Inflation is contained!
Crude Oil Futures, June 2008
Crude Oil = $129
May 20, 2008 11:13am by Barry Ritholtz
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and to think that at one point people were upset over an increase in tea…
Mr. Bernanke’s group over in Princeton has declared that oil is not in a bubble. It will stabilize and start coming down slowly in an orderly manner as the futures mkt is pricing. it was pricing that 2 years ago. Nasdaq, housing, credit – same Fed forecasts have been proven wrong. When will the Fed learn? Mr. Kohn spoke today and declared Fed cuts have little to do with commodity price rises.
http://blogs.wsj.com/economics/2008/05/20/did-feldstein-criticism-get-under-kohns-skin/?mod=WSJBlog
It is not just Feldstein. Rogoff over on his blog has explored the issue in detail. Just look at the move in CRB since the Fed cuts started. The move is astonishing. 41% move up in CRB! So are Fed cuts 5.25% down to 2% (cost of money is down 61%). Is it a coincidence that the rise started the day of the rate cuts? Inventories my a$$. Nothing is 100%. Of course the Fed cuts are NOT 100% responsible. But they are largely responsible. The same movie played out in the 70s. Then the Volcker Fed tightened and cracked the commodity prices and inflation in general. THose who say that the fed can’t do anything about the commodity prices is dead wrong. Read up on your history. You too Mr. Kohn.
http://www.marketwatch.com/news/story/boone-pickens-sees-150-barrel/story.aspx?guid=%7BB0946F64%2DDB78%2D4630%2D81ED%2D6DE5E1258C17%7D&dist=hplatest
– Hedge fund manager and Texas oil man Boone Pickens on Tuesday said he expects oil will hit $150 a barrel by the end of the year. Speaking on CNBC-TV, Pickens said world oil supplies are falling and that speculators have “nothing” to do with the record prices.
http://www.marketwatch.com/news/story/funds-play-key-role-commodities/story.aspx?guid=%7BC8522E84%2D07CA%2D417D%2D8DD3%2D10C0C377F3A2%7D&dist=sp_inthis
Pension funds and other institutional investors are driving commodity prices to the moon by allocating massive amounts of money to energy and agricultural investments and sidestepping regulatory limits on big speculative bets, according to research expected to be presented to Congress on Tuesday.
..Lapolla said Monday. “The argument that they’re having no effect is ridiculous.”
ReturnFree,
Great post…unfortunately the Fed has been corrupted by political forces…given a choice, they would rather now avoid recessions than fight inflation. It’s Obama-Volcker time. Wonder how Kudlow would feel about that…loves Volcker but will choke if Obama gets in.
Crude prices are quoted per 42-gallon barrel. So a price of $126 per barrel is a kind of round number, at which crude oil costs $3.00 per gallon. As the graph shows, $126 acted as resistance for a few days of trading. Now it may be support.
Crude was below $20 a barrel in 2001. So the run-up has exceeded a factor of six. Oil shocks I and II only involved a factor of four increase, and both produced severe recessions.
But it’s different this time — as the remarkable economic genius Greenspan used to proclaim, derivatives have spread the risk and hedged away the pain. Prices are all relative, right, comrades? As the BLS tells us in the inflation statistics, if gasoline’s too expensive, why you can just burn used french-fry oil for free. Or ride your bicycle. Or dress in a clown suit and wobble down the sidewalk on a high-hat unicycle, whilst beating your chest and bellowing “I’m from the Federal Reserve, and I too support the strong dollar!”
There’s a whole bunch of speculation in that chart. I wouldn’t want to be long oil when the inevitable occurs.
The universe is also contained.
But also infinite.
>>>When will the Fed learn?
When will WE LEARN?
The “FED”‘s “job” is to fight inflation but yet they are the root of inflation?
We boast about freedom and democracy and the “American” spirit and yet we allow this foreign parasite to dictate the course of our markets?
WTF?
The horror….the horror…
pull back already so I can get my feet wet…
So what you are saying is that supply/demand has changed enough in the past year to justify a doubling of oil prices. If that’s the case then just to be sure, we should eliminate ETF’s that buy oil and regulate hedge funds out of the Nymex just to be safe.
Return Free,
Exactly, and if I hear one more time the chanting of the tech-stock, housing mantra that “It’s different this time” (this time regarding oil) I think I will puke at the garbage being fed me.
