Do we have an oil bubble?

[GRG55]

Re: We have an oil bubble : the proof

...In the countries with no price controls the refiners are choosing the optimum return path according to mechanism used by that aluminum producer during the Enron scam. No one can blame them for making a few extra bucks to improve their bottom line...

Do you actually have anything definitive to support this statement? Or is it a supposition on your part?

As for the refiners trying to improve their bottom line, judging by their stock price performance they're doing a rather poor job of it so far this year wouldn't you say?

...BP says oil may tumble if financial factors removed...

Don't forget that BP is the company that:

• repeatedly refused to attribute [in their influencial Annual Review] any material resource to the Canadian oil sands;
• sold off virtually every bit of their Canadian oil sands and heavy oil assets acquired in the Amoco purchase, and purged all the employees who had any technical knowledge of same;
• now is belatedly buying back into the oil sands playing a weak hand in a joint venture deal [with Husky] at what may prove to be top dollar;
• used to be headed by someone that steadfastly and repeatedly said the "proper" price for oil was $25 while the price ran to well more than double that;
• revised that to $40 just before he retired, which apparently still remains the corporation's official view;
• is unable to replace the reserves it produces each year or meet its own corporate production targets;
• has seen its stock price fall in the greatest petroleum bull market in history.

BP thinks it knows more than it actually does...

[Supercilious]

Re: We have an oil bubble : the proof

I can think of several reasons why SWFs and national oil companies don't play well together in this theme of derivative based market distortion:

1) NOCs are in the business of making money on oil. SWFs are in the business of preserving already made wealth. For an NOC - selling 10 future years of oil production is just a management tool, for an SWF it is a naked speculation - unless the SWF can force the NOC to commit future delivery.

2) NOCs and SWFs are generally not managed by the same groups of people

It would be amusing, though, to see an Enron-style collapse in the oil market due to a sudden price turnaround forcing an ETN sponsor bank to cough up $10B in cash or oil.

The SWF's are mandated to find a better return for some of the mounds of low yield T bonds accumulated by OPEC and mercantilist currency peggers . This drive for a profitable, and safe inflation-hedged places, created the high demand for mortgage CDO's (houses are the most solid investment and the price of houses always goes up ) or commodities futures (oil will always go up because of: rapid development in China + Peak Cheap Oil+ dollar falling )

Look what happened to the Chinese investment in Blackstone.... The Chinese put in $5 billion in T Bonds and now after the subprime money (credit) destruction fest they have $2-3 billion in Blackstone non-voting shares

The funny math behind ETNs and ETN-like paper insures solid and good returns as long as the price of oil increases. As long as the price continues to increase (or for the Powershare architecture if it stays in the shear limits) this type of paper provides a guaranteed high return. No doubt about that. But if the price goes bust (or leaves the shear limits).... :p

If oil goes busts to $65/barrel.... poof goes half of the ETN value and the issuing bank get to keep all the T bonds. If the ETNs and ETN-like paper is well managed and well designed there is no direct reason for the backing bank to collapse ... this is much better than CDO's and commodity ETF's

I couldn't find any solid data even for peanut size, public traded, consumer-bait ETNs and there is absolutely nothing on private floated ETN-like (paper for big boys, SWF's etc )

As a last resort assuming: a daily global consumption level of 86mil barrels, 71% of non commercial hedging futures transactions (oil paper traders, according to Masters) and an average transaction lifespan of 90 days, if the price of oil goes from $135/barrel to $65/barrel the total global financial losses from the oil bubble bust could be estimated at about 1.3 trillion dollars.

This is a very rough estimate and anybody who can come with better numbers and better data sources, will receive from me 10 million Zimbabwe dollars in carbon emissions index ETNs backed by the highly reputable $#* Bank (terms and conditions apply) (Please, if you have better sources don't hesitate ..... I'm very frustrated after so much fruitless searching.)

If this rough estimate is valid, the subprime meltdown would be soon considered a joke (something like a $50/barrel price )

If this whole scenario is correct, there are two more interesting conclusions:
-the T Bone renewable bubble cannot be the next immediate bubble if the oil price goes bust (plus there is no way renewables can absorb $1.3 T losses in only a couple of years)
-the subprime meltdown was not even in full swing when the oil bubble was already inconspicuously gathering momentum.

IMHO that means that the next bubble (capable to absorb $1t losses from the current one) is already in initial pumping stages. But what exactly can provide a laundry machine for $1t+ of bad debt and has an undeniable prospect of appreciation when stocks, real estate , insurance, dollar and commodes are going down???

I think there is just one valid answer: the currency of countries with large reserves, artificially low exchange rates and huge forex reserves... Ok let's narrow it down...

