During the oil price runup of 2008, economists liked to harangue market participants and observes who thought a move that rapid could not be solely the product of fundamentals. Where were the inventories, they demanded. If the price was “too high” as in excess of supply and demand, surely there would be excessive inventories.
There were reasons the story wasn’t that simple (oil consists of multiple grades, pricing is not based on spot or the nearest futures contract, but on a formula, there were in fact diesel inventories building up in China, and because oil storage capacity is limited, it is often “stored” by not pumping it).
Now we have the specter of oil bumping up against above ground storage, and no sign that things will get better soon.
From the Telegraph (hat tip reader Michael):
Rotterdam, Europe’s biggest port, is running out of room for more oil, US reserves are at a 19-year record and tankers are being used as floating storage off Britain’s south coast, even though OPEC is reducing production.
“From a commodities point of view, world trade is appalling and the demand is just not there,” said Ahmad Abdallah, commodities analyst at Gavekal, the economics consultancy. “All inventories are rising – they are bursting at their seams.”
Oil prices rose to a five-week high last week above $53 a barrel in line with the recent bull run on the world’s equity markets.
Yet despite an OPEC decision last November to cut output by a record 4.2m barrels a day, a move which began to come into effect in February, the fall in demand has been even more striking.Goldman Sachs estimated last week that global storage capacity could be exhausted by June….
Mr Abdallah said official estimates of oil usage for this year had been based on more optimistic assumptions than economic reality.
An average of analysts’ predictions reckons on a reduction in demand of 1.5m barrels a day for 2009 over last year, while the International Energy Agency is predicting a fall of 2.5m barrels, but an estimate based purely on current economic growth figures would put the overall decline at 3m.
He said it was a similar story in other commodities, with companies building up inventories while prices were cheap. “I can’t see demand picking up for the rest of this year,” he said. “Even if it picks up next year it is going to be from a very weak base.”
Goldman Sachs set a price target 10pc lower than at present, at about $45, for July, while Peter Voser, chief financial officer for Royal Dutch Shell, told reporters last week that it was “difficult to see an uptick in the oil or gas price” in the next 12 to 18 months…
“The further (the oil price) rises, the more sceptical you become,” said Mark Pervan, head of commodities research at ANZ. “We are operating in a global recession and oil markets are a proxy for global growth.”
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but are invetnories rising because:
– the contango can be played profitably only by taking physical delivery;
– supply outpaces demand.
if the latter were true, then prices will be falling, but since they are not for some time (even rising), the former seems the more likely reason.
I think there are two explanations:
1. speculative purchase of more and more days of future deliveries
2. rising marginal costs at producers
“During the oil price runup of 2008, economists liked to harangue market participants…”
I think you’re pulling punches here. Paul Krugman provides traffic to this site and often writes superb columns. That doesn’t mean he should be given cover for mistakes–especially since he has yet to acknowledge any mistake in “The Oil Nonbubble.”
http://www.nytimes.com/2008/05/12/opinion/12krugman.html
Who else are you talking about?
If everybody recalls, phil verleger put forth a study last year (actually late 07 — go to page 11 if you want to skip to the chase) that talked about how much effect that the US’ daily purchase of crude for the SPR had on the price of oil…something like 30k bbls per day of WTI were being stuffed in the salt caverns right when oil was starting to make everyone’s noses bleed. So over a six month period that amounts to about 5 or 6m total barrels taken off the market. i’m pretty sure he said it added 15-20% to prices.
Now, the fact that the private sector is now effectively doing the same thing, but on a much bigger scale — 100m bbls in 6 months floating at sea, plus another 25m in finished products, so not even counting land-based storage — i think this is overwhelmingly the reason for the perfect positive correlation between inventories and prices over the last few months.
(btw…I still don’t buy the dollar/oil rule.)
Excess speculation, i.e. speculation not related to price discovery has dominated oil markets since 2004. You can go back and look up the year over year price increases. This should surprise no one since this is when the housing bubble really took off and limits on leveraging were removed. In other words, housing was never the only bubble in town.
I have never understood why people are so attached to the idea that supply and demand drives oil markets. I suppose it is a residual belief in markets as efficient price setters. I don’t know if this was ever true, but it hasn’t been true for years that I can see.
If you look at the shape the world economy is in and you figure that the rational price for oil should be in the $45-50/bbl range, then the current price of oil should in these deflationay times be trading in the $30-35/bbl area. That today’s near futures price is $55.90, (and yes, with the current high inventories) should tell you that speculation is back. Goldman and some of the other players have been pulled back from the brink. They have access to credit lines through the Fed and FDIC, so it’s really back to business as usual for them, and that means speculation.