Humans are not different this time, nor any other. Oil, and many other commodities, are in a speculative, inflation-induced, frenzy of buying. Inflation creates its own demand, and destroys (at least short-term) the incentive to supply. Why not hoard food or oil, when you get about a 1% return per DAY by doing so?
The antidote is a responsible fed. Fat chance that’s happening anytime soon.
Thanks Haygood, that unicycle was a great picture.
Steve Barry,
Yes, incredibly, the fed still thinks there is a tradeoff between inflation and recession.
The inflationary recessions of the seventies and the deflationary expansions of the eighties and nineties are just anomalies, I suppose?
“Inflation is everywhere and always a monetary phenomenon.”
Friedman’s observation should be tattooed on the forehead of every fed governor in reverse image so that they have to read it every day while looking in the mirror to shave or put on makeup. Of course, that probably wouldn’t work for hairy Ben.
“The “FED’s ‘job’ is to fight inflation but yet they are the root of inflation?” — Whisky Tango Foxtrot
What can you expect, when the Federal Reserve is cast into a kind of ambiguous, quasi-official limbo between public and private?
It’s high time, say I, to upgrade the Fed to a federal department, making Bernanke an ex-officio member of the Cabinet. You will not be surprised by the proposed moniker:
“Department of Stable Prices”
Have you hugged your bankster today?
As 2007 was the year of the credit black swan, perhaps everyone should be at least cognizant of the geopolitical black swan: GWB & Co. going out of office in messianic style by bombing Iran before Labor Day.
http://www.jpost.com/servlet/Satellite?cid=1210668683139&pagename=JPost%2FJPArticle%2FShowFull
Maybe the premium in the Oct 155 USO calls isn’t so crazy after all.
For those who have the time, here is the greatest essay I have ever read on gold and fiat currency. Read and let me know what you think.
Once and Future Money
Growing oil demand of miniscule elasticity meets world supply in the process of maxing out: big, non-speculative price increases?
“Pension funds and other institutional investors are driving commodity prices to the moon by allocating massive amounts of money to energy and agricultural investments and sidestepping regulatory limits on big speculative bets, according to research expected to be presented to Congress on Tuesday.”
Let’s not forget who is in no small part responsible for that: Wendy Graham, wife of Sen. Phil Gramm. The story of how it came to that is rather interesting.
From AngryBear:
“The illogic of limiting position sizes for indexers dealing directly in futures while exempting indexers who use a swap deal intermediary has apparently not escaped the Commission’s attention. And it has a proposal on the table to correct this inequity. In November the agency proposed new exemptions for “risk management positions,” which would open the door to all indexers while, of course, leaving the swap dealer exemptions in place.
[…]
In proposing the new exemptions, the CFTC acknowledges that index-based positions differ enough from bona fide hedges as to make hedge exemptions inappropriate under current law. It does not state where it found the authority to classified swap dealers as hedgers in the first place. It is also unclear why swap dealers should be accorded special treatment.
Their cozy arrangement began during the Reagan Administration under CFTC Chairman Wendy Graham (the other half of the Texas Senator Phil Grahm’s duo that Barron’s dubbed “Mr. & Mrs. Enron”). She began exempting swaps from CFTC oversight in 1989, and in 1992 granted Enron regulatory exemption for its energy-swap operation just five days before resigning her Chair to join Enron’s audit committee.
The whole article is here:
http://angrybear.blogspot.com/2008/05/index-funds-and-commodities-2.html
More fuel for the fire – inflation vs. speculation:
Dec/2013 – the only long date to trade today – $134.60 @ 12:35
>Andrew, So what you are saying is that supply/demand has changed enough in the past year to justify a doubling of oil prices.
Up until this recent run up, there has been excess supply in production. Not anymore. So, say oil is $50 a barrel one day and there is an extra barrel of oil for sale that goes unsold ’til the next day. The next day two buyers want that last barrel of oil. How much are they willing to pay for it, given that it contains the equivalent work of 23,000 man hours of labor and there are no close substitutes? Well, it turns out we are finding out how much those last two buyers are willing to spend.
So, looking at this graph
If the widening in the gap between supply and demand between 2005 and 2008 was enough to increase the price of crude by 2.5 times, then imagine what it will do when it gets even wider. Without a world-wide recession to dip the demand line down a bit, there is no ceiling to this.
