Sunday, March 13, 2011

notes on the past week & thoughts on oil speculation…

it's hard to write about the week just past without mentioning the devastating earthquake in japan, but there's not much i could say that would add to what you've probably already seen if you've caught any news at all; just to put that 8.9 earthquake in perspective, the energy released by that movement was nearly 800 times greater than the energy released by the 7.0 earthquake that struck haiti last year (the richter scale is logarithmic)...my GGO blog coverage on that or any such natural disaster will be limited to the economic & environmental impacts; as there's no way for a once a week blog to serve as a "breaking news" site anyhow...if you want more in addition to your regular media, End of Empire News has been monitoring the news outlets on the situation there and has been posting videos & links to updates more than once once a day since the story broke...

not much has changed in the budget debate in congress, since all we got last week was a two week continuing resolution, which only funds govt operations at last years level until march 18th...we're still without a budget for the current fiscal year, never mind the 2012 budget that obama released a little over 3 weeks ago; & right now the tea party wing in the house is digging in & refusing to compromise, even with their moderates, on their $61 billion of ideological spending cuts, in areas such as education, medicaid, air & water quality, & the weather bureau (had their cuts been enacted, you might have had no tsunami warnings) and the democrats are offering a package of around $10 billion; both proposals were rejected by the senate...at this rate, the democrats will be bought out 2 weeks at a time & the tea party will get their way...i've already explained why govt spending is not the problem, that it's the solution, so i wont harp on fiscal policy today...

something that often happens to me while combing through hundreds of articles each week is that i'll see a relationship between two on different topics where none was meant to be; one such occurrence was after encountering the adjacent chart on how much corporations werent paying their fair share to reduce the deficit; later, i ran into the wall street journal “Number of the Week”: Companies’ Cash Hoard Grows to $1.9 trillion, which bragged that "executives have been able to act with lightning speed, slashing costs during the recession and hiring only as much as they need during the recovery— tactics that have generated record profits, if not jobs" in order to accumulate the largest corporate cash hoard in history...this, while their apologists are out in force complaining that big government spending is crowding out the private sectors ability to expand & hire...

there was quite a bit of press after bill gross, co-CEO of PIMCO, the world's largest bond fund, announced in an interview that he'd totally eliminated US treasuries from his flagship "total return" fund, with most of the commentary almost implying that US debts were somehow insecure; first of all, this is nothing new; he stated he was going to divest the fund of treasuries when QE2 was first announced, suggesting that he believed with US interest rates so low, better opportunities we to be had elsewhere, and with bernanke buying, he'd be only too happy to sell to the Fed...my read on what he's up to by going so public now is that when QE2 is over & the Fed stops buying & the price on Treasuries goes down from his bad mouthing them, he'll be back in to buy them again..

another piece of media bullshit that was brought to my attention midweek was a CNBC article that alleged welfare made up 35% of national income in 2010...its origin was from the investment research firm Trimtabs, so i went to the trimtabs site and couldnt find the methodology, and couldnt put my hands on the real numbers myself quickly by searching, but i did notice that "research" being quoted elsewhere...so i sent the articles to friends at angry bear, and Kash did a proper debunking here: Government Transfers: It's All About Health Care ....but even so, calling social security and medicare welfare is just wrong; most people have been paying into those programs as insurance against aging for 40 years; to call them welfare is to call all insurance welfare...and the social security trust fund is separate from the general fund, invested in treasuries, & fully funded until 2037...so why are all the attacks being leveled at social security?  well, the trust fund is made up of Treasury securities, which are promises to pay money that the government has already borrowed & spent for other purposes back to the trust fund...so that money will now have to be repaid, plus interest, by future taxpayers to the social security trust fund...so those who want to cut social security or otherwise eviscerate the safety net want to do so in order to permit the government to avoid paying back that debt, and thereby not have to raise taxes to do it...

DESCRIPTION

last week i included a chart on the number of weeks the unemployed were without work and mentioned that according to a report by the National Employment Law Project, most of the new jobs created during this recession have been low paying…this week Krugman led a blogosphere-go-round with an article about the Falling Demand for Brains, that even the most skilled & educated were being replaced by machines; that seems to reflected in the breakdown of duration of unemployment by education chart from the Cleveland Fed here, which shows that unlike the 90s where those out of work the longest were the uneducated, those out of work the longest are now those with a college degree or more…

despite attempts by the Fed and the Treasury to whitewash it, there was progress in the foreclosure fraud investigation by the 50 state attorney generals as they sent a 27 page proposed settlement to the mortgage servicers; the banks, and especially moynihan of BofA were outraged, of course, but the blogosphere was split between those who saw the banks being rewarded and those who thought it was an improvement...as ive followed this with yves smith, im inclined to see it as she does, "A Bailout as Reward for Institutionalized Fraud"; in other foreclosure fraud news, oregon joined the handful of states to halt foreclosures based on titles transferred thru MERS...there were also a couple interesting reports out from CoreLogic; the first, that 23% of all mortgages were now underwater, amounting to over 11 million properties with a total negative equity of $750 billion, the second, that their index of home prices had declined 2.5% in january, and was now at a post-bubble low..

