What 60 Minutes Missed on Oil Speculation

Last night’s 60 Minutes had a story on Oil Speculation. Its not that they said anything that was factually wrong per se, its more that they told 10% of the story of the rise and fall of energy prices. The entire report was surprisingly thin, and avoided discussing all of the many other factors that had been impacting energy prices during the 7 year rise and subsequent collapse (60 Minutes video here).

Very often, major bull market moves begin on fundamentals, but shift towards the end of its life into a speculative frenzy. These always end in a price surge (i.e., a blowoff top), which is followed by a collapse. But note that it is in the end game where speculation dominates, not the first 7 or 8 innings. That was true as much for Housing in 2005-06 as it was for dot com stocks in 1999-2000.

Hot markets always attract hot money.

But merely claiming that the run up in Oil prices was due to unprecedented speculation misses the big picture of what actually occurred. And, it reflects a lack of understanding of how markets work, and the psychology of booms, bubbles and busts.

Here are a few factors that I believe the folks at 60 Minutes either misunderstood or overlooked completely during the run up from $20 to $100:

1. Oil is priced in US Dollars. Since 2001, the Dollar fell 40% (from 120 to 72); Oil rise nearly 5 fold over the same period. And Oil’s collapse occurred over a period when the dollar formed a short term bottom; it has certainly had its most significant rally in years (72 to 88).

2. Over the same period that Oil prices were rising, the US was fighting two major wars in the Middle East, Iraq and Afghanistan. These impact prices via psychology and risk of supply disruption — especially at a time when producers were running flat out.

3. Energy prices rose during a global economic expansion (fueled by low rates and cheap money); Oil fell during a period that marked the beginning of the US recession and the start of a global slowdown.

4. Since 2001, Commodities of all sorts rose significantly: Steel, aluminum, cement, cotton, soy, livestocks, foodstuffs, precious metals, etc. Were they all driven by speculation, or was something else going on?

5. Since the 1% Fed funds rate of 2002-03, inflation has had a dramatic impact on ALL prices — from medical costs to insurance to education to health care to transportation to housing to food and energy. That 60 Minutes failed to even mention inflation in a piece on Oil prices is a terrible oversight on their part.

6. Throughout the 1990s and 2000s, cars were increasingly replaced with SUVs and trucks in the United States. Not only did these get appreciably worse gas mileage, that fleet transition took place as the total US miles driven rose. Over the past 20 years, people have lived increasingly further away from their jobs. Hence, increased US demand for energy accompanied (and increased prices).

7. Since gas prices hit $4 a gallon and the recession began, total US miles driven fell significantly, by several billion miles. As expected,t he drop in driving was followed by a fall in prices.

8. 60 Minutes interviewed Mike Masters, a hedge fund manager who had testified before Congress that speculation was driving prices. They omitted to mention he was talking his book.  His holdings in energy sensitive stocks — with large positions, the vast majority in call options, in AMR Corp (AMR), the parent of American Airlines, Delta Air Lines (DAL), General Motors (GM), UAL Corp (UAUA) and US Airways (LCC) — were responsible for his fund losing 35% of its value before the Fall 2008 market collapse..

9.  China boomed~! More and more global manufacturing outsourcing saw factories being built throughout China. They also went through a wild process building out the nation in preparation for the 2008 Olympics held there. Oh, and China, like the US, also began filling its Strategic Petroleum Reserves. Another small country, India, was booming over this period also.

10. The rise of extremist terrorist groups like al-Quada, the hostility of Iran towards the West, supply and political disruptions in places like Nigeria, and overt hostility to the US by oil producers like Venezuela President Hugo Chavez also contributed to drive prices up.  The political factors were also omitted.

There’s a lot more, but the bottom line is this: Higher energy prices were caused many many factors over the past 8 years. Certainly, speculation played a part at the end of the run — but it always does. Oil fell more precipitously than it rose, but don’t all markets do that? Didn’t the S&P just plummet nearly 50% in a year, after a 5 year run?

Speculation is merely one aspect of what happened. 60 Minutes missed the other 59 elements . . .

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Previously:
The Costanza Energy Policy: 25 Ways to Drive Oil to $150 (May 29th, 2008)
http://www.ritholtz.com/blog/2008/05/the-costanza-energy-policy-25-ways-to-drive-oil-to-150/

Clarifying CNBC Oil Comments (December 22nd, 200)
http://www.ritholtz.com/blog/2008/12/clarifying-cnbc-oil-comments/

Sources:
Did Speculation Fuel Oil Price Swings?
60 Minutes: Speculation Affected Oil Price Swings More Than Supply And Demand
CBS, Jan. 11, 2009
http://www.cbsnews.com/stories/2009/01/08/60minutes/main4707770.shtml

Fisking Michael Masters
NakedShorts, June 26, 2008
http://nakedshorts.typepad.com/nakedshorts/2008/06/fisking-michael-masters.html