I did some quick digging and guess what:

Michael Pettis recently has found that the Chinese government got out the blue an unexplained $75 billion dollar incease in their reserve. You can read a good article about this story in his excellent blog:
What? $74.5 billion? Is this a mistake? (Piaohiaoreport-Michael Pettis)

The Chinese government is loosing the battle with hot money inflows betting on Renminbi going up:
http://www.bloomberg.com/apps/news?p...9c&refer=china

July 7 (Bloomberg) -- China is drafting regulations to control cross-border payments for services to curb rising inflows of ``hot money'' betting on gains in the yuan, according to an official at the nation's currency regulator.
Controls on international payments for consultancy or franchising fees are ``relatively weak'' and need to be strengthened to stop speculative capital inflows, said the official at the State Administration of Foreign Exchange, who declined to be named. The regulator is consulting with agencies including the commerce ministry on details before announcing the new rules, he said.

OR

http://www.chinadaily.com.cn/bizchin...nt_6817240.htm

Stepping up the battle against "hot money" flowing into and out of China, three Chinese central governmental departments are to link their internal electronic systems from July 14 in a trial check of foreign exchange receipts and exports settlements, the State Administration of Foreign Exchange (SAFE) said Thursday.
These measures were interpreted by analysts as one of the latest efforts by the Chinese government to monitor capital flows and prevent more so-called "hot money" from flooding in and out of the country.
"Hot money" is usually defined as short-term global speculative funds moving among financial markets in search of the highest short-term returns.

Better traces of the hot money flowing into the next bubble can be found in Brad Setser's blog at the Council of Foreign Relations:

http://blogs.cfr.org/setser/

Searching at the other end of the affair, guess what a quick Yahoo session brings up ?

Chinese Currency ETN for a Bet on China

The Chinese currency, the renminbi, slipped below 7 Rmb to the dollar on Thursday. This marks a 4% gain for the currency year-to-date, the speediest since China loosened the dollar peg in July of 2005. This recent speedy increase will likely attract additional "hot money" into renminbi, adding to what is already substantial pressure for its appreciation. This is good news for investors in a new Chinese ETN, the Market Vectors-Renminbi/USD ETN (NYSEArca:CNY - News).

:rolleyes:

Everybody is free to draw his(hers) own conclusions....

[jtabeb]

Re: We have an oil bubble : the proof

The SWF's are mandated to find a better return for some of the mounds of low yield T bonds accumulated by OPEC and mercantilist currency peggers . This drive for a profitable, and safe inflation-hedged places, created the high demand for mortgage CDO's (houses are the most solid investment and the price of houses always goes up ) or commodities futures (oil will always go up because of: rapid development in China + Peak Cheap Oil+ dollar falling )

Look what happened to the Chinese investment in Blackstone.... The Chinese put in $5 billion in T Bonds and now after the subprime money (credit) destruction fest they have $2-3 billion in Blackstone non-voting shares

The funny math behind ETNs and ETN-like paper insures solid and good returns as long as the price of oil increases. As long as the price continues to increase (or for the Powershare architecture if it stays in the shear limits) this type of paper provides a guaranteed high return. No doubt about that. But if the price goes bust (or leaves the shear limits).... :p

If oil goes busts to $65/barrel.... poof goes half of the ETN value and the issuing bank get to keep all the T bonds. If the ETNs and ETN-like paper is well managed and well designed there is no direct reason for the backing bank to collapse ... this is much better than CDO's and commodity ETF's

I couldn't find any solid data even for peanut size, public traded, consumer-bait ETNs and there is absolutely nothing on private floated ETN-like (paper for big boys, SWF's etc )

As a last resort assuming: a daily global consumption level of 86mil barrels, 71% of non commercial hedging futures transactions (oil paper traders, according to Masters) and an average transaction lifespan of 90 days, if the price of oil goes from $135/barrel to $65/barrel the total global financial losses from the oil bubble bust could be estimated at about 1.3 trillion dollars.

This is a very rough estimate and anybody who can come with better numbers and better data sources, will receive from me 10 million Zimbabwe dollars in carbon emissions index ETNs backed by the highly reputable $#* Bank (terms and conditions apply) (Please, if you have better sources don't hesitate ..... I'm very frustrated after so much fruitless searching.)

If this rough estimate is valid, the subprime meltdown would be soon considered a joke (something like a $50/barrel price )

If this whole scenario is correct, there are two more interesting conclusions:
-the T Bone renewable bubble cannot be the next immediate bubble if the oil price goes bust (plus there is no way renewables can absorb $1.3 T losses in only a couple of years)
-the subprime meltdown was not even in full swing when the oil bubble was already inconspicuously gathering momentum.

