Oil Bubble Breaking? Barron's Outlines the Case, But the Argument is Weak 23 comments
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As reported in the cover story this week, Barron's outlines the argument that we may be seeing a near-term top in the crude oil markets, and in fact, this may be a sign of a bursting bubble. To setup the argument, Barron's discusses the impact of supply and demand, along with the effects of institutional investments in commodity-linked indexes. For a quick overview, Barron's provides a nice one page overview of oil supply and demand, along with a chart showing the linkage of the price of crude oil as compared to the rise of the Nasdaq Composite in the late 1990s. While Barron's does present the various points for crude oil prices increasing and decreasing (discussed more below), it refers in both the article and video linked below to the "eerily similar" linkage between crude oil prices and the Nasdaq Composite, and how this implies a correction is possible. While a correction is possible, and may be setting-up as we speak, I am not sure it will be happening simply because the price pattern looks like a previous non-commodity bubble, technical analysis notwithstanding. Even Barron's straddles the fence somewhat by stating that prices could increase to $200 a barrel in the next decade, but could fall to $100 a barrel by year end - not exactly your typical deflating bubble, but more like a short-term pull back or correction.
So what exactly are the pro and con arguments regarding the bubble bursting? As to demand, it is mentioned how while the U.S. per-capita oil consumption is 25 barrels annually, both China and India are small in comparison, with China consuming only two barrels per person per year, with India consuming less than one barrel per person per year. Given that China and India have 1.3 and 1.1 billion citizens, respectively, there is an expectation that oil demand will increase in each of these countries as more of their citizens look to enjoy the fruits of the world, such as air conditioning, automobiles, refrigeration, and computers.
It is further speculated that China has been hoarding diesel fuel ahead of the Olympics in order to produce electricity without coal generation - which has been polluting the country, in particular Beijing where the Olympics are being held. China will likely go back to the cheaper coal once the games are over, thereby reducing diesel demand. China has also recently raised prices on gasoline by 18% (see previous post), a move that is expected to place further pressure on demand, although as described in the post, some feel this may just allow pent-up demand to be satisfied as profitability will return for refiners who have been hurt by higher crude oil costs, but have not been able to pass prices on to customers. This has essentially reduced the gasoline supply in China as refiners shut down or scale back operations. Better margins will now increase supply for consumers demanding gasoline, even at higher prices.
It is also mentioned in the article how Saudi Arabia has pledged to boost production by 200,000 barrels a day, from 9.5 million barrels a day to 9.7 million barrels a day, in order to take pressure off prices (see previous post). The potential for supply-oriented news out of this weekend's summit for oil producers and consumers may also generate additional production increase promises. Unfortunately, much of this oil is sour, and not the light sweet crude currently demanded by the markets, and also subsequently responsible for driving up prices. Whether the Saudi's even have the ability to increase production in their aging fields is also a concern regarding any promised production increases.
As for global oil consumption, it is down in total for the OECD nations (which account for more than half of all global oil demand). Demand itself is currently running about 86 million barrels a day and is expected to be relatively flat as nations cut back on consumption, in particular, automobile miles traveled. Yet, oil demand continues to grow in the developing world, and it will be difficult for even developed countries to reverse their trends quickly. As stated by Byron Wien, the chief investment strategist at Pequot Capital Management, "The world isn't finding oil fast enough to replace the 3% to 4% that gets pumped every year." With oil being controlled by governments that have an interest in maximizing revenues, it is unlikely they will have any near-term interest in boosting current production until the signs of demand destruction become more evident. With supply projections even less, at around 85 million barrels a day, with excess demand currently being made up from inventories, lower demand may result in break-even levels at best.
Some analysts are also speculating (hoping) that the U.S. Federal Reserve will begin raising interest rates later this year, which while helping to fight inflation in general, would also help boost the dollar, thereby reducing the cost of dollar dominated crude oil. Given the upcoming presidential election, and the history/attempts of the Fed to stay neutral during the second half of election years, it is unlikely they will do anything until the elections are over in November. The same could also be said for opening up the Strategic Petroleum Reserve. It is unlikely that the president will begin flooding the market this year in an attempt to increase supply and lower prices, although the government recently did stop purchasing oil for the reserve. If the president would begin selling, it would no doubt appear political, even if welcomed. Ironically, opening up the SPR might end up being a good trade if the country was able to sell oil at current prices when it was bought on average at much cheaper prices. Of course, what prices would be paid in the future to replace the oil is unknown.
