Jan 23 Blog - High Oil prices caused by China's growth

[tobyguy]

Freddyv wrote: " think you're missing the big picture here; it's easy credit that built everything else from the China bubble to the housing bubble to the consumer credit bubble to the latest and greatest bubble, government handouts. "

You need to re-read me post. I am saying basically that. It was easy credit that lead to the increase in every market and oil is no exception (money flowing around to every corner of the market), the same way it affected of all commodities, eg. corn, wheat, silver, iron, gold, etc. etc. Demand or use of these resources, was not the key factor in setting it's price (which is what John was saying).

People like John will have you believe that oil's price has crashed because China is no longer using as much oil. I don't question that China is using less oil now then it was (of course they are now, we are in the midst of an international depression).

If you look over the last 10-20 years, the fluctuation in oil prices have had nothing to do with how much of it was being used up (or because of tropical storms, or because of regional conflicts, etc.). Oil prices fluctuate wildly regardless of consumption. Is the world using 3/4's less oil now then it was 6 months ago? Well that's how much prices have come down (if you look at it's recent lows).

Have you had to wait in lines for gas? Was there ever really a shortage of oil/gas to justify 140+ oil? What happened to the peak oil theory? Did we find a whole bunch of new oil reserves somewhere? Are we now using 1/4 the gas we were using before? Then there's the China consumption theory.... Fundamentals are a load of garbage.

It was NOT China's use of oil that lead to the crazy increase in the cost of oil. The same way that other commodities like wheat, corn, etc. have all crashed. Think about it, did people stop eating? Is that why wheat and corn prices have dropped like a brick too? Why can't you apply the same logic to other commodities? Because it's plainly obvious that you can't - people haven't stopped eating.

Fundamentals have almost nothing to do with the out of control prices of commodities. China had nothing to do with the out of control prices of oil - how much we all want to believe it did. It takes a historian, not an economist to understand why that is.

Take a look at periods before other deflationary crashes and see what happened to commodity prices, yes, you got it, they experienced large price appreciations too. Why is that? Credit. And no, not credit that lead to production for it's own sake, but credit itself and social mood (the willingness to pay almost any price for anything, regardless of it's actual worth, sound familiar? - Yeah, like the housing market. BTW. I guess there was a real shortage of housing too right? That's what lead to the home price appreciations, right? We all know that's a load of garbage). It was social mood (and easy credit) that lead to the housing boom (and the belief that housing prices would go up forever - and NOT the lack of housing).

People will pay almost anything if they continue to believe prices will go up forever (especially with easy money available, regardless of demand and supply - we all know there was no oil shortage, just peak oil theories, etc. yet prices went through the roof).

If you read between the lines, I'm hinting at psychology as being a key driver (that mass psychology/social mood is the key to price appreciation in most things and not demand/supply). Is it generational? Maybe partly, but that's a whole other discussion.

Tobyguy

[tobyguy]

John said "However, none of that contradicts the fact that China's huge bubble
economy had been sucking up every drop of oil in the world, growing
at an exponential rate."

I guess I must have missed those line ups at the gas station (due to shortages and China "sucking up every drop of oil in the world").

I guess we've all stopped driving then. I guess we were only using 1/4 of the oil we use to use a few months ago (oil prices have droped about that much at it's lows).

Do you apply the same logic to other food based commodities such as corn, wheat, etc?

Did the world stop eating to? Or do these commodities not fit in your nice little picture about how the economy is driven by "fundamentals"?

Maybe there are conspiracies for those, right?

John also said "However, there's a perfectly reasonable explanation for the parabolic
behavior of oil at the end: panic buying. As you were saying, people
were talking about $200 oil, "

Panic? likely, fear? Absolutely. Commodities went through the roof because of fear, certainly. However, high oil prices over the last number of years were mostly due to easy credit and social mood and the easy flow of money into almost every corner of the market (the same social mood that turned into fear/panic a little later). This is nothing new, always happens just before a deflationary crash.

Tobyguy

[MarshAviator]

Panic? likely, fear? Absolutely. Commodities went through the roof because of fear, certainly. However, high oil prices over the last number of years were mostly due to easy credit and social mood and the easy flow of money into almost every corner of the market (the same social mood that turned into fear/panic a little later). This is nothing new, always happens just before a deflationary crash.

Oil in particular had price behavior which matches a tight supply-demand relationship.
It is possible that some sort of amplifier effect (Role of speculators) with respect to general commodities slightly increased the price of crude.
However this is more than offset by demand destruction experienced by many third world countries (Uganda for example) which were priced out of buying any crude.

