What's the Real Story With the Price of Crude Oil?
Thursday Bill asked me to take a look at the crude oil market. So here is a quick overview of what I think is going on.
Here is a long term chart of the price of crude oil along with its distance from the 200 day moving average:
OPEC Tax
The price of oil, above a certain point, becomes a tax
on western economies. The higher it goes, the less will be consumed and
the less economic growth we’ll have. One of the reasons we had an
amazingly powerful economy between 1998-2000 was that oil fell to
single digits. So there is a built in mechanism in place to moderate
price but due to structural reasons it doesn’t work with instantaneous
or perfect regularity.
Indexing Fever
The recent parabolic rise may be explained by something other than a
supply demand imbalance. In the past few years we’ve seen a trend
towards commodity
index funds which creates a positive feedback loop. The better the
performance of commodity markets, the more funds are allocated to it by
pension funds, hedge funds, and other institutions.
We’re talking about billions and billions of dollars which it is flowing to long only strategies. Just buy, and buy some more! It is somewhat similar to the hyper indexing phenomena we saw happening in the tech bubble years. As the Nasdaq 100 index went sky high, it attracted a lot of hot money who would buy ETFs or index mutual funds to chase performance. This would then propel the index higher as these funds would create new baskets to put this money to work in the market. So a positive feedback loop legitimized itself through self-created performance:
Source: It Takes Crude To Contango by Howard Simons at thestreet.com
The problem with a scenario like this is that it becomes increasingly difficult to call an exhaustion point. You can easily be steamrolled flat by the tremendously robust trend. Believe me, many very smart and well capitalized traders were flattened trying to short the internet bubble stocks. The trend will last until it doesn’t. That’s about as lucid an explanation as you can get.
Contango
The normal situation when the price of oil is rising is for future
prices to be lower than spot prices. This is called backwardation. But
right now the oil market is in contango - where future prices are
higher. This is a rare occurrence which creates incentives for
speculators to purchase oil, take it off the market, store it and then
sell it at some point in the future to gain arbitrage profits.
So now we have speculators who are piggybacking on the commodity indexing trend, pushing it even further, as well as buying contracts in an attempt to “front run” the inevitable buy orders coming down the pipeline.
Flying Turkeys
All of this is happening in the derivatives markets and it is rather
complicated for most people to wrap their minds around. Here’s a simple
sign of froth in the oil market which most people can identify much
easier. We are seeing small, extremely speculative stocks in the energy
sector fly off into the stratosphere. For a quick example, take a look
at the charts for Pyramid Oil Corp. (PDO) and MEXCO Energy Corp. (MXC).
Most of the stock spam is now pumping oil, gas and energy related over the counter penny stocks. This is the last stage of a parabolic blow-off. When the lamest and sickest of turkeys start to fly as if they were hawks. But good luck in actually pin pointing the top.
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This article has 30 comments:
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john s. gordon
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707 Comments
May 25 08:15 AM> jack
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richjoy
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126 Comments
May 25 08:54 AMThere is a critical decision to be made...will we invest sufficiently in alternative energies (solar, wind, wave, etc.) that will (over some years) relieve the demand pressure on oil--or won't we?
It is not an easy answer. Alternatives require subsidies and infrastructure. We have no national energy policy. If oil prices fall, we may lose interest in alternatives.
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oil baron
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21 Comments
May 25 09:14 AMUntil we here in the US get over the "three mile island" syndrome and start building the required number of nuclear plants to provide our future energy needs I don't see why oil won't ultimately rise to well over $200 a barrel.
All the other alternative energy sources whether it be solar, wind, bio-fuel, hydrogen or ethanol still wont offset more than 4-5% of our energy needs in the future.
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ship shape and bristol fashion
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59 Comments
May 25 10:17 AMNow they seem to get, that the oil supply situation won't get any better than this, which makes 140$ for June 2016 WTI looks like a real bargain.
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ship shape and bristol fashion
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59 Comments
May 25 10:17 AMNow they seem to get, that the oil supply situation won't get any better than this, which makes 140$ for June 2016 WTI looks like a real bargain.
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John L.
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19 Comments
May 25 10:30 AMProbably, recession fears will trigger this to occur. Recession will be much more likely with higher oil prices, so I would expect we will see a correction in the next 6 months for sure.
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elliot_mllr
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66 Comments
May 25 11:04 AM-
NOWHEREMAN
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1499 Comments
May 25 11:34 AMThink of the WTI grade as The premium Gas at a gas station. It should always have a premium because it is the easiest to refine.
Since 2002, backwardization has been the anomaly not contango. Take gold, please show be any period of time when contango was not the norm.
