Tag Archives: Oil

Saudi/Fed teamwork

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Looks like markets are still trading with the assumption that as the Saudis/Russians hike prices the Fed will accommodate with rate cut.

That’s a pretty good incentive for more Saudi/Russian oil price hikes, as if they needed any!

Likewise, the US is a large exporter of grains and foods.

Those prices are now linked to crude via biofuels.

And the new US energy bill just passed with about $36 billion in subsidies for biofuels to help us keep burning up our food for fuel and keeping their prices linked.

This means cpi will continue to trend higher, and drag core up with it as costs get passed through via a variety of channels. In the early 70’s core didn’t go through 3% until cpi went through 6%, for example.

Ultimately everything is made of food and energy, and margins don’t contract forever with softer demand. In fact, much of the private sector is straight cost plus pricing, and govt is insensitive to ‘demand’ and insensitive to the prices of what it buys. And the US govt. indexes compensation and most transfer payments to (headline) cpi.

And while the US may be able to pay it’s rising oil bill with help from its rising export prices for food, much of the rest of the world is on the wrong end of both and will see its real terms of trade continue to deteriorate. Not to mention the likelihood of increased outright starvation as ultra low income people lose their ability to buy enough calories to stay alive as they compete with the more affluent filling up their tanks.

At the Jan 30 meeting I expect the Fed to be looking at accelerating inflation due to rising food/crude, and an economy muddling through with a q4 gdp forecast of 2-3%. Markets will be functioning, banks getting recapitalized, and while there has been a touch of spillover from Wall st. to Main st. the risk of a sudden, catastrophic collapse has to appear greatly diminished.

They have probably learned that the fed funds cuts did little or nothing for ‘market functioning’ and that the TAF brought ff/libor under control by accepting an expanded collateral list from its member banks.

(In fact, the TAF is functionally equiv of expanding the collateral accepted at the discount window, cutting the rate, and removing the stigma as recommended back in August and several times since.)

And they have to know their all important inflation expectations are at the verge of elevating.

They will know demand is strong enough to be driving up cpi, and the discussion will be the appropriate level of demand and the fed funds rate most likely to sustain non inflationary growth.

Their ‘forward looking’ models probably will still use futures prices, and with the contangos in the grains and energy markets, the forecasts will be for moderating prices. But by Jan 30 they will have seen a full 6 months of such forecasts turn out to be incorrect, and 6 months of futures prices not being reliable indicators of future inflation.

Feb ff futures are currently pricing in another 25 cut, indicating market consensus is the Fed still doesn’t care about inflation. Might be the case!

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Crude oil demand revised up

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This means Saudis/Russians will continue to be price setters for at least the next few quarters.

IEA Lifts 2008 World Oil Demand Growth Forecast

By Reuters | 14 Dec 2007 | 05:32 AM ET

World oil demand will grow more quickly than expected next year fueled by the Middle East and proving resilient to record-high prices, the International Energy Agency said on Friday.

The IEA, adviser to 27 industrialized countries, said in its monthly Oil Market Report that demand will rise by 2.1 million barrels per day (bpd) next year, up 200,000 bpd from its previous forecast.

“A lot of this demand is in the non-OECD countries, where we don’t have any downgrades in economic growth forecasts,” said Lawrence Eagles, head of the IEA’s Oil Industry and Markets division.

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UST ASW update

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(an interoffice email)

>
>
> 16bp day for 2yr spreads today:
>
>
>
> The market went into the fed announcement expecting perfection
>
> 25-50bp cut and 50bps on the discount window.
>
>
>
> Spreads were 6 lower on the day in the 2yr sprds and 3 lower in tens before
> the Fed.
>
> Needless to say the market was disappointed…
>
> Spreads moved back to the wides in the front end
>
> and now are repricing an expectation of extended financial market /
> financing turmoil

Hi,

Looked to me like the post fed moves were unwinds of all sorts, and didn’t fit any other theme, so I’ll be watching for reversals after things settle down tomorrow am.

Interesting that the markets were shocked that the Fed cared about inflation. I read the speeches as saying they do care a lot, but the media glossed over those parts and didn’t even report those references.

And also interesting that interest rates went lower in response to the Fed caring about inflation.

Also, the strong yen vs the pound and euro, for example, was the reaction to ‘stress’ type of move we saw beginning in August.

While the FOMC didn’t do much to alleviate stress per se, they didn’t actually *do* anything to make it worse, either, and there were signs it was running its course, with the year end issue the remaining
hurdle. I’ll be looking for signs the NY Fed is working on that tomorrow and watching to see if 3 mo libor comes back down over the next few days.

