Book of the Month

Donal's picture

Third Strategic Oil Release, Theory Update

We are in US summer driving season, but Tom Whipple observes that both oil and gasoline stocks are unusually low :

The US weekly stocks report came as a bit of a surprise by showing a decline in US crude inventories of 1.7 million barrels last week. This was the third weekly decline in a row and came as US refineries ran at the highest level in 10 months. The inventory news was undercut by a statement from the Federal Reserve saying that the US recovery was going “somewhat more slowly” than expected. Concerns about the US economy are among the factors keeping US crude trading some $20 a barrel below London crude.

US gasoline stocks also took an unexpected dip of 500,000 barrels last week. Analysts had been expecting an 800,000 barrel increase. The EIA also reported that US gasoline consumption averaged 9.3 million barrels over the last month, up by nearly 1 percent over last year despite gasoline prices averaging a dollar or so a gallon higher. This news sent NY gasoline futures up by 9 cents a gallon to close at $2.97 a gallon. The government report was reinforced by MasterCard who reported gasoline demand last week was 9.34 million b/d, the highest consumption since Memorial Day.


Looks like everyone noticed. The US has released some of its reserves 17 times, but for only the third time in 37 years, the International Energy Agency has authorized an emergency release of international strategic oil reserves. The first time was during the Gulf War, the second time was during the Katrina supply disruption and the third time is during ... the Libyan civil war?

Reuters reports:

Industrialized oil consumer nations on Thursday announced the release of 60 million barrels of oil from strategic government stockpiles in a bid to push down crude prices and underpin the global economy.

The 28-member International Energy Agency said it would release 2 million barrels a day (bpd) over an initial 30 days to fill the gap in supplies left by the disruption to Libya's output. The United States will provide half the volumes, about 1.5 days of U.S. consumption.

The Wall Street Journal adds:

"I expect this action will contribute to well-supplied markets and to ensuring a soft landing for the world economy," said IEA Executive Director Nobuo Tanaka in a statement.

The U.S. release represents a pivot for an administration that has long resisted calls to unleash its storage of oil despite persistently high gas prices. The move will likely send ripples through the stock market and cause a political backlash in Washington. The administration has said the reserves should only be tapped during emergencies, not solely because Americans are feeling pain at the pump.

"We are taking this action in response to the ongoing loss of crude oil due to supply disruptions in Libya and other countries and their impact on the global economic recovery," Energy Secretary Steven Chu said in a statement.


It seems to be getting harder and harder to maintain the appearance of normalcy.

Update - Destor thinks we're messing with OPEC, Rmrd0000 thinks we're messing with speculators, I've read the "Obama wants to keep prices low so he will be reelected" theory, and the "Obama wants to stop the speculation bubble" theory. At Forbes, this fellow said yesterday:

Saudis Set To Bankrupt Iran With Flood Of Oil

Today [Jun 22] the Wall Street Journal has a fascinating piece describing a speech given this month by Saudi Prince Turki Al-Faisal. The prince, speaking to a group of U.S. and British servicemen at an airbase near London, explained that Saudi Arabia was so concerned about Iran’s continued march toward attaining nuclear weapons that it was considering opening its oil spigots and swamping the world with oil in the interest of gutting Tehran’s government revenue.

Guess who's running out of ways to spur the economy...

I buy the argument that this is a way of messing with an OPEC on the verge of disunity.  I think it's interesting that the price of oil started dropping well in advance of this announcement.  Saw one speculator say it's just an anti-risk day but I'd caution people that insider trading is legal in commodities markets.

I read one opinion that said they were trying to pop a speculation bubble in advance. There's a first time for everything, I suppose.

Why? Do you have a good explanation?  Do you think Oil will drop below $3? $2? how would this break OPEC? Anymore then Russia and the US (as large producers) already do? Or for that matter thier own internal contradictions?   How big a player do you think OPEC is? (not saying you are wrong here, just curious).  

