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Saudis to pump 10 million bpd

Posted by WARREN MOSLER on June 10th, 2011

The Saudis don’t sell in the spot markets, they only post prices to refiners and then take orders at those prices.

That is, they post price and let quantity vary.

So the only way they could definitively get to 10 million bpd would be to change policy and sell in the spot market, which would let loose a downward price spiral until some other producer decided to cut production to stop the fall.

As always, it’s their political decision, and no telling what they might actually do.

Saudi Shows Who’s Boss, to Pump 10 Million Barrels Per Day

June 10 (Reuters) — Saudi Arabia will raise output to 10 million barrels day in July, Saudi newspaper al-Hayat reported on Friday, as Riyadh goes it alone in unilaterally pumping more outside OPEC policy.

Citing OPEC and industry officials, the newspaper said output would rise from 8.8 million bpd in May. There was no immediate independent verification of the story.

The report suggests Riyadh is asserting its authority over fellow members of the Organization of the Petroleum Exporting Countries after it failed to convince the 12-member cartel to lift output at an acrimonious meeting in Vienna on Wednesday.

“The Saudi intention is to show that they cannot be pushed around,” said Middle East energy analyst Sam Ciszuk at IHS. “Either OPEC follows the Saudi lead or they will have problems.”

A proposal by Saudi and its Gulf Arab allies the UAE and Kuwait to lift OPEC production was blocked by seven producers including Iran, Venezuela and Algeria.

The two sides blamed each other for the breakdown in talks. Saudi Oil Minister Ali ali-Naimi called those opposed to the deal obstinate. Iran’s OPEC governor Mohammad Ali Khatibi responded by saying Riyadh had been overly-influenced by U.S.-led consumer country demands for cheaper fuel.

“The hawks in OPEC called their bluff and now it is up to Riyadh to show that they were not bluffing — that they will go ahead unilaterally if pushed,” said Cizsuk.

Saudi Arabia has not pumped 10 million bpd for at least a decade, according to Reuters data, production having peaked at 9.7 million bpd in July 2008 after prices hit a record $147 a barrel. It is the only oil producer inside or outside OPEC with any significant spare capacity.

Asked in Vienna on Thursday whether Saudi would reach 10 million bpd Naimi said: “Just send the customers, don’t worry about the volumes.”

Gulf delegates said Riyadh was planning to pump an average 9.5-9.7 million bpd in June.

Saudi is already offering more crude to refiners in Asia, which, led by China, is driving a global rise in oil consumption.

Forecasts from OPEC headquarters show demand will increase about 1.7 million bpd in the second half of the year from recent cartel output of about 29 million bpd.

Brent crude rose to a 5-week high of $120 a barrel after the OPEC talks broke down. Prices eased after Friday’s Saudi news, last dipping 63 cents to trade near $118.94 a barrel.

32 Responses to “Saudis to pump 10 million bpd”

  1. scarmani Says:

    Saudis offer fixed amounts of oil at posted prices to refinery customers, allowing for +/- 10% leeway in quantity delivered. But if the posted prices always track the spot prices, I can’t see the major distinction between this and just selling into the spot market.

    I will be extremely happy if Saudi Arabia hits and holds 10 mbpd+ production for 3 months or more (after revisions), accompanied by a price drop to the $70-$90 / bbl range – it will confirm that Saudis are indeed still the price makers and the world has at least a little more time and room to get serious. Given the stakes, that would be cause for celebration.

    I will be relieved if the Libyan mess gets resolved within the next few months and aside from some minor damage the infrastructure is found mostly intact and ready to resume significant exports by year’s end, allowing Saudi to stay below 10 mbpd. Close call pushed out by a year or so to beyond the 2012 elections.

    I fear though that the outcome will be Libya takes a year plus to get mostly back online, Iraq can’t meet its optimistic production growth targets, Saudi Arabia cannot or does not hit and hold 10 mbpd+, but instead tops out somewhere around 9.5 – 9.7 mbpd again. Then sometime between now and the end of 2012, crude price starts climbing month after month until the economy completely stalls out once more. Saudis once again irrelevantly claim that they supplied all that was requested, having as before posted ever climbing prices while claiming to want lower ones. Well yes, if they charged a million dollars a barrel they could deliver nothing and still claim to deliver all that was demanded.

    Dot – Saudi Arabia had the chance in late 2008 and 2009 to hold posted prices down near $30 / bbl for a longer period of time, with major spare capacity to back up the low price. After a year or two of such sustained low prices, Iran’s regime might well have toppled and Saudis would have the upper hand against their sworn adversaries just across the gulf. Yet they passed up on this chance (why?) and the window of opportunity is gone.

    Dot – the EIA has stopped publishing International Energy Statistics.

    Dot – OPEC meeting collapses in acrimony for the first time in decades, failing to increase the official production quota despite data showing current OPEC production falling far short of projected Q3 demand (http://www.moneycontrol.com/news/business/oil-demandh2-strong-opec-mustsupply-barclays-cap_555898.html).

