With supply following demand, as with any monopolistic arena, it looks like the world crude oil balance remains very much neutral leaving the Saudis in full control as swing producer where they set prices and let quantity adjust to market demand.
Stable crude prices with 0 interest rates, high excess capacity and low aggregate demand should keep inflation at bay indefinitely, with productivity increases making deflation the greater risk.
(an interoffice email exchange)
>
> On Fri, Sep 19, 2008 at 9:50 AM, David wrote:
> So creating liquidity for toxic assets RTC style.
>
maybe, jury is still out on how that might work
>
> Make the government a little money and inspire confidence in banks, ok.
>
> We are thinking that this is overtly inflationary for financial assets (maybe all
> assets?)
>
supports a lot of equity value by removing a large element of risk, but cost to shareholders still unknown
fixed income going higher in yield, prices there going down
>
> Should I expect this to re-inflate the commodity asset bubble in the medium
> term???
>
not directly. crude price up to the Saudis.
>
> Do you think the dollar’s rally will help cap any commodity asset price rise???
>
yes, in the competitive markets. crude is not a competitive market. saudis merely set price and let quantity adjust
>
> PS- I expected to come in today to $110+ crude, $8+ gas, and $900+ gold.
>
as above. crude up even with dollar up, but gold down.
warren
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Heard last night index funds have liquidated the equivalent of maybe 140 million barrels of crude.
Add to that trend followers who went from long to short, and it’s way more than enough to explain the sell-off.
Since the Saudis don’t want to make their price setting status obvious, they ‘get out of the way’ for these type of liquidations, and if they want prices back up, as I suspect they do, they start bringing them up after the smoke clears.
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(an email exchange)
>
> On Wed, Aug 6, 2008 at 4:45 PM, Craig wrote:
>
> It seems that the ‘right’ price for them to set oil at is not
> necessarily the highest price possible.
>
All the 911 passports were Saudi; so, they might have other agendas.
>
> If I were them it would seem like the best policy to maximize
> the total value of their oil holdings over the life of those
> holdings. By cranking the price up ‘too high’, they incent
> substitution and potentially kill their sales in the long term.
>
Right, classic monopoly analysis.
> It would seem their goal would be to keep the price as high
> as they could w/o setting off a chain of
> substitution/invention/philosophy which would move the world
> meaningfully away from oil (or towards increased oil exploration
> or towards invading them). There is also the little matter of
> how much money do they really need (a somewhat silly question
> but this situation does create an embarrassment of riches/market
> dislocations in excess of where a rational accumulation might lie).
>
Yes, understood.
>
> It looks to me that on the highs they got everybody’s attention.
> There may still be political responses towards
> innovation/substitution/conservation at these levels, but it seems
> likely that at or above the old highs, US folks will be making their
> next car a hybrid, beating their government to get prices down
> (including pluggables/nuclear – a long term threat to Saudi
> dominance) and the like. Then there’s China’s slowdown and food
> riots. I’d have thought quietly bleeding the world would be better
> business than actually setting it on fire.
>
Yes, but again, it’s their ‘political choice.’ There is no ‘market price’.
Also, with only 1.5 million bdp in total excess capacity, it might be too close to the line for them, and they might want to get prices high enough to build their excess capacity by a million or two bpd.
Otherwise they risk losing control of price on the upside, as happened a couple of years back when output briefly hit 10.5 million bpd when the funds were buying intensely enough to cause builds of physical inventory and a large contango as storage went to a premium.
>
> Of course, even if this is all true, they may be looking at it
> differently.
>
Worst case for us is they understand that they can hike all they want if they spend the extra revenues on imports of real goods and services. This keeps foreign GDPs muddling through in positive territory as they exact ever higher real terms of trade and they increasingly prosper at our expense.
And out leaders think more exports and less consumption is a good thing and are encouraging more of same.
Almost seems from the data this is exactly what they are up to?
Think they read my blog???
:)
warren
>
> Craig
>
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Russel asks:
Any reason why the Saudi’s are allowing the price of oil to slide?
Just a guess. The futures liquidations were large enough such that holding spot prices up and letting futures free fall would have made it obvious the Saudis are price setter.
There also could be some liquidation of physical inventory going on in which case they would have to let inventories fall before resuming control of prices, or else actually buy in the spot markets which is out of the question of course.
It’s like if some pension fund had a hoard of NYC subway tokens and decided to sell them ‘at the market’. The price would go down from the current $2 price until that selling pressure abated. Then the price would go back to whatever NYC was charging.
So most likely they just let this inventory liquidation run its course, and then work prices higher again.
Much like happened in Aug 2006 with the massive Goldman liquidation and again in a smaller way at year end back then.
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Lehman cuts oil demand forecast
by Richard Valdmanis
(Reuters) Investment bank Lehman Brothers (LEH.N: Quote, Profile, Research, Stock Buzz) said Wednesday it slashed its forecast for 2008 world oil demand growth due to a steeper-than-expected slowdown in energy consumption in the United States and other OECD countries.
Lehman added it believes the oil market is “approaching a tipping point” with prices expected to decline to an average of $90 a barrel in the first quarter of 2009.
“We now forecast annual oil demand for 2008 at 86.3 million barrels per day, a growth of 790,000 bpd from 2007. The growth has been revised down from projections of 1.5 million bpd in December,” Lehman said in a research note titled ‘Demand Demolition’.
If true, and non-Saudi supply remains about flat, Saudi production might fall to about 9 million bpd and the price would still remain wherever the Saudis set it.
There has been some talk that the Saudis may have agreed to lower prices after the last round of meetings with US officials. Could be, but with their output running within a million or two bpd of their total capacity, it seems doubtful they would do anything to increase demand before they have the excess capacity to meet it. But there could be other factors (including the US 7th fleet and concerns about a united Iran/Iraq threatening them) that might be influencing their decision. Only time and prices will tell. Should be more clear in a week or so.