Don't we want prices to rise? Doesn't OPEC have an incentive for prices to fall, or at least stay below the level where EVs become practical?  Cause I certainly think so.  Why the hell would Abu Dhabi be building something as dumb as Masdar? I mean they have 9% of global hydrocarbon reserves. Sure oil still rules, but the days are numbered. I mean shit, even the IEA belives peak crude already happened:

http://www.energybulletin.net/stories/2010-11-11/iea-acknowledges-peak-oil

yeah, we have shale oil and tar sands, but still they are pretty damn costly to extract. The have a break even point somewhere in the range of 60-80 a barrel.  And OPEC is... well doing what? Why would we want to promote even more disunity in the region? Do we have that as a political goal? 

But yeah oil still rules:

http://www.consumerenergyreport.com/2011/06/23/highlights-of-bps-2011-st...

 

I'm not expert enough to answer all of your questions but I think the thinking behind this argument is that OPEC is divided.  The Saudis would like to see a somewhat lower price, to preserve global growth.  But the Saudis can no longer unilaterally drive prices down.  Venezuela and Iran want to keep prices on the higher side, for internal budget reasons.  Obama's action, in concert with other oil importing nations from the developed world, just shows a little muscle on prices, even if it's temporary.  Reminds OPEC that it isn't, as you say, the only game in town.

The real problem is people can make bets, globally, if the price of oil will go up or down. Stop that and the price for a barrel will drop to the level OPEC says a barrl is really worth ... $65. But that would take the GOPer's in Congress to take action against the free markets, business sector and Wall Street ... ain't gonna happen.

Beetlejuice, can you or anyone else who might read this question run through the mechanics of bidding up the price of a commodity on the futures market and then making a profit by the price of that commodity becoming higher? I hear from many sources that it is happening and I don't doubt for a moment that if it is doable that it will be done, I just don't see how the entity bidding up the price of a commodity, which is done by contracting to pay that higher price, makes a profit after paying that higher price. Whose pockets do the extra bucks land in?

Following is a link to an attempt by an analyst to answer my question. Most of it is beyond my understanding and would require a lot of study on my part, including learning the jargon, before I could hope to have a conclusion of my own. The article does seem to come down on all sides of the question and to contradict itself.

What seems correct to me is the view expressed in many/most of the comments that followed. Here is one.

“I am an active private investor, with interests in both markets and private equity. Until 1999 I was largely invested through my business career. Then I sold to a good offer and, since then, I have concentrated on managing my own money. I split my funds between trading and investment, with the...

TiPs, there are some things you say here that I agree with.

In particular, you're right to say that the ETFs are the chumps and that other traders can exploit them, over time, by selling long duration futures and buying the short duration ones.

But again, none of that discussion has anything to do with "the price" of oil i.e. the spot price. Again, the only way there is any impact on the spot price, is if there are transactions in physical oil. So, if MS, or whoever, trades against the ETFs by buying and selling futures, it makes no difference. Only if they enter in to what was referred to above as "the good old contango trade -- store now and sell later" is there any impact on spot. Some speculator has to be buying physical oil, not futures, for the price to include a speculative element. Or, as Taylor and Van Doren put it:

"How do bets about the future price of oil affect current oil prices? They can do so if and only if those bets increase or decrease oil supply in the here-and-now through changes in inventory or production."

Now, as we know, there is some of this good old contango trade going on. But, the articles referred to above (and the academic evidence they refer to) say that there is not enough to make much difference.

So, what you're describing only makes a difference to "the oil price" if it involves trades in physical oil. Most of it doesn't because it's just offsetting trades on the futures market. If it involved trades in physical oil, then we would be able to see the physical evidence in increased inventories, but as Taylor and Van Doren say:

"While crude inventories in the U.S. are increasing, they always increase at this time of year, and this year's increase is well within the normal range."