    In the worst case (the one I prepare for until proven otherwise), once Saudi production falls short of Saudi promises, there will be no lasting recovery from the next recession until alternative transportation energy sources and modes are scaled up to meaningful levels and rolled out on a wartime basis. Likely in an actual war.

    Reply

    Tom Hickey Reply:

    @scarmani,

    Agree. Even if this scenario does not play out this round, it will in a succeeding one. The petroleum age is necessarily winding down due to decreasing energy returned on energy invested. The world’s militaries are gearing up for the coming resource conflicts, which are expected to dominate the 21st century.

    While MMT focuses on money as basic, energy economics looks at energy as fundamental. There are two major issues converging. Declining EROEI and the negative externality associated with carbon-based fuel, which is implicated in global climate change. If one horn of this dilemma doesn’t gore first, the other will.

    What MMT shows is that countries with soft currencies can always “afford” to provide the necessary capital publicly for developing required resources like alternative energy sources and scaling them up quickly, which private industry could not do on its own based on profit. The task is very capital intensive, large-scale coordination is required, and private risk high. This is something that governments need to cooperate on globally. It is no longer in US hands, since China has just surpassed the US in energy consumption.

    Reply

    Art Reply:

    @Tom Hickey,

    “What MMT shows is that countries with soft currencies can always “afford” to provide the necessary capital publicly for developing required resources like alternative energy sources and scaling them up quickly, which private industry could not do on its own…”

    Exactly! This is why I’m so happy and excited that Obama’s visionary and ambitious public investment in energy technology development has finally come to fruition. What a historic milestone! It’s like the Manhattan Project, but promising far, far more in the way of social and economic well-being. Larry Summers and Peter Orszag, who put their “financing be damned” imprimatur on the plan and its eye-popping budget, will be heroes for the ages. I can’t tell you how proud I am to be an American today…

    oh….damn…typing in my sleep again….what a wonderful dream I was having…

    Reply

    WARREN MOSLER Reply:

    selling in the spot market means you sell to the highest bidder, and then the next highest bidder, etc. until you’ve sold all of your oil

    Reply

  2. Gary Says:

    yes, it is an interesting game. I see no reason why Saudis would want to bring the price down – unless it is a self preservation instinct from unofficial US threats. Oil is a scarce resource and getting scarcer. Why sell the rest of if cheaply? I doubt they are scared by the alternative solutions.

    Reply

    scarmani Reply:

    @Gary, You’re right, if they’re not running out it’s pretty hard to explain things like this:

    http://www.bloomberg.com/news/2011-06-03/saudi-s-solar-energy-will-equal-its-oil-exports-al-naimi-says.html

    “Saudi Arabia plans to generate solar electricity equaling the amount of its energy from crude exports, Oil Minister Ali Al-Naimi said.

    Saudi Arabia, the world’s largest oil exporter, has the potential by 2020 to produce enough solar power to meet more than four times global demand for electricity, al-Naimi said…

    Al-Naimi said that Saudi Aramco is planning to build the Kingdom’s biggest solar energy plant that would produce 10 megawatts of power.”

    This combination of statements is absurd. The energy in Saudi Arabia’s crude oil exports is equivalent to 1/4th of the world’s current electricity consumption. 10 megawatts of power is the equivalent of burning 6 barrels of oil per hour. Saudi Arabia produces 400,000 barrels of oil per hour.

    Even if Saudi Arabia could put in place all the solar electric generation capacity it is talking about, to whom would it sell the electricity? Is it going to ship it out on tankers?

    And (assuming they’re going to use PV), what happens at night?

    You wouldn’t hear ridiculous delusions like this from the world’s energy bank unless they knew the game was up, the oil was half gone and all they had left was a lot of granular silicon dioxide and a lot of sun.

    Reply

    jimi Reply:

    @scarmani,

    or unless they have a high population of young unemployed men that they need to keep busy. Perhaps combined with a McKinsey Consultant convincing them that with their vast natural resources of heat and silicon, they could one day be the swing producer of the global solar market!

    I have a friend who worked with Exxon in Riyadh (since evicted). He stated that the primary negotiating consideration of the Saudi’s for public works projects was the number of employees. Not ROI. Not price. Not effectiveness. But, how many men will it take and for how long?

    A low oil price hurts Shiite Iran more than it hurts the Sunni Saudis. Given the “Arab Spring” revolution throughout the region, the Sunni’s want to put the financial squeeze on the production constrained Shiites while keeping the Saudi idle youth in max production mode. Profit margin optimization is not a current objective.

