Thursday, April 28, 2011

Good Question About Oil Traders


WSJ -- At Mr. Obama's request, the Justice Department announced Thursday that it has created a task force to investigate the oil and gas markets, a move some Democrats in Congress have advocated. "The attorney general is putting together a team whose job it is to root out any cases of fraud or manipulation in the oil markets that might affect gas prices, and that includes the role of traders and speculators," Mr. Obama said during a town hall event at a renewable energy company in Nevada. "We're going to make sure that nobody's taking advantage of American consumers for their own short-term gains."

WSJ Letter to the Editor from John Malgar -- "The challenge for investigators isn't proving that traders drove up oil prices. The real puzzle is, why did these public enemies suddenly have a change of heart during 2008 and drive prices down?"  

See chart above showing gas prices falling from $4.12 per gallon to $1.61 in 2008.

27 Comments:

At 4/28/2011 1:37 PM, Blogger morganovich said...

oil is mostly traded with futures. how can speculators keep such prices high? it's impossible.

futures have physical delivery. you have to sell before expiry or they send you the oil, which is quite expensive to store.

so what do you, evil speculator, do when the may contract is coming due?

if you all sell, the price will drop. if you don't, you have to take the oil. this whole premise that the price is being kept high by "speculation" is ridiculous.

to do so, you'd have to keep oil off the market. so where is it all?

you might see very short speculative surges, but not for more than a month or two.

 
At 4/28/2011 1:56 PM, Blogger VangelV said...

...why did these public enemies suddenly have a change of heart during 2008 and drive prices down?

As we all know, there was no change of heart. The danger of a supply disruption vaporized as the economy collapsed. The futures bets had to be liquidated by the longs and when there were no buyers stepping up to the plate the oil price collapsed.

Some smart people rented tankers, bought oil that they parked for a few months and sold at a much higher price. It was a riskless arbitrage play for those that knew how the system worked and they got rich as they should have because they stopped the decline on one end and capped the price increase on the other.

 
At 4/28/2011 2:13 PM, Blogger morganovich said...

how is sitting on a tanker full of oil riskless?

it seems like that strategy would have had a great deal of risk in the back half of 2008 unless you had already sold the oil in a futures contract.

storage has costs.

why would the market remain inefficient enough to allow the slope of contango to exceed the storage costs for any length of time?

it seems like a contango above storage rates would drive spot purchase (and thus price) for storage (driving up storage costs) and close the arb.

 
At 4/28/2011 2:15 PM, Blogger Ron H. said...

"It was a riskless arbitrage play for those that knew how the system worked and they got rich as they should have because they stopped the decline on one end and capped the price increase on the other."

It seems to me that this is exactly the effect of "speculators"; to smooth out volatility in the markets. We get early warning about price movements, thus avoiding violent swings both up and down.

They should be thanked for this, not cursed. Their rewards are well earned.

On the other hand, we seldom hear stories of the massive losses they incur when they are wrong.

 
At 4/28/2011 2:24 PM, Blogger juandos said...

"Some smart people rented tankers, bought oil that they parked for a few months and sold at a much higher price"...

That had to be at a phenomenally higher price especially since the Exxon Valdez incident...

 
At 4/28/2011 2:45 PM, Blogger Rufus II said...

Obama knows it's supply/demand driven. He's just taking the "speculation" argument off the table.

He's, also, cutting the anti-ethanol arguments off at the knees by making a big whoop-de-doo over Oil Subsidies.

 
At 4/28/2011 3:00 PM, Blogger Bobby Caygeon said...

what a bunch of know nothing demagoguing clowns we are saddled with as leaders. seriously, we are all doomed if the electorate can't see past this garbage (or more to the point, if the electorate has zero understanding).

won't investigate voter intimidation, will take legal recourse vs the states on immigration, won't defend DOMA (no matter if right or wrong), and will now go after "traders". seriously, who are these people?

 
At 4/28/2011 3:01 PM, Blogger Bobby Caygeon said...

This comment has been removed by the author.

