Comments on: Robert Bryce on Oil Speculation

By: posvex

posvex — Fri, 09 Jul 2010 04:44:58 +0000

Any discussion about oil demand/prices over the next decade must include an attempt to quantify emerging economy demand as an important driver at the margin. Here is a simple thought experiment using Chinese demand to generate some rough “back of the envelope” forecasts:

- China moves from 3 bbls/person/year to the South Korean per capita consumption level of 17 bbls/person/year over the next 30 years
- No peak in global production

Result: In next 10 years we must find 44 million BOPD – 26 million BOPD to maintain supply and 18 million BOPD to keep up with demand increases.

If you superimpose peak production on top of this demand profile using the following parameters oil prices would increase approximately 250% in real terms over next 10 years – something would have to give far before that price level:

- Oil demand elasticity of -0.3
- Current production 84 million BOPD, current price US$ 80
- Peak production 100 million BOPD
- Post peak decline rate of 3-4%

If you want to try the model for yourself using your own assumptions it can be found at Petrocapita in the “Research” section: http://www.petrocapita.com/index.php?option=com_content&view=article&id=128&Itemid=86

By: Richard L. Gordon

Richard L. Gordon — Mon, 12 Jan 2009 22:04:55 +0000

Blaming speculators is a lazy man’s way to deal with markets. It is what we would expect from Sixty Minutes but bad economics. Speculators simply make their best guesses about where the market is heading. If the fundamentals are not there, others will enter and correct the price. This is particularly true of the oil makers where many of the participants are major participants in the physical market.

By: Kevin Duffy

Kevin Duffy — Mon, 12 Jan 2009 05:34:36 +0000

Ah, the dreaded “speculator,” the perennial whipping boy of anti-capitalists. What is so evil about the speculator? Just like the entrepreneur, he makes judgments about the future, risks his own capital, and is the bearer of uncertainty. If his crystal ball is clear he profits and expands; cracked and he incurs losses and eventually works for someone with better vision. He allows the farmer, oil company, and refiner to offload uncertainty and risk. He is a hero, not a villain.

Co-managing a hedge fund makes me a speculator I guess, and as a short seller, one of the most dreaded kind. Last spring we began shorting crude oil around $100/bbl and backed up the track at $145/bbl. I remember friends complaining at the time that speculators were driving up gas prices and that they would continue higher. It was a conspiracy of Big Oil, OPEC, and those “greedy” speculators. I simply replied, “if you’re so concerned, put your money where your mouth is – buy a futures contract.” And I reminded them I was doing the same, taking the other side of the trade.

What caused the bubble in oil prices? A variety of economic actors – consumers, producers, and yes, speculators – bet wrong. Some bought into Peak Oil theories, others believed in the “decoupling” theory which extrapolated growing demand in the BRIC countries despite a retrenching U.S. consumer. Many underestimated the severity of global recession and ignored conservation measures crimping demand. Also forgotten is the role of Fed policy which was aggressively easing in order arrest the bursting of a massive credit bubble. Investors and speculators feared inflation and bid up inflation hedges – not just crude oil, but grains, precious metals, and other commodities. Platinum, for example, jumped 77% in just 6 1/2 months after the Fed began cutting interest rates in August, 2007.

That the future is uncertain and human beings are prone to error is a given. The question is, who is better at this endeavor, the entrepreneur/investor/speculator risking his own capital or the politician/bureaucrat/regulator influenced by special interests and risking taxpayer money? The free market – as the oil spike and collapse shows – has a feedback mechanism for correcting error. The political system has a way of ensuring the worst come out on top, as the recent presidential primaries make clear.

By: David R

David R — Fri, 09 Jan 2009 15:11:48 +0000

The elasticity of demand for oil and other energy products is subject to sticky elasticity of demand, analogous to ketchup. Tap a ketchup bottle ten times and nothing happens, yet give it a whack equivalent to 5 or so taps and out the ketchup comes. Same with energy. I still remember an executive at NNG in the seventies saying that natural gas had no elasticity of demand. That November in Omaha, people’s gas bills skyrocketed (price and temperature reasons). My bill went from $80 the prior November to $330. You have never seen a thermostat go down so fast – from 72 to 62 and out came the sweaters. Tougher to respond with gasoline, but if the price goes high enuf, fast enuf – and people think it will stick, because of the idiots in the media telling them so, they will modify their habits. Thus looks like a prime example of catastrophe theory in action in both directions.