IMHO that means that the next bubble (capable to absorb $1t losses from the current one) is already in initial pumping stages. But what exactly can provide a laundry machine for $1t+ of bad debt and has an undeniable prospect of appreciation when stocks, real estate , insurance, dollar and commodes are going down???

I think there is just one valid answer: the currency of countries with large reserves, artificially low exchange rates and huge forex reserves... Ok let's narrow it down...

I did some quick digging and guess what:

Michael Pettis recently has found that the Chinese government got out the blue an unexplained $75 billion dollar incease in their reserve. You can read a good article about this story in his excellent blog:
What? $74.5 billion? Is this a mistake? (Piaohiaoreport-Michael Pettis)

The Chinese government is loosing the battle with hot money inflows betting on Renminbi going up:
http://www.bloomberg.com/apps/news?p...9c&refer=china


OR

http://www.chinadaily.com.cn/bizchin...nt_6817240.htm
Better traces of the hot money flowing into the next bubble can be found in Brad Setser's blog at the Council of Foreign Relations:

http://blogs.cfr.org/setser/

Searching at the other end of the affair, guess what a quick Yahoo session brings up ?

Chinese Currency ETN for a Bet on China
:rolleyes:

Everybody is free to draw his(hers) own conclusions....

We'll I'm biased because I happen to agree with you, so take this for what it's worth, I agree with you.

You and I are running on the same wavelength about this smelling (without conclusively proving) distinctly Enron'esque. I also agree on you point that the oil bubble was gearing up as housing collapsed just as the housing bubble was gearing up as the stock bubble collapsed. EJ agrees in principle if not in substance in this case (his Haper's article talks about many more bubble being created to counter the blows from each preceeding bubble collapsing). He's not on board with our analysis on this subject at this time.

(EJ, you should listen to your own analysis, it good. Just examine how it applies in this case. I think you may end up changing your opinion.)

And, I think you are barking up the right tree in your train of thought. I've dumped my alt-E play plans for now. I think you are correct that that Alt_E bubble is a bubble cycle or two yet ahead.

I'm not dumping my really real PM's. That FIRE (pun intended) insurance is just too valuable and comforting right now.

Why I intuitively think you are correct is that at the heart ETN's are DEBT instruments, and that's exactly what's gotten us into trouble in each of the preceeding bubbles. So you analysis is consistent across the recent history of bubble collapses that we have witnessed.

Keep it up!

I'm reading (and learning) so don't pack it in.

[BlackVoid]

Re: We have an oil bubble : the proof

"If oil goes busts to $65/barrel...."

I am sorry, but it ain't gonna happen. There were a few oil bears here in January as well. They actually shorted oil from around $100. They lost a lot of money. A few of us here warned them, that it is insane but they did not listen. If you believe your own theory, go buy some shorts. You will lose a LOT of money. Oil price will rise spectacularly in 2009/2010 when the actual production declines begin in earnest globally.

The only way for the oil price to collapse in the next 5-10 years, if the world economy collapses completely. Now, that will dwarf anything, including the 1930s. BTW, it is quite likely, we are having exponential growth on a finite resource base - it is just a matter of timing.

[GRG55]

Re: We have an oil bubble : the proof

"If oil goes busts to $65/barrel...."

I am sorry, but it ain't gonna happen. There were a few oil bears here in January as well. They actually shorted oil from around $100. They lost a lot of money. A few of us here warned them, that it is insane but they did not listen. If you believe your own theory, go buy some shorts. You will lose a LOT of money. Oil price will rise spectacularly in 2009/2010 when the actual production declines begin in earnest globally.

The only way for the oil price to collapse in the next 5-10 years, if the world economy collapses completely. Now, that will dwarf anything, including the 1930s. BTW, it is quite likely, we are having exponential growth on a finite resource base - it is just a matter of timing.

As we head to $15+ natural gas at Henry Hub, I wonder if the ETNs will be responsible for that too? :rolleyes:

[Supercilious]

Re: We have an oil bubble : the proof

"If oil goes busts to $65/barrel...."

I am sorry, but it ain't gonna happen. There were a few oil bears here in January as well. They actually shorted oil from around $100. They lost a lot of money. A few of us here warned them, that it is insane but they did not listen. If you believe your own theory, go buy some shorts. You will lose a LOT of money. Oil price will rise spectacularly in 2009/2010 when the actual production declines begin in earnest globally.

Correctly calling a bubble and correctly calling the bust moment are two separate things. A lot of people got burned by betting on the premature collapse of Enron too.

I don't have any hard numbers about how much money is in ETFs , ETN's and ETN-like paper. Without a clear picture no one can make any bust predictions. If there is still a large volume of stinky swaps to recycle and a lot of excess T Bonds in search for better returns, the oil price can very well go up to $500/barel and more before a bust.

