Sunday, July 6, 2008

A funny thing happened on the way to the gas pump

Oil is not priced like most sane goods. The price is not a buyer, say, me, will pay today to a seller with a gallon of crude. Rather, the price is an average of the futures contracts for some percentage of the world's supply. Got that? The price is what people think it will cost off into the future, not what someone will pay right now. (I'm having trouble finding links, but this is the way it works, baybee--I used to work for an energy company and wrote rather bewilderingly complex spreadsheets to determine this stuff--I'm looking, google, don't let me down......) Ahh, here's something. Notice, the futures contract price is the same as the spot price (actual cost) for "light sweet crude) in OK.

Because the price (and this is the actual price) we all hear quoted on the radio is unrelated to the price some average jo would pay, Oil is destined to bubble.

Plus, Oil does not require inventory. If no demand, the producers just don't pump it out of the ground. So, there's no pile-up of inventory when the price outpaces the demand.

If oil was considerably overpriced, and if the price was not set by the consumer, then you would expect that at some point, buyers couldn't find sellers.

Here's one, Iran.

Here's an entire blog that discusses these ideas rather exhaustively. As a disclaimer, the geologists I worked with seemed to think that oil had peaked around 1998 (unlike the website I linked to here) however, the current drastic run up in price is a bubble. It will go down prior to its slow, steady rise back up.


mr. pink's mom said... take me back...

once upon a time, this little fmh nobody use to be a commodities broker and crude oil (CL) was a market a conservative broker like myself tried to stay away from. too volatile.

thanks for the trip down memory lane and a reminder why i got the hell out the business.

djinn said...

Mr. Pink's mom, as your (***) stop calling yourself a nobody. Don't like. Just stop now. You're not convincing me.

I saw some crazzzeeee money lost trading commodities meself. (Simply from the sidelines.) Frightening stuff. As far as I can tell, it's happening at a huge scale right now. Which investment banks will fall? Whose pension is being hollowed out as we speak?

mr. pink's mom said...

Mr. Pink's mom, as your (***) stop calling yourself a nobody. Don't like. Just stop now. You're not convincing me

first of all, i take pride in my nobody-ness. (did i really piss you off? sorry if i did)

second, what is (***) ?

and third, the hardest part about pitching pork bellies to podunks in peoria was watching ma and pa jones's money disappear.

the money was really good for me but the minute i joined the lds church, i was out.


djinn said...

You didn't annoy me; I just grew up with women with inferiority complexes; I now see that you are of a different breed entirely. Congrats on the job change, I'm impressed. Better to be a nobody than a somebody that abets ma and pa's money vanish.

I'm convinced that the only way to win in the current financial quagmire is to be the bank; and they keep screwing up royally (see bear stearns, etc.) So, perhaps "nobody" is the best option.

How dreary to be somebody, how public, like a frog...

Steve said...

Granted, I have to take the back seat here to you regarding the commodities market knowledge, but I'm not sure what you are saying is that bad.

For starters, the futures contracts are just a bet that the supply and demand are going to above or below that cost (depending if you are buying or selling, respectively). I understand that is different than typical supply and demand price quotes for other commodities like corn, wheat, etc.

But this is probably due to the fact that as you stated, there is no excess supply, other than our "strategic reserves" and what we are sitting on in the ground.
Again, I don't think people in the oil industry, whether they are American corporations or Middle Eastern royalties, are worried about "running out", thus it starts to become a supply chain problem.

Any disruption in the supply chain of crude between ground and refinery greatly reduces the supply, driving up price. Also, US refineries are maxed out. Thus, any problem (ie hurricane, strike, etc.) to US refineries or other refineries, decreases supply, thus price goes up. Oh, and the fact that demand is going up, makes the price go up.
I don't see any way in the short term (less than the time it'd take the US to bring a new refinery online) the price for gas, which is the true inflationary culprit (besides heating oil for some), for prices to come down.
I do believe there is a bubble, but unless investors over react, which I bet they probably will (a huge negative to the informational age), it shouldn't be as bad as the housing or tech bubbles.
In other words, I have money in oil AND other commodities just in case, haha.

djinn said...

Consumption of Gas has been going down. I don't think the refineries are maxed out; if this were the case there would be gas shortages, which I certainly haven't seen. Any long lines at the pumps in your neck of the woods? Its a bubble. It's the next bubble. Its where hedge funds, et al., are parking their money after housing blew up in their face. That is, the price increase is being fueled by speculation, not true demand.

The point with inventory is not that our strategic reserve is our inventory, but rather, producers just don't have to pump oil out of the ground quite so fast if there is falling demand, so actual inventory (in the barrels of oil sitting around on a loading dock sense) doesn't develop.

September? Popped?

Steve said...

Well, it's down almost 10% the past few days, so maybe you are right! I actually like the price being high, I think it is good for our country to get off the cheap oil Kool-aid.

tamar said...

I find myself agreeing with both djinn and Steve in both posts. ( Maybe this means I don't understand the issue.) Since oil is nonrenewable, one would expect the price to rise continuously. If the rate of price increase outstrips other investment opportunities, investors will naturally want to hold on to their oil holdings; of course this contributes to a spiraling escalation in oil prices. As the price goes higher, fewer investors are willing to sell, so the price shoots up making oil an investment that no one would want to part with.

The current upswing is most certainly a bubble, but could be good for economy in the long run if it gets people focused on reducing oil consumption. The next generation will look back and wish that oil prices had been even higher during this period, because that would have preserved more of the resource for them. In a way futures markets can protect the interests of people down the road. We just have to hope that there will not be too many retirement plans that tank when the bubble bursts.