Holy Crap! You Mean There Really Was Overspeculation On Oil?
If you’re one of the many (let’s face it, everyone) whose eyes have been glued to the recent price of oil you might be a little confounded as to why there has been a recent $14 drop in prices barring some kind of energy intervention. Economists were a little confounded too, as there were a number of favorable developments in the world of oil recently, the drop could not be explained by any single, or combination of, events. Despite many economists’ charge that oil speculation didn’t “do that much” to oil prices they now are beginning to fess up to the fact it may have been a significant part of the cause…
Did the collapse of a little-known private oil-marketing firm, SemGroup, play a roll in oil’s 14% price drop over the past 10 days? The Wall Street Journal thinks it might have:
The Tulsa, Okla., company filed for Chapter 11 bankruptcy protection Tuesday, citing among other financial woes a loss of at least $2.4 billion in crude-oil futures. Changes in its hedging strategies coincided with big moves in oil recently.
The company had taken out short positions, or bets that crude prices would fall, as a hedging strategy for oil it intended to move through a subsidiary’s pipelines and sell to refiners, according to an affidavit filed in Delaware bankruptcy court by Terrence Ronan, SemGroup’s senior vice president, finance.
Then, when oil prices rose, SemGroup moved to “cover” its short positions by taking out equivalent long positions, or bets that oil prices would rise.
Eventually, SemGroup was unable to put up collateral for its swelling bets and sold its futures account to Barclays Capital on July 16, according to the affidavit…
One theory making the rounds in the market is that as SemGroup’s long positions snowballed, so did the oil rally. SemGroup’s rapid exit from the market removed a force for upward momentum when the market, under siege from negative U.S. economic indicators, needed it most.
“In the three days surrounding that transfer” to Barclays, crude futures “plunged $15.89…thus, with SemGroup removed from the market, crude oil has been free to fall,” wrote Stephen Schork, editor of the Schork Report, a newsletter tracking the oil market.
The linkage isn’t entirely clear. Some traders note that SemGroup’s activity dried up well before July 16, and there is no indication of what Barclays did with SemGroup’s positions once it took control.
Now that SemGroup is toast, we’ll know in the next couple of weeks.
Now don’t that warm your heart?
-Marc-
Not meaning to brag or anything Marcus, but I called the bottom dropping out of the oil market before the experts did…like two weeks ago today.
If I hadn’t returned to being the poor college student, I could have made a few nickels.
However, SemGroup (which unfortunately I have a few friends that work there) was in trouble even before the oil bubble according to my buddies. They had overextended themselves by a wide margin the last two years. Foolish, but it seems to be a common trend in these fast growing private firms.
P.S. – I will forewarn your audience in case any of you lefties are ready for a break at the pump. Even if oil goes down to $80 a barrel, it will take a significant amout of time before you begin seeing it at the rack. And it will have nothing to do with big oil ripping you off.
Gasoline margins/wholesale margins have been squeezed for at least the last four months – the substantial earnings reported over the last two years were due to the sale of reserves on the open market.
You’ll get a break but not a big one.
I do Tex, Remember that conversation and I generally agreed with you at the time, though not on offshore drilling aspects of it.
Also, yes I am sadly aware that gas prices won’t drop sometime. Even though prices on oil have been receding Alabama’s gas broke $4.00 in the rural areas for the first.
I have a camry and a 15 minute commute so it doesn’t bother me much but everyone here with dualies and v-8’s feeling the pinch.
Not that I pity most of them.
The problem lies in this fact. 20-30% of the people in china and india, the worlds biggest markets, own cars. Thus as those nations industrialize the demand for oil increases. We in america have around 70% car ownership. That means as china and india near our level of industrialization the demand will increase drastically. Even a simple 5% increase in demand in those markets would be significant enough to propel oil to new record highs. Oil is a product dealt on the world market, not a local economy.
Off Topic,
Your name suits you. Yes, I agree that Chinese and Indian demand is the biggest factor in Oil prices. However, a $14 drop in prices while Indian and Chinese demand increases doesn’t make much sense unless you account for speculation of some sort.
The truth is the rate of oil price increase has far outstripped the increased demand coming from China and India. What has happened is oil speculators, speculating continually rising prices, drove the market up. Now that they see the U.S. and europe are serious about alternative energy and most noticeably, that Chinese demand rose at half the rate of what was predicted you see a huge drop in prices.
As you can see, none of this has to do with actual supply and demand, just the ill begotten predictions of numerous speculators.
IT WAS OBVIOUSLY PRESIDENT BUSH’S LIFTING THE EXECUTIVE ORDER BARRING OFF SHORE OIL DRILLING
I’m not entirely sure why it’s all caps, whether that was to denote sarcasm or just overemphasizing your point but either way, i’ll address it.
