Why I'm not into oil or oil stocks

[c1ue]

http://seekingalpha.com/article/4754...-crude-over-80

I don't know if this is true - but it would seem that the non-delivery of spot oil contracts (20M cancelled in one example) would affect prices.

Again, my caution was not because of specific knowledge of a scam, but in the belief that any huge overhang of derivatives vs. actual deliverables made lots of room for manipulation.

October table from the link above - much more in link:

Date   Oct Close   Volume   To be delivered  Cancelled since 9/9
9/11  $76.60        296,467   266,423            22,577
9/12  $79.91        291,803   248,609            40,391
9/13  $80.09        302,927   249,619            39,381
9/14  $79.10        237,513   197,270            91,730
9/17  $80.20        257,062   171,442           117,558

The corollary to this - of course - is that if there is manipulation, the reversion to 'true market' prices will be head-spinningly fast.

[Rajiv]

Re: Why I'm not into oil or oil stocks

Another derivatives futures iisue -- similar to what I discovered exists with Index Futures

[GRG55]

Re: Why I'm not into oil or oil stocks

http://seekingalpha.com/article/4754...-crude-over-80

I don't know if this is true - but it would seem that the non-delivery of spot oil contracts (20M cancelled in one example) would affect prices.

Again, my caution was not because of specific knowledge of a scam, but in the belief that any huge overhang of derivatives vs. actual deliverables made lots of room for manipulation.

October table from the link above - much more in link:

Date   Oct Close   Volume   To be delivered  Cancelled since 9/9
9/11  $76.60        296,467   266,423            22,577
9/12  $79.91        291,803   248,609            40,391
9/13  $80.09        302,927   249,619            39,381
9/14  $79.10        237,513   197,270            91,730
9/17  $80.20        257,062   171,442           117,558

The corollary to this - of course - is that if there is manipulation, the reversion to 'true market' prices will be head-spinningly fast.

The author of the original article would be an excellent candidate for Congress, where he can embarrass himself further in televised public hearings grilling nefarious oil company CEO's, thereby providing comic relief from the burdens of everyday life for the rest of us. His article is a specious dissertation authored by someone who is either lazy, uninformed or intellectually dishonest - journalist traits that today, regrettably, appear in the ascendant with no imminent danger of reversal.

Very little physical (real barrels of oil that are actually sold and delivered by producers to refiners) exchanges hands at a daily spot price.

Producers, traders of physical, refiners, and consumers all use the paper (derivative) market to hedge price and manage risk as part of their normal course of business. Like any such market, in its original incarnation, the speculators that took the other side of the trades were an essential ingredient to make a market.

However, as with the rest of the FIRE economy, the oil derivatives trade has exploded exponentially and paper "virtual" barrels now completely dwarf the roughly 85 million real barrels that come out of the ground each day. For the author to imply this blizzard of derivative confetti is some seditious conspiracy of "Big Oil" is ludicrous - that is analogous to blaming the massive growth in the CDO mortgage backed securities pyramid on the Homebuilders or Property Developers. The producers, physical traders, refiners and consumers in the paper market are now outnumbered, and often outgunned, by the legions of "professional traders" that man the energy prop desks at Goldman, Morgan Stanley, and friends. These hyper-traders (Aaron Krowne's apt description) rake off an enormous amount of economic rent without ever getting anywhere near a drilling rig, tanker or refinery - it's a great gig if you get it. To my knowledge they have contributed not a single drop of physical oil to any customer, anywhere, ever. Yet they are conspicuously absent from every forum or public hearing into oil pricing (hence my disparaging opening comments about clueless Congressmen and journalists).

C1ue: Don't confuse the FIRE economy paper derivatives oil trade with the real economy business of finding, developing, producing, transporting and refining energy so that you can fuel your car, heat your home, and your family can enjoy a quality of life unparalleled in human history. The elected representatives in D.C. are doing a splendid job in the confusion trade - your time is better spent here with us on iTulip
Kindest regards, GR.

[Finster]

Re: Why I'm not into oil or oil stocks

The author of the original article would be an excellent candidate for Congress, where he can embarrass himself further in televised public hearings grilling nefarious oil company CEO's, thereby providing comic relief from the burdens of everyday life for the rest of us. His article is a specious dissertation authored by someone who is either lazy, uninformed or intellectually dishonest - journalist traits that today, regrettably, appear in the ascendant with no imminent danger of reversal.

