Video: Get ready for big hike in gasoline prices

Hot Air ^ | February 15, 2012 | Ed Morrissey

[thackney]

We are looking at 2008 through different eyes. I strongly believe that market fundamentals were secondary to speculative pressures.

By its very definition, a futures market is a speculative market. But when the spot market is within a a few points of the near month future market, that speculation is based upon current supply and demand. Speculation equally occurs going up as going down. By definition, for everyone buying a position thinking it is rising, someone else sold, thinking it was time to take the money.

But there was some significant unsustainable demand at that time, driven by a bubble in the economy outside of the oil market. General spending, real estate construction, etc; these items helped push up a short term demand for fuel.

But even if you hold to the idea that speculation can drive prices significantly without a tight supply/demand market, it shows how even more unreliable future gasoline predictions are.

My point was, looking at a estimated future demand curve, even created by "experts", is not enough data to consistently predict prices 6 months out.

[dragnet2]

I could not help but notice you completely evaded the question below, as you were explaining how hard it is to suck oil out of the ground.

Let me guess, you think these prices are not manipulated by super wealthy insiders and the corrupt in D.C.?

[dirtboy]

Of course not, they are "manipulated" by the market.

I agree with you 90 percent of the time, but I gotta disagree here. Seventy percent or more of the oil futures contracts in 2008 were held by speculators - entities that neither produced the oil or planned on using it. And investment banks such as Goldman were exempt from position limits, and new exchanges such as ICE were exempt from many of the regulations binding NYMEX trading. I am firmly convinced that policymakers looked the other way because the cash hoovered in by the oil bubble helped prop up many financial entities until that bubble burst as well.

We were told all through the price spike of 2008 that Asian demand was driving the spike. However, once you looked into Asian demand, you saw no such spike, only modest growth.

And the very nature of the steep price rise and the subsequent collapse indicates the inflating and rupturing of a speculative bubble.

One does not have to buy into left-wing economics to look at the history of speculation and the impact on commodities, such as we saw with the Hunts and silver. Position limits on speculators were put in place for a reason in the past, and in 2008 we saw just why.

I lived through oil price gains and falls in the past. 2008 was vastly different.

[dragnet2]

Let me guess, you think these prices are not manipulated by super wealthy insiders and the corrupt in D.C.?

Of course not, they are "manipulated" by the market.

Let me guess, you believe our, "Free Market" is free and not manipulated by the super wealthy and well connected corrupt?

[dirtboy]

By its very definition, a futures market is a speculative market

You are clouding the issue. There are two types of participants in such a market - producers/consumers trying to lock in prices for planning, and those who plan on neither producing nor consuming the commodity in question. It was long-standing policy to establish position limits on the second category after the antics of the Hunts, but gradual regulatory changes made it possible for speculators to control the lion's share of oil contracts in 2008 (which is documented), mainly because too much speculation in a commodity market changed from a guess in what direction prices were going to an ability to direct where prices were going. The bubble always pops in the end (just ask the Hunts), but outfits such as Goldman can profit both on the way up and the way back down, as long as enough chumps such as pension funds get sucked in near the top to take it in the shorts on the downside.

[GOPJ]

Nice - let’s hope it’s only that high - and no higher...

[thackney]

Let me guess, you think these prices are not manipulated by super wealthy insiders and the corrupt in D.C.?

You are correct. I work in the industry and know how to read the expenses it cost to produce the oil we consume.

The reason the oil companies typically make less than 10% profit is the cost of producing that oil and maintaining their reserves.

You want to fantasize that oil is actually much cheaper to produce than it is sold on the market. It simply is not true.

[thackney]

There are two types of participants in such a market - producers/consumers trying to lock in prices for planning, and those who plan on neither producing nor consuming the commodity in question.

Yes, that is true. The oil producers and the oil consumers are only a portion of that market. My experiences working with several of the major oil companies on capital projects, leads me to understand the risk management is a critical part of their business. And at time, regardless of a boom or bust cycle, some companies are at a position where cash flow is king and they cannot afford to hold out for a chance at a couple more bucks.

