Oil, the Dollar, and Speculation

Here I was, with a nice polite post set to print, when I read the related links to this article at Naked Capitalism. And what do they all say? "Oil is surging because the dollar is tanking."

So excuse me, but I have to toss the politeness out the window and shout, "IT'S NOT THE DOLLAR, STUPID!!!" Here's a graph from Worthwhile Canadian Initiative including a variety of currencies, just against Oil:

OK, smartypants, if it's all about the dollar, then why is the price of Oil surging in EVERY CURRENCY??? And don't give me that "Peak Oil" cr**....

Last time I checked, we hadn't also arrived at Peak Copper, Peak Lumber, and and Peak Pigs. Which brings me to Exhibit 2: below is a graph from Yahoo finance, comparing appreciation in the Euro vs. the dollar (in blue) vs. appreciation in energy commodities (in red):

If it were all about the dollar, the two lines in the graph above ought to stay together (commodities shouldn't be rising more than the Euro). But they're not. While the Euro has appreciated about 10% against the dollar, energy commodities have appreciated 30% in the same time. In other words, even though the Euro has nowhere near the structural external debt problems that the dollar has, the price of commodities are surging in Euro terms too.

So let's be clear: (1) it's not just Oil, and (2) it's not just the Dollar. Every commodity is surging in price vs. every currency. Stuff is beating paper.

You may recall I've dubbed the EIA statistics on gasoline demand the "graph of the year." Here's the update:

For the graph-impaired, this shows that with the exception of the week of Memorial Day, demand is lower than it was a year ago, which in turn was lower than it was two years ago.

In other words, energy prices are surging for no apparent fundamental reason. All of a sudden June 2009 feels like June 2008. Here we are, a year later, noticing the exact same thing: the price of Oil is surging,from $48 to $68 in just the last 40 days (the percentage equivalent of going from $96 to $136 last spring).

OK, now I will revert to politeness....

Prof. James Hamilton of Econbrowser has written, in Supply, Demand, and the Price of Oil that:

Whatever recent developments in Asia may mean for the future, there is a physical product being produced and consumed in the here and now at a price that Friday moved above $66/barrel. If that price is such that the current quantity produced exceeds the current quantity demanded, it would have to show up as an addition to storage, either as inventory build-up, or, as Dave Cohen emphasizes, held in tankers at sea. ... The fact that inventories were significantly below average in the first half of 2008 is one of the indicators to me that you can't attribute the whole run-up at the time to speculation.

By contrast, so far this year inventories have been well above average. Futures prices had exceeded spot prices by enough until recently that there was a risk-free profit to be had from buying at spot, storing the product physically, and hedging by selling futures. Had it not been for the added demand for oil coming from inventory accumulation, the price would have fallen further. Nevertheless, it is interesting that U.S. inventories have been coming down significantly during May, the same month when oil prices started to rise significantly, although inventory levels remain above average.

Prof. Hamilton seems to believe that, this time around, it really is speculation, not true demand. But if that is so, we ought to be able to recycle Prof. Paul Krugman's rejoinder from a year ago: where's the hoarding? Last year, it turned out there was "Hoarding in Plain Sight" in the form of US and especially Chinese oil reserves. When China stopped adding to its reserves before the Olympics, the price of Oil broke.

The aforesaid Dave Cohen alluded to by Prof. Hamilton notes a Bloomberg article from May 5 as follows:

BP Plc, Royal Dutch Shell Plc and Hess Corp. are among oil companies whose first-quarter earnings were boosted by storing crude in tankers. ....

Traders are storing 100 million barrels of oil at sea, enough to supply Europe for five days, Frontline Ltd., the world’s largest supertanker operator, said April 23. Provided they can secure storage and financing for less than the difference between near-term and future prices, they can lock in a profit by buying prompt oil and selling it forward.

Cohen believes that

In the meantime, the main beneficiaries are investment banks taking the opposite side of the trade to their customers....

In effect, retail investors and pension funds are paying the bills for the record quantity of crude oil being stored in tank farms around the world and in vessels offshore, via the losses they make when they roll their positions forward every month.

This appears to confirm that there is hoarding going on. There is a tremendous speculative boom again in commodities, and it will just as surely bust. On that score, Frontline's latest weekly report from May 29 notes that "In the Atlantic, VL rates are flat as well, but tonnage availability is on the rise as floating storage vessels return to trading." How high prices will get before the bust, I can't say. Except just as I did last year, I will say that the longer Oil prices go above $80, the deeper the pain to American consumers, and the bigger the hit the economy will take.

Meta: 

Comments

It is speculation.

Speculation that world economy is improving but when it comes to the oil market some thing about "too much of a good thing" comes to mind.

The market is anticipating increased demand from improved economic conditions - it is not the dollar. We can't blame the dollar for everything.

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'zackly

The market is anticipating increased demand from improved economic conditions.

