Why Oil Prices Will Tank

[TheNiche]

Civility, please!

I wasn't talking to you. I was talking to the apparent Lou Dobbs fan. And I'm giving him the benefit of the doubt with the sober remark.

In all seriousnes, the Telegraph article is the best of the ones you've listed. An "essential widget with complete patent protection" describes oil in this country pretty well.

My point in posting those articles was not to add content so much as it was to prove that there do in fact exist people that short oil.

[brerrabbit]

Okay, I know how oil futures settle and was a natural gas trader for over ten years. I like you Cotton did not believe that speculators were necessarily to blame for the price run up. Maybe there was a small bit attributable to them but I conceeded it was more due to increased demand, devaluation of the dollar and other factors. Bit then again I had my doubts. In August of 1997 I was director of the Midwest trading desk for a gas trading company that was a subsidiary of a Texas Utility. I was a fundementals kind of guy and poured over weekly AGA storage reports, demand, utlity burns, average temps by electrical producing regions and the like. Storage was at 99% full and the gas storage season runs until the end of October. Generation load was light as a lot of places were not that hot in 97. Every stinking fundemental I could find said the price should drop. I got short as did most of the traders in my shop along with managements approval. The Nymex gas prices went up. No problem someone short covering. They continued to go up for three weeks straight. By the time I stopped my bleeding I was $4 million in the hole. Amoung my companies traders I lost the least because I bailed earlier than the rest. An after the death autopsy revieled that a coupl of hedge funds with some deep pockets had chosen gas at that time and because the market was as thin as it was they were able to manipulate prices. It was revieled they got very long with most of their money and then threw just enough into the market each day after that slowy raising the prices. Not completely sure but rumor had it they walked away with several hundred million.

Now even after that I rationalized that it was because of the market being really thin and since then I figured there were to many players, to much liquidity and to much oversite for it to happen again. Then someone sends me this link.

http://rawstory.com/news/2008/McCain_aides...efend_0619.html

Now I worked for Enron from 1986 till 1993 and the one thing I can swear to about these guys were they were smart in a real sneaky sort of way. They knew the best way to make money was figure out the right angle and then get the right rules and regulations in place to make the scheme work. They were masters at lobbying and Ken Lay honestly did not know what was going on half the time because he was to damn busy smoozing the politicians. I actually sat in on a couple of the briefings they gave him prior to his trips to Washington. I was amazed because he took it all in and never once asked, "why do we want these rules". He just did what he was told.

So being an ex trader and still in the game albiet in a different role, I'm not quite sure that speculation ain't playing a significant role in this thing anymore.

[cottonmather0]

Okay, I know how oil futures settle and was a natural gas trader for over ten years. I like you Cotton did not believe that speculators were necessarily to blame for the price run up. Maybe there was a small bit attributable to them but I conceeded it was more due to increased demand, devaluation of the dollar and other factors. Bit then again I had my doubts. In August of 1997 I was director of the Midwest trading desk for a gas trading company that was a subsidiary of a Texas Utility. I was a fundementals kind of guy and poured over weekly AGA storage reports, demand, utlity burns, average temps by electrical producing regions and the like. Storage was at 99% full and the gas storage season runs until the end of October. Generation load was light as a lot of places were not that hot in 97. Every stinking fundemental I could find said the price should drop. I got short as did most of the traders in my shop along with managements approval. The Nymex gas prices went up. No problem someone short covering. They continued to go up for three weeks straight. By the time I stopped my bleeding I was $4 million in the hole. Amoung my companies traders I lost the least because I bailed earlier than the rest. An after the death autopsy revieled that a coupl of hedge funds with some deep pockets had chosen gas at that time and because the market was as thin as it was they were able to manipulate prices. It was revieled they got very long with most of their money and then threw just enough into the market each day after that slowy raising the prices. Not completely sure but rumor had it they walked away with several hundred million.

Now even after that I rationalized that it was because of the market being really thin and since then I figured there were to many players, to much liquidity and to much oversite for it to happen again. Then someone sends me this link.

http://rawstory.com/news/2008/McCain_aides...efend_0619.html

Now I worked for Enron from 1986 till 1993 and the one thing I can swear to about these guys were they were smart in a real sneaky sort of way. They knew the best way to make money was figure out the right angle and then get the right rules and regulations in place to make the scheme work. They were masters at lobbying and Ken Lay honestly did not know what was going on half the time because he was to damn busy smoozing the politicians. I actually sat in on a couple of the briefings they gave him prior to his trips to Washington. I was amazed because he took it all in and never once asked, "why do we want these rules". He just did what he was told.

