Why is Oil falling?

[Supercilious]

Re: Why is Oil falling?

At the end of the day I don't think it matters [and here is where $#* and I have our greatest divergence], for I remain convinced that in the end the fundamentals will prevail. Over the financiers and over "the-US$-determines-the-oil-price-100%" crowd.

We have no real divergence here GRG55. I'm just saying that as long as a greedy crowd is allowed free reign over commodities markets, and they are wrecking havoc with impunity using an "innovation" (started under Hank Paulson's leadership at Goldman Sachs) which generates obscene profits from investing (not hedging) in futures, then it's unreasonable to believe that physical supply and demand of oil are the fundamentals determining the oil price. When this "index investing innovation" is stopped things will return to normal fast.

The point where we have a major divergence is that IMHO you refuse to accept that a market dominated in proportion of over 90% by Vitols and "commercial swap dealers" such as Goldman, Morgan and Merrill has nothing to do with physical supply and demand fundamentals. Do you remember the last CFTC interim report? This is what they consider commercial hedger exempted from position limits, where you have commercial swap dealers like Goldman Sachs and commercial dealers like Vitol (which in July had 10% of all oil futures contracts).





On top of that you have straight hedge funds and managed money funds plus the classic futures speculator and floor traders...


When the producers and manufacturers are the only ones who actually buy (use) or sell (produce) physical/real oil, and their presence on the market is dwarfed by the buyers and sellers of financial oil, how can you expect to have the oil price determined by physical supply and demand fundamentals? This is where we have a major divergence.

Did the final report came out with the correct classification?

[GRG55]

Re: Why is Oil falling?

...When this "index investing innovation" is stopped things will return to normal fast...

I do not expect the overlevered paper market to be "stopped". These things usually exhaust themselves via their own excesses. Nothing else seems to work. How long that will take? Who knows? But it will happen in due course. In the meantime we can agree that current futures market pricing signals [at least the spot and near month contracts] bear little relationship to the pricing of physical transactions [how much changed hands at ref $145 or last week's Jan 09 contract close near $32]. And the chaos now gradually enveloping the physical supply chain will eventually be felt in the price. Likely in an unpleasant way, and perhaps abruptly.

As for returning to normal...well I suppose that depends on how we might define what passes for "normal" .

[c1ue]

Re: Why is Oil falling?

$#*,

The graphs you post are interesting - if I remember correctly, oil contract sizes are 1000 barrels, thus the total amount of oil under contract is well into the billion barrels for commercial swap dealer and 500M barrels for Hedge funds.

However, total usage in the world - assuming around 80 million barrels per day - is 29 billion barrels.

Even assuming all of above contracts are one way (i.e. not offsetting), we're looking at the contracts representing only 5% of overall usage.

This doesn't seem like that much.

Now on the flip side - demand delta - the amount of futures could definitely be a factor. If IEA in June 2008 was predicting upward supply increases of 3.5M barrels a day, the futures could be as much as doubling 'apparent' consumption.

But again the operative questions are:

1) If there is indeed an impact from futures, is it upward, downward, future, or present?

2) If the spike up in summer was due to manipulation upward, is the spike down also due to manipulation in reverse?

2b) or is what we're seeing due to deleveraging as dealers and hedge funds exit their positions due to lack of liquidity? In which case the present trend will be reversing quite soon.

3) (Question for GRG) Is there some reason why the oil nations and or oil companies don't lock in some profits via selling of futures? And from there it would be a quick short trip over to straight manipulation of prices via futures contracts as well as production?

I ask this last because if there truly is manipulation, is there some reason why Saudi Arabia, Russia, Venezuela, Nigeria, and a few other oil producing nations couldn't just pool $1T or so and use it to stabilize oil prices via futures?

[GRG55]

Re: Why is Oil falling?

3) (Question for GRG) Is there some reason why the oil nations and or oil companies don't lock in some profits via selling of futures? And from there it would be a quick short trip over to straight manipulation of prices via futures contracts as well as production?

I ask this last because if there truly is manipulation, is there some reason why Saudi Arabia, Russia, Venezuela, Nigeria, and a few other oil producing nations couldn't just pool $1T or so and use it to stabilize oil prices via futures?

Nobody knows for certain what the important oil producing nations [e.g. their national oil companies] are doing, but there has been talk that some, including Rosneft and Gazprom, have been prominent players speculating in the futures market [and I mean speculating, not hedging] during the recently departed, cheap-money go-go years.

