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

[tobyguy]

From today's blog....


Claim [It] "was pretty clear that they were all caused by the demands of China's exponentially growing bubble economy".

Really.... for someone who argues that the mass amount of credit is what has lead (leading to) a deflationary crash, I find the above statement interesting.....

I do not believe high oil prices had anything to do with China's growth or for that matter any of the so-called "market fundamentals", which the China argument is one of them.

I also find it counter to the "credit bubble" argument and resulting deflationary crash result.

You had one point right, all commodities experienced high prices at the same time. So did all the markets too (realestate, commodities, stock indexes, etc. etc.). ALL MARKETS reached their highs basically around the same time (all within a year or two of each other). This is almost historically unprecedented (except in times in which a deflationary crash results shortly after).

Thus, it isn't "China" or any market fundamentals that led to high prices of oil (or any other market for that matter), but the easy and countless supply of credit.

The same market fundamental arguments have been proven wrong again and again. If it was true, oil prices would have sky-rocketted right after Katrina and the recent houston hurricane when many, many refineries were destroyed or when Russia invaded Georgia (but the opposite happend), prices have dropped, along with the supply of easy credit.

I think the blogger needs to re-evaluate such claims and allign them with his own thinking.....

Tobyguy

[Higgenbotham]

I haven't studied the details of who all is storing oil and everything that is being said about it, but I can comment on what is probably going on based on general knowledge.

As everyone would surmise, there are cost associated with storing commodities. Those costs are normally reflected to some extent in the futures markets and include interest, storage, and insurance.

Currently, interest rates are very low. Storage costs are very low, I believe, but am extrapolating that statement from the fact that shipping costs are very low. So oil can be stored very inexpensively.

I don't believe the companies that are storing oil today are speculators, but are instead locking in risk free profits by buying oil on the cash market and selling futures contracts. From what I saw recently, it seems like futures contracts just a few months out were selling for as much as $10 over cash.

http://futuresource.quote.com/quotes/quotes.jsp?s=CL

That spread looks to have narrowed somewhat recently and should reflect actual carrying costs soon.

Normally, it should be impossible to lock in risk free profits in this manner. I don't have the numbers to back it, but this almost certainly would have been a losing proposition at the peak of the market or any other time until recently.

[Higgenbotham]

As far as whether oil and commodities were in a bubble, I don't know if people are aware, but many pension funds were putting a few percent of their money into commodity index funds. Pension funds! Many hedge funds and individual investors were doing the same thing.

I've watched this debate go on and on. Most, but not all, futures traders believe that oil prices were driven higher to some extent by speculation. Estimates vary. My guess is that the last $30-40 was mostly due to speculation. That's based on how the chart went parabolic at the end and what people were generally believing ($300 oil, $8 gasoline, etc.). In my opinion, there was also a fundamental story but fundamentals weren't the whole story. That's not an informed opinion based on knowledge of the oil market.

I'm not intimately familiar with delivery in the oil futures market. All I can remember reading is that it doesn't work like other futures markets. I am familiar with some of the other markets. Most futures markets have the current month listed in the price quotations (for example, January at present) and it is possible to buy a futures contract at any time and take delivery within a couple days; therefore, the futures market and the cash market end up being priced competitively with one another. I don't see that being the case for oil based on the quotes posted in the previous message.

[tobyguy]

I think we all need to be on the same page as to what speculation means... some of us have different definitions about what speculation is.

Some believe it was greedy people "buying" and "holding" oil to make profits and that this was responsible for the oil bubble.

I'm sure there was some of that going on, but I believe there's a much better explanation.

I follow the blogger's opinion that we are in a deflationary period/soon to follow crash (but I believe he fails to connect it to oil though). What has lead up to this is the crazy amount of credit available in EVERY market. Since 2000, we have experienced an unprecedented amount of available credit. So many (borrowed) investment dollars have been chasing so few profit dollars in EVERY corner of EVERY market. Ever wonder why GOLD hasn't gone through the roof and why it's still well off it's high? You bet, the same reasons, people pouring money into EVERY market - thus even gold's price is off it's high - and likely will crash in the coming months (it too was part of the credit bubble, like oil). Anyone who believes in the so-called "fundamentals" would have you believe gold would be at 2000$ considering the likelyhood of another depression, but how do they explain that gold is actually well below it's high? They don't and can't.