    Reply

    SethM Reply:

    @jimi,

    Jack Barnes has an interesting take on Saudi & Iran:

    “You only have to look at the latest OPEC meeting to see between the lines. Iran and Saudi Arabia have drawn lines in the sand, and sides are being taken. It is my expectation that Saudi will now try to flood the world with oil, to drive down the Iranian revenue available to fight a war with Saudi Arabia.”

    http://jackhbarnes.com/3-cross-currents-in-the-global-macro-world/

    Ed Rombach Reply:

    @jimi,

    “I have a friend who worked with Exxon in Riyadh (since evicted). He stated that the primary negotiating consideration of the Saudi’s for public works projects was the number of employees. Not ROI. Not price. Not effectiveness. But, how many men will it take and for how long?”

    In other words…they want to build pyramids. Maybe Egypt should try that too. They have lots of sun & sand along with a legacy of building pyramids.

    kkken530 Reply:

    @jimi, “The primary negotiating consideration of the Saudi’s for public works projects was the number of employees. Not ROI. Not price. Not effectiveness. But, how many men will it take and for how long?”
    Smart move,keeping the young actively employed keeps them busy and with spending money so they aren’t as apt to revolt..

  3. Mario Says:

    fascinating play of events Warren. And who said chess wasn’t applicable to real life!?!??!

    I think the Saudis are hell-bent on bringing oil down b/c they are tied up with the other big power players in the world to gain more of the world’s wealth. As Warren has said, higher oil prices leave the Saudi’s more vulnerable to a swifter and more complete transition out of oil energy altogether. I also think/wonder if the Saudi’s weren’t “bought out” by the US in some way and are simply puppets on a string in this move to “increase production.” It will be much easier for the current standing government to seriously cut spending in the US and elsewhere when oil prices are lower and “consumption” (inflation?) is up a tad. Without that, serious government spending cuts looks more than just “responsible.” At best it would be stupid, at worst diabolical.

    Reply

  4. ron Says:

    What seems like logic sometimes turns out to be merely a preconceived notion.

    http://www.mcclatchydc.com/2011/06/09/115551/key-regulator-speculators-swamping.html

    Reply

  5. scarmani Says:

    @ron, I get irritated every time people talk about how “speculators” are distorting the price. Warren is right, speculators are not price makers, they are price takers. Whoever has spare capacity is the price maker.

    or every long position in the futures or forwards market, there is a counterparty with a short position. The futures price always converges to the spot price at expiry. So someone please explain to me how these paper “speculators” can drive the price away from the supply-demand balance for any meaningful period of time? Every time hot money gets too long or short, there is a correction that clears them out. Day to day and week to week price noise doesn’t change underlying trends.

    There is only one way financial speculators could persistently drive the price above or below what physical producers and physical consumers would agree on – and that is by affecting actual physical demand (or actual physical supply) in the physical market. As in, buying up oil and stashing it away in unreported floating storage.

    During the housing bubble, speculators pushed prices above sustainable levels by using super easy financing to push up demand for physical houses. During the precious metals bubble, speculators push prices higher by using super easy financing to hoard physical gold and silver.

    Where is the evidence that speculators are using super easy financing to stash away physical crude oil? (Or instigating unrest to take production offline? Hmm…)

    By the way, if big investment banks were actually artificially bosting demand and storing away the extra barrels, they would be doing the world a favor, earning their profits by carrying out a socially constructive economic service. By maintaining large petroleum inventories, they would be helping to smooth out price volatility for a commodity with low supply & demand elasticity, keeping oil priced high enough to dissuade waste during periods of excess supply, and selling physical oil into price spikes during periods of inadequate supply, keeping the gas pumps open.

    Reply

    Gary Reply:

    @scarmani,

    instigating unrest seems possible ;)

    Reply

    Art Reply:

    @scarmani,

    “[F]or every long position in the futures or forwards market, there is a counterparty with a short position.”

    And because of that, you assume that a supply-demand imbalance between long and short has no effect on the forward ask???

    There’s no-arb theoretical forward pricing, and then there’s actual market forward pricing. And there is simply no way that the HUGE increase in demand for long commodity-related positions has not had an effect on the marginal price required to entice a counter-party into a short position. To me, that’s the more obvious and immediate explanation for positively-sloped commodity curves.

    Maybe it’s the latest asset allocation fetish, maybe it’s peak oil, or maybe it’s both. Whatever the cause, there’s nothing ‘normal’ about continuous contango. And just because a forward contract has two sides to it doesn’t mean that there aren’t financial supply and demand imbalances at work in the price.

    Reply

  6. ron Says:

    When were all those rules limiting speculation in the commodities futures markets changed?

    http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=RWTC&f=D

    How long has Saudi had spare capacity?

    Reply

    Matt Franko Reply:

    @ron,
    Late 90′s, Bill Clinton (Wall St.)/Phil & Wendy Gramm (Enron) good places to focus bipartisan ire. Resp,

    Reply

    Art Reply:

    @Matt Franko,

    Didn’t know about Mrs. Gramm’s Enron connection, thanks. Good grief.

