Federal Enforcement Regimes ". This report ( which I have read and have a copy of ) was given to a US Senate committee on June 3, 2008. Professor Greenberger teaches at the Univ. of Maryland School of Law and he has worked for the CFTC.

3. Anthony Schneider who wrote the article "Greenberger's testimony- I Banks Control the Energy Market" You can get links to Greenberger's report from Anthony's article. ( On SeekingAlpha )

4. Representative Bart Stupak's statement that "Goldman Sachs and Morgan Stanley are manipulating oil markets".

5. Comments made by me on some of the above articles on the subject of the fraud that has been perpetuated on the American people by the folks who tell us " oil is going to $150 per bbl by July 4, 2008 and $200.00 by 2009. These people at Goldman and other I- banks are lying to us for their own benefit as some of them are part owners of the NYMEX and ICE. It's similar to the NAR and Real Estate Brokers telling everyone " invest in real estate now while you have the chance because prices are headed up".

5. William Eichler who wrote an article on SeekingAlpha on June 8, 2008 telling us how oil futures trading is pushing up the price of oil.

I also would like to remind everyone about what Enron did in manipulating energy prices.

It will take some time for you readers to research the articles I have written about. But if you do, you will not be bamboozled or conned by articles that present only one side of the story. Good luck.

JJASON has no positions in any futures contract or funds or ETF's that involve this article or post

2008 Jun 12 10:37 AM

[maher:]

It's Iran stupid!

2008 Jun 12 05:42 PM