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Oil Price: Steady Up or Pullback First?
Here is a comprehensive essay on the history of oil prices and a reasonable attempt to forecast them. It come from The Oil Drum’s Australian Bureau. Readers will find a number of similarities to my recent essay in Newsletter #16. But it covers some additional ground using only a few well chosen charts. I cannot recommend strongly enough that you read it.
One of the interesting assertions in it is a Goldman Sachs estimate that current oil prices have reduced global oil demand by 5 mb/d. I’d love to know how the smartest guys in the room figured that out. If anyone is able to send me the full text from GS, I’d appreciate it.
The essay finishes on a high note. It offers two general theories of future oil price changes and tries to evaluate them. In the end the author comes out very close to where I have always been: It is really, really hard to know anything about short term future oil prices. But if you look out two or three years it is clear that they must be a lot higher.
Tags: peak oil energy investments
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5 responses so far ↓
1 KV // Jul 8, 2008 at 12:39 am
Look at the oil price chart carefully: oil is priced in the money-of-the-day.
Or, the 2002 oil cost was about $5 – in 1975 dollars, and in 1975+ the oil was near $30 a barrel in 1975 dollars. Or, oil had deflated in price through 2002 nearly by a factor of 6. Such deflation is unprecedented unless the supply is beyond excessive. It is also unprecedented that such abundance disappears in a flash, unless it is by design. Figure out for yourself. Hint: oilmen took over the politics in 2000.
Goldman fellows are under estimating the reduction in demand: as I have previously posted, there are no cars on the road after evening hours (used to be steady flow of 20 vehicles timed with signal lights). On my street, SUVs are all parked in the driveways and small cars are moving about. It used to be other way. Also there is a change in road manners: those who drive big vehicles, do not stop at stop signs, run lights, and are engaging in dangerous fuel saving techniques like shifting lanes bullying their way in. I will not be surprised if oil consumption drops by 20% or more, and fast, within a year or two.
In 70s, nearly 60 cents of a dollar earned was spent on oil and oil based products. After the oil crisis, within in a decade, we improved usages – mostly industrial – and spent 30 cents of a dollar on oil and oil based products, while our incomes were rising. From mid-1990s through today, the trend was reversing, and we are being jolted out of our laziness by high oil of today. Here is an example of change that is happening now:
From AP story: http://biz.yahoo.com/ap/080707/gm_cuts.html
…GM, the person said, also is considering wider white-collar job cuts and bringing more small cars to the U.S. from elsewhere in the world to deal with the sales slump a huge market shift from trucks and sport utility vehicles to cars and crossovers.
…Critics have said GM still has too much fat in its middle management, despite cutting white-collar employment to 32,000 last year from 44,000 in 2000.
Note the HUGE MARKET SHIFT. Honda and Toyota began their life as suppliers of fuel efficient cars.
This is just the beginning as all auto mfgrs – foreign and domestic - parts and other suppliers will adjust downward. In effect, the US auto manufacture will be down significantly and permanently. These companies will have to adapt fast to support massive restructuring for mass transport or they will disappear.
And, we as a nation, if do not adapt fast, will be known as a empire that imploded in future history books.
2 Robert Essian // Jul 8, 2008 at 3:50 am
Jim, I love the comments by all your readers. They are engaged in this very serious problem, they have their thoughts and I respect them all. The more people involved with this situation the better. Personally the subject of Peak Oil reads like a sports section. Stats, stats and more stats. All of which comes down to Pitching and Defence or in this business Supply and Demand. To me it’s the only stat. Enjoy your day Jim…
3 Robert Ferraro // Jul 8, 2008 at 7:20 pm
I read the article and found it very informative. I hope you can shed some light on a subject that was brought up in that article.
It was mentioned that the price of oil is, in the end, determined by refineries that contract for delivery of a tanker load of oil at specific time and place. The article mentioned that this was different than trading in futures, but never explained how futures trades relate to the final price that is actually paid for physical delivery.
I hope you can explain this relationship, because it causes much confusion in understanding the role of speculation.
4 Jim Kingsdale // Jul 8, 2008 at 9:00 pm
Robert - good question. I’d like to understand the mechanics of spot pricing vs. futures pricing better than I do. In general, as you know, when the front month of the futures contracts expire any contracts not liquidated in the futures market must either buy or sell real oil. The price they pay or get must be the spot price on that day. So the futures prices tend to mimic the spot (”real”) prices at the point of their exiration.
That’s the theory of how the real market is controlling and speculators only play a role to the extent that they take delivery and store the oil somewhere.
If anyone has deeper insights or references to written information, please help us.
5 KV // Jul 9, 2008 at 8:42 pm
I am surprised that many do not understand future trading, and underestimating role of speculators. Oil futures are traded world over and much of the world trading is uncontrolled. Much of the oil of the producing countries is spoken for – or contracted for long term. It is the speculators’ play on a commodity that run up or down the spot price – much like fluctuations in stock price motivated by day traders, and minute traders, shorts, etc. If a long run develops (like the oil) lots of people are making and losing monies without ever seeing a barrel of oil, or ever knowing what the heck is a barrel. Further, futures are highly leveraged, and it is a very high margin game.
Nobody ever takes delivery through playing futures unless they are plain novices. If you forgot to close your commodity future positions, you start paying storage charges immediately, while struggling to meet margin calls. In 15 minutes, you will start sweating blood as you unwind at SPOT price, or jump from window high enough to not to ever know future any more. Commodity futures are big boys and big money game.
Following is from Wiki: http://en.wikipedia.org/wiki/Futures_contract. All I can say is the line from Hill Street Blues: Be careful out there.
Settlement
Settlement is the act of consummating the contract, and can be done in one of two ways, as specified per type of futures contract:
• Physical delivery - the amount specified of the underlying asset of the contract is delivered by the seller of the contract to the exchange, and by the exchange to the buyers of the contract. Physical delivery is common with commodities and bonds. In practice, it occurs only on a minority of contracts. Most are cancelled out by purchasing a covering position - that is, buying a contract to cancel out an earlier sale (covering a short), or selling a contract to liquidate an earlier purchase (covering a long). The Nymex crude futures contract uses this method of settlement upon expiration.
• Cash settlement - a cash payment is made based on the underlying reference rate, such as a short term interest rate index such as Euribor, or the closing value of a stock market index. A futures contract might also opt to settle against an index based on trade in a related spot market. Ice Brent futures use this method.
Expiry is the time when the final prices of the future is determined. For many equity index and interest rate futures contracts (as well as for most equity options), this happens on the third Friday of certain trading month. On this day the t+1 futures contract becomes the t futures contract. For example, for most CME and CBOT contracts, at the expiry on December, the March futures become the nearest contract. This is an exciting time for arbitrage desks, as they will try to make rapid gains during the short period (normally 30 minutes) where the final prices are averaged from. At this moment the futures and the underlying assets are extremely liquid and any mispricing between an index and an underlying asset is quickly traded by arbitrageurs. At this moment also, the increase in volume is caused by traders rolling over positions to the next contract or, in the case of equity index futures, purchasing underlying components of those indexes to hedge against current index positions. On the expiry date, a European equity arbitrage trading desk in London or Frankfurt will see positions expire in as many as eight major markets almost every half an hour.
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