Ready for the Oil Bubble?

Ft. Worth Star-Telegram ^ | May 21, 2008 | Ed Wallace

[wildbill]

Ready for the Oil Bubble? Source: http://www.star-telegram.com/104/story/651928.html

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One law is causing prices to go through the roof By Ed Wallace Special to the Star-Telegram

"There’s a few hedge fund managers out there who are masters at knowing how to exploit the peak [oil] theories and hot buttons of supply and demand and by making bold predictions of shocking price advancements to come, they only add more fuel to the bullish fire in a sort of self fulfilling prophecy." — National Gas Week, Sept. 5, 2005 as reprinted in the US Senate Permanent Subcommittee on Investigations’ report, "The Role of Market Speculation in Rising Oil and Gas Prices," June 27, 2006

Fiddling While We Burn

There it is in plain sight for everyone to see, exactly what I’ve been reporting for the past few years: Many individuals who are investing in oil and natural gas futures are going out in the media and trying to convince the American public that either we are out of oil or there is a serious supply shortage of crude against worldwide demand. The question is: Does it surprise you to discover that the US Senate investigated the rigging of the oil market by speculators in the summer of 2006 – and concluded that there was no supply and demand problem with oil? Did you know that their conclusion was that speculators were responsible for a 70 percent overcharge in the price of oil in the months leading up to the summer of 2006?

This from page 1 of the Executive Summary of that Senate investigation, there is this one troubling line: "Today, U.S. oil inventories are at an eight-year high, and OECD (Organization for Economic Co-operation and Development) oil inventories are at a 20-year high."

That’s odd because, in 2006, just like today, the media reporting covered the serious international shortage of oil and justified oil’s high price. Even more troubling is that the House of Representatives held a hearing this past December, ominously titled "Energy Speculation and Price Manipulation." How did it pass under the radar that both the Senate and the House studied the issue of price manipulation in our energy markets and both concluded that it was unregulated, massive trading in one futures market that was really driving up the price of oil and natural gas? And given that conclusion, why has Congress done nothing about it?

Investors Make the News, Literally

A week ago Goldman Sachs issued a new investor note, suggesting that somewhere between six months to two years, the price of oil could go into a "super spike" and prices jump as high as $200 per barrel. It became the major story of the night. Ignored in the reporting frenzy was that many legitimate and well-respected oil analysts dismissed Goldman Sachs’ prediction as groundless.

Get ready for the next shock to your system. In the past month we have added 11.9 million barrels of oil into our stock reserves, giving us 32.3 million more barrels of oil than we had on hand January 1. On May 5, we found out that for the second time in as many years, Iran was storing its excess crude oil on tankers in the Persian Gulf, because it had run out of storage space in the desert and was awaiting buyers for its heavy crude. That same day Saudi Arabia cut the discount price for its Arabian Heavy crude to $7.45, hoping to entice more buyers for immediate delivery. We didn’t hear that news, either.

While researching my third article for BusinessWeek online about the world’s oil situation in 2008, I asked for the most current report from Oil Movements. Because the oil industry is not transparent, Oil Movements tracks every tanker at sea, from both OPEC and non-OPEC oil countries, along with their cargoes’ final destinations. Anne O’Shea responded immediately to my request with their report dated May 8, 2008. Just so you will know, oil shipments are up from a year ago in almost every class, including Middle East oil in transit and Non-OPEC in Transit. The only class of oil shipment that has declined is covered on page 3 of that report. That chart is labeled, "4-Week Changes in Westbound Oil at Sea."

That’s right, shipments of oil headed west have shown serious declines during the month of April, down 800,000 barrels per day in the week before the publication of the report. Now, let me give you the first line from under the Westbound Oil shipments chart: "In the west, a big share of any [oil] stock building done this year has happened offshore, out of sight."

Could this be true? Oil Movements, the unimpeachable source for finding the real world situation on oil transits, is saying that oil is being hidden offshore, not declared in inventories? Yes, that is exactly what they are saying.

That same week our refineries cut their production runs back to 85 percent, down from 89 percent a year ago, to trim more gasoline out of our stock reserves, to increase their profits per gallon.

National Short-Term Memory Loss

It’s amazing how quickly we forget our recent history. Congressional hearings in 2001, blasting certain Wall Street executives for using the media to sell the public on stocks in order to bid up the price – so their firm could divest of its shares without taking a beating. Meanwhile, other trusted advisors pushed stocks that were fundamentally worthless, because their affiliated banks had large loan agreements with those companies.