The problem is that, as always, those who do have access to hard numbers and have a clear picture don't talk, because they are too busy making money. Remember what happened last time, when Goldman quietly got rid of all mortgage CDO's exactly in time, so when the brown matter reached the mobile parts of the air circulation device they had nothing cdo-ish on their desk. I suspect this time will be the same.

The only way for the oil price to collapse in the next 5-10 years, if the world economy collapses completely.

On this one we have to agree to disagree for time being. I don't deny though a decline in oil prices would result in the collapse of China especially the loses will go in the $1t+ range. But that's another story.

As we head to $15+ natural gas at Henry Hub, I wonder if the ETNs will be responsible for that too? :rolleyes:

No. That increase is based only on fundamentals:
http://www.bloomberg.com/apps/news?p...E&refer=energy

July 11 (Bloomberg) -- Natural gas in New York declined to the lowest in six weeks amid speculation supplies are adequate to meet demand lowered by milder weather conditions.

:rolleyes:

I believe that when one sees Qatar resorting to personals ads on internet trying desperately to marry 1.2 million barrels of Al-Shaheen crude for loading in September

or when the rise in oil prices is justified by such strong fundamentals:

July 4 (Bloomberg) -- Crude oil traded little changed near records above $145 a barrel as investors purchased commodities as an alternative to flagging equities markets.
Oil has set new highs the last three days as money managers bought futures, shunning stocks as global equity indexes fell for a fifth week. Crude may rise further next week, according to analysts surveyed by Bloomberg. Some cited the risk Israel may bomb Iran, starting a conflict that cuts supply from OPEC's second-largest producer.
``Investment demand has been driving prices higher,'' Eugen Weinberg, an analyst at Commerzbank AG in Frankfurt, said in a television interview. ``Longer-term pension funds, investment funds, but also banks and insurance companies are pouring their money out of the equity market, out of the U.S. dollar and into commodity markets and especially oil.''

common sense dictates that taking a second look at the supply and demand fundamentals should be wise.

[c1ue]

Re: We have an oil bubble : the proof

$#*,

I think the other major item missing - which we'll not know about until a bust happens - is how from an accounting standpoint the extra risk/derivatives are hidden.

The swap loophole allows larger positions than normally legally possible, but at the same time the outsize risk in putting one-way bets on commodities also violates all type of risk management.

To truly be Enron II (or III), there need to be some nifty accounting gimmicks as well. What would be the off balance sheet vehicles? SIV equivalents?

I don't know enough about this to even speculate.

[GRG55]

Re: We have an oil bubble : the proof

...I believe that when one sees Qatar resorting to personals ads on internet trying desperately to marry 1.2 million barrels of Al-Shaheen crude for loading in September

or when the rise in oil prices is justified by such strong fundamentals:
common sense dictates that taking a second look at the supply and demand fundamentals should be wise.

All this demonstrates is that OPEC is still a price taker not a price setter [no change from when I posted this last fall when oil was about $80]. Something that many find difficult to accept apparently...

[Supercilious]

Re: We have an oil bubble : the proof

All this demonstrates is that OPEC is still a price taker not a price setter [no change from when I posted this last fall when oil was about $80]. Something that many find difficult to accept apparently...

I completely agree, even if some may argue that OPEC may have influence over a proportion of the price, IMHO that's just academic dispute since they have to do it on a price they don't control. There are more and more rumors about the saudis trying to become again setters by making contracts directly with commercial hedgers (consumers of physical oil/refiners). They want to decouple the price of physical oil from the price of paper oil circumventing the commodity exchanges altogether.

Before responging to c1lue I would like to remind that Fred in his rebuttal of an oil bubble said that:

6 .No government deregulation (No change in government regulatory environment fueled the oil bubble; policy has been a constant)
[...]
8. Lack of enforcement of securities law or other market regulations (No instances of market regulators looking the other way while laws are broken)

I don't know how can one still say that after reading Greenberger's testimony before the Senate. IMHO after reading it the natural reaction is shout : "I love the smell of Oil Bubble in the morning!"

$#*,

I think the other major item missing - which we'll not know about until a bust happens - is how from an accounting standpoint the extra risk/derivatives are hidden.

The swap loophole allows larger positions than normally legally possible, but at the same time the outsize risk in putting one-way bets on commodities also violates all type of risk management.

To truly be Enron II (or III), there need to be some nifty accounting gimmicks as well. What would be the off balance sheet vehicles? SIV equivalents?

c1lue I believe you have and excellent point here. I'm struggling too with these questions. First, everybody knows that the much hated speculators actually help with price discovery and help reduce volatility. That is pretty hard to deny. I've found though an old article which has a very interesting take:

http://www.gata.org/node/4787/print

In my reading, the author makes a good point that there is too little classic (physical commodity) speculative liquidity to allow for true price discovery, because, as a result of the Enron and Swaps loopholes, the classic speculators were overwhelmed by investment banks and hedgefunds pouring money into commodity futures. So, maybe it's not a commodity bubble, but some sort of credit/investment bubble attached somehow to commodities.

