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June 13, 2009

Oil price speculation captures Maine senator's imagination

World oil production situation underlies "speculative" trading

This graph from Atrios shows that a commodity price will rise steeply if supply quantity cannot or DOES NOT rise beyond a certain point when aggregate demand wants to do so. It's economics 101. Read Atrios posts on this matter HERE and the recent follow-up HERE.

A Friday McClatchy story printed today in the Bangor Daily News today under a somewhat fawning headline, "Collins 'gets it,' taking on Street oil speculators," makes Senator Susan Collins out to be some sort of brilliant analyst and critic of oil markets.

Why a Maine GOP senator is taking on oil speculators
David Lightman and Kevin G. Hall | McClatchy Newspapers | Fri. June 12
WASHINGTON ? Oil prices shot past $72 a barrel this week, and a growing number of experts point to Wall Street speculators as a key reason why Americans are suddenly paying a lot more for oil and gasoline.

Although soaring oil prices threaten the fragile economic recovery, most Capitol Hill lawmakers have remained silent about them, but not Sen. Susan Collins. The Maine Republican pumps her own gas and heats her Bangor home with oil, and on trips home, she gets an earful from angry consumers, who, like her, blame speculators.

"Constituents get it," she said. "They don't see the reason for it. They don't see (supply) shortages. They don't see (the Organization of Petroleum Exporting Countries) greatly reducing production or other reasons prices are going up so much."

Collins has been one of the few on Capitol Hill and even fewer Republicans who blame the rising oil prices in part on Wall Street investors. She and her allies, mostly Democrats, are trying to limit speculative investments in oil and other commodities, but they say they need more support from President Barack Obama. [emphasis added]
Damn! Now I know! She's just like us at the gas pump! And she thinks just like us as we blame those dastardly traders for the gasoline and heating oil prices going through the roof. And later in the article, more on the "ordinary" Collins: "She returns home every weekend. Asked if she knows the current price, she quickly shot back, 'You bet I do!'"

Beyond the unnecessary stroking of Collins, I'm not going to disagree with the suggestion in the article that "investors" now are seeing opportunity in oil, given a situation where "a weaker dollar and bullish views on a global economic recovery are driving speculators back into the oil market, prompting a new wave of speculative investment from non-commercial traders ? those who don't actually use the product ? into contracts for future delivery of oil."

But I also believe the Collins analysis promoted by the article ignores the important underlying issue of world oil depletion, is basically wrong that mere financial speculation is the driver behind oil prices, and leaves key questions unanswered. According to a quote in the article, current oil prices are "divorced from the underlying fundamentals of weak demand, ample supply, and high inventories." True, due to economic meltdown, we have an oil market where potential supplies are well above present fundamental physical consumption. But why the divorce from reality? Why doesn't the market correct itself? Can "non-commercial" trades, as Collins believes, explain everything?

I'll answer the last question. No. While I believe that traders can amplify price swings, the fundamental situation is that due to depletion of a number of giant reserves worldwide, there is an upper limit on production capacity. Recently, the world has tested that upper limit, causing price to enter the "vertical" portion of the graph Atrios sketched.

Furthermore, because demand receded rapidly last year, the oil price quickly crashed down the vertical slope. Since then, oil producers have struggled to take enough supply off of the market in order to push prices back into that steep region. That's the real market force--intentional supply constraint. Even though the world seems to be "awash" in oil, it's a gap between supply and demand that developed more rapidly than supply withdrawal could compensate for the crash of the market last year.

Last January, 60 Minutes presented a flawed report on oil speculation that nevertheless presented some good insights on how "supply" has been managed by these "speculators." They concluded "speculation affected oil price swings more than supply and demand," which I believe is wrong. My belief is that the unstable supply and demand situation--swings between glut and near-shortage that have been going on for more than three decades now--enables speculation.

Did Speculation Fuel Oil Price Swings?
60 Minutes: Speculation Affected Oil Price Swings More Than Supply And Demand | Jan. 11, 2009
Morgan Stanley isn't an oil company in the traditional sense of the word - it doesn't own or control oil wells or refineries, or gas stations. But according to documents filed with the Securities and Exchange Commission, Morgan Stanley is a significant player in the wholesale market through various entities controlled by the corporation.

It not only buys and sells the physical product through subsidiaries and companies that it controls, Morgan Stanley has the capacity to store and hold 20 million barrels. For example, some storage tanks in New Haven, Conn. hold Morgan Stanley heating oil bound for homes in New England, where it controls nearly 15 percent of the market.

The Wall Street bank Goldman Sachs also has huge stakes in companies that own a refinery in Coffeyville, Kan., and control 43,000 miles of pipeline and more than 150 storage terminals.
These firms are smart. They are dealing commercially with the physical product. They are storing actual oil in order to keep it off the market and keep profits high.