The year before Enron had been caught manipulating the California energy market, even forcing rolling blackouts across the northern part of their state apparently just for effect – to support their claim that there just wasn’t enough electricity to go around. Again, we now know that claim was untrue. It was Enron shutting down certain power generation plants, while placing bets on their unregulated energy futures market. The net cost to California consumers was almost $8 billion.

It didn’t end there. Amaranth Advisors, a hedge fund, literally was cornering the market on natural gas futures, to make it appear that there was a shortage of natural gas, when the Commodities Futures Trading Commission told Amaranth to liquidate its position on the NYMEX because its bidding had already moved natural gas prices far beyond the reasonable limits of supply and demand. Now, remember this name: ICE, short for Intercontinental Exchange – the "dark futures lookalike market."

Once the CFTC told it to back off its natural gas futures contracts, Amaranth simply shifted gears, got out of the NYMEX, placed its massive bets outside of government regulation in ICE and managed to drive natural gas futures to $8.50 per MBtu.

As the Senate investigation into the manipulation of the energy markets showed, "Amaranth – the day before they failed, natural gas was about $8.50; the day after it failed, it went to $4.46 MBtu." That’s right, one major hedge fund managed to double the price of natural gas simply by loading up on futures contracts; when the government told them their bets were unwarranted, they simply moved their monies to a futures exchange that was unregulated. Only when Amaranth failed did natural gas prices fall back to what was considered normal for supply and demand.

Sadly, like oil today, when this was happening we were being told that natural gas supplies were tight worldwide. That statement simply wasn’t true.

Dark Future

Likewise, British Petroleum was busted for manipulating the propane market in the winter of 2004 and fined $373 million. Of course, in Texas, under deregulation of our public utilities, our electric rates can be set using the futures market for natural gas, so the manipulation of the natural gas market spelled trouble for us. Consider this, by 2006, according to www.powertochoose.org, electricity rates for us had climbed to 15 cents a kilowatt-hour due to the high cost of natural gas. But, that was the exact same time period that Amaranth was proven to be manipulating the market and sending natural gas futures through the roof. Two months later the hedge fund collapsed and natural gas prices fell. Therefore, most Texans paid higher electric bills for Amaranth’s manipulation of the natural gas market.

Professor Michael Greenberger of the University of Maryland, a former board member of the Commodities Futures Trading Commission, testified in front of the House Committee on Energy and Commerce on December 14 of last year. Under discussion that day was the manipulation of the energy markets and prices, but Professor Greenberger added these comments: "Three, four months from now, you’re going to have a hearing on the subprime meltdown, and you’re going to find that the very same legislation [deregulating energy] deregulated something called collateralized debt obligations, CDOs." That legislation, friends, directly ties the mortgage meltdown to the high price of energy today.

It was called H.R. 5660, the Commodities Futures Modernization Act of 2000. At first this bill went nowhere in the House, not even up for debate. Then, a few months later, late one night a 242-page bill written by Wall Street lawyers, with the exact same name as the former House bill, was quietly added to an 11,000-page appropriations bill, and the Enron loophole was created. The power behind that bill was one Texas Senator, one Texas Congressman and their wives.

Next week: How the unregulated futures market pushes the price of oil, natural gas and gasoline far beyond those commodities’ market value, thanks to the creation of the Intercontinental Exchange. Worse, Congress knows this, but does nothing.

[Scotswife]

cool!

it works for baseboard heating?

[thackney]

I am suspicious about an article that states oil movements are "UP" in every class but one, then focuses on the one that is down implying that oil is being stored off books and not compare the volume of movements to all the others that are up. Are these volumes simply going to Asia? The authors says he went to the report, why is the total change in movements not discussed? That would indicate possible storage, not one line down and all others up.

In the past month we have added 11.9 million barrels of oil into our stock reserves, giving us 32.3 million more barrels of oil than we had on hand January 1.

The author is correct in comparisons to January 1, but neglects to mention that his comparison point is a low point on the chart, like it normally is.

On May 5, we found out that for the second time in as many years, Iran was storing its excess crude oil on tankers in the Persian Gulf, because it had run out of storage space in the desert and was awaiting buyers for its heavy crude. That same day Saudi Arabia cut the discount price for its Arabian Heavy crude to $7.45, hoping to entice more buyers for immediate delivery. We didn’t hear that news, either.

Previously discussed here on FreeRepublic, the crude Iran is having a hard time selling is heavy and sour. The worldwide spread between heavy, sour and light sweet is growing. It is more common for new fields coming on-line to tend towards heavy and sour than light and sweet. More supply in the lower quality is naturally going to lower its price relative the lighter-sweet grades that tend to have declining sources of supply.