Note also in support of this logic that oil prices only really surged when supply and demand diverged.
Regarding the comments above about the CFTC’s “Enron Loophole” for oil futures trading…FYI, Congress overwhelmingly erased the loophole and the proposed index fund exemptions a few weeks ago (around the time of the last brief energy correction)- so much so that GWB’s veto power was nixed. Also, last week, Congress voted overwhelmingly in favor of increasing the regulatory oversight powers of the CFTC within the futures market to crack down on speculative trading and market manipulation. Again, Bush’s veto powers were nixed. This was at the same time that Congress shut down GWB’s ridiculous practice of adding to the SPR “at any price.” They must now wait for a $70 oil price to add.
What does it all mean? Who knows, but for all the chatter, oil prices have not skipped a beat in spite of this news.
Why? Well I doubt the “new powers” of the CFTC have any consequence given that its board was tainted to begin with. It’s all political posturing. Just like Bush’s trip to Saudi Arabia. Ya think he really begged for more production? More like they smoked some opium and had an orgy with the harem while the spin doctors worked their magic.
The Jerusalem Post says Bush is going to attack Iran before he leaves office. And you call oil speculation? Where is it being stored by the speculators?
me, Where is it being stored by the speculators?
Some of it seems to be in tankers
Darkness,
Do you even understand the chart you attached? Demand is growing, yes. Production is slowing, true. But production has slowed many times in the past (as your chart shows). Economics states that production will accelerate again as prices rise to justify more drilling, new methodologies, etc. Chances are that the trajectory for demand will not be as favorable in the current environment. As you said, a world-wide slowdown is required to slow demand – we are getting this. Check out the global leading indicators. Decoupling is a joke.
I would attach a chart if I could, but I can tell you that (based on IEA, DOE, OPEC data) after about 3-4 quarters of negative net world oil supply growth (supply less demand), production growth accelerated in Q4-07 and continued through Q1-08, closing at a 3.2% year over year clip. Global demand growth was still positive at 1.8%, but this is roughly where it has been since 2005. OECD demand weakness is off-setting emerging mkt strength. So now we have NET world oil supply stocks GROWING at 1.4%. Hardly bullish for prices, yet they continue to rise.
Do your homework. Bubble, bubble, toil and trouble…
me,
I suppose you are saying that the market has known about the US’s imminent attack on Iran since December, since oil prices have relentlessly rallied long before the JP’s article.
By the way, do you believe everything you read? Nice of the JP to give Iran a nice big head’s up before the US attacks – that way they can get all their guns lined up and ready for the invasion. I guess Jerusalem and Iran are best buds now?
me, it is easy to put the burden on Bush alone or picture Iran as a innocent future victim. But that is not the whole picture and might not be the right picture at all.
The OPEC secretary might be telling the truth, that current production level is enough. He’s also accusing speculators for the price action, which is right. What he didn’t say was that the main speculators might not be in the financial markets.
Think about it.
bitmo,
If and to the extent speculation is causing this run, I’d expect production to drop off (suppliers hoarding in the ground) and demand to increase (buyers looking to resell at a profit). With supply/demand curves diverging (no clearing price), physical shortages would likely appear.
I’m more in your “normal” supply/demand curve camp, but I’m open to the idea that there’s a speculative aspect.
New Fed paper questions the belief that core inflation is better:
http://www.philadelphiafed.org/files/wps/2008/wp08-9.pdf
Two rationales offered for policymakers’ focus on core measures of inflation as a guide to underlying inflation are that core inflation omits food and energy prices, which are thought to be more volatile than other components, and that core inflation is thought to be a better predictor of total inflation over time horizons of import to policymakers. Our investigation finds little support for either rationale. We find that food and energy prices are not the most volatile components of inflation and that depending on which inflation measure is used, core inflation is not necessarily the best predictor of total inflation. However, we do find that combining CPI and PCE inflation measures can lead to statistically significant more accurate forecasts of each inflation measure, suggesting that each measure includes independent information that can be exploited to yield better forecasts.
Bitmo, you can attach a chart easily, by sticking in a link…
>Economics states that production will accelerate again as prices rise to justify more drilling, new methodologies, etc.
