Globalisation and the costs of international trade from 1870 to the present - Vox EU

Summary:
Many analysts suggest that rising oil prices will sharply reduce international trade. This paper argues to the contrary, noting that transport costs constitute a limited share of trade costs (about 1/3rd). Instead of transportation costs, the biggest reversal of international trade in recent history is linked to large increases in protectionist measures. Moreover, evidence from the first wave of globalisation suggests that higher shipping costs are unlikely to significantly dampen international commerce – only protectionism would seriously threaten trade. Compared with historical patterns, the level of bilateral trade costs is still high for many country pairs, especially for those that are far away from each other. This means that there is scope for trade costs to fall further. Unless there is a backlash in the form of rising protectionism, world trade has the potential to keep growing strongly over the coming decades. (Published: 16/08/08)

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The Dangerous Myth of Energy Independence - Informed Comment

Summary:
Robin M. Mills argues that the world is not running out of oil, that the current high energy prices are the result of a long period of low prices and under-investment, as well as irrational hostility between suppliers and consumers. Ideas about forestalling an oil crisis by ‘energy independence’, or by military action, are mistaken. The proper energy policy should be energy security, not energy independence. Objective profoundly harmed by climate, with elements of paranoia, racism and Islamophobia. Energy security is achieved when suppliers find markets, and markets find supply, at prices permitting both of them economic stability and growth, which requires a complex web of inter-relationships between producers and consumers. Policies to encourage US domestic production, increase efficiency and introduce alternative energy sources are desirable, often for environmental rather than energy security reason, but they have to be pursued with vigour and resolution. Promises to ‘jawbone’ OPEC into supplying more oil sit very oddly with the US’s uniquely comprehensive moratoria on offshore oil and gas production. Need a rational and balanced dialogue about how to co-operate on bringing that abundant energy to consumers. (Published: 02/09/08)

Comment:

• current high energy prices emerge from a long period of low prices and under-investment
• fruit of the breakdown of international energy relationships in the oil crises of 1973-4 and 1978-80
• high prices are not due to a lack of resources in the ground
• remains vast potential around the world for increasing recovery from
  
• existing fields,
  
• discovering new oil, e.g. recently deepwater Brazil
• largely untouched US offshore
• ‘unconventional’ sources such as Canada’s famous ‘oil sands’
• biofuels
• synthetic fuels from natural gas and coal, and others
• ideas about forestalling an oil crisis by ‘energy independence’, or by military action, are therefore mistaken
• such ‘solutions’ are likely to create the crisis they seek to mitigate
• proper objective of energy policy: not independence, but security
• objective profoundly harmed by climate, with elements of paranoia, racism and Islamophobia
• energy security is achieved when suppliers find markets, and markets find supply, at prices permitting both of them economic stability and growth
• requires a complex web of inter-relationships between producers and consumers
• attempts by a major nation to achieve energy self-sufficiency are very distorting to economic competitiveness
• even worse when bad relations with major energy suppliers, and conflicting messages about future energy policy, discourage much-needed investment
• if one side believes they are buying oil from terrorists, and the other thinks they are selling to neo-imperialists, it is not surprising that
  
• oil prices are high
• investment is lacking and
  
• most of world oil reserves are monopolised by state companies
• the Middle Eastern nations have generally been very reliable suppliers, and use of a mythical ‘oil weapon’ is very unlikely
• any régime would be reliant on its oil earnings to sustain the economy
• while strategic reserves in the industrialised countries give some ‘staying power’ to outlast an embargo
• policies to encourage US domestic production, increase efficiency and introduce alternative energy sources are desirable
• often for environmental rather than energy security reasons
• but: they have to be pursued with vigour and resolution
• US energy policy has been more erratic and hostile to increasing output than most of the Middle Eastern countries
• ‘pork barrel’ subsidies and the interminable, inconclusive debates over whether to open new exploration areas, build new pipelines and terminals for clean natural gas, extend support for renewable energy and increase mileage standards
• promises to ‘jawbone’ OPEC into supplying more oil sit very oddly with the US’s uniquely comprehensive moratoria on offshore oil and gas production
• military ‘control’ of oil is not achievable or cost-effective
• expenditure on such wars vastly exceeds the value of any oil ‘secured’
• while production can struggle along in war-torn areas, it is impossible to develop major new fields
• ‘Police actions’ to deal with specific threats are entirely reasonable
• as long as they are multi-lateral and proportional to the danger posed
• and carried out competently
• grandiose military adventures destroy the co-operation which is essential for global energy trade
• ‘Energy independence’ is a chimera, expensive, unachievable, and swimming against the tide of greater global economic integration
• world is not running out of oil
• we need a rational and balanced dialogue about how to co-operate on bringing that abundant energy to consumers
• if the profound misunderstanding of, and hostility towards, the Middle East, continues, the house of energy security is being built on sand

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The Outlook For Inflation and the Likelihood of $60 Oil - Hussman Funds' Weekly Market Comment