All of the major multi-national IOCs [like BP, Shell] and what I consider the professional NOCs [such as Aramco and Petrobras] have trading desks [often part of the marketing dept] that are responsible for their production hedges. And in every case they have trading operations that use the futures market to trade around their physical. The best run of the pure trading companies, like Vitol and Trafigura, also do the same...use the intelligence that comes from being in the physical markets to trade the paper markets.

If I understand correctly, $#* thinks Vitol was one of the companies with outsize positions participating in the organized gaming of the market. Certainly in the fevered years of grand speculation in absolutely everything [from Spanish villas to modern art] the temptation to increase the speculative component of the trading desk would have been difficult to ignore for any company [that's what happened to Enron]. But I have no idea if Vitol, or any of the others, are gaming the market. All the people I know in Vitol are doing exactly the same thing today that they were doing two, three years ago. And none of them made enough money in 2008 to quit working, unlike thirty-something bond traders and MBS packagers .

Finally it became fashionable in recent years for the independent E&P [exploration and production] companies to establish "risk management" functions or departments. In almost every instance these idiots managed to lose their shareholders tens of millions of dollars by being perpetually behind the curve, and doing exactly the wrong thing at the wrong time. All the way up most hedged forward and locked in low prices against which they had to produce their physical. At the very moment they should have been locking in, most were under so much pressure from their banks, due to previous mark-to-market losses, that they were too timid to make the commitment. Guess who was on the other side of those trades? Yep. Same investment banks [Merrill, Goldman...] that were advising them to hedge or not hedge.

Hope that helps.
And my best wishes to all for the Holidays, and may 2009 bring good health, happiness, peace and prosperity.

[mcgurme]

Re: Why is Oil falling?

Care to point out exactly where you think I "tore down" something you posted? I do not think we are in complete disagreement; but I do not think the timing of an oil price rebound can be determined, and under the present economic circumstances I am coming to the view that any durable recovery may be much further off than one would normally anticipate.

Your post here is excellent, and we are in agreement. It seemed that the response to my previous post from both of you indicated disagreement; perhaps I misread. But my point was and continues to be a simple idea, that has nothing to do with oil per se, but any needed and consumed commodity. My point is that if the price is held artificially low for too long, then this encourages excessive consumption of that commodity, while at the same time squeezing the producers of that commodity. That sets up for physical shortage of said commodity, because production is discouraged while consumption is encouraged.

We experienced that here in the Southeast after the Hurricanes last summer. Supply became short, but gas stations were not allowed to raise prices (lest they be prosecuted under the anti-gouging laws). So, shortages ensued.

My only other point is that, if/when shortages develop, one can bet on the government getting involved in it.

[GRG55]

Re: Why is Oil falling?

Today's closing figures for the NYMEX WTI crude curve [note $#*'s previous point-out that today was the final day for trading on the January contract] Columns show close price and the change. For those wondering why global oil inventories are swelling, it's the contango more than demand destruction that is governing. It pays the traders to hold inventory, and this happens every time the market goes into contango. In other words, if the curve was backwardated [which is the historical "normal" situation] the declining demand would be met with more production curtailment than we are witnessing presently [it's cheaper to "store" the oil underground in its native reservoir than produce under that circumstance].

