3 Aspects to Pricing Oil

There are three reasons for the huge spike in the oil price, starting in 2004; they are: 1) the pricing method; 2) type of refining capacity; 3) non-commercial oil futures speculation.

1. Oil is priced using only two grades of crude: WTI and Brent or the light, sweet crude that is always in high demand. The heavy, sour crude is discounted to the good stuff. Of course, there is less of the sweet crude and more of the sour crude. But the price drop in October 2006 through February 2007, when there was significant, monthly, inventory growth over 2005 on WTI at Cushing, OK, does not indicate robust price support at the margin; the imbalance was corrected in 2007.
2. There is a heavy, sour crude, refining capacity deficit; if refinery capacity were increased to handle this source, demand pressure would be decreased on WTI or Brent and their price should moderate. But environmentalists don’t want refineries…no one wants them [NIMBY]. As an example, look at the denial of the ConocoPhillips (COP) Wood River Refinery expansion in Illinois [Appeal No.07-02]; it was going to handle heavy, Canadian crude. A view of the Environmental Appeals Board work is instructive as to any possibility of future capacity expansion. Couple environmental obstructionism with refinery cost, government refining requirements and the bottleneck on expansion is assured.
3. Non-commercial, oil futures speculators only add financial pressure to the commodities market. These parties are significantly different from the commodity producers and buyers [hedgers] who trade oil in order to manage the risks of rising or falling prices in their own businesses. They are engaged in price discovery as producers and users of oil. What ‘special knowledge’ would speculators add that commercial hedgers don’t? They add more trading volume, but that was never a problem needing a solution. They do bring a mode of excess; best described by Charles P. Kindleberger in Manias, Panics, and Crashes: A History of Financial Crises. Futures positions can be closed using Exchange For Physicals [EFP] by private negotiation and informing the exchange. While the CFTC prohibits ‘’wash trades,’’ how would they ever know if this method or other tricks were used by world traders to disguise fictitious trades.

Therefore, any measures that help reduce demand for WTI or Brent by increasing the availability of sour crude refining or lessen demand by putting automobile power usage partially on the electric grid, and restrictions on commodity speculators would be helpful.

 

Comments

[oaksleeksbeans]

Weak analysis... here's my analysis
1. we are running out of oil the cheap (easy to find, easy to refine, flows out of a well) stuff first.
2. demand and supply are very close - resulting in more firms wanting to hedge future prices
2. demand and supply are very close - resulting in speculators being able to influence near term pricing

[john s. gordon]

lets go after the fictitious traders.
> jack

[Shaggieman]

Let the government own the refineries. I know that sounds wrong but stop and think. How can any company survive with everyone against them? The upgrades to handle the sour crude are being stifled by the environmentalists who have the Demos ears.

[CRYSBALL]

You seem to have neglected something economists call supply & demand,however, new economics always wants to find other explanations, than the real ones. We live in a global economy, and your analysis is parochial & shallow.

[PrudentMan, CFA]

I see you have the usual whiners responding, pointing fingers. Maybe they should park their gas guzzlers and take public transportation, make their brats walk to school and quick consuming the biggest ripoff since the Tulip Scandal: Petroleum based bottles for water that some peddler says is "pure". Wake up you idiots!

If I extrapolate the cost of my first home and correlate gas prices accordingly, gasoline would cost $7.50 a gallon. So increase supply, decrease demand, put up, shut up and walk off your love handles.

[fjasyr]

In May, another huge block of oil speculators came on board when the Dubai commodities market began trading in WTC sweet crude. Free of any transparency other than the numbers, NYMEX and other exchanges provide excellent cover for those who may be manipulating the market. Otherwise the US oil industry has great transparency with the Energry Department's statistics and analysis of the industry and the SEC which provides supplemental documents, especially 10-K reports that disclose much greater information about individual producers activities than the quarterly and annual reports.

I would like to add a fourth reason to the three you have provided regarding the current and future status of the oil markets -- the merger of Exxon and Mobil in 1999. Not since the breakup of Standard Oil Company by the Supreme Count in 1911, has one company been able to exercises monopoly-like influence on both the market for crude and the price at the pump as Exxon-Mobil. Considering that it takes a few years for consolidation of operations, productions and marketing strategy, the current volatility of the market appears to have emerged at the point on Exxon-Mobil's timetable when consolidation was completed and the oil company giant was capable of exercising its influence.

I suggest you go back to the time of the merger and read the comments by company officials and marketing gurus predictions of the company's times.

[oil baron]

Question:
If speculators are at least partially responsible for the runup in oil prices why are the outer contract months almost always in backwardation and rarely in contango?
The speculators rarely if ever take delivery and over time that is proof that speculators play virtually no part in the pricing of oil.
The reason for oils runup is supply and demand and geopolitical risks.
By 2020 oil consumption will exceed 120mmbopd and I suspect production will be considerably less.

I would like to hear some dissenting arguements to this theory...

Thank you

[mixter]

Fjasyr must be an Arabic word for idiot! How can Exxon-Mobil, as well as the other major western oil companies that control less than 3% of the world's oil, greatly influence the price of crude oil? Foreign country owned oil companies (Pemex, Aramco, Statoil, Petrobras, etc. control 70% of the world's crude supply.

Fjasyr sounds as stupid as most of the members of the US Congress, especially the "Dim-wit-o-craps!