The CPI and PPI are expected to be off the charts Thursday and Friday, and the media could start harping on inflation, blame the Fed for high oil prices, questioning whether a half point in the funds rate over the last few months was worth a $20 increase in the price of crude, and continue pushing that theme if crude goes up as I expect it will, as Saudis continue to (irregularly to hide what they are doing) hike posted prices and let the quantity they pump vary. (and Russia
probably doing same as well.) At 120 crude, retail gasoline should be pushing $4 and food up as well via the biofuel connection, and the media attack on the Fed for letting the inflation cat get out of the bag can elevate expectations rapidly, with tips breakevens and Michigan expectations numbers elevating rapidly.

So far, higher crude means lower yields, as it is anticipated the economy will weaken and the Fed doesn’t care about inflation. If/when that changes- as evidenced by higher crude causing higher interest rates even with risk to gdp- tensions and stresses move up several notches, as anyone working through the 70’s and 80’s should recall.

Given the coming inflation numbers, a segment of the mainstream will start to point out that the ‘correct’ fed funds rate is about 7% with inflation at about 4. To them a neutral real rate would put the ff rate at 6, so it will take 7 to be restrictive. They will argue headline cpi is the rate to use, as food and energy are trending and sustaining the higher levels, along with import and export prices rising at more than 5% rates, and therefore this group will give greater weight to core moving up to headline as happened in the 70’s when crude trended upwards for an extended period of time. And should crude continue to move up, this initially small group of mainstream economists will grow, and CNBC will help promote this ‘scare story’ as it attracts more and more viewers.

Hoping things don’t go that way but concerned they will. Looking forward to reactions to the data later this week and what commodity prices do from here.

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Fed expected to lower rates despite raging inflation – MarketWatch

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And the risk is headlines could get much worse after they cut.

For example:

‘Oil prices rise as Fed rate cuts drive down the dollar’

‘Fed cuts rates, driving up gas prices, to bail out banks’

MarketWatch article – Fed expected to lower rates despite raging inflation

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Saudi oil production rose last month

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2007-11-30 Saudi Oil Production

Saudi production rose last month, meaning demand for their output increased even at the higher prices. They are acting as ‘swing producer’ and let output vary to meet actual demand. By definition, therefore, markets are ‘well supplied’ at their price. To avoid controversy, they deny this policy, but in fact they have no choice as a point of market logic.

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Bank capital NOT a constraint on lending

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Here’s the response to Jan’s (Goldman) concern about lost capital constraining lending.

Bank capital grows endogenously- it’s not a constraint on lending apart perhaps from the very near term.

Banks ‘know’ the cost of capital, and the roe’s they need to make to pay for new capital.

For example, if Citi paid 11%, and they can leverage it 15 times, that’s about a .75% ‘add on’ to their cost of funds for funding loans.

With floating fx, the causation is ‘loans create deposits’ and this applies to availability of bank capital as well.

So it’s all about price, not quantity, for both loans and capital.

And banks currently do have a lot of ‘room’ for lending with current capital levels.

Like the recession, this all reminds me of the sign that says ‘free beer tomorrow.’

High oil won’t hurt gdp us as long as the producers are spending their income here.

It will hurt our standard of living and help theirs- real terms of trade and all that.

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Saudis are Necessarily in Position of Price-Setter

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Published November 16, 2007 in the Financial Times

From Mr Warren Mosler.

Sir, Adrian Binks’ letter “Oil price conspiracy theories get in the way of facts”(November 14) is precisely the response indicated in my letter (November 12); in this case from an energy information service. While Mr Binks’ statements are indeed factual, the institutional structure outlined, which the Saudis initiated, leaves more than sufficient room for the Saudis effectively to set prices and meet the demand at that price.

Note that their current production level of about 8.5m barrels per day is down about 2m bpd from just a few years ago. If they were simply producing based on capacity and selling the resulting output at “market” prices, their output would be higher and the price of crude much lower.

Furthermore, if they were not acting as swing producer, it would be far more difficult to organize general Opec production levels.

Regarding Russia, Mr Binks’ statement that “the Kremlin proposed that an oil exchange be established at St Petersburg to set the price of Russian oil, although this has not yet come into being”, is indicative that President Vladimir Putin is well aware that Russia is indeed a “price-setter”, and I suggest that it is an error to underestimate his progress in this direction.

To address Mr Binks’ conclusion: this is not a “conspiracy theory” and not precisely a “price-setting cartel”. It is, rather, a point of logic describing a case of “imperfect competition” where (at least in the short run) a given supplier’s output is sufficiently large and flexible, and demand sufficiently constant, that the supplier is necessarily in the position of “price-setter”.

Warren Mosler,
Chairman,
Valance & Co,
St Croix,
USVI 00820

Copyright The Financial Times Limited 2007

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