Jan-09	33.87	-2.35
Feb-09	42.36	0.69
Mar-09	45.16	0.77
Apr-09	47.15	0.71
May-09	48.74	0.61
Jun-09	50.05	0.53
Jul-09	51.15	0.46
Aug-09	52.06	0.40
Sep-09	52.90	0.36
Oct-09	53.71	0.40
Nov-09	54.50	0.46
Dec-09	55.28	0.52
Jan-10	55.97	0.52
Feb-10	56.65	0.52
Mar-10	57.31	0.52
Apr-10	57.95	0.52
May-10	58.58	0.52
Jun-10	59.16	0.52
Jul-10	59.72	0.52
Aug-10	60.28	0.52
Sep-10	60.83	0.52
Oct-10	61.33	0.52
Nov-10	61.79	0.52
Dec-10	62.23	0.52
Jan-11	62.63	0.54
Feb-11	63.02	0.56
Mar-11	63.40	0.57
Apr-11	63.77	0.58
May-11	64.12	0.59
Jun-11	64.44	0.60
Jul-11	64.73	0.61
Aug-11	65.00	0.62
Sep-11	65.26	0.63
Oct-11	65.51	0.64
Nov-11	65.74	0.65
Dec-11	65.97	0.66
Jan-12	66.21	0.68
Feb-12	66.45	0.70
Mar-12	66.68	0.72
Apr-12	66.91	0.74
May-12	67.13	0.75
Jun-12	67.34	0.76
Jul-12	67.52	0.77
Aug-12	67.70	0.78
Sep-12	67.88	0.80
Oct-12	68.06	0.82
Nov-12	68.24	0.84
Dec-12	68.42	0.86
Jan-13	68.60	0.86
Mar-13	68.96	0.86
Jun-13	69.48	0.86
Oct-13	70.15	0.86
Nov-13	70.31	0.86
Dec-13	70.47	0.86
Jun-14	71.41	0.88
Dec-14	72.31	0.90
Jun-15	73.20	0.91
Dec-15	74.04	0.92

Something $#* will find unsurprising...

[The author deals with the peculiarities of NYMEX WTI contracts at Cushing, but neglects to point out that Brent and other reference crudes around the world are also in steep contango. Brent Feb 09 closed at $36.61 today, while Dec 09 closed at $50.08.]

December 23rd, 2008
NYMEX oil benchmark again in question

– John Kemp is a Reuters columnist. The views expressed are his own –

The record differential between the front-month and more liquid second-month contracts at expiry last week once again raised pointed questions about whether the NYMEX light sweet contract is serving as a good benchmark for the global oil market, or sending misleading signals about the state of supply and demand.

The expiring January 2009 contract ended down $2.35 on Friday at $33.87, while the more liquid February contract actually rose 69 cents to settle at $42.36 - an unprecedented contango from one month to the next of $8.49.

Criticism of the contract is not new, and past calls for reform have been successfully sidelined. But with policymakers taking a keener interest as a result of wild gyrations in oil prices this year, and a continued focus on regulatory changes to improve market functioning in future, there is at least a chance changes will be adopted as part of a wider package of futures market adjustments...

...Now the market risks overshooting in the other direction. Intense pressure on the front month in recent weeks has more to do with the contract’s peculiarities (in particular storage restrictions at the delivery point) than a further deterioration in oil demand or a market vote of no-confidence in the 2.2 million barrels per day further cut in oil production announced by OPEC at the end of last week.
The collapse in NYMEX prices nearby risks exaggerating the real degree of oversupply and demand destruction, sending the wrong signal to producers and consumers about the wider availability of crude in the petroleum economy...

...Financial speculators were able to push NYMEX higher safe in the knowledge Saudi Arabia could not take the other side and overwhelm them by delivering physical barrels to bring prices down. The resulting spike exhibited all the characteristics of a technical squeeze: tight contract specifications ensured there could be shortage of NYMEX light sweet inland oils even while the global market was oversupplied by heavier, sourer seaborne ones.

Now the opposite problem is occurring. Crude stocks at Cushing have doubled from 14.3 million barrels to 27.5 million since mid-October. Stocks around the delivery point are at a near-record levels and approaching the maximum capacity of local tank and pipeline facilities (https://customers.reuters.com/d/graphics/CUSHING.pdf).

As a result, the market has been forced into a huge contango as storage becomes increasingly expensive and difficult to obtain, ensuring the expiring futures trade at a substantial discount...

[Sharky]

Re: Why is Oil falling?

But I have no idea if Vitol, or any of the others, are gaming the market.

Have you been following the unraveling at Glencore? It wouldn't surprise me if that ended up being one of the causes of the current decline in oil prices.

[GRG55]

Re: Why is Oil falling?

Have you been following the unraveling at Glencore? It wouldn't surprise me if that ended up being one of the causes of the current decline in oil prices.

Sure have. Spoke to a metal trader friend in based in Europe a few days ago and he told me Glencore's credit default swaps were trading at an astounding 4000 basis points above Libor. That's basically pricing in a bankrupcy I would think.

Interestingly the trading community regard Glencore as "bulletproof", the strongest of all the trading companies. We'll see. Something is going on with CDSs at that spread.

[GRG55]

Re: Why is Oil falling?

