Commodity Bubble Proponent

Options Trader: Tuesday Outlook

Great work as always Phil. I don't believe we'll have a sustainable stock market rally until it is led on a consistent basis by a S&P group that is not oil/gas or commodity related

Options Trader: Tuesday Outlook

Phil,

Just a few thoughts on some of your earlier posts.

The whole point of oil futures, like options, is to allow for producers and consumers to come together and trade oil.

In a contract in any other industry, when you enter into a contract, one person buys oil, the other person sells. If one party defaults on the agreement (which is basically what rolling the contract forward is), then they owe the other side of the transaction their entire deposit. If the producer defaults on the deal, then they are responsible for paying recourse to the buyer. End of story.

This is how real estate, buying a car off of a factory line, major purchases by industrial users, and conceptually how a futures contract should work. If there is no recourse (penalties for breaching a contract), the entire market is a complete fraud because both sides of the transaction could be lying through their teeth.

The game is completely disconnected from economic reality. It's basically like me selling you a 5 star hotel I don't own that you won't buy, and then the entire hotel industry uses that pricing as a basis to set the rents on their buildings. This game would work for awhile until all of the sudden supply and demand catch up to you. Sound familiar?

The Enron loophole allowed parties to enter into bilateral agreements between parties that don't have any crude oil between them which have then been used as market comparables for the pricing services(Platts, etc.).

These issues are easily regulated without really impacting the "free market", margin requirements, position limits, etc.:

1. Recourse for the other party in a cancelled future contract. If buyer rolls the contract, seller gets his margin. If the seller cancels out of their deal to sell oil, buyer gets a recourse fee.


2. Any publicly traded company that clears OTC trade swaps on a non-approved market will face fines of several millions of dollars/transaction per dayl.


3. The buyer and seller must use an independent clearing house for oil futures transactions. This would stop the conflicts of interest where goldman acts as the seller, takes a fee for clearing the contract, and then loans the money to the buyer for the contract.

4. The independent clearing house can not loan money to either party to complete the transaction.

These are pretty simple benign changes, but it would fix the issues of non-recourse contracts.

A Note to the Bubble-Phobes

I'd be interested to see how much demand there would be for commodity futures if traders were required to post 25-50% of the value of the contract before buying rather than the pitiful 7% that they do now.

Based upon the capital layout to expected cashflow from these "commodity" investments (and I say that b/c these investors don't buy the actual commodity), these futures markets are ripe for speculation. (cough...Amaranth...co... "Runaway" world oil demand has increased at it's height by 2% per year (2001-2003) and is now less than 1%. In any other industry, that type of demand growth would be pathetic.

BUT...I don't think bubbles are a horrific thing. There was a real demand for new housing, and the tech "bubble" produced one of the highest margin industries in the world (typical margins exceed 25% of revenue today), and this commodities bubble will breed and create new business that grow the global economy.

Greenspan's Latest: Oil Boom Will Likely 'Go on Forever'

Just a thought here...but historically speaking long run oil demand (5-10 years) is fairly elastic despite most of the inelasticity arguments posited. For example, between 1979-1985, oil use actually declined internationally by approximately 10 MB/D due to higher conservation and changing energy policies.

Eventually (and we are seeing the first seeds of change), alternative energy solutions (algae based biofuels, cellulosic ethanol NOT food based fuels) will make a gigantic impact on energy demand. The argument that oil demand will rise indefinitely and that alternatives will take hold in 300 years is akin to saying in 1989 that the cellphones and the internet would be niche technology for at least 30 years (and yes people said that in the early tech boom).