I don't see any trace of commodity CDOs and I haven't heard of any bank packing mounds of futures together, then shredding and splicing them in structured spreads ( something like a security backed by: 300 barrels of WTI long in september, 223 barrels of brent short in Aug, [....], 3 bushels of corn short in 2009 and ...5.31 lbs of lard and 31/4 cowhides long in 2012). Nobody would buy something that silly.

But, I still smell something fishy... I tried to get some insider information and the people who wanted to talk about "where are the oil CDO's?" were as puzzled as me, while the people who might know something didn't want to touch this subject even with a 30ft pole.

So without any solid source of information, based solely on wild (intellectual not oil) speculations one can construe the following purely imaginary scenario using only three pieces of public information:
Exhibit A: Let's consider DB, a typical bank selling ETNs (they are not innovators, but imitators)

The ETNs issued by Deutsche Bank use a simple mechanism to assure close tracking of the index. They pledge to redeem ETN shares at the calculated market value, thus preventing indexing drift. The bank doesn't actually have to buy the underlying futures, but instead "acts as if it had." The guarantee of the bond and the guarantee that it reflects the futures are backed by Deutsche Bank.

Here one may find the formulation very interesting. The part with "acts as if it had" not only brings fond memories about the Enron virtual energy market, but the conjunction with "doesn't actually have to buy the underlaying futures" is the most interesting. So is DB buying those underlaying futures or not? IMHO such a formulation means that the bank buys futures only if (or when) it needs to buy futures...:rolleyes:

Don't forget that Enron collapsed because their virtual market was a closed model, therefore inherently unstable ( They could not produce virtual return without increasing the virtual prices, but eventually they had to partially open their closed virtual market by passing the high virtual electricity prices to California)

Exhibit B: Are ETNs a Ponzi scheme? Of course not!

For the gamblers with conviction out there, I am going to offer up the latest exchange trader's tools. These are not meant for buying-n-holding; rather, they are meant for making a calculated bet and exiting when you've reached your profit target or stop-loss.
1. PowerShares DB Crude Oil Double Long (DXO). This exchange-traded note backed by Deutsche bank gives investors exposure to 2x the monthly performance of the DB optimum yield crude oil index, plus the monthly T-Bill index return. The annual expense ratio is 0.75%.

2x monthly performance of an oil index + T-bill return ... gee that's a very good deal ... almost as god as a Ponzi deal The problem is that nobody can expect the Germans to be so stupid as to imitate a Ponzi scheme model. Germans are very thorough and if they decide to do something stupid by imitation ... they will definitely do something really stupid.
But here we come to the SIV-like issue. When one buys an ETN, he doesn't bets on oil (an ETN is not a tiny slice of an oil lot). The bet is on an index ... that means that when one buys ETNs the investment is already structured, being based on a private structured futures spread, or in some cases it's based on the spread of a publicly traded ETF.

But guess what? The lovely DXO has a little brother called DTO

PowerShares DB Crude Oil Double Short ETN (DTO). This exchange-traded note backed by Deutsche bank gives investors 2x the inverse performance of the DB benchmark crude oil index, plus the monthly T-Bill index return. The annual expense ratio is 0.75%.

(I have intentionally chosen as an example a PowerShares architecture ETN to make the long-short betting pair obvious, but all architectures are usually also paired one way or another)
By now it should be clear how DB has created it's own virtual and private commodity futures market, but this is not like the Enron scam .. it's even better because it's not only already ready structured but it's completely hedged against the fluctuation of the whole commodity spread . It's also far more stable being opened at both ends. On one end are the ETN investors (Enron had only it's own shares) and on the other end the paper Nymex futures market (California). Nothing can go wrong with this math .. or at least they believe so

Exhibit C: Allways seek strength and safety in numbers.