Um, energy being a major input into energy production, the law of diminishing horizons kicks in. The economics you refer to can’t state anything if there is no more easy oil to be pumped. The economics that now rule the market is the one that asks: how many barrels of oil will we leave in the ground because it takes more than a oil barrel in energy to get it out? Technology can’t save us from the basic laws of physics.
Total U.S. crude stocks are down from last year this time by 5 million barrels, so clearly no glut locally. If the current oil price is partly a reflection of free money from the Fed (not unlikely, because borrowing money is the easiest alternative to finding efficiencies) then we have created a grand experiment on consumer behavior that if I were an oil producer or, especially a cartel, I’d be taking pretty close note of. Managing supply to keep the price high is good, good business and people will just suck it up and whine. So, while the price is elevated by excess money chasing it, it may stay there because supply is easy to control, and will only become more so as more countries keep their production for internal use. What you are neglecting in your numbers is that a worldwide increase in production does not equate to a worldwide increase in oil on the open market. Internal price controls by oil producing countries are leaving them no choice but to sell internally first to keep civil unrest down. This makes them even more likely to price gouge externally because they have to to subsidize.
Speaking of oil…Since March 14th, the oil/gas sector has been Doug Kass’ favorite short position via a long position in DUG. Not sure when he originated the position, but it was no later than 3/14 at around $35. He subsequently announced that he was pressing his DUG bet and it was his largest long position (i.e. heavily short oil stocks). At the same time, he announced his largest short position was in XOM, which has also moved against him, though not nearly as much as DUG. This all happened shortly after he announced a plain vanilla long position in General Electric in the $33s. So please forgive me if I was a bit confused by Kass self-proclaimed status as a “dedicated shorts”, and more than a little surprised by his performance through April 30th. As Laudani pointed out, Kass doesn’t put all his moves on TSCM, but up 16% with your largest bets being against oil stocks is rather…..um……impressive(?).
Darkness,
I didnt think a link would work for a chart that I created (it’s not a web link, I dont have my own blog…sigh).
Good points by the way. I think you are right, surely all production is not open mkt – we are seeing hoarding in tankers as we speak. But I think the Hubbert’s Peak crowd is having a field day saying we are out of oil, when in fact the statistics do not point to such a trend (yet). Hubbert’s Peak is being pushed enough to surely scare many into being long the oil story and cause some degree of hoarding. It becomes self-fulfilling.
As for the ‘cost-of-extraction’ argument, I think that certainly applies to the bullshit ethanol hoax, but not to Oil. Sure, costs have risen, but oil companies are still printing money. The costs are not all variable. In fact, many E&P company CEO’s have publically stated that $70-80 oil can be jsutified based on costs, but beyond that, the drivers are unclear. It is commonly known that lesser-quality oil (tar sands) becomes ecnonomic to extract north of around $60, opening a whole new avenue for production with oil at $130. Venezuela now trumps the Saudis for OPEC control under the new economics!
Crude market is sort of a joke right now. There is no lack of supply in the market. There is no producer selling on the deferred strips as producers are the ones stopping out of big time losing hedges, similiar to the way gold producers gave up on their hedges at $1000, effectively putting the top in there.
The entire crude curve is now in contango…this is clearly NOT a sign of strong fundamentals, at least in the shorter term. It’s not about supply and demand of real oil; it’s about the supply and demand of the deferred futures contracts–there’s huge demand for the contracts and the really large oil companies who could meet the demand, refuse to hedge.
Flat price crude has a little further to run…would love to see a big blowoff to 133-138 to peak this thing…expect to hear some e&p companies announcing the closing of their “hedge books”…when you hear them make those kinds of announcements then you’ll know the top is in.
AT
Steve Barry,
That was an excellent synopsis of monetary history, fiat v hard currency.
Another good history is Milton Friedman’s “Monetary Mischief”.
History rhymes, as Mark Twain put it. And a recurring pentameter has been the debasement of currency by the governments or other entities that issue it.
Steve Barry,
enjoyed reading that history of fiat currencies. Thanks for posting.
Someone should inform Bernanke that the backwardation in oil futures contracts has completely disappeared. The futures are now pricing in continuously rising prices (supply??). Now what is his new excuse for inflation coming down?
speaking of contango (thanks, Andy Tabbo):
Dec/2016 (E) – the absolutely longest-dated NYMEX contract
currently at
139.00 – up 9.02 today
Now if I were a speculator, and I were to buy June 2008 today @ ~129, would $10 over 8.5 years be enough to make me happy? And how big is my backyard tank? (Or, if you remember Plainview’s storage facility, how big is my swimming hole?)