The executive ban being lifted did nothing. nada. No one can now drill or explore as a result, even Bush said it was symbolic, so then why (and I don’t ask this question necessarily just of you but anyone who shares this sentiment) would it effect the market at all?
Marc,
so then why (and I don’t ask this question necessarily just of you but anyone who shares this sentiment) would it effect the market at all?
Surely you jest? For the same reason when Bernanke makes a statement about inflation and the stock market swings 200 points.
I got news for you doubters. The drop in price of crude had everything to do with the threat of domestic drilling. Now that may only last a short time but the fact is speculation is based on just that – speculation of future events. And since the U.S. consumes 25% of the world crude, as the U.S. moves, so does the market.
I don’t think short term India and China have near the clout you guys are speaking. I believe that is based on a false premise. While I agree they make up 1/3 of the world’s population, they are still several years away from challenging us in production. If it wasn’t for government subsidies, the average consumer in both places couldn’t afford to drive.
I’m not saying it won’t happen – but not yet.
If I were you lefties, I’d be a whole lot more worried about Medicare and Medicaid remaining solvent.
All the research I have done on this topic says that oil speculators cannot play a part in the long-term pricing of oil because they don’t actually take possession of the physical product and hoard it.
I only play around with economics, so I am hesitant to say much without knowing. But it seems there is a time limit that goes along with commodity speculation. And when the time limit expires, the commodity must either be physically recieved or the future sold. Since they don’t recieve the oil, selling the future is like putting oil on the market.
At least that is how I understand it.
I would add that if commodity speculation had as much to do with pricing as basic supply and demand then the oil spill effecting shipping on the Mississippi River, a hurricane coming through the Gulf and hitting Texas, and Iran’s beefed up rhetoric of closing the Straight of Hormuz if attacked would cause an increase in speculation (and prices), not the major decrease we’ve seen. In my opinion, anyway.
To Tex and Pill,
I never intended on giving the impression that speculation was the sole cause of price inflation just A cause.
I also should have been more specific and said futures speculators as well, instead of blanket speculation. Future’s speculators you’re right Pill don’t actually deal with actual product, however, companies do plan their future oil supplies based on what the futures market does. When they start seeing a shortage in future supplies, they start raising prices on their services now to compensate.
Hence when Semgroup started buying up long-terms in the hopes of hedging their own misbegotten short-term futures and investment, other companies became concerned about future supplies and bumped prices up. When it became evident to the market what was happening, and those futures were changed hands, the markets relaxed and prices went down. Or at least thats my understanding of it.
Things such as the oil spill (a real PR image problem for future drilling and shipping) the hurricane (a temporary shipping issue) and Iran’s rhetoric ( I don’t take that overly serious, not sure the market does either) will create a rise in prices or more, lessen the rate of the drop.
Of course the biggest reason for the rise in prices is the shit level of the American dollar right now.
Dear all,
This is a discussion because the suppressed assumption is that we can continue our resource fueled growth spurt indefinitely. It’ a moral argument, not a scientific or economic argument. (This is Tex’s position.) Yes, people speculated on the price of oil. No, they were not liberal granola crunchers who want to take away your god-given right to show off in a ridiculously wasteful truck. Off Topic is right, not off topic. Oil prices are determined by the intersection of supply and demand curves, and the fundamentals say that demand is rising as supply is diminishing. Oil prices will fluctuate up and down, but in the long run — five to fifty years — oil will have to be replaced as our main source of fuel, and the internal combustion engine will go the way of the buggy whip and the steam powered locomotive.
Sorry Tex. This one is for you:
http://stuffwhitedbagslike.wordpress.com/2008/05/20/conspicuous-waste/
This is a zero sum game… SemGroup’s intitial short position would have depressed the price of the futures by the same amount that their buy to cover increases the price. Sure their trade would have a temporary market impact, but the key word there is temporary.. Also the fact that it was a “hedging strategy for oil it intended to move through a subsidiary’s pipelines and sell to refiners” means that it was not speculation… Clearly it was a bad hedge… Also, The Red Pills comments about futures prices not affecting physical prices is right on target. Being long the futures is making a bet that the price of oil will go up, it does not actually make the price of oil go up, since the speculators do not take delivery… As others have mentioned there are glaringly obvious fundamental reasons why people are expecting price of oil to go up (china is the big one).. Holy crap!
it was sarcasm btw
i was ironically referencing mccain’s recent claim to the same effect
So let me get this straight…crude oil has been in a relentless, 700+ percent rally since late 2001 and you want to believe this is because of speculators, and in particular one single company??
