If there were just end users consuming only the minimum of oil they need and upstream producers operating at maximum capacity and that’s how oil prices were determined - how much simpler our investing lives would be. We could see that old oil fields are declining a la Hubbert and new demand is exploding a la Chindia and prices would rise gradually as a constant stream of oil users become gradually priced out of the market. But alas, real life is so much messier.

The Consumer Class Expands, Ironically, With Higher Oil Prices

One complication obvious to all is that in addition to “real” users there are “speculators.” Egads! Not speculators!! Actually, it’s worse than that. We think of speculators as those rich Park Avenue and Greenwich over privileged high testosterone jerks who just feed off the misery of consumers. I have news. The specs nowadays come in a whole lot of shapes, sizes, and organizational structures.

Some financial writers are advising mere mortals who don’t live anywhere near New York to hold gold and oil ETF’s in their “cash” accounts as a way to keep up with inflation. With ETFs just a simple mouse-click away, Joe Investor can easily substitute gold and/or oil for cash, and bingo, he is inflation protected. This is a trend that is non-trivial now but could really take hold as inflation accelerates. In fact, it could become a self fulfilling prophesy by pushing down the dollar and up the price of oil which then cycle through the real economy further raising general price levels - and inflation fears. And so on.

Another new class of oil buyer, institutional investors, are using these same ETFs for a slightly different purpose. Pimco and many other managers are increasing their allocations to commodities as an “investment category” - not for trading or inflation hedging. As one “local” trader interviewed on CNBC recently observed, such institutional category allocations take substantial inventory out of various futures markets and add to the long side on a “permanent” basis. The impact on the price of oil is the same whether a fund buys an oil ETF as a long term investment or a “speculator” buys a tank farm and fills it up with oil.

Speaking of filling up tanks, one of the most prominent speculators nowadays are certain well respected countries. The growth of strategic oil reserves in China, the U.S., Japan, and a growing list of other countries is no more than rampant speculation. Price and profit are not the object of this speculation; security is the motive. But the effect is identical. Rumor has it that India will start an SPR soon.

Another rumor is that major corporate oil users like airlines are starting to hoard a collection of long dated oil future contracts in order to put some predictability into their financial projections by stabilizing their future costs of fuel. In fact, when you think about it, why wouldn’t a lender to an airline now require the company to lock in its fuel costs over the term of the loan by buying long dated futures? That seems to be the only rational way for a bank to feel secure in lending money to an airline today. There may not be enough long dated oil and distillate contracts to make all the banks happy.

So now various sorts of folks are buying oil for purposes other than to use it. Besides you and me, the innocents, filling up our cars and trucks, it’s also now the institution trying to invest like Yale (”be diversified across asset classes”), the private citizen afraid of inflation, corporate users of oil looking for cost predictability and various oil importing countries looking to enhance national security. Add that all up and you get a LOT of demand. And that does not even count Chindia and the oil producing countries like the Middle East and Russia where basic demand is growing at near double digit rates.

I could be wrong, but it strikes me that these various types of oil buyers who are not planning to consume it in the short term are more likely to increase their oil purchases over time than to decrease them as oil becomes scarcer and more expensive. The same is true of oil demand in the oil producing countries. There we know that rising oil prices swell their treasuries and lead to more in-country oil demand. Bottom line: whether the OECD experiences recession or not, oil demand is growing much more rapidly than reported numbers indicate.

Supply is Stymied

And then there is a second complication to consider. What about those faithful oil producers going full tilt to produce whatever oil they can? Well, that world is gone. For one thing, oil producers have so much money from higher oil prices that they don’t need to produce at “Hubbard capacity” in order to have all the money they want. For another they want to leave some oil in the ground for future generations as the King of Saudi Arabia recently proclaimed. You would too. It only makes sense. For a third thing, even if you want to produce at full tilt, as Brazil does for example getting sufficient manpower and equipment to do so is increasingly difficult.

Moreover, life in all producing countries is not as honest and uncomplicated as in Saudi Arabia. Some places, like Russia and Mexico, cut off investment to limit new production. Some like Venezuela, Nigeria, and Iraq face violence and incompetence that limit new production. Some, like the good old U.S. of A. and Canada claim environmental purity as a reason to restrict oil production. All these countries might be producing more oil than they are. The fact that they are not is a form of hoarding by them, whether intentional or not.

Hoarding, the Theme Song of the Age of Expensive Oil

Take a step back and it becomes quite apparent that all these various forms of oil hoarding on the part of both consuming and producing entities is swelling. Higher oil prices that cause increasing anxiety will produce even more of this same behavior. In fact, hoarding could become the determinative set of human actions that make oil so expensive that the world will finally have no choice but to accelerate its transition to the ultimate solution: electricity-driven transportation.

In this sense, hoarding may save the bacon for humanity (forgetting for a moment the enormous human tragedy of those priced out of the oil market and into unemployment and, for some, starvation). In a purely macroeconomic sense, hoarding may be the healthiest form of behavior that we human beings could possibly be taking at this point in history. It may finally force us to move in the direction that nature is dictating, toward electric transportation. And it will conserve some oil to make what we have last longer.

Now, if only we could stop our dumb politicians from yammering about the high price of oil and instead focus on facilitating the future we must inherit.

Tags: peak oil energy investments

This entry was posted on Thursday, May 22nd, 2008 at 6:52 pm and is filed under Energy Policy, Hoarding, Peak Oil, Price of oil. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.