    Enron was decidedly bipartisan. I’d read about Krugman’s brief dalliance.

    So looks like the bipartisan ire would have to be ground-up. Good luck, eh?

    P.S. You should have mentioned Clinton’s lead dance partner Bobby R, who still seems to suffer from the delusion that he’s a force for good in the world…which might be more dangerous than the GOP-types who only pretend to give two sh*ts about everyone else during campaign season. :)

    Reply

  7. scarmani Says:

    @Art,

    There’s no-arb theoretical forward pricing, and then there’s actual market forward pricing. And there is simply no way that the HUGE increase in demand for long commodity-related positions has not had an effect on the marginal price required to entice a counter-party into a short position. To me, that’s the more obvious and immediate explanation for positively-sloped commodity curves. Maybe it’s the latest asset allocation fetish, maybe it’s peak oil, or maybe it’s both. Whatever the cause, there’s nothing ‘normal’ about continuous contango.

    Here’s a recent graph of the term structure of Brent crude oil. I must be missing the contango?
    http://www.hardassetsinvestor.com/images/BRENT20110603.jpg

    And because of that, you assume that a supply-demand imbalance between long and short has no effect on the forward ask???

    If there are large numbers of relatively price-insensitive buyers purchasing futures or forwards contracts, and the people willing to take the opposite side of the trade are relatively price-sensitive, then the buyers will push the price in the seller’s favor (higher).

    This much is obvious – since there are two sides to any trade in any financial instrument, yet the prices of all financial instruments move up and down. The fact that there are two sides to any trade obviously does not mean that buyers can never push prices higher or sellers can never push prices lower. The side of the market that is less sensitive to the price at which they transact the trade will push the price up or down in favor of the more reluctant counterparty.

    I’m not disputing the above; I’m only stating that I fail to understand the argument that “financial speculators” are persistently driving crude oil prices away from levels that balance supply and demand (including demand for inventory buffers). I do not understand the mechanism by which this can occur.

    If the price is too high today, a seller with access to a full oil tank (or a producer with spare production capacity) can make a risk free profit. Conversely, if the price is too low today, a buyer with access to an empty oil tank (or a producer with production that can be postponed) can make a risk free profit.

    I could understand how if financial speculators were hoarding physical oil to artificially elevate crude oil demand, or instigating unrest to artificially curtail crude oil supply, they could successfully be manipulating oil prices.

    But I cannot understand how financial speculators could use paper financial instruments to, in a lasting way, displace the spot price of crude oil from that which physical buyers and physical sellers would agree upon in the absence of a futures market.

    Suppose foolish speculators drove up the price of oil deliverable today or in the near future far beyond what was physically warranted. You would expect to see supply from oil inventories (both above ground, and still in oilfields) coming out of the woodworks to capture the excessive profits that could be made by selling at today’s price.

    Suppose foolish speculators drove up the price of oil far in the future relative to what was physically warranted in today’s market. You would expect to see oil inventories surge, as smart large investors sold overpriced long dated futures / forwards contracts and hedged by storing away today’s less pricey oil, locking in a risk free profit from the mispricing and driving the too-high price back in line.

    Suppose foolish speculators pushed the price of oil up all through the curve way above what was warranted by market fundamentals. Well, then, you would expect to see a combination of physical consumers cutting demand and physical producers increasing supply, outdoing one another to compete in partaking in the windfall profits gifted to them by the idiots in Wall Street.

    If you don’t see consumers cutting demand and producers increasing supply in response to the price of oil, but instead see the opposite, then it’s hard to argue that the price of oil is way above what is warranted by market fundamentals.

    I listen to oil market commentators like Fadel Gheit, Stephen Schork, and even oil company executives like Rex Tillerson and officials of oil producing countries like Ali al Naimi of Saudi Arabia all claiming that speculation run amok has severely distorted the oil market and is elevating prices by as much as $20 – $50 / barrel over what the fundamentals warrant. These people presumably all know what they are talking about.

    I also read the following book http://www.amazon.com/Oils-Endless-Bid-Unreliable-Economy/dp/0470915625 and it makes no sense to me.

    The claim of this book is “after passage of the Commodities Futures Modernization Act opened up the oil markets to a flood of ‘dumb money.’ According to him, the ‘assetization’ of oil, and the rapid growth of oil index funds and ETFs, has created an incessant upward pressure on the price of oil—the lifeblood of American industry. And that pressure has severed it from the practical realities of oil and the oil industries. Hence, ‘oil’s endless bid.’”

    So I ask this – if the above is true, why haven’t oil producers increased production to exploit this supposed egregious overpricing?

    I can tell you, if I were a banana farmer, and if a bunch of dumb money investors started buying up paper financial instruments entitling them to future supplies of bananas, and as a result the price of bananas quadrupled above fair value, I would happily start growing and selling as many bananas as I possibly could.