 
At 4/28/2011 3:33 PM, Blogger juandos said...

"what a bunch of know nothing demagoguing clowns we are saddled with as leaders"...

Well bobby C I feel your pain...

If these folks at CNBC know what they're talking about (opinion piece) then we are in for a longer, uglier, and far more expensive hosing...

The Fed Will Make Sure Obama Wins in 2012: Strategist

 
At 4/28/2011 3:44 PM, Blogger Cash212 said...

The whole global economy is a leverage-driven speculative Ponzi of sorts- as long as the Fed keeps the punch bowl out the leverage will be rolled over and even increased. It certainly is The Bernanke.

 
At 4/28/2011 4:18 PM, Blogger Michael Hoff said...

Luckily for Obama, his teachers' union co-conspirators have been dumbing down the population long enough that millions of people will solidly believe he's on to something.

 
At 4/28/2011 4:30 PM, Blogger bix1951 said...

The sad thing is how this reveals either Obama's intellect or his disingenuousness.

 
At 4/28/2011 6:54 PM, Blogger VangelV said...

how is sitting on a tanker full of oil riskless?

Easy. The futures price was significantly higher and the tanker storage rates were low. Buy at a low price and add so many dollars per barrel. Sell a futures contract for a price that is 20% higher than your cost plus the interest and cost of storing the oil in the tanker. There is no risk involved.

it seems like that strategy would have had a great deal of risk in the back half of 2008 unless you had already sold the oil in a futures contract.

That is what happened. The near contract was much lower than the futures contract. People bought the contract and took delivery. They sold the futures contract. With financing costs being next to nothing because the bankers could see that there was no risk involved and the cost of storage being very low the profits were risk free.

 
At 4/28/2011 6:57 PM, Blogger VangelV said...

why would the market remain inefficient enough to allow the slope of contango to exceed the storage costs for any length of time?

It is called panic. When there are severe dislocations there are many opportunities for those with capital.

it seems like a contango above storage rates would drive spot purchase (and thus price) for storage (driving up storage costs) and close the arb.

That is what happened after a while. But the opportunity was there for some time for those that had the means and the knowledge to pull off the scheme. There were many articles on this at the time explaining how the process worked.

Here is one.

 
At 4/28/2011 6:58 PM, Blogger VangelV said...

They should be thanked for this, not cursed. Their rewards are well earned.

I agree. The speculators reduced volatility.

 
At 4/28/2011 7:00 PM, Blogger VangelV said...

The Fed Will Make Sure Obama Wins in 2012: Strategist

The hard asset investors will love it.

 
At 4/28/2011 9:26 PM, Blogger Doug Allen, CRM, CDIA+ said...

Let's open another investigation. The second investigation should focus on how our current foreign policy and economic policies (spending us to oblivion) contribute to a world environment where we are seen as week and ineffectual.

 
At 4/28/2011 11:01 PM, Blogger Bloggin' Brewskie said...

While people can complain about speculators driving up oil prices, the truth is they've created what's better known as a commonly recurring phenomenon which, although it can defy supply and demand fundamentals for some time, it ultimately can't defy supply and demand's gravitational effects indefinitely: a bubble. When US gas supplies are at an 18-year high, when you have the Saudis (who previously bumped up production in response to Libya's crisis) saying they're going to cut production because of ample supply, it teaches us a recurring theme throughout history: no bubble is permanently sustainable. It happened in '08, and when this bubble pops, oil will return to levels the market dictates.

 
At 4/29/2011 6:56 AM, Blogger VangelV said...

The second investigation should focus on how our current foreign policy and economic policies (spending us to oblivion) contribute to a world environment where we are seen as week and ineffectual.

You are weak and ineffectual. The great advantage that the US used to have is now squandered and real meaningful action is needed, not the fake debate between Ryan and Obama. Stop wasting money. Pull the troops back home. Start encouraging capital formation. Make it easier for those who work hard and take risks to keep the rewards provided to them by the competitive marketplace. Stop subsidizing losing companies in order to advance political goals. Start going back to being a Republic with a limited government rather than a Democracy where the Tyranny of the Mob rules.