I think too that it is funny that Goldman as one of the leading gamers of oil prices should also be the source in the Telegraph article for future directions in them. That’s a real fox meet henhouse moment.
Oh and mxq, world daily oil consumption is ~85 million bbls of oil a day so any purchases of oil for the strategic reserve doesn’t amount to even a blip on the screen.
“Oh and mxq, world daily oil consumption is ~85 million bbls of oil a day so any purchases of oil for the strategic reserve doesn’t amount to even a blip on the screen.”
ok, fine, don’t read the study…i’ll just summarize it:
– less than 1/4 of the world’s supply is WTI
– less than half of that (so 1/8 of the total supply) is available for purchase on the market
– so roughly 10m bbls of that 85m is WTI…sometimes its 5m per day sometimes 20
-DOE’s SPR action took between 0.1 and 0.5 percent of the sweet crude supply from the market.
-the price elasticity of demand for WTI crude is -0.04
-Therefore, the elasticity Verleger cites says that a reduction similar to the DOE’s would require a price increase of 5-20%.
Finally, while not all the bbls floating at sea are WTI, i’m guessing the proportion is roughly the same as the DOE’s sweet/sour mix. As a result, theres a really good chance its a multiple of what the DOE was depriving the market of, and therefore would have a much larger impact on WTI prices than the DOE every did.
Perhaps a tactic that would make sense to OPEC could be to increase production to force prices down to the point where the speculative hoarders have to exit; and then cut production again. It seems to me that control of oil prices is in the hands of Fed-backed bankers rather than producing countries at this point. Since OPEC’s interest is to have oil prices at a level just high enough to avoid consumers switching to alternative energy sources, it’s surprising that there hasn’t been more heard about putting in limits at the CFTC for oil traders similar to the regulations in place for agricultural commodities.
@Hugh
Why would the “rational price” for oil be in the 45-50 $ range?
Regarding the “blip on the screen”: If 1.5 days of world consumption is added to reserves over a 6 month period, that equals nearly 1 % of world demand during that period. 1 % demand more or less can certainly move the price.
mxq,
I think you are using light sweet crude as a synonym for WTI.
West Texas Intermediate is the benchmark grade for establishing prices in the US and Western Hemisphere markets, not the world market.
The US produces something like 5 million barrels of oil a day and only about a quarter of that comes from Texas and only some percentage of that is actual WTI. So we are not talking about a huge amount in either terms of the world market for liquids ~85 million or the US market ~21 million but I digress.
The real kicker is the idea that an elasticity factor has any meaning in a market that is driven by excessive speculative pressure. Indeed since such speculation has been going on for the last 5 years, I wonder what kind of data set could be used to establish a baseline for this elasticity factor.
In addition to speculation, there are other much bigger factors that affect the price of oil: hurricanes, wars, the threat of wars, political instability, etc. These would mask even further the effects of small contributions like SPR buys to the overall supply-demand equation for the US and the world.
Thomas, I think Hugh meant that oil prices based on fundamentals such as cost of production/demand/supply would be much lower than the present prices which, if one bothers looking into the history of oil pricing regimes on one hand and of composition and size of commodity ‘players’ on the other, can be seen to have been financialized, i.e. causality runs more from the financial to the real than vice versa, something folks like Krugman refused to admit as it interferes w/theory.
Thomas,
Oil prices were seen as unusually low in the 1990s when they were in the $20s for most of that decade. When they increased at its end to $30 or so this was seen as a realistic correction. If we add in the 8 Bush years of inflation, devaluation of the dollar in relation to other currencies, greater costs for extraction, that gets us up to the $45-$50 range.
In a deflationary phase, it would be expected for prices to drop below these levels. They fell to the $30-$35 range and they did so when the excess speculation money had fled the market. I do not see economic conditions improved since then so that is where I think oil prices should currently be.
If you are looking for a specific formula for this, there isn’t one. And if anyone told you they had one, they would be BS-ing you.
Also you have to put current pricing in its proper context. I once wrote up what I called my Iron Laws of energy and one of them was that oil in the short term was way overpriced (excess speculation) and in the long term absurdly underpriced (peak oil).
Hugh…good point…for whatever reason i went on autopilot and slapped WTI everywhere instead of light sweet…but the conclusion of the study doesn’t change as the study was done using light sweet and the SPR’s effects on light sweet prices…so it did ecompass worldwide demand — brent, wti, bonny light, etc. (not just wti).
“Indeed since such speculation has been going on for the last 5 years, I wonder what kind of data set could be used to establish a baseline for this elasticity factor.”
Verleger cited the study (which can be found here) that figured this out, but if you go to page 4 it says:
“We estimate that the
one-year price-elasticity of demand for crude oil in the U.S. for the period
1970:Q1 to 1995:Q4 was -0.04″