So outside those are the speculators. They are the ones to assume risk for an expected profit. But a futures market requires both a buyer and seller to make a trade.

It was long-standing policy to establish position limits on the second category after the antics of the Hunts,

I take it you are talking of their silver games. Do you honestly believe that a stock pile of oil is rising, while nearly 90 million barrels a day continues to be produced?

bubble always pops in the end

Yes, supply and demand are going to rule. You can only buy up so many tullips before you run out of people willing to pay your price.

Much oil is bought and sold outside the futures market. But the future markets provide a measure of what those barrels are really worth. The oil companies will not consistently sell their oil at less than the going rate.

[dragnet2]

Let me guess, you think these prices are not manipulated by super wealthy insiders and the corrupt in D.C.?

You believe our, "Free Market" is free and not manipulated by the super wealthy and well connected corrupt?

You are correct

Well, that's all I need to know Mr. thackney.

However, I am unable to waste anymore of my time with your level of ignorance.

Take care!

[thackney]

So why is there not a bigger gap between the cost of the production of a barrel of crude oil and the final market price? If you claim there is a vast run up in a speculative middle man, why is the cost of production within 10% of the final selling price after the trades in market? It is was significant, these prices would be significantly apart.

Your claim of ignorance on my part is entertaining. But besides insults, can you answer my basic question?

[dirtboy]

The oil companies will not consistently sell their oil at less than the going rate.

You are ignoring the flip side - when oil companies for years have been exploring for and producting oil with a planned price of, say, $60/bbl, and suddenly it spikes to $100, that extra $40 is gravy. I don't begrudge them such - they have to pull in the money when times are good to slog through when times are bad - but that is beside the point. Namely, that they are not the ones causing the price spikes, they are just the short-term beneficiaries of such - and when the bubble pops, it can hurt them as well if they launched on development projects at the high bubble price.

Once again, a fact that you steadfastly refuse to address is that speculators - not oil companies, not refiners, not airlines - controlled at least 70 percent of the futures market in 2008. One cannot manipulate the market for years, but 2008 showed it can be manipulated for months, especially at 12-1 leverage. And the slick ones - the Goldmans of the world - get the suckers lined up to take the fall at the peak as they short it all the way down.

The Hunts got stuck holding the bag. The Goldmans, the Morgan Stanleys of the world learned from that. I actually think it would be far better for the oil industry if position limits for speculators were enforced, as the price of oil would find its market mid and long-term levels and allow for more stable financial projections.

[dirtboy]

So why is there not a bigger gap between the cost of the production of a barrel of crude oil and the final market price? If you claim there is a vast run up in a speculative middle man, why is the cost of production within 10% of the final selling price after the trades in market?

Here's the problem - the futures are a step ahead in that equation. Let's say the price of oil this month is $100 for easy math. Someone puts in a futures contract for $105 for April. They then put in a futures contract for $110 for May.

They then turn around and sell the April contract in March to someone for $110 since, well, May is already up to $110. So the speculator made a tidy five percent profit in one month (sixty percent annualized) while the production price obeys your ten percent guideline for the initial contract. This works as long as leverage and well-planted media sources keep up the perception that there are market fundamentals behind all this.

Of course, sooner or later market fundamentals will rear their ugly little head. But by then gobs of investors are pushing in the doors to get in on the action and you short it all the way down, leaving them holding the bag.

Also, regarding your ten percent figure, is that a long-term average over say, a decade, as opposed to specifically for 2008?

[dirtboy]

Do you honestly believe that a stock pile of oil is rising, while nearly 90 million barrels a day continues to be produced?

Once again, SEVENTY PERCENT or more of the contracts in 2008 were held by speculators. At 12-1 leverage. That allows a smaller amount of money than expected to exert influence on pricing.

And it's not like you have to stockpile the oil over the mid-term. Just keep pushing the next contract's price higher as you sell the contract you bought a couple weeks ago at a lower price to someone else at the new, higher price your most recent bid just set. And be ready to get the shorts in place once mob mentality takes over.