As Sterling Newberry pointed out, no one knows exactly how the anticipated economic "recovery" will play out, but everyone knows it will involve burning more oil. So, since there are no other decent-looking investment "opportunities", idle money (and there is what, $2 trillion to $3 trillion or more that was "injected" these past nine months) is being parked in plays on oil, and other commodities.

This is speculation, but to be entirely accurate, I believe, we should recognize it as rent-seeking behavior. As such, it is a horrible mis-allocation of capital - and mis-allocation of capital into speculation, usury, and rent-seeking behavior is exactly THE problem of the past three decades that we need to solve. 

NFC Capex from Equity Markets

What is that the French say? The more things change the more they remain the same. Sigh. . . . .

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revisiting oil speculation

I want to alert people more to NDD's older post on the argument that somewhere oil futures contracts must have supply associated with them and therefore we must have supply somewhere.

Hoarding in Plain Sight: did Strategic Oil Reserves trigger Oil's Parabolic Move?.

This is where NDD concludes it was the strategic oil reserves where the excess supply was hidden.

Now, that said, I'm reposting the same comment I had in NDD's post:

One thing Krugman said was that Congress finds witnesses to testify before Congress to tell them what they want to hear. Well, that might be true in terms of who they invite but I sincerely doubt experts put their reputation on the line to go before Congress and simply lie (unless they are a corporate lobbyist, then they sure do!)

From the House Subcommittee on Oversight and Investigations they held a hearing, Energy Speculation: Is Greater Regulation Necessary to Stop Price Manipulation? – Part II.

I found in Mr. Fadel Gheit's, Oppenheimer Oil analyst, testimony he addresses these other causes point by point. For example, he says the weak dollar is attributable to about a $10-$15 increase in a barrel of oil. He goes through India/China increased demand, speculators in his analysis.

Then, I hesitate to comment on this part, because I haven't even traded commodity futures, let alone understand this market, but he points out the massive increase in volume of futures trading. Myself, I don't see the correlation to say a tech stock bubble in a company versus their actual product prices increasing for the company is not a physical commodity per say. I also don't see how playing the futures trading game requires someone to hold inventories. I know that's a physical commodity so maybe there is something I'm missing here on oil, but I don't see how the two must follow considering all of the futures trading vehicles. I'll let someone else answer this one but it seems that there are multiple layers of abstractions with all of the methods to trade commodities to separate out the physical commodity from the actual price points out there. To me it's like water in a global oil based economy and when you must have something, you'll be willing to pay anything for it, esp. if a cartel like situation is creating an extortion fee to get it. But does that follow that one must have massive inventories built up somewhere?

Inventories:

Back to the hearing and other reports:

Oil.com analysis paper by Lehman Brothers, has actual supply and demand numbers at the bottom (last page) and they seem fairly inline with each other with certain points supply exceeding demand (a few where demand exceeded supply too). From the title of their analysis, you can see what they think this is, a speculative bubble.

Masters testimony requests a hording investigation, due to referencing a report which he summarizes:

It has come to my attention that some Wall Street Banks are offering commodity swaps based on actual physical commodities

I must recommend this hearing testimony. I've been reading it and there are arguments for all elements in this debacle. Prof. Greenburger, Center for Health and Homeland Security, is the one who lays out the most detailed legislation and policy fixes. I sure don't think they just went and "said" what "Congress wanted to hear", each witness presents some in depth analysis and when you look at all of the commodities futures trading graphs, from almost every witness, it brings home the argument on speculation driving up prices.

I have a side comment, perhaps Krugman, an economist, who lives in the real Supply/Demand world just isn't in tune with fictional money world of wall street complex investment vehicles? Krugman is one intellectual powerhouse, (plus a blogging fool!), but I notice that those debating the causes on oil price spikes on the blogs, well, I'm not seeing too much awareness on all of these new credit swaps and other investment techniques in commodity futures trading. I for one have little clue on all of it, maybe that's the overall case here?

Now that a tad of oil prices was attributed to dollar deflation in this testimony. So CreditWritedowns (who is the guest poster on Naked Capitalism) isn't coming from outer space in his post, to me he more attributed way too much cause and effect to dollar devaluation, it's not the primary cause.

But, considering the above congressional testimony from last summer and that hedge funds at the same time started getting margin calls, running out of funds due to subprime, it is possible they had to liquidate their commodity speculative positions to deal with the impeding subprime/financial crisis...

which would imply that speculation and market manipulate by very large institutional investors...without some supply hidden somewhere, is still possible.

Where I thought that was possible (to not have real inventories associated with a price bubble) was with derivatives, i.e. default swaps and other new trading vehicles on commodities.

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Intentional punishment of consumers

quite possibly endorsed by public officials who recieved campaign donations in the 2008 election cycle from banks involved in energy trading.

http://houseofexile.blogspot.com/2009/06/protect-your-neck-punishing-ame...

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And we have cap and Trade

waiting in the wings. Think I'll start cutting down some trees to heat the old home. Oh but wait...I think there is some local law against it. darn.

In my State electric rate regulation ends around the same time that they want cap and trade to be cook'in. Ouch!

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