So being an ex trader and still in the game albiet in a different role, I'm not quite sure that speculation ain't playing a significant role in this thing anymore.

OK, fair enough. Were you trading physical or financial gas? (I can't tell - you mention generation load but also that "Nymex kept going up") Where did the spot price (and the price the generators and electricity consumers paid) eventually settle in your busted year?

My point is that you can buy Buy BUY the forwards all you want, but the actual delivered price is ultimately whatever Exxon or Shell or BP or whoever is willing to pay when the tanker shows up (or what the NRG's of the world are willing to pay when they flip the switch) and if that spot price is lower than where I bought the forwards, it doesn't matter how many contracts I bought, I am going to lose money in the end (unless I sold it for a higher price to some other "speculator" and he's going to lose money instead). And they base the spot base price on what they think you and I are willing to pay for the refined product, regardless of the forward price. Period. So far, I'm not driving fewer miles and I don't know hardly anyone else who is either, and the nationwide data backs that up, so it only makes sense to assume that the refiners are paying up for the crude because they know that consumers are willing to pay for it.

All speculators do is make a bet on what Exxon's ultimate purchase price will be. That's it and that's all. And for everyone who's long crude, there has to be someone who's short (ie for every "speculator" who buys there is a "speculator" who sells). It's a zero sum game and you can't just manufacture contracts if you think the price is going up, you have to find someone who thinks the settlement price will be lower and is willing to go short. Ultimately, the only consumers and the only parties who actually set the price are you and me and Exxon - everyone else in the market is just making bets. That the futures price happens to be close to the eventual spot price just means that the futures market is efficient, it doesn't mean that they're setting the price.

Your example about Enron is illuminating - first off we need to note that a lot of the money Enron made wasn't "real" money, it was book earnings based on mark to market accounting. That's the whole reason Enron went bust - because the actual cash went dry. I don't know the specific numbers, but I do know that in the highly liquid commodity markets like natural gas and crude oil, Enron's profits were not all that remarkable compared to the rest of the players in the market. Enron's specialty was gaming the illiquid and inefficient markets like emissions credits (which I used to trade) and california electricity(which I also used to trade), where there were opportunities to monkey around with the accounting and the crazy regulations that were put in place by a completely ignorant California government . Anecdotally, (there's that word again) I have heard of Enron lawyers threatening to sue certain brokers into oblivion way back in 1999 if they went ahead with creating a published index for Sulfur Dioxide emissions allowances. Why? Because such an index would have undermined Enron's getting to use their own creative methodology for determining their portfolio value - because of the absence of such an index - under the accounting rules that were in place at the time.

Comparing Enron's gig to the crude oil market, however, isn't a very applicable example, because crude oil is so big and so liquid that it's very hard to game the accounting around it.

[cottonmather0]

http://rawstory.com/news/2008/McCain_aides...efend_0619.html

Ummm, what specifically is this "Enron Loophole". It's nice that this article blames it for a lot of different things, but specifically, what does it apply to? Is it saying that online futures exchanges like Enron Online (and subsequently, ICE) were exempted from regulatory oversight? I watched the Keith Olbermann piece and I think that's what he said. Nonetheless, what difference does it make? The ultimate spot settlement price doesn't change - all online exchanges do is increase liquidity by allowing traders to buy and sell financial contracts based on the underlying futures contracts, but even the Olbermann piece makes the jump that somehow speculation in financial forward markets distorts the physical spot settlement price. And even today, 99% of all physical delivery contracts - the price that matters to consumers - make reference to the Nymex settlement price, which IS regulated. So I'm kind of missing the point of this whole thing.

(BTW - any "news" item that uses the word "____ed" in the text kind of loses credibility as being unbiased.)

What Enron did in California in 2001 was certainly unethical, but it was the fault of the regulators in California for cobbling together an inefficient market - they decoupled the wholesale price from the retail price and expected utilities to eat the losses without disrupting service.

Crude oil, on the other hand, is worldwide and relatively free of artificial market constraints, so it's more liquid and very much unlike whatever happened in California back a few years ago.

I also need to say that I am leaving for a week's vacation tomorrow and won't have regular internet access so I'm checking out. Sorry.

Now I'm going to bed.

[brerrabbit]

Well I really don't feel like getting in a long back and forth on this one but can answer my own curiosities real easy. I traded paper (basis), Nymex, physical, and transportation when I traded. We were not nearly as segmented as you guys are today. My question to you is what do you trade, paper, physical, Nymex. I really need to know because your argument about zero sum game and the real price is the price Exxon agrees to sell it for tells me that you really don't have a clue how physical oil is sold, if you are seperating the exchange from physical. Up until three months ago I was buying upwards of 5 million barrels of oil every month and it was all driven by the exchange prices because thats how most of the oil coming in from overseas into the US is priced.