Very little physical (real barrels of oil that are actually sold and delivered by producers to refiners) exchanges hands at a daily spot price.

Producers, traders of physical, refiners, and consumers all use the paper (derivative) market to hedge price and manage risk as part of their normal course of business. Like any such market, in its original incarnation, the speculators that took the other side of the trades were an essential ingredient to make a market.

However, as with the rest of the FIRE economy, the oil derivatives trade has exploded exponentially and paper "virtual" barrels now completely dwarf the roughly 85 million real barrels that come out of the ground each day. For the author to imply this blizzard of derivative confetti is some seditious conspiracy of "Big Oil" is ludicrous - that is analogous to blaming the massive growth in the CDO mortgage backed securities pyramid on the Homebuilders or Property Developers. The producers, physical traders, refiners and consumers in the paper market are now outnumbered, and often outgunned, by the legions of "professional traders" that man the energy prop desks at Goldman, Morgan Stanley, and friends. These hyper-traders (Aaron Krowne's apt description) rake off an enormous amount of economic rent without ever getting anywhere near a drilling rig, tanker or refinery - it's a great gig if you get it. To my knowledge they have contributed not a single drop of physical oil to any customer, anywhere, ever. Yet they are conspicuously absent from every forum or public hearing into oil pricing (hence my disparaging opening comments about clueless Congressmen and journalists).

C1ue: Don't confuse the FIRE economy paper derivatives oil trade with the real economy business of finding, developing, producing, transporting and refining energy so that you can fuel your car, heat your home, and your family can enjoy a quality of life unparalleled in human history. The elected representatives in D.C. are doing a splendid job in the confusion trade - your time is better spent here with us on iTulip
Kindest regards, GR.

You make a good point, GRG55. Speculators weren't just invented in the past couple years. Something else has to have changed in order for oil prices - due to whatever cause - to now be doing what they're doing.

In this case, it's not about the oil. If it were, then how do we explain similar price action in wheat? And numerous other commodities? And is it mere coincidence that this has really picked up momentum as the Fed and other central banks have been printing money to bail out speculators in the credit markets?

I don't think so. When you see numerous prices rising in sync, the logical place to look is not for supply and demand factors for each one individually. Global stocks, oil, gold, agricultural commodities - denominated in dollars - have all been on a tear, for one common reason: people are fleeing dollars.

[Jim Nickerson]

Re: Why I'm not into oil or oil stocks

You make a good point, GRG55. Speculators weren't just invented in the past couple years. Something else has to have changed in order for oil prices - due to whatever cause - to now be doing what they're doing.

In this case, it's not about the oil. If it were, then how do we explain similar price action in wheat? And numerous other commodities? And is it mere coincidence that this has really picked up momentum as the Fed and other central banks have been printing money to bail out speculators in the credit markets?

I don't think so. When you see numerous prices rising in sync, the logical place to look is not for supply and demand factors for each one individually. Global stocks, oil, gold, agricultural commodities - denominated in dollars - have all been on a tear, for one common reason: people are fleeing dollars.

Finster, I am sorry, but I don't follow what you wrote. I anticipated you would end your comments with something like "dollars are losing more value, thus the items priced in dollars are taking more dollars in order to buy the items." How does "fleeing dollars" make the prices of commodities increase?

[c1ue]

Re: Why I'm not into oil or oil stocks

C1ue: Don't confuse the FIRE economy paper derivatives oil trade with the real economy business of finding, developing, producing, transporting and refining energy so that you can fuel your car, heat your home, and your family can enjoy a quality of life unparalleled in human history

GRG,

Thanks for the pointer.

The reason I put this up was not that I believe there is some conspiracy, but that the derivatives overhang is much larger than actual production.

Given this - it is possible, nay probable that there is some significant amount of 'irrational exuberance' that could be priced into oil and oil stocks. Actual or imaginary manipulation is irrelevant - it is the possibility that I don't like since this type of thing is 100% out of analysis or hedging against.

The oil industry certainly wouldn't go away if oil prices drop to $30/barrel, but their profitability would. Any major drop in oil prices due to 'animal spirits' exiting this space would smash the sector - again I don't consider this probable but I do factor it as a risk.