Crude oil has a long development cycle typically 5 to 10 years (sometimes more) from the seismic to pump ,
demand ramped up much more quickly under the influence of easy and abundant (debauched) credit than the underlying supply could match.

Oil (and all of the present energy sources including uranium) has structural limits and is finite, renewable's are providing maybe 5% of current global demand. Renewable energy sources like solar and wind only produce electricity and do not address transportation. The alternative have an even longer cycle than crude oil, the joke in the industry is that tar sand production is about 50 years away and has been that way for 50 years.
Burning food for fuel (soybeans,corn) is both stupid and thermodynamically untenable as well as immoral in a world where some starve for lack of food.

While Generational Dynamics stand on it's own with respect to a lot of today's issues, peak oil (and peak a lot of things) is also a function of some (but not most) of the problems we are experiencing presently.

China's growth reminds me of the yeast growth curve experiments in biology where the yeast expands exponentially until it overshoots and dies off.

I don't believe we (people or the earth) are going to die off, but the current progress and growth model will have to be revised unless some unexpected breakthrough happens on the order of paradigm shift.

In short the underlying causes of crude (gasoline as well) price rise are completely explained by normal macro economic principals (the only part of the macro economic model that is useful).

[tobyguy]

MarshAviator said: "Oil has structural limits and is finite".

And?? So what. Long term the price of oil will not be infinity or anywhere near absurd prices, it will actually be zero. Alternatives will be used or discovered. People will substitute it for something else. We always have. Peak oil crap. Did it go away? Did we find more oil, is that why the prices have crashed? Are we really using that less oil to justify 1/4 of it's price (with more to come shortly)??

This is more of the "fundamental" garbage going around. You keep believing that. I guess you must have been one of those $200 oil people. The same ones who were arguing fundamentals will drive it to that. Fundamentals almost has no play in the price of oil. It's all about mass pshycology, period. Again, the China consumption argument is but only one. Conflict, refinery damage due to hurricanes, etc. are many others. If you take a look at the numbers, dates of conflict (russian invasion of Georgia), dates of hurricanes wiping out many refineries (Katrina/Houston), etc. that could all potentially affect supply, you'd quickly realize what a load of garbage those arguments are. But of course no one points it out. The "fundamentalists" ignore those FACTS. It's easy to ignore things when they don't fit in your tiny [faulty] model.

I find the claim interesting that oil is the exception to the rule. Why not wheat? Why not corn, etc. etc. Why are these different? Is oil more important than the food we eat? Why would oil follow supply/demand more closely then food (we can do without oil, but we can't do without food!!!!).

Also said: "In short the underlying causes of crude (gasoline as well) price rise are completely explained by normal macro economic principals (the only part of the macro economic model that is useful)."

Macro economic theory does not address mass psychology and thus fails to address probably the most important part of what drives the demand and how it can be turned off like a light-switch due to panic, fear, etc. etc. Oil is NO exception.

Tobyguy

[freddyv]

I am so often amused by those that wish to suggest that oil has some special quality that makes it immune from the basic rules of economics. As oil approached $150 a barrel less than a year ago only one thing was in my mind regarding that situation: oil is self-regulating; the high price itself will cause demand destruction and therefore prices will drop.

The only trick was to determine when the collapse in prices would come, but just like every other crash in history there were obvious signs of weakness and plenty of opportunity to profit on the way down - as long as you don't deny reality. As usual many would claim that this time was different (the peak oil theory) but as usual this time wasn't any different and oil came crashing down.

Why people insist on using all sorts of complex BS to deal with situations that are quite simple is beyond me. History also suggests that once people alter their driving habits they tend to not go back to their old habits for a quite awhile, which is another factor that so many people are still getting wrong.

We should apply that same rule to the stock market where people are being frightened off by the destruction of their wealth and will not be back in droves, as Generation Dynamics suggests, until the people who have lived through these times have vansished.

But let me make it clear that people will start driving more within years while it will take decades for them to forget the losses they took in the stock market or in the value of their homes.

--Fred

[freddyv]

Freddyv wrote: " think you're missing the big picture here; it's easy credit that built everything else from the China bubble to the housing bubble to the consumer credit bubble to the latest and greatest bubble, government handouts. "

It was NOT China's use of oil that lead to the crazy increase in the cost of oil. Tobyguy

Yes it was, at least in part, and I provided evidence to prove it. That China's use of oil was caused by the credit bubble is also true. You seem to be arguing just to argue and that's a shame, IMO, because it takes us away from what this site is supposed to be about and that is Generational Dynamics.