The largest swing in energy usage has to come from the largest consumer, so when the US drops into a multi-year depression, maybe oil prices will come down.
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Harus
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12 Comments
May 25 11:55 AMwww.marketwatch.com/ne...
www.star-telegram.com/...
hsgac.senate.gov/publi...
www.spiegel.de/interna...
online.wsj.com/article...
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Jimbo
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140 Comments
May 25 12:27 PM-
Charlie Peters
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34 Comments
May 25 12:29 PMWhat was the cause of death of Alexander Farrell, 46, expert on alternative fuels?
www.sfgate.com/cgi-bin...
* Was Dr. Russell Long/REAP/Pavley 2002 CA tailpipe bill for corn fuel ethanol, Bill Jones’ Pacific Ethanol business?
* Clean Air Performance Professionals (CAPP) supports a Smog Check inspection & repair audit, gasoline ethanol fuel cap and elimination of dual fuel CAFÉ credit to cut car impact over 50% in 1 year.
* Some folks believe ethanol in gasoline increases oil use and oil profit
* Ethanol uses lots of water
* A Smog Check audit would cut toxic car impact in ½ in 1 year. Chief Sherry Mehl, CA/DCA/BAR, has never found out if what is broken on a Smog Check failed car gets fixed.
* An ethanol waiver would stop a $1 billion California oil refinery welfare program coming from the federal government @ $0.51 per gallon of ethanol used
* About 60,000 barrels per day of the oil used by cars is allowed by the "renewable fuel" CAFE credit
* Clean Air Performance Professionals
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bill d
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195 Comments
May 25 01:22 PMI don't have any idea how much it costs to store oil and we sure as hell don't know how much is being stored but as soon as that cost begins to affect the profit bottom line there will be a miraculous increase of supplies. There is NO shortage - demand may exceed supply (if you believe the figures - I don't) but until I see gas lines, rationing, etc., I'll still believe in TRUE supply & demand indicators.
The lines will be at the banks - a lot of people are going to lose a lot of money - think 1929 - speculators are actually using margin to invest. When the prices turn around - and they will - stay away from the phone. Those "calls" you'll be getting (pun intended) won't be happy ones unless your broker has jumped out of the window.
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cynic69
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236 Comments
My Website
May 25 01:41 PM-
lblaine
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30 Comments
May 25 02:39 PMThe short-term "solution": $10/gallon gasoline.
The medium term solution: Nuclear power and battery driven cars.
The long-term solution: Solar.
Solar is the long term solution
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Harus
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12 Comments
May 25 03:21 PMfrom Texas newspaper
www.chron.com/disp/sto...
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x8jx
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3 Comments
May 25 03:21 PMHedge funds, index funds, leveraged structures?? In the end its the SPOT price that counts, and thats controlled only by supply/demand!
And demand is high!
Will high gas prices cause Americans to drive less? Not if you take Israel as an example. Here we already pay $9 per gallon (due to high taxes), and I dont see less traffic jams on the roads!!
Wages here are lower than in the US, taxes are higher, but it appears that no-one is willing to cut back on driving!
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surgcare
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153 Comments
May 25 05:54 PM-
Brian Pursley
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279 Comments
My Website
May 25 06:49 PMwww.offshore-mag.com/d.../
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tedS
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12 Comments
May 25 07:39 PM-
surgcare
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153 Comments
May 25 08:17 PM-
tincansailor
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1 Comment
May 25 10:29 PMThe question I have is why is the price of gasoline being sold to the public as being controlled by the supply & demand factor ?
We all know the demand is growing, but we also all know the supply is being controlled by the oil companies - Duh
Also - in the 1970's during the last gas "shortage" - I can't remember the price of gasoline even being traded on the commodity market back then. When did gasoline actually began public trading ?
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ship shape and bristol fashion
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59 Comments
May 26 04:31 AM'They (heating oil prices) defied crude's pullback Thursday to break $4 a gallon after China's customs administration reported a 17-fold jump in diesel imports last month,...'
Hoarding is conspiracy bull...
Demand is real.
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barnburner
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75 Comments
May 26 10:51 AM-
rjswiss
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2 Comments
May 26 11:01 AMWould you please elaborate as to why? I do not wish to challenge this, only to learn more.
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ArtfulDodger
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133 Comments
May 26 02:41 PMChina doesn't even report how much oil it buys, uses, or stores. The best we can guesstimate over the last five years China has gone from 4.6 million bpd to a little over 6 million bpd. The US uses about 20 million bpd.