My question, what precisely do you do in this industry? Real answer, no BS. If your not comfortable writing it here them PM me with it. That one answer will tell me how much you really know about this stuff.

[RedScare]

The IEA is edging ever closer to adopting Peak Oil. And that liberal rag, the Wall Street Journal, appears to agree with them.

[TheNiche]

The IEA is edging ever closer to adopting Peak Oil.

Is it? The IEA doesn't seem to say that anywhere in its website.

New supply is being brought to the global market. See the IEA's chart, below.

The truth of the matter is probably that gross global production can continue to grow for any kind of forseeable time horizon, but that it will not keep pace with demand so as that production on a per capita basis peaks and declines in the near- and mid-term.

[RedScare]

Is it? The IEA doesn't seem to say that anywhere in its website.

Also from the IEA website.

[TheNiche]

Also from the IEA website.

Yes, I read through that, and I believe it to be supportive of my position, but not necessarily the Peak Oil theory. Actually, everything I've seen seems to support the idea that a shortage of oilfield equipment, energy infrastructure, and the long fuse of many large-scale oil projects are the predominant short-term supply constraints. Declining reserves are not an issue affecting the forseeable future. See quote from your link below:

Speaking at a press conference at the World Petroleum Congress, Mr. Tanaka emphasized that market fundamentals were the main underlying factor behind high oil prices.

[Subdude]

Oil passes $144, $145 Brent.

Bloomberg article

[RedScare]

Oil production may indeed be constrained by a shortage of pipe and equipment, but this is to be expected in a climate where the easily produced oil has been found and produced, leaving the deeper and more difficult oil to be produced. This IS indicative of Peak Oil, as is the fewer number of large scale projects that are taking so long to come online. While these factors may not "prove" Peak Oil, and I do not suggest that they do, they are in fact "consistent" with Peak Oil, as both the IEA and WSJ suggest.

I don't have to tell you that Peak Oil is not a milestone that is identifiable, such as $150 spot prices are. It is a gradual number of things that occur. The lagging production levels, as well as the rate of discovery not keeping pace with depletion are signs that it may be upon us, or at least nearby. Regardless the reason, there is little to suggest that the article that began this topic is accurate.

[TheNiche]

Oil production may indeed be constrained by a shortage of pipe and equipment, but this is to be expected in a climate where the easily produced oil has been found and produced, leaving the deeper and more difficult oil to be produced. This IS indicative of Peak Oil, as is the fewer number of large scale projects that are taking so long to come online. While these factors may not "prove" Peak Oil, and I do not suggest that they do, they are in fact "consistent" with Peak Oil, as both the IEA and WSJ suggest.

I don't have to tell you that Peak Oil is not a milestone that is identifiable, such as $150 spot prices are. It is a gradual number of things that occur. The lagging production levels, as well as the rate of discovery not keeping pace with depletion are signs that it may be upon us, or at least nearby. Regardless the reason, there is little to suggest that the article that began this topic is accurate.

Peak Oil holds that global oil production will begin to decline within the forseeable future, however that is not indicated by the IEA data.

Moreover, if you consider the history of oil production, it has been dominated by a backwardation trend with a few isolated incidences of contango. Even as the lowest-hanging fruit were picked from the vine at a reasonable cost, technology advanced at such a pace that picking the higher fruit as it became necessary was in fact less expensive in real terms than had been the lower fruit. Moreover, the notion that the world will deplete its oil reserves in an alarmingly few number of years is not a recent one; it has been propagated many times in the past and always been false.

A global economic growth spurt coupled with constraints on the supply side have once again placed us in contango. As I see it there are two likely resolutions in the forseeable future. Either technological advances substitute demand for oil with something else that costs less, thereby causing both the price and level of production of oil to fall dramatically--in which case Peak Oil is true but is only symptomatic of terrific outcome--or supply ramps up to meet and quite possibly exceed demand.

[CDeb]

the notion that the world will deplete its oil reserves in an alarmingly few number of years is not a recent one; it has been propagated many times in the past and always been false.

I remember my science textbook in sixth grade stating that we only had 20 years worth of oil left.

That was in 1989, so I guess next year is really going to blow.

[BryanS]

Even as the lowest-hanging fruit were picked from the vine at a reasonable cost, technology advanced at such a pace that picking the higher fruit as it became necessary was in fact less expensive in real terms than had been the lower fruit.