So - there has to be speculation in physical oil, not futures, to affect the oil price. And, if there were speculation in physical oil, we would see the physical evidence - but the evidence isn't there.’

http://seekingalpha.com/article/270375-is-speculation-really-the-reason-for-high-oil-and-gas-prices

I am bumping this because my original comment was fairly late at night and then my follow up was fairly early and then comments rolled in on other subjects and pushed it out of sight quickly. Because of the timing the poster of the root blog and those others who commented may have missed it and I think it is pertinent to that short discussion and so thought that some who had already expressed ideas and opinions might be interested, and if so I would be interested in their reaction. If there is none that will be fine too. 
 Uh oh, just noticed, its late again. Oh well, it could be worse, I could live in Alaska where the sun never goes down this time of year.

There is way too much manipulation it just never ends.

Heres an example in another era of controlling an energy source

http://en.wikisource.org/wiki/Debs'_Speech_of_Sedition

10…..Fifty-two percent of the land kept out of use, according to their own figures! They tell you that there is an alarming shortage of flour and that you need to produce more. They tell you further that you have got to save wheat so that more can be exported for the soldiers who are fighting on the other side, while half of your tillable soil is held out of use by the landlords and profiteers. What do you think of that?

Again, they tell you there is a coal famine now in the state of Ohio. The state of Indiana, where I live, is largely underlaid with coal. There is practically an inexhaustible supply. The coal is banked beneath our very feet. It is within touch all about us—all we can possibly use and more. And here are the miners, ready to enter the mines. Here is the machinery ready to be put into operation to increase the output to any desired capacity. And three weeks ago a national officer of the United Mine Workers issued and published a statement to the Labor Department of the United States government to the effect that the 600,000 coal miners in the United States at this time, when they talk about a coal famine, are not permitted to work more than half time. I have been around over Indiana for many years. I have often been in the coal fields; again and again I have seen the miners idle while at the same time there was a scarcity of coal.

They tell you that you ought to buy your coal right away; that you may freeze next winter if you do not. At the same time they charge you three prices for your coat Oh, yes, this ought to suit you perfectly if you vote the Republican or Democratic ticket and believe in the private ownership of the coal mines and their operation for private profit.

The coal mines now being privately owned, the operators want a scarcity of coal so they can boost their prices and enrich themselves accordingly. If an abundance of coal were mined there would be lower prices and this would not suit the mine owners. Prices soar and profits increase when there is a scarcity of coal.

It is also apparent that there is collusion between the mine owners and the railroads. The mine owners declare there are no cars while the railroad men insist that there is no coal. And between them they delude, defraud and rob the people.

Let us illustrate a vital point. Here is the coal in great deposits all about us; here are the miners and the machinery of production. Why should there be a coal famine upon the one hand and an army of idle and hungry miners on the other hand? Is it not an incredibly stupid situation, an almost idiotic if not criminal state of affairs?

We Socialists say: “Take possession of the mines in the name of the people.” Set the miners at work and give every miner the equivalent of all the coal he produces. Reduce the work day in proportion to the development of productive machinery. That would at once settle the matter of a coal famine and of idle miners

 

Someday our current events will be ninety year old history and a documentation of that history will include many instances of people and institutions trying to exert control for the purpose of amassing wealth. That history will also include documentation of some of the voices that are currently attempting to channel peoples knowledge and opinions, some doing so with deception for purposes of control and some trying to honestly inform the public so they can avoid being controlled and used solely for the profit of others through deception.
 In the particular case of the particular commodity of oil, I do not see how speculation through the mechanism of futures trading can exert a controlling influence which raises the delivered price of oil and which puts the marginal difference, if it exists, between what the price would have been without the trading in futures and what it ends up being after that trading, into the hands of those would be controllers.
 The comment I quoted above seems to me to be a correct evaluation of the ability, or more correctly the inability, of speculators to push up the price of oil and to reap the resulting higher profit. If that is so, again if, then those saying that speculators are raising the price of gas at the pump are wrong. If they are spreading a meme that is wrong it is either from making an incorrect analysis or from believing an incorrect analysis and passing it on. A third possibility/likelihood is that it is deliberate misdirection [at some level] to cast blame on a financial tool, futures trading, which has a vital purpose, and so will not be done away with, but also allows gamblers to predict what is going to happen with the price of a commodity and profit by those other gamblers who predicted incorrectly. Futures trading is said to be a zero sum game, nobody makes a nickel in that game that somebody else didn't lose in the game. The only sure profit is made by the bookie/brokers who take their rake of every pot.
 If anyone can pick this comment to pieces and show me how it is, or even could be, wrong, then I honestly hope they will do so [and ideally with an explanation clear enough for my simple mind] because in every case possible I would like to know who the real bad guys are and who the bogeymen are.