...And the chaos now gradually enveloping the physical supply chain will eventually be felt in the price. Likely in an unpleasant way, and perhaps abruptly.

As for returning to normal...well I suppose that depends on how we might define what passes for "normal" .

How much of the gyrations in crude price are actually demand destruction related, and how much is pure financial chaos? :p

From the Salt Lake Tribune:

Falling oil, credit crunch trigger Flying J bankruptcy filing

A sharp fall-off in oil prices that triggered a credit squeeze forced Utah truck-stop giant Flying J Inc. to file for bankruptcy Monday.

The Ogden-based company estimated its liabilities at $100 million to $500 million on assets of more than $1 billion, according to documents filed in U.S. Bankruptcy Court in Delaware.

The Chapter 11 bankruptcy was a traumatic but inescapable step for Flying J. Over its 40-year history, the company has steadfastly guarded its privacy, while building a petroleum-based empire that includes more than 250 travel centers in North America, as well as affiliated oil exploration, production, distribution and refinery businesses.

"I've had better days," said J. Phillip Adams, Flying J's president and chief executive officer...

From the Bakersfield Californian:

Refinery may face closure

Big West must convince industry it can pay for oil

BY JOHN COX, Californian staff writer

Last Updated: Wednesday, Dec 24 2008 9:36 PM

The Big West refinery on Rosedale Highway could be forced to shut down unless its owner can persuade members of the local oil industry that they will continue to be paid for new deliveries despite the company’s reorganization bankruptcy filing Monday.

Local oil executives said Wednesday that the plant’s owner, Flying J Inc., has tentatively proposed paying for oil every eight days rather than the existing terms of payment every 50 days.

They said the idea behind the proposal, which they described as preliminary, is to ease suppliers’ fears that they won’t be paid for their oil because of Flying J’s financial constraints.

It was unclear how many oil producers may be willing to accept the proposal...

...Oil producers said they are worried the refinery may have to close if it cannot buy enough oil to sustain operations...The refinery employs 200 full-time and 150 part-time staffers. It provides 6 percent of the state’s diesel and 2 percent of its gasoline...

...Oil producers have much at stake in Big West’s survival. Some sell oil exclusively to the refinery, which is among relatively few buyers of Kern’s particularly thick crude.

“When one of the larger purchasers of that type of crude is ... out of the market, you’ve got everybody rushing (for) the exit at the same time,” Layton said. He added that it would take time for the local market to stabilize if Big West closed.

Chad Hathaway, owner of an independent oil producer based in Bakersfield, said his company could lose as much as $70,000, or a tenth of its revenues over the next two months, if the refinery closes.

“Independents need that refinery,” he said. “We need that refinery open.”

From the Gurnsey [Channel Islands] Press:

Fuel nearly ran out...

GUERNSEY came within days of running out of fuel before the States took control of the supply chain, it emerged at the weekend.

Policy Council sources indicated that stocks of petrol and heating oil were at one stage down to three to four days before the crisis was resolved.

A news blackout was imposed by senior politicians and the fuel suppliers to prevent panic buying. The fear was that unnecessary topping up of cars and oil tanks would have triggered an actual shortage.

The problem was caused by administrators impounding the two ships owned by Swedish firm Svithoid Tankers after it collapsed to prevent the assets from being lost to them...

[Supercilious]

Re: Why is Oil falling?

GRG55, here is a great entry in Jesse's blog about the subject of commodities manipulation:

http://jessescrossroadscafe.blogspot...commodity.html

[c1ue]

Re: Why is Oil falling?

Jesse talks about market manipulation, but provides zero evidence, theory, or anything other than saying there is a discrepancy between expiring contract prices and following month contract prices.

This is disingenuous.

As GRG pointed out, NYMEX is not the only area seeing contango.

Secondly there are likely dozens of potential scenarios besides outright manipulation which might result in what we're seeing.

I pointed out previously the United Airlines' failed oil hedging - it is quite likely that what UA and other airlines tried to do was repeated by other industries and companies.

In addition the amounts of money involved are quite large. The entities that could involve themselves in this trade in a small group or less are few - and these types of activities should be detectable.

If instead what we had was a monster sector bet made by the entire banking and hedge fund industry, now deleveraging with a vengeance, what we're seeing is also entirely feasible.

That's where the time factor comes in. The rise in oil prices was an 6 to 11 month process; the fall will also require time.