Market fundamentals is a load of crock period in regards to being a key factor in oil prices (eg. the chinese growth, middleeast wars, hurricanes, etc.). If anyone ever cared to actually look at the numbers they see how mistaken they are (katrina, houston hurricane, georgia invasion by russia cutting of a serious amount of oil flow, etc. etc.). Am I suggesting that demand plays no role in determining price? No, it does, however there are other factors that play a much bigger role (and namely it's what lead to the credit bubble to begin with, social mood).

Tobyguy

[Higgenbotham]

I think we all need to be on the same page as to what speculation means... some of us have different definitions about what speculation is.Tobyguy

I think I see your point. There was speculation that lifted all boats so to speak. As an example of that, if people buy the biggest houses they can afford and get the biggest mortgages they can, then that helps copper and lumber prices indirectly plus whatver they have to heat the house with for the next 50 years, etc. Then separate from that there was speculation about specific items. I was referring to the latter with regard to oil and the last $30-40.

I always looked at the general speculation like this--in general, everyone owned things that they thought would go up in price and cash was a very small portion of net worth. Since debt is the opposite of cash and it takes cash to extinguish debt, basically the whole world was net short the dollar. The mindset has been for people to look for what is going to go up in price the most, and that mindset still generally exists. In other words, I'm into stocks or whatever for the long haul. That is basically speculation that prices will go up, or that cash will lose relative value. Also, in the general sense, I look at speculation to mean that people allocate according to a directional view on things, and not for a return on investment. For example, if someone buys a utility stock because it returns 6%, that is an investment. Essentially nobody has been doing that. I got out of the real estate business because, at the prices real estate went to, it was no longer an investment. But that didn't solve my problem because I was forced to speculate until things reached a point where it seemed OK to park the money in cash and wait for the bubble to burst. It's difficult to stop a speculative bubble because people who are naturally savers and don't want to speculate are forced to do so just to keep up with inflation.

[John]

> You had one point right, all commodities experienced high prices
> at the same time. So did all the markets too (realestate,
> commodities, stock indexes, etc. etc.). ALL MARKETS reached their
> highs basically around the same time (all within a year or two of
> each other). This is almost historically unprecedented (except in
> times in which a deflationary crash results shortly after).

> Thus, it isn't "China" or any market fundamentals that led to high
> prices of oil (or any other market for that matter), but the easy
> and countless supply of credit.

If I understand what you're saying, you're arguing that I've
identified the wrong bubble to blame for the oil spike. I'm not sure
how one would distinguish one bubble from another, since the bubbles
have all been feeding into one another, to create an "entire world"
bubble.

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've watched this debate go on and on. Most, but not all, futures
> traders believe that oil prices were driven higher to some extent
> by speculation. Estimates vary. My guess is that the last $30-40
> was mostly due to speculation. That's based on how the chart went
> parabolic at the end and what people were generally believing
> ($300 oil, $8 gasoline, etc.). In my opinion, there was also a
> fundamental story but fundamentals weren't the whole story. That's
> not an informed opinion based on knowledge of the oil market.

As you and tobyguy have noted, it depends on what you mean by
"speculator." If you and I make a bet with each other about what the
price of oil will be next month, then you and I could be called "oil
speculators" in a sense, and that's not much different from
speculating on oil futures contracts.

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, and people could well have been buying
and storing oil to beat the high prices. In fact, I would be willing
to bet that China did exactly that. Is that "speculation"? Yes, but
only in the sense that almost anything can be called "speculation".

Sincerely,

John

[freddyv]

From today's blog....


Claim [It] "was pretty clear that they were all caused by the demands of China's exponentially growing bubble economy".

Really.... for someone who argues that the mass amount of credit is what has lead (leading to) a deflationary crash, I find the above statement interesting.....

I do not believe high oil prices had anything to do with China's growth or for that matter any of the so-called "market fundamentals", which the China argument is one of them.

I also find it counter to the "credit bubble" argument and resulting deflationary crash result.