 
At 4/29/2011 6:58 AM, Blogger VangelV said...

When US gas supplies are at an 18-year high, when you have the Saudis (who previously bumped up production in response to Libya's crisis) saying they're going to cut production because of ample supply, it teaches us a recurring theme throughout history: no bubble is permanently sustainable. It happened in '08, and when this bubble pops, oil will return to levels the market dictates.

First, the '08 crash in energy prices was triggered by a very real collapse in demand, not new supply. The supply problems are still with us.

Second, the Saudis can't get their production any higher. They will cut back not because they want to drive up prices but because they can't produce much more without permanently damaging their fields. All of those new rigs and new projects are designed to keep production from collapsing, not to increase it.

 
At 4/29/2011 9:30 AM, Blogger morganovich said...

vangel-

yes, i know you sometimes get short terms dislocations, but my point was they are never going to be durable over any even medium term period.

arbitrage is a part of any market, but its existence also drives the market toward efficiency.

this makes it unlikely that this sort of "speculation" is going to have much medium term effect on price.

to a certain extent, sitting on a tanker full of oil even if hedged by futures still has risk.

natural disasters, accidents, theft, and the like are still real issues, even if highly unlikely as are things like solvency. such issues are still risks, no?

 
At 4/29/2011 10:52 PM, Blogger Bloggin' Brewskie said...

VangeIV,

Nice to know you're still around. I was actually halfway looking forward to your grumbling. My one rebuttal to you will be a short, and simple one: one can't permanently escape supply and demand fundamentals forever; the '08 drive up was artificial, like this one, when there was adequate supply while demand was going down (which was occurring before the crash hit high gear). The real price for oil, at least I think, should be around the $70-$80 per barrel range.

You of course will want your rebuttal, and you'll have it. The gentlemen thing to do is to agree to disagree.

But since you're a pessimist, let's hit the smart bet made being made by smart people, such as Dr. Burry: the bet against the USD through gold, silver, commodities (including food), and betting on companies in emerging markets. You see, VangeIV, I used to think you were an obsessive loser who trolled in comments section because you had no life; but now, based on your investment decisions and your dour assessment of the US, I've come to respect many of your views, and enjoy the realistic discussion you bring to the table.

So VangeIV, go on, be stubborn, and don't change a thing to your formula: for while it's already made you rich, the doe ain't gonna stop rollin' in - not with the mental peons in America who work at Walmart who are obsessed with American Idol. The American Empire suffered a stroke in '08, and will spend a decade or more sliding down to purgatory; expect living standards for many Americans to decline 50%.

 
At 4/30/2011 7:59 AM, Blogger VangelV said...

Nice to know you're still around. I was actually halfway looking forward to your grumbling. My one rebuttal to you will be a short, and simple one: one can't permanently escape supply and demand fundamentals forever; the '08 drive up was artificial, like this one, when there was adequate supply while demand was going down (which was occurring before the crash hit high gear).

You may be right. The demand was artificial as central banks flooded the system with newly printed money and people thought nothing of buying large low mileage vehicles and paid the higher prices. But that demand was not sustainable because people who are technically broke cannot keep borrowing forever. Demand collapsed and took prices with them.

But what you expected to happen did not happen. There was no material supply response. Even though hundreds of billions were invested the total production of crude did not go materially above the 2005 peak. Total liquids only went up because of biofuel subsidies and the reclassification and counting of other liquids.

The real price for oil, at least I think, should be around the $70-$80 per barrel range.

There is no way to make any claim about what the price should be. If we get another collapse in the economy you could see oil hit a floor of $50 or even lower for a while. But if there is any problem with supply $250 is just as likely.

The fact is that we do not have any idea about the short term. What we have a much better idea about is the medium to intermediate term and on that front prices will be going higher.

 
At 4/30/2011 8:34 AM, Blogger VangelV said...

But since you're a pessimist, let's hit the smart bet made being made by smart people, such as Dr. Burry: the bet against the USD through gold, silver, commodities (including food), and betting on companies in emerging markets. You see, VangeIV, I used to think you were an obsessive loser who trolled in comments section because you had no life; but now, based on your investment decisions and your dour assessment of the US, I've come to respect many of your views, and enjoy the realistic discussion you bring to the table.

I am not a pessimist. I simply refuse to be naive and like to look at the facts. Unlike Mark, I do not accept the BLS reports without actually doing some digging and coming up with methodological comparisons. I do not accept what CERA or the EIA say without digging under the headline numbers and looking at what is material.

It is because I am a realist that I oppose the naive optimists who want to pretend that immaterial prospects are viable and will provide a solution. There is little doubt in my mind that a solution will appear. What I have a problem with is misallocating resources on white elephants.

 
At 4/30/2011 8:46 AM, Blogger VangelV said...

So VangeIV, go on, be stubborn, and don't change a thing to your formula: for while it's already made you rich, the doe ain't gonna stop rollin' in - not with the mental peons in America who work at Walmart who are obsessed with American Idol. The American Empire suffered a stroke in '08, and will spend a decade or more sliding down to purgatory; expect living standards for many Americans to decline 50%.

The 2008 crash was not the problem. It was the inevitable outcome of a century of government and central bank meddling. And I suggest that those who see the lower quartile individuals as the big victims need to reexamine the picture. If we get a hyperinflationary depression the biggest victims will be in the parasite class, who have been living off the taxpayer for a very long time. Imagine being a teacher when interest rates are double digits and inflation is raging. That pension just became worthless and that next pay is not going up fast enough to keep up with inflation. The working poor are already poor and have a standard of living that is manageable. They are used to dealing with hardships and crises. But that teacher who is married to a firefighter, lives a large home, and is driving a leased vehicle cannot deal with a crisis in the same way. As the NPV of the family pension plans vaporizes and real income collapses the family will have to make severe adjustments to its standard of living and will fall much faster and harder. And in an environment where skills have to be marketable the individuals who used to make a great living working for the government will find it incapable of competing in the free market.

Before I divert too far from the topic let me be very clear about what I am seeing. I think that Mark and the naive optimists do not see reality as it is. While the optimism will be vindicated eventually, there is a huge chasm between here and there. And when the dust clears most Americans may find themselves to be in the same boat as Britons after World War I.

 
At 4/30/2011 4:14 PM, Blogger Benjamin said...

Oh, I think the NYMEX or Brent exchanges can be gamed, and probably are. Thug oil-exporting nations have huge sovereign wealth funds. It would be in their national interest to game NYMEX prices higher. It is easy to cloak identities on the NYMEX.

A Russia could take both sides of trades and keep pushing prices higher. Short-term demand for oil is inelastic, so this works. Of course, a Putin would try to game prices higher. Why would he not game prices higher?

In the medium-term, oil supply outstrips demand, and you end up with oil tankers full, sitting idle in Malta and looking for some place to offload.

I'd say we are within a year of another oil price crack. $120 to $45 this time? Who knows. I doubt oil can be sustained above $100, although the fact that so much of the oil production of the world is in monkey-thug states is worrisome. Russia, Saudi Arabia, Nigeria, Mexico, Venezuela, Iran etc etc etc.

Still, each oil spike is another nail in the OPEC coffin. We are only about 10 years away from technologies that make oil what stones were to iron. The oil spikes hasten that process.

The future, in terms of energy, promises to be more prosperous and clean.

 
At 5/01/2011 9:13 PM, Blogger VangelV said...

yes, i know you sometimes get short terms dislocations, but my point was they are never going to be durable over any even medium term period.

arbitrage is a part of any market, but its existence also drives the market toward efficiency.

this makes it unlikely that this sort of "speculation" is going to have much medium term effect on price.


I am with you on the point that speculation can't do much to influence energy markets over the medium to long term. I merely pointed out that during dislocations the speculators could take advantage of the pricing differences to make easy money without taking any risk. By doing so they helped stabilize the market at both ends.

 

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