There is a reason for position limits. And we saw why in 2008. There were pension funds - PENSION FUNDS, normally bound by prudent-man rules - getting into commodities funds. Insane.

[thackney]

60/bbl, and suddenly it spikes to $100, that extra $40 is gravy

You are imagining a stagnate lasting condition that doesn't exist. As the price begins to rise, those same companies start spending more on exploration and production. As the number of engineers, drillers, fabricators, tons of steel, cable, etc grows, so does the price per unit of these to meet the increased demand. The cost of drill pipe goes up, engineers like me either get paid more, or we move elsewhere to the higher rates.

Look at the cost versus profit year after year of those same companies. Go to a site like rigzone and look at the dayrates of offshore rigs and see how they rise with the oil price and demand. That $40 isn't gravy. It may be $5~7 gravy and the rest is accelerated cost spread out to many trying to keep up with demand.

And the same happens at the slow times, the demand for rigs and new facilities goes down. Pipe prices fall, people are laid off, etc.

To many people imagine magical wells that pump at constant rates forever. It is a constant flow of cash to maintain a constant flow of oil. New reserves must be found to balance oil sold. If an oil company is not replacing their reserves, they are going out of business. In some places they spend more money at the same location to enhance recover with more technology.

You cannot think of them as a factory or farm that produces steady. It would be a factory/farm that produces 5~25% less each year and must be constantly replaced or upgraded.

And while that market price is up, the cost for those up replacements and upgrades go up as well. It has too, there are limitations to the resources. There are only so many engineers, pipeshops, etc.

you steadfastly refuse to address is that speculators - not oil companies, not refiners, not airlines - controlled at least 70 percent of the futures market in 2008

You still seem to believe there was some large gap between the cost of production and the selling price. Sure, on the NYSE oil future price reached around $147 for a few hour or less. Do you realize how little oil was actually sold at that price? Buying and selling the same barrel of oil 20 times a day doesn't have 20 times the impact on the end sale.

And the slick ones - the Goldmans of the world - get the suckers lined up to take the fall at the peak as they short it all the way down.

It is a speculative market, by definition, a futures market has to be. Those that think they can make money jumping on the band wagon the last 50 feet of the parade often find a surprise.

actually think it would be far better for the oil industry if position limits for speculators were enforced, as the price of oil would find its market mid and long-term levels and allow for more stable financial projections.

Do you realize how far we are from the original question? Some economist think one way. Some think another. The NBC’s Today show decided to report one side to make a story that would gather attention. Do not confuse that with an attempt to get out a full analysis and balanced opinion.

[thackney]

Of course, sooner or later market fundamentals will rear their ugly little head. But by then gobs of investors are pushing bag.

The end result puts much of those spikes in speculator wallets, both going up and going down. Much of the oil that finally changes hand is at a more stable price.

You seem to want me to hate the speculator that won on the front end and feel sorry for another speculator who lost on the other. If you cannot handle the risk, don't play the game. But don't think in the long run, supply and demand won't win out. There are not enough oil tanks in the world. 90 million barrels per day are going to have to find a willing consumer, or the price is going to fall.

Don't think the refinery company doesn't use its incoming tanks to balance out short term spikes and take advantage of dips.

Also, regarding your ten percent figure, is that a long-term average over say, a decade, as opposed to specifically for 2008?

Cost to the oil companies skyrocketed in 2008. Rigs couldn't get built fast enough, not enough people could be hired. Steel, copper, labor, etc prices were blowing the budgets of big projects budgeted a year or two before. Go look at the 2008 annual reports, what was their percent profit?

[dirtboy]

You still seem to believe there was some large gap between the cost of production and the selling price. Sure, on the NYSE oil future price reached around $147 for a few hour or less. Do you realize how little oil was actually sold at that price? Buying and selling the same barrel of oil 20 times a day doesn't have 20 times the impact on the end sale.