Markey Report: Big Five Oil Companies Approach $1 Trillion in Profits for the Decade, Yet Still Rely on 100 Year-Old Subsidies to Sell $100 Oil

http://democrats.naturalresources.house.gov/press-release/big-five-oil-companies-approach-1-trillion-profits-decade-yet-still-rely-100-year-old

but also allows gamblers to predict what is going to happen with the price of a commodity and profit by those other gamblers who predicted incorrectly.

Where do you suppose these oil companies are placing their profits?

The only sure profit is made by the bookie/brokers who take their rake of every pot.

They are the bookie and the Gambler, who can positively predict what is going to happen..  

A sucker born every minute? WE the People are being played, dont you just love the Capitalistic Free market?

Debs proved how they can manipulate the market.

Generally the articles I've read agrees with your take, such as these Econbrowser articles:

May 17, 2008 http://www.econbrowser.com/archives/2008/05/oil_bubble.html
Aug 21, 2008 http://www.econbrowser.com/archives/2008/08/more_speculatio_1.html
May 11, 2011 http://www.econbrowser.com/archives/2011/05/oil_prices_and_2.html

but even though Hamilton thought supply and demand governed, he gradually accepted that speculation had had some effect.

Donal, I initially missed this response and then it took me a while to get to the links you provided and to give them a read. Thanks.

As I read it, supply and demand do govern in the long term, but when there was a rush of inexperienced traders looking towards commodities as a safe haven it was easy enough for large traders to play around with prices and fleece them in the short term.

I agree with what you say here but your comment does not make a distinction  that clarifies where the fleeced money comes from and who that money goes to. If, as we both suspect/believe, the smart players can fleece the inexperienced players, that fleeceing does not necessarily affect the delivered price of a barrel of oil one bit.
 To try to summarize my position: Speculators do affect price movements in the futures market. Some might be able to deliberately cause moves in one direction or the other [Since they can get rich either going long or short, maybe they push that market down] and thereby fleece other players through manipulation. The important distinction though is that this is a side game among players separate from the oil industry itself and which has miniscule affect, if any, on the delivered price of oil, and so it is a mistake to blame rising prices at the pump on speculation within the futures market. I am not saying that you have done that, but Beetlejuice, who I first responded to, did.

I'm guessing that the futures market eventually develops a panicky momentum that can affect otherwise careful buyers. For example, airlines routinely hire speculators to lock in prices as a hedge against price increases. If they lock in at higher prices, can they back out without taking a loss? I don't know the market that well, but it seems to me that while someone will profit from the difference when the barrel is delivered at a much lower price than the locked-in future price, it might not be the buyer.

In this case you are confusing the practise of "hedging", which is the legitimate purpose of the market, with "speculating", which is just made possible by the market.

Congress and the CFTC also lumped those hedge buyers in with speculators when they were proposing methods, like reinstating the uptick rule, to limit speculation. But in any case, I don't see how being a hedger or speculator changes the scenario whereby someone agrees to a high futures price, then still has to pay more when the delivered price is much lower.

Suppose you agreed to pay me $50 to fill your gas tank next week, but now the price is lower elsewhere. You can go elsewhere, pay $40 and save money. I don't think it works that way on the futures market. As I understand it, you have to cancel out your futures purchase by taking an opposite position, or actually accept delivery. Maybe I'm missing something, but it seems to me that even though on paper the delivered fuel is cheaper, someone is paying the (inflated) futures price for it, whether by accepting delivery or through margin calls.

Latest Comments