You had one point right, all commodities experienced high prices at the same time. So did all the markets too (realestate, commodities, stock indexes, etc. etc.). ALL MARKETS reached their highs basically around the same time (all within a year or two of each other). This is almost historically unprecedented (except in times in which a deflationary crash results shortly after).

Thus, it isn't "China" or any market fundamentals that led to high prices of oil (or any other market for that matter), but the easy and countless supply of credit.

The same market fundamental arguments have been proven wrong again and again. If it was true, oil prices would have sky-rocketted right after Katrina and the recent houston hurricane when many, many refineries were destroyed or when Russia invaded Georgia (but the opposite happend), prices have dropped, along with the supply of easy credit.

I think the blogger needs to re-evaluate such claims and allign them with his own thinking.....

Tobyguy

I 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.

Here are a few information sources to prove my next point:
http://news.xinhuanet.com/english/2008- ... 075648.htm
http://www.bloggingstocks.com/2008/06/1 ... ion-jumps/
http://www.eoearth.org/article/Energy_profile_of_China

China was the focal point of the oil bubble without a doubt and the fact that oil has dropped as much as it has and continues to be weak is clear evidence that China's economy is weaker than we are being told.

Simply blaming the oil bubble on easy credit might have been accurate but would be like someone blaming the foreclosure on a house they couldn't afford on easy credit when the more precise reason was that they bought a house they couldn't afford.

--Fred

[mannfm11]

I am not even going to read one bit of the nonsense posted and agree with John. I have debated this subject for a long time and I have followed the oil markets since the 1970's with the advent of the first crisis. I have fairly good knowledge of commodity markets and how they work and a market the size of oil couldn't be cornered in the manner it was claimed to be cornered.

One has to remember this bubble was not a 3 month ordeal, save the last portion of it. But, for 3 or 4 years, claims were that oil shouldn't be as high as it was. When you are speculating on oil, the guy on the other end is Exxon or Saudi Arabia or Goldman Sachs or any number of huge concerns. They know the oil markets better than most of the traders. You can't discipline producers when prices are cheap, as they were in the 1990's, so why would they not produce with oil at $70, $80, $90 or $100 a barrel? If there was a glut of oil on the market, which there should have been under the idea of exessive speculation at $70 a barrel, $80 a barrel or even higher, then Exxon, Saudi Arabia, Iran and other huge entities would have let the speculator have it. There is a thin line between shortage and excess in the oil markets and even 500,000 barrels a day for 6 months creates a surplus that can't be managed too well. It wouldn't take long for XOM or Saudi to let the speculator have that oil and in fact force them to sell it back to them a reduced prices.

To believe this speculative nonsense is show your ignorance of how commodity business is done. There was a one day short squeeze in September that achieved the objective of a technical retrace of the October contract, but it was in a small market. It was clear that the longs realized the shorts didn't have oil in Oklahoma to make delivery forced their hands. All it takes to squeeze a market is the refusal of one side to close their side of the contract and the other side to not need delivery or be able to make delivery. In this case, it doesn't make a difference as to whether the trader is a spec or a commercial.

In order for the game to have gone on as long as it went on, there would have had to have been storage somewhere for well over 1 billion barrels of oil a year likely. The commodities market works like this generally. Most of the contracts on one side or the other are held by large commercial concerns. Unlike specs, commercials come to do business and when they decide it is time to do business, you own their product if long or deliver it if short. The specs are rarely ever there to do business because they actually have no use for the product, so what they are really doing is providing liquidity to the markets and in fact hope the commecials end up on their side when all is said and done. Not all commercials are there to buy or sell, but instead to lock in prices on one side or the other, as they have product to buy somewhere else or sell and merely want to ensure they get their price.

There is a complaint about naked shorts in the gold market and silver market holding down the price. If the shorts are naked, then it is clear the longs are even more naked and have no intent to take delivery. If the fact that the shorts in the gold market had no intent or capacity to make delivery of gold, the big players would crush them by next delivery date to the point that it would never be done again, yet most of the gold bugs cry foul on this account. The reason the shorts don't make delivery is the longs don't go to expiration and no other reason. The real problem is that the people that have all the gold are on the short side and there is never going to be enough money on the long side to buy them out. It is crying foul because they won't let them win.