    Well, here is a chart of global crude oil production since 2002. Correct me if my eyes are deceiving me, but it looks like production hasn’t increased much at all for nearly 7 years.
    http://gregor.us/wp-content/uploads/2011/01/Global-Crude-oil-Supply-2002-2010-4-by-6.jpg

    Overpricing kills demand and boosts supply. If demand is growing and supply isn’t, how could this be due to overpricing? Do the laws of causality not apply to the oil market?

    Reply

    WARREN MOSLER Reply:

    let me add that part of the problem is getting unlimited funding for producers for margin calls for their hedges. even though economically sound, a hedge eats up cash as prices rise, and if lenders want haircuts for their loans the producer needs heaps of capital to keep up with a speculative boom. many silver producers, for example, were forced out of their hedges, best I can tell, in the run up.

    what happens in crude is the saudis hide behind the speculators, claiming they just set their prices at a spread. maybe they do, but that’s price setting nonetheless.
    if they have excess capacity, they’re price setter, as mentioned elsewhere on this website. and how they set price is a political choice.

    and yes, if you have storage capacity you can buy spot and sell forward, and as the demands for that rise and fall the cost of storage- the spot fwd spreads- varies.
    i recall the cost of storage going up to maybe $10/barrel per month not long ago? and note the returns on funds holding spot crude losing big time vs the absolute price of crude due to the storage charges.

    Reply

    Art Reply:

    @WARREN MOSLER,

    Thanks. Rising storage costs would seem to imply that the long fetish might be topping out?

    I recall reading somewhere (last year?) that a major WS B-D (JPM?) was entering a JV to acquire storage capacity. Seems telling.

    Reply

    Art Reply:

    @scarmani,

    Fair enough…as I noted above, it could be a market demand thing or a genuine supply issue, but I’m leaning hard towards the former.

    “I’m not disputing the above; I’m only stating that I fail to understand the argument that “financial speculators” are persistently driving crude oil prices away from levels that balance supply and demand (including demand for inventory buffers). I do not understand the mechanism by which this can occur.”

    The ‘real assets’ allocation fetish among institutional investors (and retail, I’m assuming they’re not the marginal demand actors yet, but could be wrong; when they are, I’d take it as a sign of a top) that as a financial industry insider I don’t seen signs of slowing down yet (though it is now long in the tooth based on past bubbles).

    “If the price is too high today, a seller with access to a full oil tank (or a producer with spare production capacity) can make a risk free profit. Conversely, if the price is too low today, a buyer with access to an empty oil tank (or a producer with production that can be postponed) can make a risk free profit.”

    It depends on the curve, right? If investment demand pushes a commodity into contango (even a humped contango) that creates an arb opportunity if net cost of funds and storage are low enough. That in turn makes the price today, even if it’s way above fundamental value, “too low” by finance/arb standards and encourages hoarding. The ‘smart money’ (i.e., the dealers taking the other side of the trades that their allegedly Chinese-walled sales force a/o asset allocation gurus are recommending to those institutions and retail clients) and their favored associates will continue to hoard and sell forward. There may be plenty of juice left in that trade, unfortunately, even if reports of above-ground supply gluts are accurate (though as noted, it is long in the tooth by historical standards).

    “I could understand how if financial speculators were hoarding physical oil to artificially elevate crude oil demand, or instigating unrest to artificially curtail crude oil supply, they could successfully be manipulating oil prices.”

    As above, there is evidence of hoarding by the ‘smart’ guys and gals. Ever heard the audio tapes of Enron traders during the CA blackouts? There are some really shitty people in this business, don’t underestimate them or listen to their BS/delusions about ‘helping markets clear’.

    As far as political unrest, I don’t think they’re that powerful (though some are surely devious and unethical enough). The MENA unrest looks like an organic cause of price dislocation (esp Libya), and may be a factor contributing to the current contango in Brent, which has been pretty testy since tightening of Europe’s refinery regs (though it could be explained by differences in contract specs and market regs too, or other factors; I’d have to take a closer look).

    “But I cannot understand how financial speculators could use paper financial instruments to, in a lasting way, displace the spot price of crude oil from that which physical buyers and physical sellers would agree upon in the absence of a futures market.”

    Agree with you that they can’t do it indefinitely. But as long as the music is still playing, they will, and it’s self-reinforcing for a time as people outside see what look like gains and decide to jump in at some point. Remember housing? Nasdaq? Japanese real estate and Nikkei? I suspect that’s the situation today, but granted, can’t be 100% certain. But still confident enough to not want to put bets on the long side, even though it means leaving potential gains to others. Risk-adjusted expected return just isn’t there for me (of course, if you’re right about long-term oil supplies, I’ll be kicking myself at some point).

    “Suppose foolish speculators drove up the price of oil deliverable today or in the near future far beyond what was physically warranted. You would expect to see supply from oil inventories (both above ground, and still in oilfields) coming out of the woodworks to capture the excessive profits that could be made by selling at today’s price.”