How can so many people believe that, all of a sudden, there is a shortage of oil?
Does no one remember the 1970s?
Known reserves (fairly easily retrievable oil) in 1970 were about 560 billion barrels. By 2000 they were over 1 trillion. Eight years later they are about 1.6 trillion.
The world uses somewhere between 75 million bpd and 86 million bpd.
What's the problem? Where's the shortage?
The telling sign that the first major downturn is about to come is that after Goldman Sachs and T. Boone and nearly everyone else you can imagine came on the tube pumping the ppb at $150 & $200, the price has not moved even 5% since then (from $127).
Pickens has been an oil bull since the 70s, and GS always piles on late to get the public in after the momentum players are fully invested.
If the ppb continues to stall, the momentum players will know the public is finally fully invested. There will then be no more money to go in.
So they'll start dumping and the public, which is now buying oil and energy stocks as never before, will get killed—per usual.
That's a view from someone who bought his first stock in 1967 and has been watching the NY crowd run these scams on the public for the last 35 years.
Rebeldog
PS: Iraq has just announced that its latest survey shows that they have another 225 billion barrels in reserve. Thus, add another 225 billion barrels to the World's reserves.
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ship shape and bristol fashion
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59 Comments
May 27 03:41 AMWhat matters is daily production!
You can't make gas and diesel from reserves in the ground, only from production.
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jjason
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408 Comments
May 27 10:30 AMHarus has posted some good links and if you got this far, go back to the links Harus has given you so you can get an opinion or two about price manipulation in energy markets ( like in ENRON) that have been written that will explain HOW oil prices are rigged. It will require some work on your part but if you don't take my advice, you deserve to lose your money.
By way of the Los Angles Times I downloaded four reports that were submitted, verbally, to Senator Joseph Liberman's committee this past week. It is outrageous that the economist who works for the Commodities Futures Trading Commission testified " the commission has found no correlation between oil prices and speculation in oil futures." The CFTC employee had absolutely NO INFORMATION in his report on FUNDS FLOW! In other words, nothing was said in his report about the amount of money that is being invested in oil futures contracts around the world by speculators, hedge funds ETF's, individuals, pension funds or government entities!
I don't like the comments from guys/gals like ship shape BS who mislead us.
Also, re Housing Speculators...they screwed things up for the US economy too.
Phil Davis, Barry Ritholz, and Judy Weil are three of the best and most honest writers on this site in regards to the high prices of commodities and housing.
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DuBoShi
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2 Comments
Jun 16 06:07 AMHere are some things that one can see in China: People are recycling anything possible on a grassroots level. They don't throw things away if it still works or if it's fixable. I see taxi drivers queued up and when one gets a fare, all the drivers behind him PUSH their cars one spot up. People turn off their engines at stoplights when there is a long wait at a red light. (Incidentally, lots of people also drive around with their headlights turned off at night to save even that tiny bit of energy - not necessarily a good idea.) In their homes most people don't have heating in winter - they wear more clothes instead. Heating is available, but at a high relative cost. Even though the rate of people driving is on the increase, train, bus, and bicycle traffic are all flourishing. Buses usually don't leave for their destination until every seat has been sold for longer trips. These are inconveniences perhaps but it's the norm. It's this kind of mentality, yes, as SOCIALIST as it is, that is better for almost all people.
When I have bottled water delivered, it arrives by bicycle. When I have gas delivered, it arrives by bicycle. In other countries, people would snub their nose at such ideas, but mostly they have never understood the need - they are too busy keeping themselves happy rather than trying to think how everything they do affects everyone else.
Here the roofs are also covered by solar hot water heaters. People unplug their TV (when they have one), so that tiny little light that some TVs have won't use power. These are things most North Americans would never even bother with, but the whole point is this. It's all about attitude and approach. Whatever energy you're using, whether for heating, driving, or to power your toys at home, or having all the lights on in your home at the same time, is costing not only you, but everyone in your country and the world as you're cutting into the supply of the world. It doesn't matter how much oil is still in the ground, I think everyone can agree that it is being used much faster than the earth can replenish it.
I sincerely hope that oil prices can maintain their current levels or even go up, so that all the alternative energy sectors have a chance to plant firm roots and become part of everyone's daily life to such an extent that they will be considered the norm.
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Saffie
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9 Comments
Jul 06 04:12 PMNow I get it. So those cool dudes in Armani suits, driving tankers full of crude are the speculators taking the oil off the market for storage. Where are these storage depots, pray tell ? In a tank farm in the backyard of the speculator's house in Brooklyn?
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lph
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1 Comment
Jul 08 11:58 PM