And please don’t lecture me on NYMEX contracts – that isn’t the point – someone really really believes the value of oil in the ground is greater than today’s price, by a fair bit.
If one were to believe this were spec, then maybe one could makes lot$ by being on the Dec/2016 sell side? At least one could claim one’s going to be right for 8.5 years….
Someone needs to explain to me the GOP orthodoxy of why we must drill in ANWR but we must fill the SPR.
Why not one or the other?
VennData – I would look at the contract signatorys to fill the tanks.
ANWR – gotta beat the others to it. Just in case it flows in & outta territory lines. Save the polar bears with artificial icebergs.
You all are on to a grand plan, be the last oil well pumping. Plastics and roofing materials need the petro when we are drive’g electric cars.
The price of crude oil has several components. The % of each component that contributes to price varies considerably over time. A good analysis of crude oil prices would include consideration of each of these components, and the relative contribution (%) of each component to the price at a given one time. In addition, there may be one component, such as demand exceeding supply, that may be a long-term fundamental driver that enables other components to have increasing influence on the price of crude oil. For example, T. Boone Pickens assertion that 87 million barrels of oil demand exceeding 85 million barrels of oil supply would be a fundamental long-term driver of upward oil prices.
Some components that influence crude oil price are listed below along with a guess as to their % contribution to crude oil price. Folks who have good information could make better guesses (a.k.a. “estimates”). But the point is that there are many factors justifiably producing a rise in oil prices. To focus exclusively on speculators, as if magically removing speculators from market, would stop the rising price of oil is a half-baked approach. The blind focus on speculators diverts attention from the fundamental and rational reasons for the rising price of oil, and from the tough analyses and decisions that need to be made on fundamental issues.
So here is a snapshot guess at what is contributing to crude oil prices today.
40%? – Cost of oil production.
5%? – Normal investment interest in energy.
10%? – Demand exceeding supply.
15%? – Geopolitical risk: Suppliers seeking to insure current and future supplies at best prices.
10%? – Rational investors seeking to invest in a rising asset.
10%? – Rational investors seeking to in invest in inflation-defensive investments, including protection against debasement of currencies.
10%? – Speculators seeking to profit from the trend for rising oil prices.
These %s may change every day and every week. What components of crude oil price and %s would you use?
1. Comparing the oil price rises during the 1970s with that of the last few years is apples and oranges, not only because of the political aspects but since then and now are two distinct price regimes; during the earlier period, price was administered (set) by OPEC, a condition which broke down during the 1980s as more non-OPEC supply came onstream and as world consumption of crude oils fell sequentially from 1979-83.
The present price regime is centered not in the physical but in the futures markets hence, at least in theory, a ‘market price’ but a market price that’s open to return seeking financial and socio-psychological pressures.
In very short mechanical fashion, there have been three dominant oil price regimes since 1928: oligpolistic (as evidenced not only in years of hearings but the 1928 Achnacarry and Redline Agreements); cartel (OPEC’s relatively short reign); so-called market pricing tied to a benchmark and reference structure which fails to capture the changing composition of world production of crude oils and, given the thinness of benchmark physicals’ trade, became reliant upon various daily assessments such as Platts but moreso futures activity.
Notions that the oil markets should conform to neoclassical economic theory and its efficient market offshoots are only that, notions.
2. Enron loophole closing — except lanquage of the earlier Senate Bill did not make it into the Farm Bill attachment but was watered down to give “the CFTC limited authority to regulate certain trades on ICE on a case-by-case basis.”
One might reasonably say a ‘lets pretend closing’.
3. Not all storage or production is captured by governments and/or IEA, the latter of which arose during the 1970s to represent a type of OECD consumers cartel. There is such thing as institutionalized bias, especially when hopes for a green bubble have been percolating.
tom a taxpayer,
I’m sorry, but given your post I’m going to assume you’re an engineer of some kind. My advice to you is to NEVER ever trade commodities. EVER.