This article, along with the rest of the MSM, is just breeding ignorance. The same B.S. they are trying to spew in the financial fiasco, attempting to blame short sellers. The fact that only one person so far even mentioned the decline of the U.S. Dollar as a major contributing factor, and that no one has mentioned that the biggest oil fields are already peaking and no more are being discovered only confirms this…
Yes, speculation exists, but pretending that speculation accounts for 50% of the value of the world’s most important commodity is just fooling yourself. 15-20% corrections are normal in every market, and the same will happen here. I think the $120 (20%) price support will hold and we will see some sideways movement in the $115 – $130 range for a few more weeks and it will begin moving up again. I doubt it will drop below $110 and I would bet the farm on it never going below $100 again.
Well I was just looking at a crude graph, and around Nov 2006, there was a 30% correction from $70 – > $50. So, with that precedence I believe a 30% correction could happen again which would be $147 – > $105. A correction that large is pretty rare though so we shall see…
Wow Myke,
Nowhere did I say that this was the sole reason for the rise in oil prices; just that it was a contributing factor. ’significant’ is what I said, not all.
Also, the person who mentioned inflation as the main reason for the rise in price was in fact, I, the author.
Neither did anyone speculate as to what point prices would drop.
Der. Reading before Writing.
You said that “the drop could not be explained by any single, or combination of, events” so that would leave overspeculation as the remaining explanation yes? You also said economists are beginning to “fess up to the fact”. What fact??? Your headline implies that it was proven that speculation was involved in high oil prices, yet in the quote from the WSJ it admits that it is possible this company was already toast before the recent drop…
So if you know that the US Dollar / oil price combo are so closely linked, why write this article trying to say that the collapse of this company fathered a $15 drop in the price? Why not examine the fact that the US Dollar has made a slight recovery in the same time frame….seems like a much more plausible explanation to me. Adding that into the comments section doesn’t count.
And you got me on the third: The price point was carried over from other blogs and MSM articles who want to pretend a speculative bubble is bursting and the price will drop to sub $100 levels ($80 seems to be the most common I am hearing). This is why I am so mad, and I apologize for saying that you are repeating this nonsense!! People need to wake up to the fundamental reality of our monetary system and stop blaming “speculators” and “short sellers” for our woes. Requiring mortgage brokers to be finger-printed is not going to solve anything!!!
Oil prices are determined by the intersection of supply and demand curves, and the fundamentals say that demand is rising as supply is diminishing.
I continue to be amazed that after working in the petroleum industry for 20 years, including the trading room, I didn’t learn shit but some rube appropriately named chunk has it all figured out…
Please explain to me Chunk at those intersection of demand and supply curves you speak of, did demand drop 15% in three days or did we find some rather large hidden supply we hadn’t accounted for? With apologies to your appropriately named NIC, this one’s for you:
http://www.dumbassdaily.com/
And for those who believe the price of crude is tied to the weakening dollar, I have one very simple question. The value of the dollar has basically remained constant since March. The barrel of crude has increased dramatically. Please explain this incongruity…
I sure wish there were people here ready to place some bets. It would be a far more sure thing than the market.
By the way, for folks like Myke I don’t disagree that “much” of the price of oil is decreasing supply and an incremental increase in demand. I would “speculate” it more to do with supply than demand. There’s no doubt many of the fields are drying up as Mexico currently attests.
I could make a very good case that oil was artificially low up until a couple of years ago.
But I adamantly disagree that no large portion of this recent runup is not speculation as the price of crude has already dropped 18% in two weeks. And that has nothing to do with the value of the dollar or supply/demand.
BRING BACK THE GOLD AND SILVER STANDARD!!!
Aren’t we all just speculating?
This “bidding” on futures and the complex derivatives are a time bomb for the World’s Economy, that is why Bear Stearns was “saved”.
I am no economist, just an ordinary working man. If I can’t understand it and the experts can’t explain it, then there is something wrong.
This is no different than betting on a favorite horse in the Kentucky derby. More people lose than win, and winning is more luck than anything else.
Problem is there is too much money in this world with no place to go, that is why Internet companies like Google acquired more market capitalization than brick and mortar companies like GM a few years ago, with no hope of ever making enough revenue to justify the investment.
Wall Street is digging it’s own grave and dragging the world down with it.
Zorba,
This “bidding” on futures and the complex derivatives are a time bomb for the World’s Economy, that is why Bear Stearns was “saved”.
I am no economist, just an ordinary working man. If I can’t understand it and the experts can’t explain it, then there is something wrong.
This is no different than betting on a favorite horse in the Kentucky derby. More people lose than win, and winning is more luck than anything else.
This may be a first here at IOE-OTO. I agree completely with your post.