[thackney]

In fact, very little of the oil taken out of the Alaska Pipeline goes to our domestic use. Most all of it is contracted to Japan and is tankered there the moment it hits Valdez. The reason is logistics and shipping distance and difficulty dealing with shipped products

It never was that way. When first built the pipeline oil could not be exported; that was part of the deal to get the pipeline approved through congress. The ban against exporting Alaskan North Slope was lifted in 1996 yet 100% of Alaskan North Slope oil is kept in America. This has been the case for all but 4 years of the nearly 3 decades of Alaskan oil production. Between 1996-1999 5.5% of North Slope oil was exported to Asian countries. These exports were overwhelmingly supported by the US Congress and by the Clinton Administration to offset an oil glut in California at the time. In June 2000 Alaskan North Slope oil again ceased to be exported, and 100% of Alaskan North Slope production has stayed in America.

You can look at the export history from this area since the ban was lifted.

Exports, US West Coast including Alaska and Hawaii
http://tonto.eia.doe.gov/dnav/pet/hist/mcrexp51a.htm

Here you can see data from the California Energy Commission. They track the amount of oil brought into California from Alaska.

CALIFORNIA CRUDE OIL PRODUCTION AND IMPORTS
http://www.energy.ca.gov/2006publications/CEC-600-2006-006/CEC-600-2006-006.PDF

Here you can see from the Washington Government that 74% of the oil used in Washington State refineries comes from Alaska.

Washington State, Petroleum FAQs
http://qa.cted.wa.gov/portal/alias__CTED/lang__en/tabID__847/DesktopDefault.aspx

Japan is much farther away from Valdez, Alaska than our West Coast Refineries.

Most of our oil comes from Canada via pipeline.

Most of our imported oil comes from OPEC. Canada is the largest single supplier, but Saudi Arabia is second.

U.S. Crude Oil Imports by Country of Origin
http://tonto.eia.doe.gov/dnav/pet/pet_move_impcus_a2_nus_epc0_im0_mbblpd_m.htm

[FunkyZero]

"The rules need to be changed so that only investors that have facilities to take delivery of the commodity can bid."

This is a seriously flawed approach. This would leave control of energy prices in the hands of a few huge companies and several less than trustworthy government entities. Not what I would call a good idea. Now requiring that they HOLD their purchases in energy for a minimum of 6 months? That would slow things down quite a bit. They would make sure they weren't paying more than it was truly worth for fear of getting stuck with it.

[freedomfiter2]

This is a seriously flawed approach. This would leave control of energy prices in the hands of a few huge companies and several less than trustworthy government entities.

I don’t see any good for the consumers coming from speculation. Trading back and forth by producers and processors can stabilize prices, but what good does allowing speculators running up prices do?

[freedomfiter2]

I am not a green thumb, but we recently bought a book on square foot gardening and will give that a try this summer.

We started using the square foot method about ten years ago. It makes gardening doable even for those without green thumbs.

[SAJ]

I was raised in Scotland, m’friend. The English futures regs don’t differentiate as to ‘’margin’’ from the US regs — it’s purely and simply a performance bond, a guaranty if you like.

However, the UK futures regs allow for substantially less mkt transparancy and much larger positions than US regs do.

You could ask Nick Leeson about that, for instance.

[SAJ]

Quite right. And said increase is harming the very people that the pols, other demagogues, and the illiterate lame-brain media love to demonise, namely, the producers.

Futures mkts exist to transfer risk. Producers hedge what they produce and users hedge their anticipated needs.

Run a mkt up to well over its measurable economic value, and BOTH long and short hedgers face increased strain on cash flow and working capital in order to maintain their hedges.

And hedging -- properly done of course -- saves money for **everyone** downstream from the producer.

[Scotswife]

Thanks!
I have a great talent for killing plants, but this looks like even someone like me might be able to handle it.

No weeding, no fertilizing.
As long as I remember to water everything it should work out.

[justa-hairyape]

And hedging -- properly done of course -- saves money for **everyone** downstream from the producer.

In your opinion, is the current hedging being done properly ? Do you think the hedgers are anticipating that the Gulf of Hormuz is going to be shutdown ?

Born in Scotland. Congrads. Half Scottish myself. My surname ancestors left a long time ago though. About the time the English decided the Scottish had to pay let again. My surname ancestors held a fairly nice keep/manor for over 300 years. Was a gift from the Rebel King for services rendered.