So there is a game being played, as noted above, and by major suppliers like Saudi Arabia too. But Senator Collins does not explain it properly. The latest swing has been quite sharp again, this time in the upward direction. And again, "speculators" are cited as the cause. Perhaps it is time to remind ourselves about how Paul Krugman explained the basic flaw in this reasoning last year at this time when oil really was spiking (h/t Contrapositive):

The Politics of Speculation
Collins Watch | June 24, 2008
For some time now, Sen. Collins' most conspicuous and forceful response to the energy crisis has been to blame speculators for the run-up in gas prices. ... Here's Krugman on energy speculation:
A futures contract is a bet about the future price. It has no, zero, nada direct effect on the spot price...

Any effect on the spot market has to be indirect: someone who actually has oil to sell decides to sell a futures contract to Joe Shmoe, and holds oil off the market so he can honor that contract when it comes due; this is worth doing if the futures price is sufficiently above the current price to more than make up for the storage and interest costs.

As I've tried to point out, there just isn't any evidence from the inventory data that this is happening.
Collins made hay with this last year, as she signed on to the dreadful Republican Gingrich-McCain-Palin-Josh Tardy "drill baby drill" nonsense. There is a lot more on that in Maine Owl, HERE.

The future? Obviously I can't predict it. But right now I believe the oil markets will correct their divorce "from the underlying fundamentals" whether or not Senator Collins makes another show attacking "speculators." This story today from Canada (where there is a keen interest in the tar sands patch) outlines well the situation:

Rally in oil prices may be running on empty, but oh, what a ride!
From $33 to $73 a barrel: That's darned good mileage
Gary Lamphier | Edmonton Journal | June 13, 2009
Is the big rebound in oil prices nearly over? That's what some analysts are saying, after watching crude prices more than double since mid-February.

"No, we are not going wildly bearish on crude oil prices," insists Martin King, FirstEnergy Capital's commodity expert.

"At the moment, however, we see oil prices as having being stretched too much," he says, based on current market fundamentals.

"A move back to the low $60s to upper $50s would constitute a healthy correction for this market." ...

Oil stocks have also skyrocketed, with shares of Suncor, Canadian Natural Resources, Talisman, Nexen and others more than doubling from their 52-week lows. ... With millions of North Americans out of work, they're driving a lot less, and gasoline inventories are high. In the face of soft demand, refiners are curbing supplies. U. S. refiners are only running at about 86 per cent of capacity, which is extremely low for this time of year. Oil storage tanks remain full and floating (ship bound) inventories also remain high, despite slack demand. The market weakness is expected to persist for the foreseeable future.

Result: the Organization of Petroleum Exporting Countries(OPEC) has again slashed its global demand forecast, to 83.8 million barrels per day. That's down from more than 87 million bpd a year ago.

Meanwhile, despite all the apocalyptic talk about the implications of "peak oil," significant new oil supplies are coming onstream, notes King. ...

Total U. S. oil demand is currently about 18.2 million barrels a day, more than two million barrels a day below the levels of the past two years, he notes. ...
The idea here is that over-supply in a bad economy met with attempt to cut production and massive storage may run it's course. If that's true, prices will slide again. That's because the slope down the supply-demand curve is very steep in these conditions, not because a brilliant Senator Collins will have tamed the rogues.


You might enjoy KayinMaine. She's photoshop happy at times, gets it stunningly right on occasion despite semi-infantile diatribes...and despises Collins.Plus she has an active crew of commenters. White Noise Insanity

Posted by opit on June 16, 2009 at 02:03

Oh yes, I enjoy the White Noise from time to time. It's linked at right under "Maine." My shop is a little less raucous, more like a fern bar. Hardly anyone talks, they just come to enjoy the jazz.

Posted by The Owl on June 16, 2009 at 02:17

This geriatric hypocrite wasn't one of us when her mentor Billy Cohen was speculating in the Searport oil storage facility and she is certainly not one of us as a physical conservative. She covorts in Washington where she has assimalated with the rest of Maines delegation, she has become "from away" and couldn't care less about the "where fors" of those living way down east or for that matter anywhere else she is to preoccupied with lining her own pockets as she competes to beat the 9 million dollars of unearned income that oly snowe has acummulated during her parasitic tenure in D.C....

Posted by Willi on August 22, 2009 at 10:57

I'm just a little confused about the meaning of "geriatric hypocrite" and "physical conservative" (fiscal conservative?). That's an interesting remark on Bill Cohen and "the Sear[s]port oil storage facility." Have a solid citation for it? Also, not sure you have the right figure for Senator Snowe's "unearned income." Here's a reference that says she's the no. 20 wealthiest member of Congress, due mainly to *Jock's* assets:

Posted by The Owl on August 22, 2009 at 13:06
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