As for speculators always having been around - this is true but you would have to admit that the speculator's have more money in late stage bull markets than in the bear markets. Between the hedge funds, banks, individual investors, and financial institutions, there is a tremendous amount of capital flying in all directions.

[GRG55]

Re: Why I'm not into oil or oil stocks

GRG,

Thanks for the pointer.

The reason I put this up was not that I believe there is some conspiracy, but that the derivatives overhang is much larger than actual production.

Given this - it is possible, nay probable that there is some significant amount of 'irrational exuberance' that could be priced into oil and oil stocks. Actual or imaginary manipulation is irrelevant - it is the possibility that I don't like since this type of thing is 100% out of analysis or hedging against.

The oil industry certainly wouldn't go away if oil prices drop to $30/barrel, but their profitability would. Any major drop in oil prices due to 'animal spirits' exiting this space would smash the sector - again I don't consider this probable but I do factor it as a risk.

As for speculators always having been around - this is true but you would have to admit that the speculator's have more money in late stage bull markets than in the bear markets. Between the hedge funds, banks, individual investors, and financial institutions, there is a tremendous amount of capital flying in all directions.

The "implied conspiracy" came, not from your post, but from the author & article you referenced - and hopefully that was clear to everyone reading my initial reply.

Regarding your second point, I would ask: In the tangible asset sphere is there now anything where the "derivatives overhang" is not much larger than actual production? If there is, it probably makes for a rather short list of acceptable investment alternatives...

...and perhaps that's exactly where we have arrived today - difficult to find value anywhere. Referring to Jeremy Grantham's "sell everything" column that was discussed on iTulip, and Finster's observations on this thread, a case can be made that the price of pretty well everything now suffers from irrational exuberance - including such exotica as modern art, fast cars, executive jets (check out the delivery backlog at Gulfstream), mega-yachts, and the homes, garages, hangars and marina's in which to stuff all this stuff.

Unfortunately, "animal spirits exiting" any of the above, as well as gold, wheat, large carat diamonds, Euros, Hermes handbags or whatever else just hit an all time record high, will probably "smash the (relevant) sector".

I understand your position, but with all due respect the global petroleum industry is an extraordinarily complex business - far from homogeneous - and therefore I would caution anyone from completely dismissing it as unworthy of consideration, or lacking investment merit, just because oil is at $80+ and paper derivative barrels outnumber real barrels. As an example (and this is an example everyone, not investment advice) - I have mentioned this recently on other threads - one may want to take a wee look at the petroleum subset of Canadian natural gas. The drillers look particularly interesting (to me). Am I talking my own book? Yes. Is there risk? Certainly. Will the prices be even cheaper tomorrow? Possibly. But to this observer the risk/reward in this truly beaten down sector looks much more attractive than buying more of whatever just hit a new all-time high last week.

I have two sayings, the second of my own creation, taped above my desk at home:

• If you want to find deep value, you have to stir around in the ashes (London based hedge fund manager Hugh Hendry).
• Anytime there is blood in the streets some of the patients die. Try to avoid the cremation candidates.

[GRG55]

Re: Why I'm not into oil or oil stocks

Finster, I am sorry, but I don't follow what you wrote. I anticipated you would end your comments with something like "dollars are losing more value, thus the items priced in dollars are taking more dollars in order to buy the items." How does "fleeing dollars" make the prices of commodities increase?

I think he means that people are preferring to exchange the dollars they have for these items (various commodities or tangible assets).

What is easily forgotten is that, in every instance, someone else, on the other side of the trade, is preferring to exchange their commodity for dollars. Therefore there can be no "net" fleeing of dollars.

Hmmm. That last sentence sounds like a monetary "Hotel California". Yikes!

Finster: Back over to you...

[Finster]

Re: Why I'm not into oil or oil stocks

Finster, I am sorry, but I don't follow what you wrote. I anticipated you would end your comments with something like "dollars are losing more value, thus the items priced in dollars are taking more dollars in order to buy the items." How does "fleeing dollars" make the prices of commodities increase?

GRG55 nailed it, Jim. The two statements are different ways of getting at the same thing. Make more bonars, bonars lose value. Even the anticipation of more bonars coming on line causes people to want them less. So they trade them for other things.

As he points out, there actually is no net flight from dollars, but the net desire to flee dollars causes the rate of exchange to shift until the new rate of exchange reflects the new percieved relative value.