[Entrepreneur]

T. Boone Pickens has done the math, and concluded that wind farms (with their massive gubmint subsidies and tax breaks) will be a profitable business — for him, that is.

Spot on. With mandates in Texas for utilities to provide a certain amount of renewable energy, Pickens sees a guaranteed market with cost plus pricing. In short, there's a guaranteed return. There's no risk.

Remove the mandate and I bet you'd see a fast sell off of windmills.

[FreedomCalls]

Hopefully, they will run out of places to put the oil.

According to him there already is.

Quote: "On May 5, we found out that for the second time in as many years, Iran was storing its excess crude oil on tankers in the Persian Gulf, because it had run out of storage space in the desert and was awaiting buyers for its heavy crude."

[dennisw]

btt

[SAJ]

Energy hedgers are very sophisticated, and the hedging programmes I've seen are well-disciplined and proper by any definition. Granted, I'm only familiar with a handful of companies, and I'm quite certain they didn't show me the whole story (nor did I ask -- the programmes are proprietary), but in this mkt environment, producers would have to be stark mad to do anything but operate a disciplined hedging programme.

They've likely cut back their hedges some, too, over the past couple of years. After all, who wouldn't love his product going up 30-odd per cent in that time frame, right?

User hedging? That's a dog's dinner. Some users are geniuses at hedging -- Southwest and a couple of other airlines come to mind immediately, although most of their early-2000s hedges have run out.

Utility companies are usually very sharp when they hedge. Amazingly, not all of them do, or do so on a sometimes-yes, sometimes-no basis. This astonishes me, but I suppose a lot of them are price-insensitive because they've been granted automatic rate adjustment powers by their state goobermint. Another instance of goobermint NOT serving the citizenry.

Some users are just idiots about hedging. American Airlines is a classic example. In 2002, they point-blank refused to become aggressive about locking in costs...with the all-too-obvious sequal.

If Ahmaneedjihad and the mullets try to close the Straits, I believe they'll find out in short order that they've bit the big one. So, to that extent, ''no'', I don't think hedgers are all that concerned with such an event.

Looks like the Union Act may be about to go away, after 301 years. No weeping here, I assure you!

[Toddsterpatriot]

One said they were putting it into Commodities. I suggested that was speculative. He didn’t seem to think so.

I'd be interested to know what bank thinks they can put customer deposits into commodities.

[justa-hairyape]

I don’t see how a disciplined hedging program could foresee the massive price movement we just experienced without the prediction of a sudden and dramatic supply to consumption problem. As you have stated, the Energy hedgers are all slap happy and marveling at their good fortune. Still leaves the true culprit undetermined. And who would have the capital to cause such a move ?

[Toddsterpatriot]

Trading back and forth by producers and processors can stabilize prices, but what good does allowing speculators running up prices do?

Speculators provide the liquidity that allows producers and processors to trade efficiently.

[freedomfiter2]

Speculators provide the liquidity that allows producers and processors to trade efficiently.

Yes, but at the cost of greater volativity and higher prices to the consumer.

[Toddsterpatriot]

Yes, but at the cost of greater volativity [sic]

You think volatility is high now, drive out the speculators and see what happens.

and higher prices to the consumer.

How do you figure?

[SAJ]

Hedging isn't about ''foreseeing'' anything. It's about insuring against risk. Period.

Capital is the easy part for the big specs. As of last night, open interest in the 3 front contracts was 554,xxx lots. Figure the price at $131/bbl and a 7% initial margin requirement.

To buy new, say, 1/3 of that -- which would surely goose the price $20 or so -- would require approx US 1.693 billion. While not chump change, this is certainly WELL within the scope of, say, a half-dozen 'hedge' funds working in concert.

Of course, they couldn't do this on NYMEX because of position limits. They'd be fined within an inch of their lives if they tried.

But they can very easily do it on some combination of ICE and SIMEX, and they can buy forwards in Rotterdam to boot, if they want.

I distinctly did NOT say that 'energy hedgers are all slap happy and marveling at their good fortune'. The producers surely are not; they're having to put up tons of capital to hold their hedges IF they're doing traditional hedges. Most of them have stopped this, or lessened traditional hedges sharply. The favourite hedge right now is the ''costless collar'', a good but not perfect hedge, but one which has the advantage of being relatively VERY cheap from a capital standpoint.

Properly hedged users are probably quite happy, but scared to death of what might occur when their current hedges run out.

''Slap-happy''? Not on your life, brother.