Markets move with sentiment and herding behavior. Right now, prices are rising because prices are rising. News follows the trend…it doesn’t make the trend. Prices will continue to rise until the entire herd of sheep are in the barn….then they’ll get sheared (maybe slaughtered.) Bullish consensus is probably above 90% on energy right now. Almost everyone now believes energy “will never” go back to 50 bucks….ever.
Markets never peak on bearish news. Markets ONLY peak on wildly bullish news or a bullish event. When such an event occurs over the next few weeks/months, we will see a panic spike that sends the market up hard….followed by an immediate sell off in the same day…that’ll be the signal the move is over as all bullish news/info finally gets priced in.
-AT
I should add that I am not speaking of manipulation (though there has been some) or of speculation as major price drivers but, instead, a logical reallocation of funds which began no later than early 2004 and became a self-fulfilling, justification generating mania, placing it into contradiction with the real economy and, through this, less than logical from an overall macro perspective.
Andy Tabbo – What I said about the changing % components in crude oil price is consistent with what you state about sentiment and herding behaviour, and bull market reversals into bear markets. On the way down in crude prices (due to a normal correction, or worse, a severe deflationary recession) the % of investors seeking inflation-defensive investment could drop from 10% to O%, and a similar drop for speculators, and those seeking a rising asset. Similarly, oil demand might drop from 10% to 5%. Speculative short sellers could add to the downward drop in oil price. The result could be a big drop in crude prices.
My point is that when one looks at trends in oil prices, whether the trend is up or down, there are usually several factors at play.
Sentiment and herding are factors, and can drive prices at the extreme, but long-term trends in oil, up or down, have fundamental components that vary with time. Sentiment and herding can whip the prices to the breaking point, and cause a correction or significant retracement. But they can only pause, not, reverse long-term trends in oil prices; only fundamentals changes can reverse long-term trends.
The reason for my post is not about trading commodities, but to indicate why Congress’s witch-hunt for oil speculators is too narrowly focused. it allows Congress to demagogue the issue rather than face underlying realities.
According to GOP orthodoxy, if we could only break into that cabin full of scotch across the dirt road our drinking problem would be solved.
The average miles of commute for Americans to their job today, compared to 1970, is greater by one to three orders of magnitude.
We are a nation tied to our automobiles in a way that we were not during the Arab oil embargo. Land use patterns are a huge factor in petroleum consumption. If you drive 70 miles round trip to work each day, this is not a consumption pattern that you can easily alter.
Cheers.
>> Someone needs to explain to me the GOP orthodoxy of why we must drill in ANWR but we must fill the SPR.
>> Why not one or the other?
VennData, the SPR gives us short-term buffer, immediately deliverable to the market. ANWR will in the longer term give us additional supply.
I’m a liberal/environmentalist. But, I agree with the GOP on this and think we should do both.
Indeed, I would like to see us:
– fill the SPR
– drill in ANWR
– drill off our continental shelves
– institute GHG cap-and-trade system, which means that extra oil/ng will help us cut coal/CO2 emissions
– cut back on oil sand mining, which is far worse than drilling in ANWR and which is like “turning gold into lead” (because it involves using power from NG plants to mine oil)
– switch to electric (electric-only!) cars.
(Why would an environmentalist accept offshore rigs? Transporting oil in tankers is relatively dangerous to the environment. In contrast, transporting oil from rig to shore via pipelines is pretty safe. Leaks are stopped pretty quickly and involve fewer barrels.)
In other words, we should cut down on coal but will need more oil for a while until solar (wind, geothermal, tidal, etc) takes over.
If I might repeat myself from another thread:
– Oil/NG are cheap. Housing is overpriced.
– Innummerate, FIRE economy Amurricans now have an entitlement mentality when it comes to energy. The Empire’s citizens are getting demanding. (The rest of the world better look out!)
wunsacon – I digged (to myself) Empire Demanding comment
SPR is for desperate times because (nope)
and these are not those times
besides I heard a fact its 97% full. Dont the tanks need thermal expansion room? : )
SPR capacity is 727 million barrels; it has been filled to 703 million barrels and, mid-May, the DOE announced that it would not enter into contracts for continued fill, which frees up roughly 76,000 barrels/day.
Not much, but added to the 300,000 additional from SA and slowing world economy including actual demand decline here in the U.S., well, at least something — but nothing that a mania will notice until it’s swimming.