There is a lot of talk lately about "dark pools", but the wikipedia information may be outdated. It doesn't mention the relatively new trends of crossing networks:
http://www.nysun.com/business/dark-p...-street/64598/

'Dark Pools' Threaten Wall Street

By LIZ PEEK, Special to the Sun | October 16, 2007


In the wake of the subprime mortgage debacle of the past two months, the importance of transparency is obvious. The packaging and repackaging of impossibly shaky mortgages into sophisticated investment products resulted in securities that were overly complicated and not well understood, and that ultimately went bust and brought down an entire industry.
An increasing number of these dark pools are popping up — more than 35, it is estimated — that seek to match large buy and sell orders without recourse to the traditional trading discourse on stock exchange floors. This is not to be confused with electronic trading, which is not new. The electronic communication networks such as Archipelago and Instinet that started up in the 1990s changed trading forever by essentially replacing the matching efforts of the specialist with computers. The ECNs report trading data in a traditional manner — publicly.
[...]
The problem is that in using the dark pools, there is little way for sellers to assess whether they have received the best possible execution on the order. Although by law the participants have to print the trade on one of the exchanges, the information is after the fact, and not especially revealing.
This is especially the case if the broker has "internalized" the order. This popular activity allows brokers to match the order within their own shops, operating beyond the vision of other dealers and outside the spotlight of the SEC. Though internalization has always taken place, the development of crossing networks has greatly expanded the in-house opportunities

By now the imaginary model I'm thinking at, should be obvious. It's like an Amaranth+Enron+subprime-bubble kicked another notch.



But I want to ad something more. Let's say that the $#* Investment Bank has it's own virtual oil futures market with an $#* Oil Powershare Long ETN and an $#* Oil Powershare Short ETN. I have my private virtual futures market (no pesky SEC or CFTC) and I don't have to disclose squat to the ETN shareholders.

Let's say that i have $40 mil in short and $60 million in long. I hedge the difference ($20 millions long) according to my own private and secret spread (the $#* Oil Index) in futures on Nymex. Due to the Swaps loophole, I'm regarded as a commercial hedger (something like the Goldman-Sachs refinery) and it gets even better: I have no position limits and I don't have to make any disclosures about my clients and my own investments. I know it sound like a TV commercial but it's true

Nobody prevents me to place my own bets on Nymex (aside the $20 mil long hedge) so I can manipulate my own index and the returns of my clients, or just make an extra buck. This is called having a cake and eating it too...

Now, let's say that the GRG55 Private Equity Fund runs a similar private virtual market, but he has a $15 mil short difference to hedge in Nymex futures. Incidentally, our dark pools are crossed linked, so we internalize a $15 mil swap: he doesn't have to go anymore on Nymex and I have to go to hedge for only $5 million long. That means that for a $100 mil private virtual crude volume, my Nymex or ICE hedge is only $5 million, or in other words I have a 20:1 leverage of virtual oil over paper (Nymex futures) oil. If I'm a clearing member I have 15:1 leverage from paper oil to real oil. That means that I have a cumulative leverage of 300:1 virtual oil to real/physical oil.

There are some $11 trillion in pension funds, SWF's, CB's and private equity funds looking for a high return and safe investment such as my ETNs. Let's say they diversify only 5% in ETN's .... that's $500 billions ... with a leverage of 300:1 ....

I believe that this is what Masters was trying to say in front of the senate about Index Speculators.

The problem is that as long as the "virtual oil" remains anchored in "paper oil" which in turn remains anchored in real "physical oil" not even OPEC can lower the prices ...

[GRG55]

Re: We have an oil bubble : the proof

I completely agree, even if some may argue that OPEC may have influence over a proportion of the price, IMHO that's just academic dispute since they have to do it on a price they don't control. There are more and more rumors about the saudis trying to become again setters by making contracts directly with commercial hedgers (consumers of physical oil/refiners). They want to decouple the price of physical oil from the price of paper oil circumventing the commodity exchanges altogether...

Who do you think Saudi sells its oil to now? Banks creating ETNs? Let's be serious.

I have no doubt that OPEC [specifically Saudi Arabia] has been desperately trying to regain some pricing power [from its customers of physical oil] since it was lost when the curve went into contango in mid-2004. However, this is nothing new. The Gulf States have always had severe trading and re-marketing restrictions on all of their physical contracts. They will not tolerate any of their crude, LNG or LPGs, including cargo they may sell into the spot market, showing up and competing against them for their own customers. Once again, this is nothing new.

In my reading, the author makes a good point that there is too little classic (physical commodity) speculative liquidity to allow for true price discovery, because, as a result of the Enron and Swaps loopholes, the classic speculators were overwhelmed by investment banks and hedgefunds pouring money into commodity futures. So, maybe it's not a commodity bubble, but some sort of credit/investment bubble attached somehow to commodities...

I do not agree that the crude oil market in particular can be subjected to "too little classic speculative liquidity to allow for true price discovery". I know Dennis Gartman and others have suggested exactly that recently [to explain the high volatility, not the overall price level]. But every month tens of millions of barrels of physical changes hands, most of it through auction mechanisms directly between producers and end-users. If that isn't price discovery, I don't know what is. Every month producers put up spot cargos for bid as well. Once again, whoever is lifting that stuff is presumably an able and willing buyer at whatever price they are bidding?

