August 20, 2004
Inflating the oil crisis (Joe Kaplinsky, 8/20/04, Spiked)
What's behind the rise in oil prices? Not scarcity, according to OPEC President Purnomo Yusgiantoro: 'OPEC already oversupplies, but oil prices are too high.... This is not a supply and demand balance problem. This is not because of fundamental factors.'
He's right. The problem is that the markets are worried by a series of risks, in Iraq, Venezuela, Russia, Nigeria, and elsewhere, rather than that there is an oil shortage. Are the markets right to be spooked? And if the real risks don't measure up to market expectations, why are they so concerned?
First it is worth noting that, despite the headlines, oil is not at historically high prices. The headlines are only justified by ignoring inflation - which is to say, they are not justified. Record oil prices followed in the wake of the Iranian revolution - in 1981 the average price of oil was $31.77 a barrel, the equivalent of roughly $60 today. The peak price, in February 1981, was $39.00, or about $73.50 in today's money. This is substantially more than the $48 (or so) that oil actually costs us now.
Even so, set against reasonable expectations, today's prices are high - and these high prices reflect broader worries in society about energy. The most immediate concern is instability in the Middle East, and Iraq in particular. There is a common view that reliance on Middle East oil imports is a big problem: President George W Bush, as well as his Democratic rival John Kerry, is offering a plan for American energy independence. [...]
But a more interdependent world is not necessarily a more risky one. In fact the opposite is true. With respect to oil, the markets have got it wrong. The developed world is actually less dependent on energy for economic growth, less dependent on oil for energy, and less dependent on the Middle East for oil.
If only markets reflected reason rather than emotion...
Posted by Orrin Judd at August 20, 2004 11:56 AM
The fact is that there is uncertainty, and uncertainty commands a premium. It is a rational response in a market to charge premiums for risk.
The fact is, the margin of production capacity to world demand is thin, and getting thinner with rising demand in Asia. A disruption in any major producer country can cause shortages.
OJ, markets reflect beliefs, not reason. It is what you believe about the future that determines how you value market assets, not present conditions. Economies are complex systems, they are not predictable. Market actions are the result of millions of people answering on a daily basis the question that Dirty Harry asks the perps - "are you feeling lucky, punk?"
"War in Iraq. Instability in Venezuela. Civil unrest in Nigeria. Governmental wranglings in Russia. With so much uncertainty in so many of the world's leading oil-producing countries, energy prices continue a seemingly inexorable rise - provoking new speculation that the world may be heading into a period of permanently higher prices."
Have you looked at all you require for permanent high prices there?
Mookie goes down any day now.
Vlad gets what he wants from Yukos.
Fear and Greed, Fear and Greed. That is all there is.
If enough traders were as certain as you OJ, they could short the market and make a killing. That they aren't doing this so far says something.
Another factor at play is the emergence of hedge funds. The mountains of excess liquidity floating around the world is moving from market to market, inflating bubbles. Stocks have topped out, bonds & mortgage backed securities as well. Hedge funds are looking for under-inflated markets to earn some yield. This is part of the explanation of what is going on here. Inflated currencies find a way to inflate markets. That's the problem with loose monetary policies - the central banks can't direct where it goes. They can hope that it gets invested in new production capacity that will lead to jobs and income growth. But mostly it is used for speculation.
It says people are herd animals.
People don't go long in oil. If you want a long position in oil, you buy or create reserves. Given that part of the current supply tightness is lack of reserve development, that says that long contracts in oil aren't spiking like short term prices. Which implies that the markets believe, as does OJ, that the current price spike is unlikely to last for an extended period. If it were to do so, investing in reserves would be the correct play.
AOG, investing in new reserves requires a high enough price to promise an adequate return on investment. If producers weren't investing in reserves at the old price, then a return to that price won't spark any new investment. New investment assumes sustained higher price levels.
OJ, the market is a herd.
AOG, you go long in the futures market. Price action is not just decided by the end users of the oil, speculators jump into the market when they see a trend developing. The market "demand" includes real demand and speculative demand.
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