In addition to the SPR, lifting of off-shore and protected land oil drilling bans could also have some impact. While it is often argued that the impact would be longer-term, as much as 10 years out, the lifting of the bans would certainly send a signal that the U.S. is finally getting serious about the problem and is willing to consider all alternatives, not to mention putting political partisanship behind it. Of course, I would not hold my breath on that one, but if prices continue to rise, expect to see pubic support for lifting the bans begin to shift as the U.S. approaches the next election.
Of course, no article on crude oil prices is worth it salt without discussing speculation and investment. While speculation is not discussed in great detail in the article, the increase in commodity index investing is. Investments by endowments, pension funds, and institutional investors has totaled $260 billion as of March, up from just $13 billion in 2003, with $55 billion flowing into commodity investments in Q1 of this year. Calpers alone is listed as increasing its commodity exposure from $500 million to $7 billion. Yet, isn't this to be expected? Good managers should be expected to deploy capital to the areas they feel will see that greatest potential. While the risk are present, fund managers are under increasing pressure to generate abnormal returns. Right now, commodities and energy plays represent some of the best opportunities, but the party may be coming to an end as Congress and regulators are considering limiting fund investment in commodities, along with placing larger margin requirements on speculators. Yet to be seen is whether the higher margin cost, or increase cost of carry will force index funds and speculators to open up stored reserves - speculated in some cases to be in cargo ships off the coasts of various countries. Nonetheless, it will change the dynamic. Whether it changes to price trend is yet to be determined.
Like Barron's, a short-term correction would not surprise me. Nor would a retest to the $100-110 range. Breaking $100 would probably signal or long-term correction, and a possible bursting of the bubble, but even Barron's is not projecting the prices to fall this low. In fact, it has actually done a pretty good job of outlining both the bull and bear arguments, while also tempering how much it expects the prices to fall even if the correction it is predicting is severe enough to be bubble bursting. In the end, Barron's itself may have placed the best crude oil hedge yet.
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This article has 23 comments:
> jack
theinvestingspeculator...
High oil prices that are governed by the commodity markets are in dire need of common sense law and order. When speculation and detrimental logic and reasoning take central command of human society, the results always turn out to be damaging to the majority, at the abundance of the few. The experts and speculators will argue we need free markets and any interference will take away free trade. Well, in many cases they are correct, however, when it comes to essential commodities of food and energy they are completely out of order. Here are a few reasons why essential commodity markets require new legislation.
1. There has been no shortage of gas at any filling station for the past 10 years yet prices are up 1200% because of futures trading going out more than eight years. Even the Saudi oil minister has recently stated the price of a barrel of oil should be no more than $70.00. Demand from China and India is still far less than that of the USA. The Chinese stock market is down 50% signifying a sharp slow down. This news still is not enough to stop the wild speculators hiking the oil prices.
2. When hurricanes hit Florida many gas stations are closed and there is a real shortage of gas for a few days. However, if a gas station increases its prices they will be prosecuted for price gauging. Therefore, if we take the experts argument that there is a shortage of oil then that still does not give anyone the right to profit from the shortage as this is deemed to be prices gauging. How can the USA governments have double standards and prosecute gas station owners who price gauge and not treat commodity markets in the same manner?
3. Oil is an essential commodity for every day living in the same way as water is an essential commodity. It makes no sense to trade water so why leave oil in the hands of anyone who wants to make a quick buck gambling on prices.
4. Pension and hedge fund managers have invested billions of dollars in oil futures. The futures markets are very volatile, thus, no place for pension funds to risk the money for people who trust them to build future wealth. The fiduciary duty of a pension fund manger is to find reasonable returns with low risk and the commodity markets is not that place.
5. If the price of oil was regulated between $40.00 - $80.00 a barrel, the price could go up and down on supply and demand. This would be fair to everyone, for even when supply was plentiful, the price would not drop below $40.00 which will still give a fair profit to most oil related industries. When oil is in short supply the price would be limited to a ceiling of $80.00 which is more acceptable to world economies.
6. There is a moral issue that greed cannot come before peoples basic needs ... No right-minded, ethical, principled government can allow starvation and financial ruin because of a system of trading that is completely out of control.
7. The price of a barrel of oil effects transport, food supply, industrial production and every part of modern day living. If terrorists wanted to devise a plan to destroy the world. economies what better way than finding a method to allow oil to trade at $140.00 a barrel. Why play a game that makes terrorists and anarchists happy.
8. Goodwill to all people is the credo every democratic country is built upon.$140.00 a barrel oil delivers no goodwill. It only brings hardship and political uneasiness.
9. Noble deeds and fair dealing is the hallmark of success for every truly prosperous person. Since the world is made-up from people, where are the noble deeds and fair dealing in the commodity pits.
10. We are all put on earth to help each other succeed in the pursuit of freedom, liberty and happiness. There is no freedom when people are slaves to greed. There are only liberty takers when oil trades over $80.00 a barrel. And finally financial hardship brings misery and discontent.
The time for change in essential commodity trading is now. To quote a few voices from the past...
“Experience demands that man is the only animal which devours his own kind, for I can apply no milder term to the general prey of the rich on the poor”_Thomas Jefferson
“For greed all nature is too little.”_Seneca
“It is greed to do all the talking but not to want to listen at all” _ Democritus
“He who is greedy is always in want.” _Horace
What if we forced oil companies to sell gas at prices reflecting $40-$80/barrel oil as he suggests?
They would shut their doors and then we would see shortages like we've never seen before. Why would they want to pay $100+/barrel and sell at less than cost. They would open up stores in China and India and sell there instead.
In fact, that's what's happening. Even without price controls, Exxon-Mobil has decided that selling gas in this country is not a worthwhile endeavor. They are in the process of closing their stations.
People are always looking for a scapegoat when things aren't going well. Why not blame the "evil speculators"?
Every crude oil futures contract that is bought by a speculator will expire. When it expires, someone will have to pay cash and take delivery of the oil the contract controls. I don't know of any speculators that have been hoarding oil in their basement that they bought with a futures contract. The only parties taking delivery are the refiners who can actually use the stuff. If they went on a buying strike, that would drive the price down, but since we (as a country and the world) continue to demand their refined products at ever increasing rates, they will continue to pay whatever they need to pay to get their crude oil.
The bottom line is that we are producing oil as fast as we can and demand is pushing the limits of the supply, driving up prices. The price may fluctuate in the short term due to traders, but the only way to get a real reduction in the price of oil is to increase supply or reduce demand.
FUTURES ONLY POSITIONS AS OF 06/17/08 |
----------------------... NONREPORTABLE
NON-COMMERCIAL | COMMERCIAL | TOTAL | POSITIONS
----------------------...
LONG | SHORT |SPREADS | LONG | SHORT | LONG | SHORT | LONG | SHORT
----------------------...
(CONTRACTS OF 1,000 BARRELS) OPEN INTEREST: 1,335,207
COMMITMENTS
203,806 191,094 219,645 825,031 823,129 1248482 1233868 86,725 101,339
CHANGES FROM 06/10/08 (CHANGE IN OPEN INTEREST: -83,542)
-14,678 -2,144 -25,976 -57,714 -73,551 -98,368 -101,671 14,826 18,129
PERCENT OF OPEN INTEREST FOR EACH CATEGORY OF TRADERS
15.3 14.3 16.5 61.8 61.6 93.5 92.4 6.5 7.6
NUMBER OF TRADERS IN EACH CATEGORY (TOTAL TRADERS: 320)
85 121 126 85 100 256 270
Yeah speculators are long a whopping 12,000 contracts. You know how many they were long when oil was at $78 last august? 110,000 contracts. So the price went up 80% and the number of net long contracts fell by 90%. How my ***you are a genius...There is a positive correlation. Lets stop the presses. We have discovered the damn truth
Seems to me they used an intriguing headline to sell papers...
While you are looking to spread the blame; Go to the not-so-big-three auto makers who did not take their profits over the last 30 years to develop fuel efficient vehicles.
Then after you have blamed everyone, look in the mirror. Chances are that you are driving a gas-guzzler. And if you are, you are likely to want to use the excess power of your vehicle to exceed the speed limits to burn even more gas.
There have been speculators long before any of us were born. They can’t corner the oil market. Eventually they have to take delivery, and the cost of storage would break the price.
So wise up.
I was in Europe recently and drove a diesel 5-series BMW. 43 mpg on the highway, in a sports car with incredible power. Why is this car not in the US?
The technology for more mileage is out there, it's just that the idiots building cars haven't taken full advantage of it. We're a country controlled by oil, and the only way to solve the problem is to start using less and less of it.
"In fact, that's what's happening. Even without price controls, Exxon-Mobil has decided that selling gas in this country is not a worthwhile endeavor. They are in the process of closing their stations."
The reason they are closing their gas stations is because they see the writing on the wall. If the market for hoola hoops was going to die, you'd sell your hoola hoop stores before they became worhless, right?
Plug-in cars with range extender motors won't require very many gas stations.
The only person they make any sense to is Hugo Chavez, since they are just the types of activities he uses in his country. Are you a cousin of his, perhaps? Or related to Fidel Castro? If people want to see what consequences such silly notions would have, let them just look at Venezuela, where oil production is falling and food shortages are skyrocketing.