Enron got killed, not because of California electricity, but because it swallowed its own propaganda and started to believe it could create an outrageously profitable trading market in anything (even telecom bandwidth and weather derivatives :eek: ) without actually controlling any material amount of that physical commodity.

This was a major departure from its roots as a natural gas pipeline company that created a more efficient market between suppliers and end-users, by trading around the pipe infrastructure and BTUs in its physical inventory. In the last couple of years Enron's traders were often so out of touch with the minute-by-minute, hour-by-hour movements in some physical commodity markets, they frequently became prey [during periods of high volatility induced by, say, weather] to the traders in the more traditional energy trading houses, who stuck with the game of trading around a substantive physical presence in a market. Here's an example of one of the most savvy trading companies out there. They were in the game long before Enron and they are still at it, long after Enron blew up. Note their emphasis on physical assets...pipe, storage, processing, etc. How many of you..."experts" on Enron...have even heard of this company?

I believe that what happened in California with Enron, and a few other participants, was just one of many stupid actions it took primarily motivated by an increasingly desperate effort to maintain the illusion of continuous outsize trading profits needed to support its stratospheric share price [and ridiculously generous employee options and bonus payments]. Enron was a precursor to what has just come to pass in the mortgage paper market on Wall Street - a total disconnect from the reality of the physical market.

As for theories that the crude oil market is being gamed in some mass global conspiracy of banks and finance houses, I remain firmly incredulous. Here's a link to the Brent futures contract table. It's pretty flat to slightly backwardated [from this coming winter to the Dec 2012 contract]. I don't see any indications that there is any great concern about near term supply [or the near months would be trading much higher than the rest of the curve], nor to I see any elevated concern about long term supply [or the curve would be in contango].

As for Michael Masters, I note that BMO's Don Coxe pointed our recently that Dennis Gartman and Business Week magazine have stated that Master's offshore tax-haven hedge fund is heavily overweight airline stocks and General Motors. Which way do you think he wants oil prices to go [and soon]? And what hedge fund manager wouldn't hesitate to try to influence Congress to pass legislation, such as restricting those villainous pension funds and their commodity investments; doubtless popular and seemingly sound in the short run, but equally likely to create detrimental unintended consequences in the long run. But then what the hell do hedgies care about the day after tomorrow...:rolleyes:

Once somebody out there cracks the current conspiracy behind oil prices, I hope they'll subsequently turn their considerable talents to find out who really shot JFK.

[VIT]

Re: We have an oil bubble : the proof

It depends on how we understand the bubble:

"trade in high volumes at prices that are considerably at variance from intrisic values" (wiki)

The problem is "intrisic value" of the oil. The cost of oil production today is much much less then the price. Since oil is very unelastic commodity small shortage of production / increase in demand could rocket the price. So if you produce oil and can sell it for $25 it is ok having the expenses of $8/bbl, but it is much better to sell it for $100 having the same or little higher cost of production. So the oil producing countries take all the profit on that difference. Due to their markets are resticted by access or high taxation, free market just does not work for global oil. Today you can not put more money and significantly increase production. Now we start to see the oil which is developed on assumptions of $50-90 per barrel. But the amount of this free market accessible resources is so limited that it can not significantly change the supply.
(Oil proudction is not like buying the cars where for double price you can get 2 items.)

In these terms oil is a bubble but it may never burst.

All other factors (weak dollar, increase in demand etc) are still valid but I think they are not fundamental reason.

[VIT]

Re: We have an oil bubble : the proof

It depends on how we understand the bubble:

"trade in high volumes at prices that are considerably at variance from intrisic values" (wiki)

The problem is "intrisic value" of the oil. The cost of oil production today is much much less then the price. Since oil is very unelastic commodity small shortage of production / increase in demand could rocket the price. So if you produce oil and can sell it for $25 it is ok having the expenses of $8/bbl, but it is much better to sell it for $100 having the same or little higher cost of production. So the oil producing countries take all the profit on that difference. Due to their markets are resticted by access or high taxation, free market just does not work for global oil. Today you can not put more money and significantly increase production. Now we start to see the oil which is developed on assumptions of $50-90 per barrel. But the amount of this free market accessible resources is so limited that it can not significantly change the supply.
(Oil proudction is not like buying the cars where for double price you can get 2 items.)

In these terms oil is a bubble but it may never burst.

All other factors (weak dollar, increase in demand etc) are still valid but I think they are not fundamental reason.

[c1ue]

Re: We have an oil bubble : the proof

I don't know if OPEC is part of any Oilron/CDOil play - or even if there is such a play.

However, it is safe to say that OPEC doesn't mind raking in more money were it to exist. In fact, there is not much reason why OPEC would NOT want higher prices so long as they don't get blamed for it.