    True, but (a) you never know where that price is, (b) markets can be hideously irrational for more than a short period of time, and (c) the people who know better will let the game play on as long as there’s arbitrage available. For example, WTC futures a year out are about 3.6% above spot, one-year Treasury yield is about 19 bps, and even with a spread on the riskless cost-of-funds and net storage costs, you’re talking about a risk-free profit for the Wall Street players involved in this, and a very tidy one if they lever it up enough. And trust me, they will hit that pellet dispenser until it finally runs dry.

    The tipping point is when the true believers they’re selling to are tapped out and the marginal “targets,” I mean investors, start to exhibit signs of healthy skepticism. This really isn’t much different from the mortgage crisis. At some point, the market will run dry, and curves will collapse (again, assuming no genuine supply issues).

    Reply

    scarmani Reply:

    @Art, @WARREN MOSLER, Thanks for the replies, good points to consider. Firsthand experience with how things work in the real world trumps theoretical reasoning.

    Practical limits on hedging makes a lot of sense as an explanation for persistent theoretical mispricing.

    I can also buy the idea that asset allocation gurus pushing inappropriate passive real asset investments can maintain an artificially elevated price, so long as they can maintain an continuous incoming stream of new investors flocking to what appears like an uptrend. While the other side of the organization hoards and skims profit from the resulting contango. Admittedly, asset allocation fads do occur and can persist for a while, this has happened constantly in a rotating series of asset classes.

    But to the extent that there is oil stockpiling to profit from contango, it seems to be dampening rather than exaggerating prices – WTI futures are abnormally depressed relative to world oil prices. The rest of the world is seeing a tight market.

    -=-

    I still think the supply situation with oil is seriously constrained and the last decade’s upward price trend represents more than a fad (whereas, many other commodities have much weaker fundamentals / are much easier to substitute). If there’s a weakness in the bull case for oil prices, it’s on the projected demand side (emerging markets slow down, global economy won’t grow, demand flatlines).

    What are some of the hallmarks of an asset bubble in the growth phase? Aside from 0) abnormally large, consistent, and consecutive increases in asset price / abnormally low volatility, one would expect to see 1) increasing leverage used to participate, 2) ratio of the asset to overall GDP increasing beyond that of historical norms, and 3) increasing supply of the asset created to meet speculative demand, eventually leading to rising inventory.

    Remember housing? Nasdaq? Japanese real estate and Nikkei?

    At least in the first two cases, there’s data clearly showing all of these hallmarks were met. Leverage played a key role in allowing and prolonging the US Housing bubble and .com bubble. During the late 90′s internet bubble / US housing bubble the ratio of margin debt / mortgage debt to GDP got far out of whack. As prices got ridiculously out of line, new supply swelled to take advantage. Lots of residential and commercial real estate was constructed. Lots of shoddy .com companies filed for IPOs. I can’t find data on the Japanese bubbles at a glance but I would be surprised if these three things were the case there. The same story appears to be playing out with fixed asset investment in China today – increasing leverage, out of whack proportion to overall GDP, swelling new supply, growing inventory overhang.

    What about oil today?

    0) In terms of abnormally large, consistent and consecutive increases in asset price, three years ago the spot price of oil dropped by about a factor of 4 – not typical ongoing-bubble behavior. More recently, price dropped almost 15% in a week.

    1) Increasing leverage used to participate – well, substituting in the commitment of trader report, yes, recently there are some troubling signs of unusually high spec long positions / short commercial positions. http://image.minyanville.com/assets/FCK_Jan2011/Image/LisaCatchMAY2011/mishoil5.jpg. And yes, levels of consumer credit are higher than historical norms, so in the sense that many people are maxing out their credit cards to buy gas, perhaps demand is more dependent on leverage than usual.

    2) Ratio of the asset to overall GDP increasing beyond that of historical norms? Not yet.
    http://www.econbrowser.com/archives/2011/05/en_share_may_11.gif
    http://gregor.us/wp-content/uploads/2011/06/US-Energy-Expenditure-as-a-Percentage-of-GDP-1999-2010-Nominal.png

    To kill global growth oil would have to hit well over $150 / bbl.
    http://graphics.thomsonreuters.com/11/02/OIL_CALC0211_SB.html

    3) Increasing supply of the asset created to meet speculative demand, eventually leading to rising inventory overhang?
    On this count, according to current data, definite no. Supply has hit a wall for 7 years running. Credible forecasters have one by one come publicly over to the position that a combination of geological and geopolitical factors, investment constraints, infrastructure constraints and human resource constraints will keep supply capped close to current levels. At the moment demand is outpacing supply and inventories are being drawn down.
    http://omrpublic.iea.org/stocks/Oc_to_ov.pdf
    http://omrpublic.iea.org/stocks/Oc_tp_ov.pdf