Eventually, your vine will have no fruit on it. If we're just over half-way up the vine, we've reached peak oil. Others, who don't believe in peak oil, simply believe the vine keeps growing, bearing more fruit, which it doesn't. Or so it seems.

We won't know if we've hit peak oil - until we've past it. Based on everything that is happening, today... It makes you really wonder... Maybe we have arrived.

I remember my science textbook in sixth grade stating that we only had 20 years worth of oil left.

That was in 1989, so I guess next year is really going to blow.

Hmmm... Maybe. I read that the Saudis are going to drill and pump oil out of their last known large reserve, and they are trying desperately to get oil out of the ground by next summer. Their last known large reserve...

[RedScare]

Trying to get Niche to say peak oil is like getting George Bush to say recession. They'll say the exact same thing as you, reason it the same way as you, but call it a different word, just so that they do not have to say the word you are thinking.

Oil production has been flat since 2005. There has been an increase this year, but it will be interesting to see if it lasts all year. There are many experts who do not believe the Saudis can do what they claim. We'll see.

[Mark F. Barnes]

Trying to get Niche to say peak oil is like getting George Bush to say recession. They'll say the exact same thing as you, reason it the same way as you, but call it a different word, just so that they do not have to say the word you are thinking.

Oil production has been flat since 2005. There has been an increase this year, but it will be interesting to see if it lasts all year. There are many experts who do not believe the Saudis can do what they claim. We'll see.

And not only that, let's say they can increase their production for arguments sake, pumping it is the easy part, the idea of increasing and ramping up the logistics once it's out of the ground it nightmarish to say the least. Logistics are stretched very thin already, storage tanks are rimmed up, pipelines are at full tilt presently, what are they going to do, dig up Barbara Eden and have her blink it over to the refineries? The numerous factions involved boggle the unknowing. We cannot presently keep up with the gluttonous rate at which we are using the stuff, and it has nothing to do with how much oil is in the ground. Keep your eye on the ball people, there's no shortage of oil, there is an over extended production chain, that has been hindered over the years by more and more regulations and restricted on availability of places to expand, and that has finally come full circle and it is now biting society in the ___POCKET.

[memebag]

My problem with "peak oil" is that it seems to assume we discover oil in a predictable way. In reality, we could stop discovering new sources for 1000 years, then discover vast supplies. We won't know we're out until long after we're out, and even then we can't be sure.

[BryanS]

And not only that, let's say they can increase their production for arguments sake, pumping it is the easy part, the idea of increasing and ramping up the logistics once it's out of the ground it nightmarish to say the least. Logistics are stretched very thin already, storage tanks are rimmed up, pipelines are at full tilt presently, what are they going to do, dig up Barbara Eden and have her blink it over to the refineries? The numerous factions involved boggle the unknowing. We cannot presently keep up with the gluttonous rate at which we are using the stuff, and it has nothing to do with how much oil is in the ground. Keep your eye on the ball people, there's no shortage of oil, there is an over extended production chain, that has been hindered over the years by more and more regulations and restricted on availability of places to expand, and that has finally come full circle and it is now biting society in the ___POCKET.

She's not dead yet! She's still alive!

http://www.tmz.com/2008/06/13/jeannie-in-a-bottle/

Whoa! ... maybe the walking dead... Anyway...

[Subdude]

If you don't believe that oil is a bubble that could burst at any time, look at some coal indices.

Coal prices fell as traders speculated that a rally in the past month pushed prices too high

Coal for delivery to Amsterdam, Rotterdam or Antwerp with settlement next year dropped $27.50, or 13 percent, to $190 a metric ton in London, according to ICAP Plc prices supplied to Bloomberg. Coal jumped 36 percent from June 2 to yesterday's close.

Link

Until this week coal had been tracking up as much as oil and gas. I'm no expert, but my spidey sense still says oil will have a huge drop at some point. "Trees don't grow to the sky" as Keynes said.

[TJones]

This might eleviate prices a little ?

http://news.yahoo.com/s/ap/20080705/ap_on_...ing_off_florida

[RedScare]

I don't think that article is as helpful to your argument as you think. The very first sentence outlines the problem with all of the offshore drilling. It can be cost prohibitive. Now that oil prices are high, it may make it worth the cost. But, if prices drop, they will not drill, just as most of the Gulf is not being drilled.

[plumber2]

Can someone explain again why we need speculators in the oil market? Do we really need oil traded like a cheap stock? Does it really bring market stability to add this layer of money skimming? And why is there no government regulation of this activity? Did Phil Graham really have that good of an idea to let oil traders loose on the commodilty market without any supervision? Why not let our pension fund managers go to Las Vegas with our 401k's and play the slots, sounds just as reasonable.

I really don't expect anyone to answer these questions, but feel free to give it a try.

[BryanS]

Can someone explain again why we need speculators in the oil market? Do we really need oil traded like a cheap stock? Does it really bring market stability to add this layer of money skimming? And why is there no government regulation of this activity? Did Phil Graham really have that good of an idea to let oil traders loose on the commodilty market without any supervision? Why not let our pension fund managers go to Las Vegas with our 401k's and play the slots, sounds just as reasonable.

I really don't expect anyone to answer these questions, but feel free to give it a try.

I don't get it either... Post 154, 155... perhaps they can explain it to us...

[TJones]

I don't think that article is as helpful to your argument as you think. The very first sentence outlines the problem with all of the offshore drilling. It can be cost prohibitive. Now that oil prices are high, it may make it worth the cost. But, if prices drop, they will not drill, just as most of the Gulf is not being drilled.

Once they are tapped in, they are tapped in. I agree that where they want to drill takes alot of pipe and possible man hours to get to the depth they need to find the oil. I am wondering though just how close or far away the oil is from the surface of the ocean floor ?

[Subdude]

Can someone explain again why we need speculators in the oil market? Do we really need oil traded like a cheap stock? Does it really bring market stability to add this layer of money skimming? And why is there no government regulation of this activity? Did Phil Graham really have that good of an idea to let oil traders loose on the commodilty market without any supervision? Why not let our pension fund managers go to Las Vegas with our 401k's and play the slots, sounds just as reasonable.

I really don't expect anyone to answer these questions, but feel free to give it a try.

It isn't that we need speculators, but they don't seem to hurt anything. The main reason is that they don't take physical delivery, so they don't affect supply and demand. The Economist has a brief article about it this week, which you can read right here.

Does it really bring market stability to add this layer of money skimming?

In a sense yes, it does. The availability of exchange-traded forwards and options allows companies to safely and inexpensively hedge their fuel costs. Consumers don't necessarily see the same volatility in prices because intermediaries (airlines, utilities, etc.) frequently rely on "speculators" (markets) to lock in fuel costs.

I still believe that all this outcry over speculators is just posturing by politicians looking for an easy villain to blame, to avoid having to face up to unpleasant truths.

[RedScare]

I still believe that all this outcry over speculators is just posturing by politicians looking for an easy villain to blame, to avoid having to face up to unpleasant truths.

You mean, like the unpleasant truth that their whining and crying constituents are the cause of the problem? I have to admit, reading all of these "solutions" to the oil crisis, such as opening ANWR and the coasts to drilling, are fun to read, but it will not lower the price of gas. The three biggest causes of high priced oil are overwhelming increases in consumption, the weak US dollar and instability in the Middle East. And, the US consumer and the US government has been a major factor in all three. Whine all you want, but as long as you support politicians who pander to your wasteful habits, obliterate the dollar, and destabilize the Middle East then you will continue to pay through the nose. And because Americans are all about style over substance, it will continue.

Have a nice summer.

[TJones]

The three biggest causes of high priced oil are overwhelming increases in consumption, the weak US dollar and instability in the Middle East.

So, if we eliminate just ONE out of the three problems, do you think we would decrease the price of oil by a third ?

[BryanS]

In a sense yes, it does. The availability of exchange-traded forwards and options allows companies to safely and inexpensively hedge their fuel costs. Consumers don't necessarily see the same volatility in prices because intermediaries (airlines, utilities, etc.) frequently rely on "speculators" (markets) to lock in fuel costs.

Those seem like valid intermediaries, to me. Airlines, utilities, etc...

But what about greedy hedge funds?

What about all the non-consumer, non-producer intermediaries - who cannot actually do anything with the underlying product?

I read that 70% of oil futures contracts are owned/traded among non-producers, non-consumers of the underlying commodity. How is that helping things? Companies, like Southwest who use fuel hedges, to the envy of all other airlines, is a legitimate use of this method... No argument there. What about the other 70%?

Also

[memebag]

So, if we eliminate just ONE out of the three problems, do you think we would decrease the price of oil by a third ?

If you don't eliminate the demand, no.

[RedScare]

There's light at the end of the tunnel!!!!

Drilling ANWR would reduce oil prices by $1.44.

But the U.S. Energy Information Administration, an independent statistical agency within the Department of Energy, concluded that new oil from ANWR would lower the world price of oil by no more than $1.44 per barrel