As for physical delivery being a barrier - I actually am unsure if this is true.

I think $#* noted above that oil futures are now many multiples of actual oil produced and/or consumed, or for that matter are multiples of what oil futures were 5 years ago.

If this is an incorrect recollection, I'm pretty sure its safe to say that it is still true.

The point is that the physical delivery of oil does not need to impact the behavior of the price contracts if the majority of trading volume increases are purely speculative. In other words, until physical delivery exceeds physical production, the remaining pieces of paper can keep flying around at greater and greater heights.

Not dissimilar to the 1925 Florida land 'binders' - these were contracts conferring the right to buy or sell land, but without actually owning it.

In many cases, the land itself was completely irrelevant - both as to its state, its existence, and its intrinsic worth.

[VIT]

Re: We have an oil bubble : the proof

It is no doubt, at least for me, that the exact price of todays oil is speculative, my point is that oil producers like this game and they can support it for long time by supply control. And you can do nothing about it.

As for land you can buy different land or not buy it at all. You can not stop consume oil, there is nothing you can substitute it in mid term. And you can not tell (like for gold or land) I have enough physical oil in my storage lets play something different and sell it. Oil is 100% consumable. So oil producer countries can support a big range of oil prices, even if it is made by speculators.

It is ironically that country which consumes biggest chunk of the oil pushes the prices higher and higher.

I do not say oil producers are speculating, speculators are on the other side.

[Supercilious]

Re: We have an oil bubble : the proof

I don't know if OPEC is part of any Oilron/CDOil play - or even if there is such a play.

I don't think OPEC was on the Oilron play , although initially they may have gladly tagged along (and made good money form their SWF's too), now that the monster has grown out of control they are really scared, because the meltdown of virtual markets may bring a few years of under priced oil in the context of global recession and consequently declinign demand.

I think $#* noted above that oil futures are now many multiples of actual oil produced and/or consumed, or for that matter are multiples of what oil futures were 5 years ago.

You are correct. That's a good telltale sign. Multiply that by 5-20 times (I don't have the numbers to calculate a precise leverage for paper:virtual, so your guess is as good as mine) and you have the volumes of the money invested in virtual oil.

The point is that the physical delivery of oil does not need to impact the behavior of the price contracts if the majority of trading volume increases are purely speculative. In other words, until physical delivery exceeds physical production, the remaining pieces of paper can keep flying around at greater and greater heights.

Exactly! But the funny part is that the physical delivery cannot exceed physical demand as long as the refiners play the Enron-aluminum game and nobody wants to take delivery of excess crude production: the Iranians can't move their heavy oil, the Saudis send "ghost tankers" in hope they'll find a buyer by the time the oil gets to destination, and the Quataris are using now personal adds in papers, maybe they can ship to someone 1.2mil barrels Al Shaheen this September.

This time the Saudi King is absolutely right. Increasing the OPEC production will do nothing to prices.

Not dissimilar to the 1925 Florida land 'binders' - these were contracts conferring the right to buy or sell land, but without actually owning it.

In many cases, the land itself was completely irrelevant - both as to its state, its existence, and its intrinsic worth.

That's a good analogy. As long as Oilron remains an open system (money keeps pouring in ETNs and ETN "producers" have unrestricted access to a real/physical oil anchor) it's will work fine and continue to be extremely profitable even if oil reaches $1gazzilon/barrel.

The big question comes if we look to the monumental error in risk assessment the ETN "maufacturers" are making. The ETN spawning banks are deluded into believing they are perfectly hedged against an oil price decline, because (in their thinking) if the oil price goes down, their funny spread indexes will go down too .... theoretically they can keep making money even on the ride down...

That kind of thinking, IMHO is completely wrong, stupid and delusional. If the ETN buyers get suddenly spooked and they all go short at the same time, the virtual-paper leverage vanishes and the whole correlation physical-paper(Nymex futures)-virtual(ETN oil) breaks down. These banks will suddently have to back gazzilions of virtual oil paper and not even the Fed can dump money so fast to save them.

Of course, if one has access to good data and takes the pain/time to calculate the recycling paper-hedge frequency (by taking into account the net long volume increases on all futures markets, the total volume and the average lifespan lag) a pretty accurate prediction of the bust moment (and optimum moment for making good money ) can be made.

If the second derivative of the recycling frequency goes toward zero, that means that the so called Index specualators have to put the pedal to the metal with their paper-hedge spinning motion... ;) I guess in the end the collapse will be almost a copy of the Enron final nose dive. Maybe we will see investment banks even creating new strange funds to launch/dump the ETN anchorage there, trying to escape thorugh the Enron partnership scheme.

Well ... "this time" is never different, it's always the same!:rolleyes: