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Revival of the Petrodollar Recycling Machine

I think Gregor's point is more that oil exporters need somewhere to put all those US dollars they're collecting and Treasuries offer a big enough bin to receive them. This additional demand for dollar denominated investments would help support Treasury prices and hold down yield, but it does not create any additional demand for dollars themselves so it would not support dollar's fx value. On the other hand by offering a place to absorb the excess supply of dollars, Treasuries' dollar absorption may help prevent further declines of the dollar that would result from all those oil payment dollars being spent into the world.

Does Crude's Price Reflect Reality?

Here's another thought experiment. Let's imagine oil trades in a pure free market where only oil producers and oil consumers sell and buy oil. That is, for clarity let's take the complication of speculators out of the equation. I'll be an non-OPEC oil producer (seller), you can be a US refinery (buyer).

I've noticed that global supplies have been getting tight from time to time. I noticed OPEC countries simultaneously double their estimated reserves and I wrote that off as cheating on quotas. I think their reserves are declining just like mine are.

I've also noticed that nobody has found any large new pools of oil for decades, and all the new oil being found is hard to get at and expensive to produce. New oil is so expensive, in fact, that it is now economic to produce it from tarsands; and the deepwater Brazil discovery is actually being considered recoverable even though the technology to get at that oil does not yet exist and it would be cheaper to send Americans to Mars than to get the first barrel of that oil out of the ground.

You have seen all these facts too, and you also see continuing strong demand for your refined products. You and I both know that the economy of the world is driven by oil-based fuels and it would take a multi decade concerted effort to convert to another fuel source for transportation, if any such alternative fuel existed, which it doesn't. So you are resigned to buying and refining oil at market prices and I am happy to offer it to you for sale at those prices.

My cost structure is much lower than tarsands oil, but they represent the marginal suppliers. That is, the next new barrel of oil is going to be produced and sold at high cost or it will not be produced at all. Neither you nor I expect any new cheap oil to be discovered or any technological miracle that replaces oil.

If you, the refiner, ever run out of crude oil feedstock, you have to do a plant shutdown then a restart when you get supply again. This will cost you many millions of dollars in addition to your lost earnings during your shutdown. You and I both know this.

For all these reasons oil is a seller's market. I can hold out for a price that reflects the high cost of new marginal supply even though my own cost is a fraction of that. For decades Venezuela has been currying favor in Latin American countries by selling them oil below world price. They can do this because their cost structure is below the cost of new marginal supply, so they still make good profit selling oil below market price. I could do this too but I want the money, not the political power, so I hold out for maximum price. (Chavez' political fortunes depend on social spending of Venezuela's oil earnings, so in that sense Venezuela's 'cost structure' is now determined by Chavez' spending commitments rather than the cost of getting oil out of the ground.)

Neither you nor I nor anyone else knows for sure how much spare capacity exists in global oil supplies, nor do we know how much recoverable oil remains in the ground. We are aware of the potential for politically originated supply disruptions (i.e. wars) in places from Nigeria to the Middle East. We both know that in the short term oil is price inelastic: the world cannot stop moving itself with oil-based fuels just because the price goes up. You and I are both sensitive to the possibility of price spikes for these reasons.

I will certainly stay alert because if the opportunity arises to ramp up my prices I'll jump on it, and you know you will have to pay. You also know you can pass on the increase to your end consumers because they need your fuels for their trucks and buses and cars and ships and planes and they can't just stop doing business and going to work. In the short term they will simply suffer the higher prices you are charging.

We believe peak oil is true: there will be no more cheap oil to discover and produce. We know that I, the oil producer, must continuously find and produce new oil to compensate for the decline rates of my currently producing fields, and we both know this has been getting costlier for me. So you do not feel that I am screwing you on price even though I am making windfall profits during price spikes because you know I will have to pump much of my gains into finding and producing oil next year and the year after that.

That's the end of this thought experiment. So now, what "should" the price of oil be? My answer is that it should be whatever the market says it should be, and this includes fear (of supply disruptions) and greed (cashing in on price spikes) as well as objective economic analysis of the shifting supply and demand equation.

Do Lawmakers Really Understand the Energy Markets?

Hard Assets has described how the oil market actually works in its present form, which includes speculators creating false demand TODAY for contracts of future oil deliveries at higher prices in a contango market. If there were no speculators buying these contracts, 'providing liquidity', then suppliers would take the cue and cut production to bring supply down to demand levels. Current world supply has been cut by over 3 million barrels per day from its 2008 peak so it's not as if suppliers 'can't' cut production or increase inventory storage when the demand is not there.

And if no oil users are bidding up futures contracts, how can contango exist? Supply would be withheld in the short term until spot prices rose to futures prices. And if there's good profit for speculators to carry excess inventories during contango, why wouldn't suppliers carry their own excess inventories and cash in on the profit? You can't just turn oil production on and off, but if there's money to be made by creating your own storage capacity then why shouldn't suppliers do it themselves?

In a free market "excess inventories" is a signal to cut production. That's how all those companies reported rising profits this year: they laid off staff and cut production in the face of a declining demand market. If they had kept flooding the market with more product than could be sold at present prices, they would have found themselves engaging in fire sales to clear their excess inventories. But if speculators enter this market with 'liquidity', which means money to buy and hold the products that consumers will not buy today but which they will need in the future, speculators can hold prices up at levels which market conditions do not support. Instead of consumers getting bargains from excess inventories, speculators get profits and consumers pay full price.