Such socialist ideas have ultimately destroyed every civilization they've ever touched, yet people who tout them seem to think that the problem is just the fools who implement them. It's not the people. It's the principles! They're WRONG and DESTRUCTIVE, no matter whether they're imposed by tyrants in Venezuela or their cousins in Congress! If people listen to and take these ridiculous ideas seriously, then things will get much, MUCH worse as both the capital -- and the oil -- go to where they are more welcome.
What will THAT do to the dollar as -- just like what happened to the currency in Venezuela -- capital flight collapses the Dollar even more and crude and other commodity prices go through the roof. What a great prescription for creating hyperinflation!
Put your money where your mouth is -- SHORT the crude oil market!
Nice to read your comment, but it would be better if basic commodities that folks need to survive antoher day are not prey to attackers from the M3 money universe.
To adenovir:
Ahum, we are talking about oil futures so by definition no oil is delivered. For example; when you buy some futures on the DOW Jones, are you forced to buy stocks from the DOW when settlement is there?
To saifl: You quote some hard to read stuff, but you basic argument is that only 12,000 contracts are open by 'speculators' is nowhere to be found in your quotes. Nor do you place a link where talk like this could be validated.
Furthermore you mention 110,000 of these contracts open in August 2007 when oil/barrel was US$.
And last but not least: You talk about 1000 barrel contracts...
So 12 thousand open contracts amount to 12 million barrels of oil while world consumption is 85 million barrels a day.
Better go back to highschool and try to understand elementary math saifi...
So I correct the wrong words, quote:
Furthermore you mention 110,000 of these contracts open in August 2007 when oil/barrel was US$.
With the words as I typed them just a few minutes ago:
Furthermore you mention 110,000 of these contracts open in August 2007 when oil/barrel was 78 US$.
The quote is from datalink 1995 and datalink 1995 thinks that trading of futures is related to actual delivering of oil at your door...
Never ever it has occured in the mindset of dataling 1995 that traders that work at banks consider this 'rather unhandy' and that this is against the 'nature' of futures because futures 'only follow real markets'.
Not often you observe it as dumd as the datalink 1995.
Here is the wisdom of datalink 1995, quote:
There have been speculators long before any of us were born. They can’t corner the oil market. Eventually they have to take delivery, and the cost of storage would break the price.
www.cftc.gov/dea/futur...
As for elemenary math I thought you were smart enough to subtract the long from the short i.e 203,000 from 191000. I am sorry ..lets go over it again as to what net long means
It means the difference between the long and short.
and here..for August 2007
www.cftc.gov/files/dea...
CRUDE OIL, LIGHT SWEET - NEW YORK MERCANTILE EXCHANGE Code-067651
FUTURES ONLY POSITIONS AS OF 08/07/07 |
----------------------... NONREPORTABLE
NON-COMMERCIAL | COMMERCIAL | TOTAL | POSITIONS
----------------------...
LONG | SHORT |SPREADS | LONG | SHORT | LONG | SHORT | LONG | SHORT
----------------------...
(CONTRACTS OF 1,000 BARRELS) OPEN INTEREST: 1,504,817
COMMITMENTS
230,904 124,646 288,467 900,395 1017930 1419766 1431043 85,051 73,774
CHANGES FROM 07/31/07 (CHANGE IN OPEN INTEREST: -16,420)
-33,491 -12,258 8,230 -412 -2,565 -25,673 -6,593 9,253 -9,827
PERCENT OF OPEN INTEREST FOR EACH CATEGORY OF TRADERS
15.3 8.3 19.2 59.8 67.6 94.3 95.1 5.7 4.9
NUMBER OF TRADERS IN EACH CATEGORY (TOTAL TRADERS: 318)
99 93 130 82 99 263 262
12 million barrels for contracts that span 7 years? At current consumption rates that would not be 85 million barrels that would be 85 million barrels per day or about 210 billion barrels so 12 million is peanuts.
If the media and the politicians would start using the correct word,
"hoarders", instead of the misnomer, "speculators" then a much more understandable view of the situation might have a chance to emerge. While the full statistics are not generally available,
the numbers strongly suggest that a huge amount of money has been and still is invested by commercial ventures, investment houses and the like, on the SHORT side of oil, and if Congress passes new laws to further restrict investments, the net effect will be a rush to close those positions by BUYING more oil and the price will shoot up instead of down. In general, price controls on a free market always have destructive results and this situation will be no different.
As a little guy living in a small house in a blue collar town and hardly ever driving myself, I will continue to invest my retirement nestegg in oil instead of what the financial houses keep recommending and preaching to me. I sure have done okay with it this past decade.