    “Even if one allows for lackluster economic expansion in Organisation for Economic Co-operation and Development (OECD) economies, global demand growth, which exceeded many analysts’ projections last year and earlier this year, looks set to continue at a brisk pace. The U.S. Energy Information Administration’s (EIA) Short-Term Energy Outlook (STEO), released Tuesday, forecasts world consumption of petroleum and other liquids during the third quarter of 2011 to be 1.3 million barrels per day (bbl/d) above the second quarter level and 1.7 million bbl/d above the year-ago level… With the disruption in Libyan supplies not expected to be fully resolved by the end of 2012, much higher production from the rest of OPEC will be required to meet demand growth and replace significant amounts of Libyan supply, albeit with lower quality crude oils… Any increase in OPEC output does, however, result in reduced spare production capacity – a consideration that may partly offset the price calming effect of higher production. Assuming that roughly half of the lost Libyan production is restored by late 2012, EIA projects OPEC’s spare capacity to drop to about 3 million bbl/d and OECD commercial stocks to drop toward the low end of the last 5-year inventory range by the end of next year. Should demand growth continue to outpace expectations, or should supply increases fail to materialize as projected, oil prices and volatility are likely to climb higher… In the short term, the seasonal swing in oil demand, combined with missing Libyan supplies, raises the risk of higher prices – especially if they are unaccompanied by a significant, actual increase in oil production from countries with useable spare capacity.”
    http://www.eia.gov/oog/info/twip/twip.asp

    Overall, I don’t see a bubble in oil prices. If there is one, it’s an incipient one, not one in the process of bursting. If oil falls, it will be because the economy stalls.

    Reply

  8. Links 6/12/11 « naked capitalism Says:

    [...] Saudis to pump 10 million bpd Warren Mosler (hat tip Philip Pinkington) [...]

  9. Links 6/12/11 | Jackpot Investor Says:

    [...] Spring: Neoliberal financiers in North Africa and Palestine Pambazuka News (hat tip reader May S)Saudis to pump 10 million bpd Warren Mosler (hat tip Philip Pinkington)Senate report: The Latin American war on drugs has [...]

  10. Dan Furlano Says:

    http://news.yahoo.com/s/ap/20110613/ap_on_bi_ge/oil_prices

    Reply

  11. scarmani Says:

    Thanks for the replies, good points to consider @Art, @WARREN MOSLER. Firsthand experience with how things work in the real world trumps theoretical reasoning.

    Practical limits on hedging makes a lot of sense as an explanation for persistent theoretical mispricing.

    I can also buy the idea that asset allocation gurus pushing inappropriate passive real asset investments can maintain an artificially elevated price, so long as they can maintain an continuous incoming stream of new investors flocking to what appears like an uptrend. While the other side of the organization hoards and skims profit from the resulting contango. Admittedly, asset allocation fads do occur and can persist for a while, this has happened constantly in a rotating series of asset classes.

    But to the extent that there is oil stockpiling to profit from contango, it seems to be dampening rather than exaggerating prices – WTI futures are abnormally depressed relative to world oil prices. The rest of the world is seeing a tight market.

    -=-

    I still think the supply situation with oil is seriously constrained and the last decade’s upward price trend represents more than a fad (whereas, many other commodities have much weaker fundamentals / are much easier to substitute). If there’s a weakness in the bull case for oil prices, it’s on the projected demand side (emerging markets slow down, global economy won’t grow, demand flatlines).

    What are some of the hallmarks of an asset bubble in the growth phase? Aside from 0) abnormally large, consistent, and consecutive increases in asset price / abnormally low volatility, one would expect to see 1) increasing leverage used to participate, 2) ratio of the asset to overall GDP increasing beyond that of historical norms, and 3) increasing supply of the asset created to meet speculative demand, eventually leading to rising inventory.

    Remember housing? Nasdaq? Japanese real estate and Nikkei?

    At least in the first two cases, there’s data clearly showing all of these hallmarks were met. Leverage played a key role in allowing and prolonging the US Housing bubble and .com bubble. During the late 90′s internet bubble / US housing bubble the ratio of margin debt / mortgage debt to GDP got far out of whack. As prices got ridiculously out of line, new supply swelled to take advantage. Lots of residential and commercial real estate was constructed. Lots of shoddy .com companies filed for IPOs. I can’t find data on the Japanese bubbles at a glance but I would be surprised if these three things were the case there. The same story appears to be playing out with fixed asset investment in China today – increasing leverage, out of whack proportion to overall GDP, swelling new supply, growing inventory overhang.

    What about oil today?

    0) In terms of abnormally large, consistent and consecutive increases in asset price, three years ago the spot price of oil dropped by about a factor of 4 – not typical ongoing-bubble behavior. More recently, price dropped almost 15% in a week.