I think if you will take a few days and read through most of the site you will have a better idea of what Generational Dynamics is about and why you are wasting your breath (fingers) arguing minute details that lead us astray.

All the bubbles were caused by the taking on of debt and risk that is predicted by Generational Dynamics. If you REALLY want to argue what is the cause of high oil prices then I could go back one step farther and argue that it was caused by the generation that lived through the Great Depression and tried too hard to give their children everything instead of teaching them about hardship.

As I've stated before, I'm a big picture guy and fail to see how arguing about minutia is helpful when we know what the real cause was. Isn't the point to be able to predict the bubbles and the resulting crashes and be prepared for them? I've profited by the stock market crash and I've profited from the oil crash and I plan on getting through this recession or depression or whatever you want to call it because I keep my focus on what is important, and that isn't whether China or your Uncle Bud and his Caddy caused oil prices to spike.

--Fred

[tobyguy]

As I've stated before, I'm a big picture guy and fail to see how arguing about minutia is helpful when we know what the real cause was.

--Fred[/quote]

Minute details? Trying to better understand what drives supply/demand is hardly minute.

In itself, Supply/demand is often a load of garbage (at least at the macro level or may apply under extreme circumstances - and no, the recent oil price appreciation is not one of them).

Take your point quoted here for example "I am so often amused by those that wish to suggest that oil has some special quality that makes it immune from the basic rules of economics.".

Firstly, you are the one believing oil is the exception. I see you've still failed to address why wheat, corn, etc. have crashed in price as well. Why do you ignore that fact? Why are you treating oil differently? Is oil less important than food to the human race? Or you just don't want to address it because you can't? Because it doesn't fit in your economic theory or fundamentals? Not one person in this thread has addressed this point (interesting isn't it)? I guess we all have stopped eating as much as we use to! (yeah, that's it).

Let me get back to your "basic rules of economics" statement about economy theory: Lets take finance for example, where the basic underlying economic theory/beliefs/assumptions about utility are completely wrong. They believe people are out to maximize their utility. That means when things are cheap, they get more of them. If that were true, why is it that people are always "maximized" when the stock market is at it's highest (stocks are most expensive)? And out of the stock market when it's at it's bottom (when they are cheapest)? This is a core assumption of economic theory 101, and it's dead wrong in real life, period. Why? It all has to do wth fear and social mood/psychology and nothing to do with supply/demand.

So, let me ask you, are you "still amused by those that wish to suggest....[there's something wrong with] the basic rules of economics"?

You also wrote: "I've profited by the stock market crash and I've profited from the oil crash and I plan on getting through this recession or depression or whatever you want to call it because I keep my focus on what is important, and that isn't whether China or your Uncle Bud and his Caddy caused oil prices to spike. "

I'm glad you're doing well. Keep believing in those fundamentals and eventually you'll pay a high price for it.

Personally I'm in my mid 30's and live in one of the nicest areas of a large city North American city, with my house paid off completely (have lived as if we were already in a depression for years now, as I too have known it is coming) and have a few hundred thousound ready to get into many stocks and other investments at the bottom of the stock market crash (i.e. when the DOW hits 3000 or so). But all this is irrelevant to the topic at hand.

I for one believe that soclial mood (combination of all of society/generations) itself is a much more important driving factor in the direction the economy goes in. How generational attitudes views impact social mood (and thus the economy at large) is something I've always considered valuable and want to research more.

As you can see, what I'm talking about is hardly minute - it is the bigger picture.

Tobyguy

[John]

I'm not sure what emotions are driving this arcane discussion, but
something to keep in mind is pricing "on the margin."

A market reaches equilibrium when the marginal price charged by
suppliers equals the marginal price that buyers are willing to pay.

The marginal price is not the average price. It's the price of the
next unit.

Imagine a situation where suppliers are supplying units of a product.
By the Law of Diminishing Returns, each additional unit typically is
more expensive to produce than the preceding unit. So the price that
suppliers charge for each additional unit is typically higher than
the price for the preceding unit. Thus, the suppliers' marginal price
increases as more units are produced.

If there are few units on the market, then the few buyers are willing
to pay high prices for them. As more units enter the market, more
buyers can buy them, but only for a lower price. Thus, the buyers'
marginal price decreases as more units are produced.

As soon as the two marginal prices are equal, the market is in
equilibrium.

If a market is in equilibrium, then it doesn't take much to cause a
sharp increase or decrease in prices.

