Jul

9

WD 40I have to admit I've never read Rolling Stone Magazine before. I read it for the first time today. I found the absence of political correctness very amusing and refreshing. I don't remember seeing the word "a-hole" used in a financial publication, especially in the name-calling type of way. Rolling Stone called John Thain of Merrill Lynch fame (who spent million dollars to decorate his office) and Cramer by that word. Latest issue has a lengthy article bashing Goldman Sachs ("The great american bubble machine") for its role in last six bubbles. I am far removed from Wall Street but it seems to me that all investment banks (and Wall Street in general) supplied the WD-40 on the wheels of bubble creation. Goldman was not a alone. It is not much worse than others with one notable exception — a lot of alums joined top positions in government — Rubin, Paulson, et. al…

From a practical perspective one factoid really made me think: oil went from $60 to $147 while supply increased and demand declined. Oil's rise was completely driven by speculators. This is important; here is why: nobody knows what the oil price should be. Thus oil producers/consumers/investors are comparing $60-$70 prices to $100-$150 prices and in comparison they appear cheap. But once you realize that $100-$150 prices were a fluke, a speculative aberration driven by pension funds "diversifying" into commodities, a one time phenomenon, suddenly $60-70 may not be cheap. In fact in the world where demand for oil is expected to drop, these oil prices may actually be expensive. Also, think what impact high oil prices had on other commodities.


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3 Comments so far

  1. Jonah Ford on July 9, 2009 4:25 am

    I read that piece and I do enjoy his style, however William Greider he is not (Greider of course authored ‘Secrets of the Temple’ and was also a writer for Rolling Stone). He is a very good bridge between gen-x angst and wall street 101. His conclusions are slightly twisted.

    From yours:

    “From a practical perspective one factoid really made me think: oil went from $60 to $147 while supply increased and demand declined.”

    One question and one observation- were those figures actually known at the time or were they revised and/or after the fact calculations? I would have to dig to confirm, but there is an a priori notion that one cannot measure 85 mm bpd in real time. A 1% error in calculation yields 850,000 bpd slop factor, which would be quite significant when ‘official’ estimates place demand at about 1 million barrels above supply.

    This is the more important factor. Even using the numbers cited in the article as gospel, demand WAS eceeding supply by nearly 1mm bpd. The notion that a slowing of inventory depletion to say 500k bpd would drive prices down is seriously flawed logic, the market would most naturally remain in price rationing mode until demand assuredly exceeeded supply, as even a slowing of stockpile reduction brings one closer to no stockpile each day. Given the crucial nature of crude oil in all economies, fear of shortage exacerbates both speculative and hedging needs. A reminder of LUV boasting on CNBC they were hedged at $80 a barrel…does not look so smart in the rearview mirror.

    Was LUV mad speculating on a price spike or were they buying $80 crude as a CYA manuever in a tight market?

    “Oil rise was completely driven by speculators.”

    Answer- LUV was hedging, Jetblue nearly went bust at $150 a barrel for not having a hedge, which looked pretty smart in the rear view mirror. Neither were speculating beyond managing business risk to the best of their abilities. All is not so simple in the crude oil market as our friend at RS would have us believe.

    “This is important, here is why: nobody knows what oil price should be.”

    1- How much would the last barrel of oil cost?
    2- Everyone knows what the oil price should be. At $10 gas I take the bus. At $100 crude the petroleum based barbie doll manufacturing plant in Shanghai can no longer offload product to the Dollar Stores for 80 cents. Production halts, demand curtails. USAF on the other hand will pay whatever it costs to fill the B-1 bmbers protecting the border. $300 crude, no problem. There is no “correct” value of oil, it is an input cost in everything from hog farming to DRAM production.

    “Thus oil producers/consumers/investors are comparing $60-$70 prices to $100/$150 prices and in comparison they appear cheap. But once you realize that $100/$150 prices were a fluke, a speculative aberration driven by pension funds “diversifying” into commodities, a one time phenomena, suddenly $60/70 may not be cheap.”

    I would again have to dig it up, but there was a pointvery near the top in crude oil where approximately 6 nations were ‘cut off’ from traditional channels for Bankers Acceptance notes, thus crippling those countries from replenishing crude oil inventories through imports for lack of financing. This seemed an open secret at the time but seems to have dropped down the meory hole. Suspension of exports to 60 countries flips your 1 mm bpd deficit into a very large surplus without imposing any visible restraints in the marketplace. This is more likely what transpired with crude oil’s demise.

    “In fact in the world where demand for oil is expected to drop, these oil prices may actually be expensive. Also, think what impact high oil prices had on other commodities.”

    Most certainly a great deal of impact on all commodities, and the long-only funds were fuel for the fire as well. But the notion of crude demand falling off is difficult for me to accept, I still see billions of Chinese and Indians (or how about the BRIC’s et al) on bicycles who would much prefer a Beemer. Demand potential remains staggering, are we witnessing a dissipation of our love for all things petroleum or is the momentum of global consumerism merely being pent up to explode as soon as sufficient capital returns to facilitate another ‘bubbling’?

    Food for thought, I appreciate your comments on the story and hope you don’t mind my interjection.

  2. jeff watson on July 9, 2009 11:59 am

    It would be good to consider the effects on agriculture, especially the grain markets, that $145 oil caused. In the upper Midwest, there simply was no wheat to be had, and cash Spring Wheat traded over $26/bu for a short time. World grain stock carryover was in a short supply, despite the increased corn supply — and there was a poor wheat crop that year. The resulting dislocation in the grain markets shows the dramatic effect of government incentives and is a great example of the law of unintended consequences.

  3. Jason Brown on July 10, 2009 9:03 am

    Readers might also be interested in "The Big Takeover", another great article by Matt Taibbi. Welcome to the brave new world of crony capitalism and say goodbye to free markets.

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