Posted on 07/04/2008 5:53:48 AM PDT by kellynla
NEW YORK (Fortune) -- Atlanta hedge fund manager Michael Masters has been a star witness in two recent Congressional hearings on how speculators are supposedly driving up oil prices. Masters and I don't see eye-to-eye on this issue, so I was surprised to get a call from him after my "Don't Blame The Oil Speculators" column went up on Fortune.com last week.
Masters contends that without speculators, the price of oil would be $65 or $70 a barrel. He points out that the amount invested in commodities index products has risen from $13 billion to $260 billion in five years, a fact he thinks is key to understanding oil prices.
"When a trader sends a buy order to the exchange floor or presses the 'buy' key on their trading terminal, if he or she is attempting to buy more contracts than are currently offered for sale at the market price, then the market price will rise," Masters told a House subcommittee in June.
My own view is that speculators can't materially impact prices if all they're doing is making bets on the direction of oil prices by trading futures and not taking delivery of actual oil - hoarding stuff that would otherwise go to consumers.
People don't fill up their tanks with futures contracts, and there's no evidence investors are putting more oil into storage as a bet on higher future prices.
In the end, Masters and I simply agreed to disagree. But there was one thing he said that really piqued my interest. "What do you think would happen," Masters asked, "if the market went into liquidation-only mode [i.e. if speculators started unloading their futures contracts], like we saw with the Hunt brothers in 1980?"
(Excerpt) Read more at money.cnn.com ...
Ah, but they do in a funny way. A producer has a choice. He can sell his barrel on the spot market for immediate delivery, or he can sell his barrel on the futures market with a promise of future delivery. For the future delivery he merely needs to leave the oil in the ground until he needs to deliver it. However, with growing long side only speculators, the amount of oil that is promised for future delivery has grown exponentially. So long as long side positions continue to grow, that is oil that stays off the market. Furthermore, as demand is growing, it is safe to accumulate supply.
If one looks at futures price action in oil there is nothing that would indicate that anyone needs to start liquidating his position anytime soon. In fact, the price signals are, if anything, "buy."
And where would they store this oil anyway? It's rather dangerous to store, and it's pretty difficult to hide the facilities. Back in the 1970's when there were price controls and long lines, many consumers would hoard fuel, increasing its scarcity. High prices are a disincentive to hoard.
I’m sure you’re at least partially right. Nobody “needs” a vacation home.
Interestingly, one of the reasons people are pissing and moaning so much about the price is that supply hasn’t been interrupted.
I worked three months in Gulfport after Katrina and was forced to stay in Mobile, commuting each day.
For the first month, gas was hard to get. At that point I couldn’t have cared less about the price. Only availability was important, since I really needed the gas.
Of course it helped that somebody else was reimbursing me for the gas.
You have illustrated the fact that supply and demand curves are highly inelastic, with guaranteed demand growth. This is a speculator's heaven.
In the ground back at the well, in oil tankers floating around the world (they are cheap in comparison to the value of the oil carried), and in oil storage farms around the world that are not well reported or regulated at all.
Wrong. There is a great deal of doubt about it. You're speaking as if the peak oil theory didn't exist or had no validity. It's much more likely that you are simply ignorant than that it is wrong.
Great point,it may well take a supply interruption to drive home what is going on in energy.
People complaining about drops in real estate prices has always struck me as somewhat analogous to the guy who goes to Vegas with a $10,000 bankroll.
He gets it up to $100,000 and then loses all but $8000.
Did he lose $92,000 or $2,000?
My experience has been that when people make money on real estate investments it’s because of their own enormous acumen. When they lose money it’s because of the banks, or the Arabs (or Jews), or the Republicans.
I have also always been fascinated that the same people who think it’s immoral to sell a barrel of oil at a profit are always enormously proud of themselves when they sell their house at a big profit.
Even if these are fully loaded ULCC's rather than VLCC's that only represents half a days oil supply for the world.