You still keep avoiding the figure of seventy percent. And once again, I did not give an example involving hitting a peak price of $147. I demonstrated how using speculation to drive prices up over months can still meet your complaint of there not being that much of a gap between the production price and the settle price, while still realizing a tidy profit and driving the price steadily higher with that approach - and especially if a lot of players are in the market doing the same thing at 12-1 leverage.

And your citing cost of rigs in rigzone does NOT address my example of the impact on profitability of an existing, mature well. You don't need a drilling rig to produce oil from an existing well in Oklahoma. OK, you might have some higher labor and servicing costs because of a supply shortage, but not in the manner you are saying. And even then, that is outside the larger issue - I have laid out a scenario where a steady effort to drive the price of futures up five bucks a month can keep the price differential within your ten percent threshhold while still allowing a tidy profit month-to-month - and driving up the price of oil over $50/bbl over ten months.

[Cyber Liberty]

I am sympathetic to my friends with long commutes, but I’d like to see gas prices blow through 10 bucks if it means we cast off the yoke of this socialists boy President.

[dirtboy]

Cost to the oil companies skyrocketed in 2008. Rigs couldn't get built fast enough, not enough people could be hired. Steel, copper, labor, etc prices were blowing the budgets of big projects budgeted a year or two before. Go look at the 2008 annual reports, what was their percent profit?

Could you please stop tossing apples in the orange juice?

This was not about drilling a new well. It was the production cost of wells versus the futures contract within the time window of that futures contract. A well being drilled in the Gulf in April 2008 - that was not even producing yet on a futures contract facing delivery that month. I know the oil industry has all kinds of accounting devices to apply some of those costs to the April 2008 production cost of oil at an existing mature well, but the point is, gradual speculative pressures over the course of 10-12 months could have added over $50 bucks to the price of oil while still adhering to your ten percent guideline. So my position is hardly trumped by anything you have claimed on this thread. I doubt we will change each other's viewpoint on this and I have a very obnoxious bit of code to test from home after a 12-hour day, so you may have the last word.

[thackney]

You still keep avoiding the figure of seventy percent.

I still don't see how it matters. At the end the actual consumer of the oil is going to buy or not at the price. If that same contract go bought and sold one or a thousand times before the consumer, that doesn't seem to matter. Speculating that price will rise only works if the supply was not keepiing up with demand at the old price. Buyers and sellers of oil are not forced to go through the exchange and several exchanges exist. But they are going to reflect what the final purchasers are willing to pay or they are going to get stuck with a tanker of oil looking for a home.

When the spot market is drastically different than the near market, then tell me about it. Actual supply and demand of the spot market show reality of price. Speculation of rising prices only works in a tight market. Otherwise, they would be left holding the oil.

my example of the impact on profitability of an existing, mature well.

And you are not understanding that a mature well either takes money for enhanced production, or the production rate keeps falling. Do you understand how fast these fall?

That bottom axis is months, not years.

[dirtboy]

You seem to want me to hate the speculator that won on the front end and feel sorry for another speculator who lost on the other. If you cannot handle the risk, don't play the game.

I will comment on this. This is not about hating anyone. The opportunities were presented by relaxing regulations on position limits over the course of years and by allowing 12-1 leverage, and investors took them. Phil Gramm got legislation passed to exempt new exchanges from regulation, so a lot of this nonsense happened in the ICE exchange.

But the larger point is, absolute havoc was unleashed by the oil bubble of 2008. Reducing leverage and maintaining position limits IMO would go a long ways to preventing another such bubble. And IMO policymakers allowed the 2008 bubble to go down to channel billions into teetering financial institutions - at the expense of consumers.

We have seen what happened in the real estate market due to a lack of sane regulation and excessive leverage (and don't get me started on Dodd-Frank not being a reinstatement of such). But for many years, there were basic limits on speculative commodities positions and leverage that served as simple risk management regulation. IMO those should be restored. The oil markets are chaotic enough as it is, they don't need the help of Goldman Masters of the Universe in that regard.