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(an email exchange)
>
> On Sun, Jul 20, 2008 at 10:46 PM, Russell wrote:
>
> Brad Setser, at Follow the Money, presents a couple of graphs on changes in
> oil export revenue: The Oil Shock of 2008.
>
> The following graph shows the Year-over-year change in oil exports as a
> percent of world GDP (and in billions of dollars).
>
>
>
> Year-over-year change in oil exports
>
> This calculation assumes that the oil exporters will export about 45 million
> barrels a day of oil.
>
> Each $5 increase in the average price of oil increases the oil exporters’
> revenues by about $80 billion, so if oil ends up averaging $125 a barrel this year
> rather than $120 a barrel, the increase in the oil exporters revenues would be
> close to a trillion dollars.
>
> Assuming oil prices average $120 per barrel for 2008, the increase in 2008 will
> be similar to the oil shocks of the ’70s.
>
>
Right, the notion that oil is a smaller % of GDP and therefore not as inflationary was flawed to begin with and now moot.
Two more thoughts for today:
First, the second Mike Masters sell-off may have run its course. The first was after his testimony in regard to passive commodity strategies which I agree probably serve no public purpose whatsoever. The second was last week as markets expect Congress to act to curb speculation this week, which they might. Crude isn’t a competitive market (Saudi’s are the swing producer) so prices won’t be altered apart from knee jerk reactions, but competitive markets such as gold can see lower relative prices if the major funds back off their passive commodity strategies.
Second, just saw a headline on Bloomberg that inflation is starting to hurt the value of some currencies.
Third, the Stern statement will continue to weigh on interest rate expectations up to the Aug 9 meeting.
Seems like a sale ahead of possible Congressional action to limit ‘speculation’.
Not sure how big the dip might be, but yet another buying op as the choice remains – pay the Saudis their asking price or shut the lights off.
The price only goes down if the Saudis cut price, or if there is a supply response of more than 5 million bpd that dislodges them from being swing producer.
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Bank deputy chief warns of market trouble to come
by Ben Russell, Political Correspondent and Sean O’Grady
Britain is facing the risk of renewed turmoil in the financial markets, the new deputy governor of the Bank of England warned yesterday.
Professor Charlie Bean, the deputy governor for monetary policy and a former chief economist at the Bank, raised the prospect of a slowing global economy triggering a new round of problems with corporate loans and said that the impact of the credit squeeze could be greater than Bank projections.
Yes, but unlike the Eurozone, the BoE is permitted to ‘write the check’ as in the treasury.
National solvency is not an issue in the UK as it is in the Eurozone when weakness is addressed.
He told members of the Commons Treasury Select Committee that Britain faced “major conflicting risks” threatening the Government’s inflation target from the problems of a slowing economy and rising commodity prices.
Yes, the twin themes of weakness and inflation.
In a memorandum to the committee, Professor Bean warned that the “dislocation” in the financial markets “probably has further to run, especially if a slowing economy here and abroad generates a second round of write-downs, this time associated with corporate loans. Moreover, the impact of the tightening in the terms of availability of credit could prove greater than is embodied in the central case in our most recent set of projections”.
Agreed. And while ‘writing the check’ can readily address these issues with no risk to government solvency, it will also support the higher prices he next discusses:
He said that increasing oil and other commodity price rises would lead to higher inflation becoming “embedded in the economy”, warning that people might seek to offset price increases by making higher wage demands. He said: “There is no doubt that the UK economy presently faces the most challenging set of circumstances since at least the early 1990s and probably earlier.”
Professor Bean said oil prices could continue to rise for another two years and cautioned that Britain faced the danger of a pay-price spiral if workers tried to compensate by pushing up wages. He said: “It certainly poses a significant challenge. There is no doubt about that at all. It may be a relatively unlikely event but it could be particularly unfortunate if it happened, if households and businesses start losing faith in the idea that inflation will stay low, round about the target, they start building it into their pay and prices and inflation becomes much more embedded into the system… Provided pay growth remains subdued, the current pick-up in inflation will be temporary.”
Living standards, the deputy governor stressed, will inevitably be lower because of the global inflation in commodity prices.
Agreed. It’s all about real terms of trade, which have also been declining rapidly in the US as evidenced by the drop in growth of GDP and the drop in non-oil trade deficit.
My guess is the most likely political response in the US and the UK is proactive deficit spending from the treasury to address the weakness and higher interest rates to address the inflation.
Unfortunately the deficit spending that supports domestic demand will also support crude consumption (as well as housing) and ‘monetize’ the ever higher crude prices being set by the Saudis, thereby supporting ‘inflation’ in general.
And this will trigger ever higher interest rates from the Central Bank as inflation trends even higher.
This does not bode well for oil prices.
Increased Saudi output means demand has increased at current prices, and the Saudis (and Russians, etc.) remain firmly positioned as ‘price setter’.
The Saudis continue to have the only excess supply, with about 1.5 million bpd excess capacity.
The Mike Masters sell off seems to be over. Actual legislative effort could cause a subsequent temporary sell off but will not dislodge the Saudis from total control.
The only thing that can dislodge their ability to set price is a net supply response in excess of 5 million bpd, which is highly unlikely in the near future.
Any efforts to increase aggregate demand to support growth will also function to support prices.
My twin themes remain:
‘Solutions’ remain:
Biofuels continue to link crude to food, and the political response to food shortages and markets allocating life by price is likely to continue to be ‘cash’ payments regardless of inflationary consequences. The body count is likely to exceed that of WWII over the next few years and is probably already in the millions.
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