The most frustrating part for me personally? In a Master’s program, you were always taught that Wall Street is a predictor of things to come – it looks out six months in advance.
Baloney! It’s the most reactive thing I’ve ever seen. Some schmuck predicts oil to be $150 by July 4th. All the lemmings (money market managers) jump off the cliff after filling their tank.
For once I’m gonna give Tex an Amen.
Like you said, one of the reasons for the high oil prices is the oil speculation. But the the three big reasons are the biofuel explosion and the Iraqi and Afghan occupations. These send inflation through the roof and thus you see high oil prices and because of that, higher plane ticket costs, food prices, gas prices. I wrote an article up elaborating on these points. And I well understand that there are some parts that most people will not agree with, but much is clearly documented and undeniable.
http://warofillusions.wordpress.com/2008/06/02/how-to-manufacture-a-global-food-crisis/
Think of the speculators like the ticket scalpers at a ball game. They buy up the tickets in bulk before the game then hand them out at increased price when the box office sells out. Do you think they drive up the price? Sure. Do they take delivery of the seats in the stadium? No. It does not matter that the oil speculators don’t take delivery of the oil. They still drive up the price.
KevinFish, scalpers are actually an ok analogy here for why speculators don’t affect the delivery price. It’s not perfect for a few reasons, the most important being that scalpers can’t bet the price of the seat will fall (which is probably what’s leading to your misconception).. Picture an event with a 100 seats where each seat is being sold for $50. What if 200 people want to go? If there were no scalpers only the 100 people who have the time to sleep in line would get the seats and $50 doesn’t reflect the true value of the seat. A scalper in this situation would cater to the people who want to go the most, and are therefore willing to spend the most on a ticket. The scalper is not raising the price, the people who want to go are raising the price.. Or in the same scenario imagine a scalper bought half the tickets but only 20 people wanted to go? He would lose $2500 dollars and soon be out of business. Same with speculators.. Price is determined by supply and demand, if the scalper/speculator does not take delivery of the seat/oil they do not affect demand, therefore they do not affect the price.. They are merely helping to create liquid/efficient markets..
Well Actually Astronaut,
According to your simulation scalpers could drive up the price.
Say you have 100 seats and 100 people who wished to see the show. A scalper gets in early and buys 70 seats, and 30 other people get the remaining seats, while 70 more are out in the cold. Of course, supply exactly equals demands, but their has been a rush put on those remaining 30 seats, creating a false scarcity. If the scalper is smart, he’ll sell his tickets slowly, individually, so that there is always a scarcity on the market and he can up the prices. If he’s dumb he’ll let them all go at once and won’t be able to sell them for more than the amount of the original ticket.
As far as supply/demand goes, you’ve always had a 1:1, but a monopoly on the supply allows the person in control to drive up prices. This is why we have anti-trust laws.
What most likely happens in this situation is the scalper sells 50 tickets at a conflated price prior to the show as long as the scarcity exists, the other people not willing to pay higher prices. The scalper, if he only has 20 or so less, will then sell them at original or lower prices in order to cut his loss. Usually means real profit for the scalper.
Same with this oil company. As it bought up oil futures to hedge its bets, it begin to create a false scarcity, or at least a smaller market share of the product. Speculators saw the tightening supply on futures and began to speculate up on prices. Companies who rely on those futures, expecting a cut in future profits because of heightened fuel costs also bumped prices up.
As soon as it was discovered that the company at the root of the cause here was going to sell their futures, then the market relaxed as speculators began to realize more oil futures would be on the market.
Tex,
You may have learned that oil is a precious commodity in your 20 years drilling for it and working on an exchange, but that does not mean — necessarily — that you learned anything about human beings, human being who constitute the demand side of supply and demand. Least of all, yourself.
After being called on it you admitted that oil prices may have been artificially low during the 90s, and no one was arguing that oil is traded on a market. We all know that markets go up and down, sometimes irrationally. But the core of your conviction is that oil will continue to be the foundation of our economy — hell, our civilization! You are simply incapable of accepting that an oil crisis will come because it is limited, and our desire to use it is unlimited. How many millennia have human being being shuffling around on this planet? And how many decades has it taken us to get to the point where we talk about “peak oil”? I think your experience as an oil man has certainly clouded your judgement in this case.
Your job and your worldview will become obsolete. Your great-grandchildren will look on what you do with the same awe and disbelief as the children of the Western settlers who destroyed the buffalo by millions because wasting them was more economical to their plan for expansion than letting them live. Markets will go up and down. Eventually we’ll stop refining oil into gasoline, probably well before the last drop of it has been wrung from the Earth. That doesn’t change the fact that the internal combustion engine running of fossil fuels will be a relic by the end of this century.