[bill d]

Seems to me the "speculators"... that have as much effect on the market as anybody is the media.
They predict the price of gas will go up - it does.
They never predict it go down - but it does anyway.
Here in Kalifornia last week gas was 4.60 - now 4.45.
Why? - figure it out - if you drive you know why except for the morons who mommy & daddy must buy their gas for them.
55 mph works - why no clamor for it now - will we wait for gas lines?
Guarantee - if Dems can implement their "solutions" you will see lines, rationing, etc. History will repeat itself.
Heard very little about the 15 cent drop - I heard one report that said gas was down 1 - 3 cents.
Wait till it goes back up 1 cent and watch the coverage.

News flash from the year 2020 - Democrats claim it will take 10 years to get any oil if we start drilling now.
Arnold down to one Hummer but we still ain't gonna drill of OUR coast.

[PrudentMan, CFA]

The "clearing price" is the price where oil is actually delivered. In the meantime, anything can happen as like everything else in life.

If you think it is rigged, don't play it or use it!

[Emerald]

A reasonable reading of history would suggest that oil has been a key component of most wars in the 20th century. The Germans needed fuel and went after it in different countries. The U.S., going back to Roosevelt, made a deal with the Saudis to protect them if they keep the oil flowing. The "dictatorship of the desert" funds the madrassas in Pakistan that produce fanatics who hate us. What a wonderful circle of interests! Iraq is another oil war and we will be there forever. Put your money in oil and gas drillers because we won't sufficiently create a Marshall Plan to push nuclear, solar, wind and hydrogen. The Japanese and Chinese will corner the production market for these new products and we will pay dearly. The U.S. dollar will rally for a few months and then press the elevator button for the basement. Buy GLD and the Swiss Franc.

[smokey888]

Most of the postings here seem to have some knowledge of this present situation of which I feel very inadequate, consequently I would just like to ask a question for some comments:

What do any of you think of the idea of (1) drilling where we haven't even if it does take a few years to get here - which I figure is better than a few years plus few years more if we don't start now & changing some speculation rules if applicable; and (2) starting a serious Manhattan like Project directed towards energy to determine to the best short term direction (rather than throwing a bunch of money at everything with HOPE) and more directed towards a more longer term final solution? (or does either of these two (or three) avenues even come close to addressing the issue of energy) Thanks for you time.

[cynic69]

This is a stupid article. M. King Hubbert has the answer to why the price of oil is going up.

[maximax]

nah smokey, most posters here have an agenda, but no clue. Eichler's first two points are spot on, and actually nothing new if you had been reading industry journals like Argus/OMI etc instead of just dwelling on this site. I am ambiguous on the third point, the relationship between the spot and the futures market is very complicated, and academics are not in unison on what is happening here. Is the additional liquidity by speculators required for this market? Anyway, they risk their own money, all those gov't interventions called for risk taxpayer's money. And to all those supply-demand/Hubbert comments above - Eichler is not even contradicting them! In fact his points are based on S/D, and he calls them "aspects" not the whole picture! Indeed, economics is no more just about S vs D, they are now about truly understanding the microfoundations of a market, as well as the agent's incentives etc... not just foolishly applying two-dimensional textbook-like S-D curves like some of the above posters seem to try.

So smokey... (1) reserve estimates of the US offshore fields are old and vague, but do not expect to find another Ghahar/Cantarell etc that can keep up current US consumption ad infinitum. It will buy you time, but will not affect the price much (the US cannot use domestic fields to isolate itself from world markets), but it won't buy you very much time. (2) is much more important - solve the demand side, get yourself off the stuff. The main obstacle to progress here has been the present US gov't, which has happily invaded Iraq on behalf of its oil majors, but has been blocking climate and other progressive treaties. Political will is paramount, as energy efficiency is riddled with market failures. But many interest groups and voters are against it due to the negative short term implications...

[[e-mail]]

earfearferf


On Jun 30 05:32 AM maximax wrote:

> nah smokey, most posters here have an agenda, but no clue. Eichler's
> first two points are spot on, and actually nothing new if you had
> been reading industry journals like Argus/OMI etc instead of just
> dwelling on this site. I am ambiguous on the third point, the relationship
> between the spot and the futures market is very complicated, and
> academics are not in unison on what is happening here. Is the additional
> liquidity by speculators required for this market? Anyway, they risk
> their own money, all those gov't interventions called for risk taxpayer's
> money. And to all those supply-demand/Hubbert comments above - Eichler
> is not even contradicting them! In fact his points are based on S/D,
> and he calls them "aspects" not the whole picture! Indeed, economics
> is no more just about S vs D, they are now about truly understanding
> the microfoundations of a market, as well as the agent's incentives
> etc... not just foolishly applying two-dimensional textbook-like
> S-D curves like some of the above posters seem to try.
>
> So smokey... (1) reserve estimates of the US offshore fields are
> old and vague, but do not expect to find another Ghahar/Cantarell
> etc that can keep up current US consumption ad infinitum. It will
> buy you time, but will not affect the price much (the US cannot use
> domestic fields to isolate itself from world markets), but it won't
> buy you very much time. (2) is much more important - solve the demand
> side, get yourself off the stuff. The main obstacle to progress here
> has been the present US gov't, which has happily invaded Iraq on
> behalf of its oil majors, but has been blocking climate and other
> progressive treaties. Political will is paramount, as energy efficiency
> is riddled with market failures. But many interest groups and voters
> are against it due to the negative short term implications...