Ever wonder how a group of weak hands speculators on the long side could rule over outfits like Exxon, Chevron, Conoco-Phillips or Saudi Arabia and force them to deliver what they don't have to deliver over and over again? This is what the news media would have us believe and what some of you guys seem to be proposing as well. Now, there is oil being piled up in Oklahoma. The near contract went off the board at $35 or so, just as it did last month and the now lead contract is going for the mid $40's. Do you want to bet the longs win this trade? I will guarantee you those that have the oil in Oklahoma aren't going anywhere with it and have it sold for $45 a barrel with an eye on the April contract as their next leap when they force the spec to sell it back to them at $35. The oil bubble of the early 1980's burst and it took 20 years to get a bandaid that would stick on that problem. It took China, as John said.

Now for copper, I suspected there was a huge hedge fund or a series of them running a corner on copper. Copper stayed up even after the housing markets around the world burst, well into the middle of last summer. Copper went up 400% from its 2000 level and stayed there except for short periods of weakness. The low price in the late 1990' s was due in part to a rogue trader in Japan hiding copper in a scheme that fell apart. If the same happened here, where a group was holding enough contracts to merely squeeze the other party by taking delivery of all the product on the exchange, there is a huge hoard in warehouses around the world. No one would want to hoard copper for higher prices with that potential. It is not likely that many in the know would be doing the same with oil, as even 1 day supply of oil is hard to hide.

In closing, John makes the point that in order for a futures price to have validity, delivery has to be made at a price that can be matched in the spot market. One of the posters makes the mistake of assuming you can buy a futures contract and get delivery at any time, but this is not true. There is only a window every month where delivery is done and some contracts aren't monthly. It is clear to me that any short that couldn't get what his contract was going off the chart at on the spot market would surely force delivery and any long that could store or resell oil at a price higher than his delivery price would do so. Remember in futures you have to have an exit plan and the other side of the equation determines what that is. The idea the whole world gets a long position and then gets out of the door of the burning theatre unscathed over and over again is to believe in Santa Claus and the tooth fairy and a story as to how they show up most Aprils to help the Easter Bunny hide eggs. I might also note that something was going on to drive the demand for oil from the under 70 million barrel level to the mid 80's in less than 10 years.

[Higgenbotham]

One of the posters makes the mistake of assuming you can buy a futures contract and get delivery at any time, but this is not true. There is only a window every month where delivery is done and some contracts aren't monthly.

In November of 2007 I owned some Comex gold and silver receipts. I got a bid for some of them from a large metals dealer in Dallas who had an account with HSBC where they were stored, figuring he might want them. Then I called my futures broker in Chicago to get a quote on the November contracts. He said you can't sell a November. That's a common misconception. It's open all month too--there is no window. I told him I can and he called the NYMEX floor in New York to get some quotes and called me back saying, well, I guess you can. I should also add that the head of the back office at the firm didn't know that either. I ended up selling them through the futures market as the price was better and immediately Fed Exed the receipts, was matched with a buyer the next day, the transaction was closed the following day, and the money was in my futures account the day after that. In the case of silver, the normal trading months are March, May, September, and December, but every month is opened up for delivery.

I should also say that of all the Comex receipts I ever owned, there was not one that was ever endorsed over to a private individual besides me. My conclusion from that is that very few individual investors deal directly in these markets. In fact, when I arranged to pay storage at one of the warehouses once, I asked the manager how many individual accounts they have. He said 20-25. Very few people in the world have an in depth familiarity with these markets.

So when I say I don't have that in depth familiarity with oil, that's what I mean. I don't buy and sell physical oil, do you?

From the Nymex website, 172 January silver contracts were traded yesterday.

http://www.nymex.com/sil_fut_condet.asp ... currPrev=P

As stated in a post from yesterday, I know this is not the case with oil and I don't know if there's such a thing as a warehouse receipt for oil in storage. Do you know? My guess is there is not because a deliverable lot of oil can't be separated, identified, and stored in a warehouse like a lot of cocoa, corn, or some other commodity can.

[tobyguy]

Mannfm11 wrote "I am not even going to read one bit of the nonsense posted and agree with John."

Why do you even bother replying if you aren't going to read my response? Are you that arrogant?

Also, we all could care less how much you think you know about the oil market. How much you think you know is irrelevent and arrogant.

Tobyguy