By: Russell

Russell — Thu, 08 Jan 2009 20:10:58 +0000

Thanks… For some reason I was stuck on somewhat inelastic demand and wasn’t really considering the supply side.

By: Bob Murphy

Bob Murphy — Thu, 08 Jan 2009 16:30:52 +0000

Russell,

Even though people’s purchases of gasoline etc. are less responsive to price than for some other products, it’s still the case that when the price of oil goes up, producers sell more and consumers buy less. So if $40 per barrel is the “true” price that balances the fundamentals of supply and demand, then a price of $110 per barrel should lead producers to bring more barrels to market than end-users want to purchase.

Even if you think that the # of barrels purchases isn’t related much to the price asked, consider the supply side. Surely the owners of oil fields boost output when they get $110 per barrel rather than $40 per barrel. And indeed, world oil output rose as prices were skyrocketing, and now OPEC is cutting back to deal with the drop in price.

By: Barry P.

Barry P. — Thu, 08 Jan 2009 14:34:19 +0000

I’m an oil analyst who still believes that the oil price was cause mostly by fundamentals, for a couple of reasons.

Firstly, if the future price was artificially inflated by excess speculative demand, we would see extreme volatility in price around the contract closing date every month. We didn’t see that, except for the expiration of the October contract on September 22, in which case the price spiked up because there were too many sorts trying to settle out.

Secondly, most laypersons (and a surprising number of economists) don’t understand that prices are formed by expectations. Clearly, expectations of demand have changed drastically between July and now, and that explains most of the price decline.

When you get near a capacity constraint, supply curves become almost vertical, and huge price swings can occur on small changes in quantity consumed. That is what we have seen over the past year. It really is textbook stuff, and is a good teaching moment for those in the classroom, yet so many people remain flummoxed for reasons I can’t comprehend.

By: Robert Bryce

Robert Bryce — Thu, 08 Jan 2009 03:43:04 +0000

Let me be clear: I have never professed to be an oil price analyst.
To my mind, predicting prices in a market as complex as the oil business is a fool’s game.
That said, I appreciate Robert Murphy’s critique. I take no offense. But I will stick to my original claim, that excessive speculation was a key factor, probably the key factor, in driving prices to their July peak. As the EIA’s data shows, world oil demand peaked in 4Q07 at almost 87 MMbbl/d. See: http://www.eia.doe.gov/emeu/ipsr/t21.xls
And by summer of 2008, there was no shortage of crude. None. In fact, producers had so much crude available for sale that some Persian Gulf producers were stockpiling crude on tankers. So why the price run up in the futures market? As I stated in my piece in Energy Tribune, companies like the now-bankrupt SemGroup were taking huge positions in the futures market. I do not believe it coincidental that oil futures prices peaked on July 14 and that SemGroup got caught in a margin squeeze and was forced to unwind its positions on July 15. (SemGroup declared bankruptcy a week later.)
Yes, supply and demand is the major factor driving oil prices. And yes, worries about global supply helped drive prices up. And yes, today, the global recession is killing demand and creating excess capacity. But those are not the only factors that have been affecting prices in recent months. Looking back at what happened last summer, it’s obvious that hot money was driving the market. And now that much of the hot money has moved to the sidelines, the oil market has cooled.

By: Russell

Russell — Wed, 07 Jan 2009 14:34:39 +0000

“In other words, if the market price now equals the “correct” price of $40, whereas for much of 2008 it was above $100, then producers should have been delivering more barrels of oil to market, than ultimate end users wanted to purchase at such a steep price.”

I’m not sure I understand that point. The end users use what they need…whether $40 or $100 per barrel. So why would producers deliver “more” oil than was needed at any particular price?

I’m not trying to imply that you’re wrong…only that I don’t understand the point [probably b/c I have no formal economics training].

By: LoneSnark

LoneSnark — Tue, 06 Jan 2009 21:13:13 +0000

Quite right. It was definitely not western speculators. However, it is very likely that at least some government producers (such as PDVSA) lacked sufficient incentives and organizational ability to boost production as much as a private firm would have managed.