    1) Increasing leverage used to participate – well, substituting in the commitment of trader report, yes, recently there are some troubling signs of unusually high spec long positions / short commercial positions. http://image.minyanville.com/assets/FCK_Jan2011/Image/LisaCatchMAY2011/mishoil5.jpg. And yes, levels of consumer credit are higher than historical norms, so in the sense that many people are maxing out their credit cards to buy gas, perhaps demand is more dependent on leverage than usual.

    2) Ratio of the asset to overall GDP increasing beyond that of historical norms? Not yet.
    http://www.econbrowser.com/archives/2011/05/en_share_may_11.gif
    http://gregor.us/wp-content/uploads/2011/06/US-Energy-Expenditure-as-a-Percentage-of-GDP-1999-2010-Nominal.png

    To kill global growth oil would have to hit well over $150 / bbl.
    http://graphics.thomsonreuters.com/11/02/OIL_CALC0211_SB.html

    3) Increasing supply of the asset created to meet speculative demand, eventually leading to rising inventory overhang?
    On this count, according to current data, definite no. Supply has hit a wall for 7 years running. Credible forecasters have one by one come publicly over to the position that a combination of geological and geopolitical factors, investment constraints, infrastructure constraints and human resource constraints will keep supply capped close to current levels. At the moment demand is outpacing supply and inventories are being drawn down.
    http://omrpublic.iea.org/stocks/Oc_to_ov.pdf
    http://omrpublic.iea.org/stocks/Oc_tp_ov.pdf

    “Even if one allows for lackluster economic expansion in Organisation for Economic Co-operation and Development (OECD) economies, global demand growth, which exceeded many analysts’ projections last year and earlier this year, looks set to continue at a brisk pace. The U.S. Energy Information Administration’s (EIA) Short-Term Energy Outlook (STEO), released Tuesday, forecasts world consumption of petroleum and other liquids during the third quarter of 2011 to be 1.3 million barrels per day (bbl/d) above the second quarter level and 1.7 million bbl/d above the year-ago level… With the disruption in Libyan supplies not expected to be fully resolved by the end of 2012, much higher production from the rest of OPEC will be required to meet demand growth and replace significant amounts of Libyan supply, albeit with lower quality crude oils… Any increase in OPEC output does, however, result in reduced spare production capacity – a consideration that may partly offset the price calming effect of higher production. Assuming that roughly half of the lost Libyan production is restored by late 2012, EIA projects OPEC’s spare capacity to drop to about 3 million bbl/d and OECD commercial stocks to drop toward the low end of the last 5-year inventory range by the end of next year. Should demand growth continue to outpace expectations, or should supply increases fail to materialize as projected, oil prices and volatility are likely to climb higher… In the short term, the seasonal swing in oil demand, combined with missing Libyan supplies, raises the risk of higher prices – especially if they are unaccompanied by a significant, actual increase in oil production from countries with useable spare capacity.”
    http://www.eia.gov/oog/info/twip/twip.asp

    Overall, I don’t see a bubble in oil prices. If there is one, it’s an incipient one, not one in the process of bursting. If oil falls, it will be because the economy stalls.

    Reply

    WARREN MOSLER Reply:

    I’d say experience provides a sanity check for theory.

    wti is down because the crude coming to cushing from canada only goes that far until the pipeline is completed, and cushing is over supplied at the moment with no pipelines out.

    And asset bubbles would be a lot more entertaining and a lot less dire if we knew how to sustain aggregate demand when the popped and employment and real output stayed reasonably high throughout.

    Reply

    Art Reply:

    @WARREN MOSLER,

    “asset bubbles would be a lot more entertaining and a lot less dire if we knew how to sustain aggregate demand when they popped and employment and real output stayed reasonably high throughout.”

    :)

    Can’t, bubbles destroy real capital. :)

    Hydrogen bubbles anyways.

    Reply

    WARREN MOSLER Reply:

    Like by causing an explosion that destroys real goods and services? Never seen it.

    Art Reply:

    @scarmani,

    “But to the extent that there is oil stockpiling to profit from contango, it seems to be dampening rather than exaggerating prices – WTI futures are abnormally depressed relative to world oil prices. The rest of the world is seeing a tight market.”

    Cushing as Warren points out, but haven’t recently-enacted refinery regs in Europe caused an under-supply of Brent? Time will tell whether that can be rectified by new supply, but the relative price to WTI might be persistent unless/until regs shift again.

    Reply

  12. Henry Says:

    On the Edge with Chris Cook – 4 February 2011

    We talk to energy consultant, Chris Cook, about the role of funds in Brent in setting (or manipulating) the price of oil. It takes only $30 billion to rig the oil market and, if it weren’t for this manipulation, the price of crude would be between $50 and $60 per barrel.

    http://maxkeiser.com/2011/02/05/ote95-on-the-edge-with-chris-cook-4-february-2011/

    Reply

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