when the week began, the focus was on the situation in libya, and how it might impact the price of oil; as it appeared that libya might deteriorate into a protracted civil war, and with warnings of a "day of rage" in saudi arabia on friday, the price of oil had topped $106 by midweek with brent over $115, but slid back to below $101 by weeks end as the saudi situation remained controlled...there have been some ongoing discussions around the blogosphere (ie, see Krugman/Yves Smith (2) & Krugman again) as to whether the price of oil is being driven up by speculation or by fundamentals, and i got involved in one of those discussions this week...and right now, my takeaway from that is that i dont even really know what speculation is; here's my thinking...the NYMEX or WTI price we most often seen quoted is usually the price of the near term future's contract, which means right now we're seeing the price quoted for oil to be delivered in april...today's price, or the spot price, tracks pretty close to that contract...but the oil being delivered to refineries today is not at that price; its more likely at the price the refiner contracted for delivery of that oil over a year ago; some may have hedged their position with intervening trades, but i doubt that any of the oil being refined today was purchased at last week's spot price...quite similarly, neither an OPEC member nor an US independent driller would be selling the oil coming out of the ground today at the spot price, because they too would have contracted to sell their production well in advance of the time when the oil is extracted from the ground...the head of exploration for a domestic driller i know wont explore for oil or put a new drilling bit in the ground unless he can contract to sell that oil above $80, so his entire team of petrogeologists sat on their hands for a whole year when oil slid below $70 in '09...now lets examine how these logical players might respond to changing market conditions, especially as we have seen over the past few weeks...a refiner, for instance, sees in rising prices a sudden threat to his ability to get oil at what he considers a reasonable price and enters the market to contract for delivery well into the future, even locking in $115 oil just to be safe...the producer, on the other hand, holds off on contracting to sell his future oil as he believes prices will be higher in the future...so as future demand is excessive, and supply is being withheld, the price continues to rise, fulfilling the expectations of both...obviously, this works in reverse when prices are falling, and exacerbates the price move downward in the same way...

   now lets bring the "speculators" into the picture...one "proof" that they were diving prices higher was that they owned six times as many barrels of oil as could be stored at the WTI facility in Cushing OK...but by my understanding of the futures markets, for every long contract, there has to be a short; which means that someone had to have written a contract to sell that imaginary oil to those speculators who owned it...that means that at any given price (in this case, $105) there are equal numbers of speculators betting that oil would go down from that price as there are betting that it would go up...and just as we saw with the primary producers and users of oil, if those betting that it will go up believe it will continue to go up, they hold their positions and add to them, and those betting on a fall hold off their bets until the price has risen enough that they believe they can profit on the downside...for the "speculators", its always a zero-sum game; some win, some lose, but by the time the contracts in this casino expire, the only one who collects the vigorish is the bookie...

    and of course, what ive just explained about oil futures hold for other commodity or energy futures as well; for fuel, you have the same refiners who were on the buy side of the oil contracts on the sell side for gasoline & diesel, and you have companies like Fed-Ex, GetGo, and Delta Airlines buying the contracts...but who are the other players, the ones who control the day to day movements in price? if you recall the pie graph that i included with last weeks letter, the notational amount of futures contracts outstanding is five times US GDP! that amount of money at risk couldnt possibly just be a handful of bored backgammon players, could it?  if we recall the bankruptcy talk around the time of the oil spill, we heard that because it's presence in the energy markets, BP was also too big to fail; i recall that BP's "paper oil" in the derivatives market was about 10 times their known real reserves, but couldnt find a link to that, but did find that BP makes about $3 billion annually from trading operations alone...the other big players? it wouldnt surprise me to learn that russia, the largest producer of oil, would be involved with sovereign wealth fund, as well as the saudis...and possibly other big trading houses like goldman or Glencore (as i recall, the derivatives market in europe is larger than that in the US)

    so all these "speculators" are involved in setting the price on any given day, moving ten or more times paper oil daily than any physical oil is ever moved, but we still come back to the nature of the futures contract; for everyone buying a contract, there has to be someone willing to write that contract to sell imaginary oil at that same price, both parties to the speculation are at risk and large amount can be made or lost in a day, and traders like BP can even make more money by driving prices down than they can by selling oil...

   of course, we cant put that paper oil or gasoline in our tanks and use it; what we want to know is what the real supply situation is; and not are we only concerned about the price, but we have to keep in mind that any major interruption of supply could lead to the 2 block long gas lines & 10 gallon rationing similar to what we saw during the 1973 oil embargo...with that in mind, ill direct you to professor jim hamilton, whose analyzed the ability of the saudis to raise production in the event of a cutoff from libya or elsewhere; the bottom line: the saudis were either unwilling or unable to raise their oil production between 2005 and 2008 when prices spiked to $140 a barrel, and there's no reason to believe they would or could do it today...

i would be remiss if i didnt at least mention that in europe, greek, irish, portuguese and belgian borrowing costs all hit record highs again this week, after moody's knocked greece's credit rating down three notches in the face of german intransigence on the bailout package, and spanish debt was also downgraded later in the week; however, despite low expectations, EU talks on friday did produce an agreement, so we'll see in the coming weeks how far down the road that will kick the can; if you're interested in more links on this or other international news, they're at the end of this week's blog post, starting right after all the links on the developing oil crisis...

the above are my weekly comments that accompanied my sunday morning links mailing, which in turn was selected from my weekly blog post on the global glass onion…if you’d be interested in getting my weekly emailing of selected links that accompanies these commentaries, most coming from the aforementioned GGO posts, contact me...

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