[Jim Nickerson]

Re: Why I'm not into oil or oil stocks

Thanks, Finster and GR, for the enlightenment.

[c1ue]

Re: Why I'm not into oil or oil stocks

Regarding your second point, I would ask: In the tangible asset sphere is there now anything where the "derivatives overhang" is not much larger than actual production? If there is, it probably makes for a rather short list of acceptable investment alternatives...

True, but it is all relative. There are absolutely areas where the overhang is larger than 'average', and oil is one of them.

Incidentally gold is another...

I understand your position, but with all due respect the global petroleum industry is an extraordinarily complex business - far from homogeneous - and therefore I would caution anyone from completely dismissing it as unworthy of consideration, or lacking investment merit, just because oil is at $80+ and paper derivative barrels outnumber real barrels.

GRG,

I have never said oil is not a good investment - I merely stated why I don't invest in it.

I refuse to invest in anything which I don't feel I have a strong understanding for. This is why I did not short the homebuilders and other R.E. companies when I first concluded that the R.E. boom was ending - not because there wasn't money to be made, but because I don't like putting major parts of my money on securities that I have no experience in nor a strong understanding of. You can be right in general and still get killed by factors not known due to inexperience with the sector/stock.

I've been burned before by not following these rules, though fortunately not badly in all 4 instances.

The derivatives overhang in oil is a major factor; the other is that I am still not convinced that - in the short term - a true recession in the US will not (as historically been the case) drop the price of oil.

Lastly oil/oil stocks are richly valued. There is money to be made there, but not enough to justify a major risk.

As I've noted before, I will 'back up the truck' when I see a decade long investment - i.e. 4x or greater multiple with 90%+ probability, but oil/oil stocks are not in this category either.

Then there is trading - I'm starting to watch a few oil stocks, but I don't have enough experience to want to do that yet either.

[GRG55]

Re: Why I'm not into oil or oil stocks

...I refuse to invest in anything which I don't feel I have a strong understanding for. This is why I did not short the homebuilders and other R.E. companies when I first concluded that the R.E. boom was ending - not because there wasn't money to be made, but because I don't like putting major parts of my money on securities that I have no experience in nor a strong understanding of. You can be right in general and still get killed by factors not known due to inexperience with the sector/stock.

I've been burned before by not following these rules, though fortunately not badly in all 4 instances...

Fully respect your position C1ue. More investors should develop rules - they'd be more disciplined and probably more successful if they did. And for those, like you, who do - as you indicate there's no point having them if you aren't gonna follow 'em. Enjoyed the exchange regardless, and hopefully some of the others took away something useful from it. ;)

[c1ue]

Re: Why I'm not into oil or oil stocks

GRG,

If you have some pointers - I'm very open to listening and learning.

For example - what do you look for in an oil company? reserve size? reserve increases vs. production? expenses?

Also do you have an idea on the collusion factor? Most industries have some type of de-facto cooperation - in tech I know and am getting up to speed in the financial side, but I know nothing on oil/natural gas.

[BlackVoid]

Re: Why I'm not into oil or oil stocks

I am no invester, just an educated amateur, but I would not invest in oil or oil companies either. Oil companies depend on geology and technology. Unknown surprise factors or political developments can have huge effect on a company.

However, there are other ways to benefit from the oil sector: companies that make equipment for oil projects. There is a huge demand for drilling rigs, pipelines and related assets. Even if you do not believe that Peak Oil is coming, oil is not getting any easier to get. It is now always deeper wells, more rigs, more holes, new pipelines are planned all over the world, etc. Companies that make oil related equipment are good buys IMHO. It is also much easier to understand these companies than an oil company.

[GRG55]

Re: Why I'm not into oil or oil stocks

I am no invester, just an educated amateur, but I would not invest in oil or oil companies either. Oil companies depend on geology and technology. Unknown surprise factors or political developments can have huge effect on a company.

However, there are other ways to benefit from the oil sector: companies that make equipment for oil projects. There is a huge demand for drilling rigs, pipelines and related assets. Even if you do not believe that Peak Oil is coming, oil is not getting any easier to get. It is now always deeper wells, more rigs, more holes, new pipelines are planned all over the world, etc. Companies that make oil related equipment are good buys IMHO. It is also much easier to understand these companies than an oil company.

Interesting comment. Can you elaborate on why you think that? Or is it strictly related to the geology and technology issues you identified at the beginning?