Speculation distorts market prices and distorts supply and demand signals. Speculation is "noise", not information. Would the housing bubble have climbed so high if real estate speculators, who had no intention of ever living in or renting out the houses they were having built, had not added hugely to demand? Real estate speculators 'added liquidity' to the housing market and inflated prices to spectacular bubble levels that put housing out of affordable reach of most people.

"The market", which is real people who want a house to live in or to rent out, would have been able to inflate that high. 'Exotic' mortgages, whose 'affordability' could only be based on the expectation of ever rising real estate prices which enabled homebuyers to essentially be speculators and sell the house at a higher price because they could never afford the IPT payments on a $500k house, would never have seemed viable without all the speculators 'adding liquidity' into the housing market.

Speculation 'financializes' supply and demand markets, utterly distorting the prices that suppliers and users rely on to plan for their future business decisions. These are supposed to be commodities markets, not financial markets. Demand is created not on any need or intention to keep and use the product, but only to make a monetary profit form buying and selling it.

If future prices are higher than present prices that is a signal for suppliers to increase output to cash in, and it is a signal to end users to try to cut their use of that product in order to save money. Oil demand is price inelastic in the short term because we have to fill our tank to go to work regardless of the price, and refineries need continuous supply in order to avoid very costly shutdowns and restarts. But we saw last year how demand can decline with high oil prices in the medium term as people adjust their circumstances to the new reality.

Speculation adds nothing useful to this equation. If speculators can make money in futures markets, the only way this is possible is by inducing producers to supply too much at low prices, and inducing buyers to pay higher prices than the excess supply justifies. Suppliers make less profits and consumers pay higher prices.

We do this in service of the virtuous speculators, who add $1 million of liquidity on the front end of their trade then take out $2 million on the back end, with a net cost to the real commodities market of $1 million. I'm all in favor of making money. But I object to elbowing your way in between buyers and sellers and stealing their money.

Crude Oil, OPEC and Super Contango

At $25 per barrel a lot of non-OPEC, non-sovereign oil production will simply be shut in because it costs more than $25 to produce it. Private companies cannot survive losing money on each barrel they sell. Some who are desperate for cash flow may sell below cost for awhile, but this is obviously not a sustainable business practice. Remember, buyers can offer $25 but sellers can choose to not sell at that price even if they are 'swimming in oil'.

Plentiful Coal - Not Peak Oil - Is Greatest Global Warming Threat

"Carbon Trading Market May Reach $1 Trillion"

I read that headline in the Financial Post sometime this past year. If anyone wants to know what motivates the global warmers to ignore climate science and screech MELTDOWN!, that trillion dollar plum probably provides the answer.

Is the Market for Oil Reinflating?

The world's transportation system is powered by oil from which gasoline for cars, diesel for trucks, bunker fuel for ships and jet fuel for planes are made.

Without transportation the regional, national and global economies that supply us with our necessities of life, not just luxuries but necessities like food, is shut down.

Until some alternative to oil-fueled internal combustion power for our transportation system is invented, developed and implemented on an industrial/global scale we are hostage to oil supplies.

Before the recent financial troubles-cum-economic slowdown oil supply and oil demand were almost even at about 85 million barrels per day. At the peak there was only a few hundred thousand barrels of slack in the supply/demand equation.

Refiners were realistically worried they would not be able to buy oil regardless of the price because world demand was threatening to outstrip world supply. An oil "shortage" caused by economic fundamentals, not financial manipulations, was a real possibility.

New oil is getting harder to find and produce. It doesn't matter how profitable it might be to produce new oil, if you can't find it or can't get to it you can't produce and sell it. This is the "peak oil" scenario.

The easy oil that is readily accessible and cheap to produce has already been pumped (except for the Middle East, which still has lots of easy oil). We're into oil that is structurally more expensive to produce.

We can't not produce and use it as long as our transportation sector, without which we are literally dead, is utterly dependent on oil.

Financial troubles are arithmetic problems. We can fix them by seeing clearly and using our intelligence.

Economic shortages like peak oil are physical problems. Intelligence cannot fix a problem that cannot be fixed by finding new supplies that don't exist, or that are so hard to get at that we physically cannot do it.

We need an alternative to oil. But in the meantime our lives depend on our ability to buy enough of the stuff to keep our economy moving.

The "real" price of oil is the cost of producing the next barrel. Right now this is probably in the $65-80 range. $145 was a panic price, fear of supply shortage. Anything below $65-80 is not sustainable.

Anything over $100 is not sustainable either, because over $100 means way too big a share of our economic effort must be devoted just to moving ourselves around.

We cannot afford oil over $100. We see demand destruction at that price, which means people simply cannot afford to pay $80 to fill up their car so they take the bus instead even if that adds an hour a day to their commute time. I don't like the idea of spending my future standing at the bus stop.

Trucking costs rise so the price of everything that is transported, which in our economy is literally "everything", rise along with these structural costs.

Even if we invent the next form of energy to power our transportation system it will take 10-20 years at minimum to rebuild the infrastructure and get the new system in place.

So it looks like oil has to be over $65-80. And once the arithmetic problems of finance are solved and economies start moving ahead again we're back to tight supplies and oil price volatility until we solve our oil dependence problem.

Economic Anomalies Explained

I was talking to a guy yesterday who thinks there is some dark conspiracy behind America's loss of its manufacturing sector. When you can't produce what you need you are at the mercy of whoever exports to you. Is it time to balance free trade against national security?