Sorry. No. People who keep track of these things are very, very sophisticated. They keep track of oil tankers and how low they sit in the water. They know the locations of the storage farms and watch them too (You can't hide them the way you hid pot farms, unless you put them underground). It would be very difficult to massively slow production (hide oil in the ground back at the well) without attracting notice.
Further, the production evidence is consistant with the discovery evidence. New discoveries have been falling for 40 years. Do you really believe that someone has conspired to hide evidence of new discoveries for all that time? If you do, then I'd say you're a textbook case of clinical paranoia.
Maybe, but consider Texas in the 1970s. Peaked circa 1971. Price quadrupled during the decade. Every man woman and child in the state [okay I am exaggerating] went on a drilling campaign and by the end of the decade [with no serious impact from environmentalists] production was still down thirty percent. Pretty much a description of the peak oil concept on a easily understood scale when viewed gazing backward in time.
Now look to demand growth in India and China and the relatively small decreases in quantity demanded in response to much higher prices in the developed world.
Then go back and look at world production that is essentially flat.
Then consider the Texas example [could have used the U.S., the North Sea or a number of other places past peak for illustration, but Texas is illustrative.]
Then ask yourself why you need speculators or conspiracies or even idiotic environmentalist positions to explain increasing prices.
Apply Occam's Razor.
The facts are that supply and demand conspired to make the ground ripe for speculators and speculators (helped along by every low interest rates) are taking advantage of it. We are in a both and not an either or situation. Pointing this out does not make one a Marxist.
In fact, I would argue that we probably have, for many producers, backwards sloping supply curves. The producer of a finite reservoir wanting to maximized total revenue over time, while covering current financial needs, has every incentive to cut back production when price increases. If you can make the same revenue with half the rate of production why not go for it [pay me $500 million and I won't work another day of my life]. So net overall there is probably little increasing supply for increasing price and with steep supply curves and steep demand curves it does not take much supply hoarding to make enormous differences in price.
All of which is why normal free market conditions do not apply and which is why speculative excesses should be held in check. After all, there are enormous externalities. You will continue to buy gas at almost whatever price. You will compensate by cutting back how much you eat at restaurants (funny restaurant revenues are falling) and a bunch of other things.
Then explain why long side only index speculators have taken incredibly large positions in oils futures?
Hint - they expect to make a lot of money. How will they make lots of money. The price will go up. Why will the price go up. Because they are accumulating supplies, which is why they expect to make money. It's Occam's Razor.
You are missing the big point. By tying up a large number of tankers as storage platforms, Iran has greatly reduced the capacity of the tanker fleet to fill spot market demand and drives up crude prices. If an exporting country wished to deliver more oil to the market, they can’t get the crude off their dock.
Congress didn't resolve the problem everybody could see coming 30 years ago when the problem could have been averted cheaply. Now it is here and it is too late. It is possible we cannot afford anymore to get alternatives such as coal to liquid going.
This a very real concern. The $3T that the Bush administration added to the national debt since 2000 would have paid for 1,000 nuclear plants, had we had the will to build them. Now we might start to have the will, but not the money.
I believe the stats actually show that the specs are short. The commercials are net long.
This is a little distorted by the fact that the EFTs are listed as commercials and most of the action there is on the long side.
Momentum plays a role in markets. Some of the speculative longs are riding momentum. Some see a wiggle in a chart that has paid off for them in the past. Some fundamentally oriented speculative longs see a term supply crisis that they did not create but that can profit from if they are correct. Does this make them villains?
... but you did not answer the supply / demand questions leading up to the question you quoted. It is possible that the entire rise in the price of crude oil is caused by aliens from the planet Garfon. I just wouldn’t recommend that anyone start with this as their working hypothesis.
you are absolutely right. Congress is doing everything they can to divert attention from all their liberal policies coming home to do some real damage to the average American.
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