This is particularly true in an oil market, where it takes a long
time for suppliers to increase supply. The Law of Diminishing Returns
hits such an industry very hard. When the industry is near full
capacity, the marginal cost of supplying an additional barrel of oil
could be very high.

At such a time, if there are panic buyers who are willing to pay
these high marginal prices, then the market price will spike up
substantially in a short period of time. Then, when the panic
subsides, then the marginal demand disappears, and the spike
collapses. Thus, panic buying and marginal demand can cause a market
to be extremely volatile.

Summarizing, what I believe happened is as follows: Increased
worlwide marginal demand, especially from China, caused the industry
to reach full capacity over a period of several years. The Law of
Diminishing Returns pushed marginal costs to spike up, leading to a
bubble that grew over a period of years. Then, right at the top of
the bubble, panic buying created extreme volatility for a period of a
few weeks.

Then, when the panic buying disappeared, it didn't mean that demand
for oil collapsed, but it meant that marginal demand for oil
collapsed. (This is the point that most pundits overlook.) When
marginal demand collapses, the price can collapse very quickly, and
that appears to be what happened.

Sincerely,

John

[Higgenbotham]

There's another point in the discussion about marginal barrels, and that is the net energy extracted from the barrels on the margin. What I mean by that is those marginal barrels may have cost $80 to produce at the peak of the boom but since our accounting system is money based rather than energy based, there is no telling whether those marginal barrels were even produced at positive net BTUs. That's why I've thought for a long time that peak oil isn't actually needed to limit the economy--it can be limited before peak is ever reached.

I'm sure there are people out there who have thought about his more than I have, but I really haven't seen the concept laid out in a big picture manner. Not to say it hasn't. Look hard enough on the Internet and you'll find most anything. The way I think of it is there is a marginal energy producing "system", say the Canadian Tar Sands projects. It would be represented by drawing a boundary around the system and accounting for all the energy flows in and all the energy flows out. For example, if equipment is moved into the system to extract energy, then the energy used to produce and move that equipment would be an energy expenditure of the project. Likewise, any workers who travel to Alberta to work on the project. And so on. I don't know, but it may be that even though the project produces money profits, it may operate at an overall energy loss, in the sense that more overall energy flows into the project than flows out. Since the economy runs on energy, operating projects that operate at an overall energy loss would begin to grind down the economy without anybody realizing why. And I suppose there could be some threshold above loss where that would be the case too. Certainly, at constant production rates over time, replacing a barrel of easy to extract oil with a barrel produced in a marginal tar sands project is a net negative.

[tobyguy]

John Wrote: "I'm not sure what emotions are driving this arcane discussion, but
something to keep in mind is pricing "on the margin."

It isn't margin itself driving up the price. It's fear, panic, whatever you want to call it (I like to call it social mood). You even admit that much.

John also wrote: "If there are few units on the market, then the few buyers are willing
to pay high prices for them. As more units enter the market, more
buyers can buy them, but only for a lower price. Thus, the buyers'
marginal price decreases as more units are produced."

There never was a shortage of oil in the market. Did you have to wait in line for gas? Did you hear about any real significant shortages world wide? Were did you get your statement from that China was "using up every last drop of oil" from? If there never were any real shortages? Likely the same false beliefs going around trying to justify something with highly over-exagerated reasoning. Then when there were no obvious shortages, this garbage about peak oil came out, claiming that we'd eventually run out and that's why high oil prices are here to stay.

"This is particularly true in an oil market, where it takes a long
time for suppliers to increase supply."

If there never was a shortage, which clearly there was not, how long it takes suppliers to increase supply is irrelevant.

"Then, when the panic buying disappeared, it didn't mean that demand
for oil collapsed, but it meant that marginal demand for oil
collapsed. (This is the point that most pundits overlook.) When
marginal demand collapses, the price can collapse very quickly, and
that appears to be what happened."

I find it interesting that you keep saying, panic, panic, panic. I also find it interesting that "panic" appears in your argument every time price goes from one extreme to the other, don't you? Do you not see the common theme?

I also find it interesting, not one single person has responded to my comparison about why oil is different than other comoodities such as wheat, corn, etc. and why they crashed too (all at the same time).

Easy credit and (positive) social mood brought all markets and comodities up together. Now, with credit almost completely gone and (negative) soclial mood taking hold, it's bring down all markets and comodities together. Again, this is nothing unusual in a deflationary crash and the resultant when easy credit saturated ALL MARKETS.

Tobyguy