Summary:
John P. Hussman believes speculators are behind the rising oil prices, and that the fact that speculators don't take physical delivery for the product is irrelevant. What matters is that the purchase of futures contracts by speculators is crowding out the purchase that a bona-fide hedgers would otherwise be able to make from a producer. In a few months, however, due to broadening economic weakness we may see an unwinding of speculative pressure, resulting in steep declines in commodities prices, including oil. On the topic of inflation, Hussman believes that a combination of weakening demand for most goods and services as a result of consumer restraint, accompanied by a generally firm demand for currency and Treasury securities as safe havens from credit risk will result in disinflation, rather than inflation. Excellent tutorial on the causes of inflation in terms of marginal utility, and how government spending (whether by printing money or issuing bonds) contributes to inflation. Government spending expansion, regardless of the form, will tend to raise the marginal utility of goods and services while lowering the marginal utility of government liabilities. (Published: 07/07/08)

Notes:

Inflation

• bulk of recent inflation has been restricted to food and energy
• year-over-year change in the CRB commodity index minus food and energy is already negative
• main factors influencing the outlook for broad inflation
• US economy most likely already in a recession
• consumers are unusually strapped because of both mortgage debt and high budget constraints
• international economies are beginning to weaken
• note: China: Shanghai index down by well over half since last year's peak
• stock markets typically don't drop in half without economic repercursions
  
• credit concerns are endemic
• US government spending: relatively stable and not expanding rapidly
• given this context:
• combination of weakening demand for most goods and services as a result of consumer restraint
• accompanied by a generally firm demand for currency and Treasury securities as safe havens from credit risk
• that combination is disinflationary
• likely that we'll observe further downward pressure on inflation outside of the food and energy groups over the coming quarters

Oil prices

• broadening economic weakness and an unwinding of speculative pressure will combine to produce steep declines in commodities prices
• most probably by the end of the summer season
• is the price of oil being driven up by hedge funds, commodity pools and speculators?
• many pundits say no:
• speculators don't take delivery of the physical product
• instead they roll their futures contracts over indefinitely or until they close out their positions
• so they can't drive up prices
• Hussman says yes:
  
• disagrees with opponents:
• argument ignores the zero-sum nature of the futures market
• producers have an interest in selling their output forward to lock in a predictable price
• similarly, bona-fide hedgers (e.g. transportation and industrial companies) have an interest in buying oil forward so they can plan without concern about future fluctuations
• speculation unbalanced on one side: purchase of futures contracts by speculators begins to crowd out the purchase that a hedger would otherwise be able to make from a producer
• doesn't matter that the speculator has no intent to take delivery
• if the speculators are unbalanced on one side, the producers will have satisfied their need to pledge future delivery
• and because they can lock in a high price, they will be inclined to sell more for future delivery than they otherwise would
• meanwhile, bona-fide hedgers will be inclined to buy less on the forward market than they otherwise would
• when it comes time for the speculators to roll the contracts forward, they have to sell their existing contracts either to someone who is willing to take delivery
• or to a producer who sold the oil forward and can now clear that liability without actually producing the stuff
• given relatively high spot demand and tight supply, these rolling transactions have worked fine to this point, without driving prices lower
• problem will emerge few months from now as
1. economic demand softens further
2. planned production hikes actually emerge
3. weakening price momentum encourages speculators to close long positions instead of rolling them forward
• at that point, we can expect the net speculative positions to plunge by 10-15% of open interest
• we'll see a sudden glut on the market for spot delivery
• should not be surprising if this speculative unwinding takes the crude below $60 a barrel by early next year
• geeks rule of thumb:
• "when you have to fit a sixth order polynomial to capture price history because exponential growth is too conservative, you're probably close to a peak"
• doesn't mean that prices can't move even higher over the short term
• once prices go into a vertical spike, very small changes in the date of the final peak imply significant uncertainty about the ultimate high
• but: reasonable to believe that the often extreme cyclicality of commodities has not suddenly become a thing of the past.

• In commodity markets in particular, price trends feed on themselves in both directions, so we see pronounced cyclicality, and much more persistent trends – once set in motion – than we typically do in the equity and bond markets. It may be difficult to identify a peak in oil when it occurs, but most likely, the fallout from that peak will be spectacular.

Primer on inflation

• concept of marginal utility
  
• ice cream: 1st ice cream very enjoyable, 2nd one a little less, ..., 4th one probably indifferent
• as you increase the availability of a good, the "marginal utility" declines
• i.e. the value you place on an additional unit
• same principle holds for economy as a whole
• e.g. economy-wide supply of ice cream and pencils
• marginal utility of ice cream: 6 smileys
• marginal utility of pencils: 2 smileys
• price of an ice cream cone, in terms of pencils = ratio of their marginal utilities = 3 pencils
• money
• dollar in your wallet
• you hold onto it in your wallet, forgoing interest earnings, because that dollar of currency provides certain usefulness in terms of making day-to-day transactions and so forth
• dollar provides certain amount of marginal utility
• as a result, the prices of goods and services in the economy, in terms of dollars, will reflect the ratios of marginal utilities between "stuff" and dollars
• i.e. the dollar price of good X is just the marginal utility of X divided by the marginal utility of a dollar
• how do you get inflation?
  
• either, increase the marginal utility of "stuff"
• happens either if the supply of goods and services becomes more scarce
• or if the demand for goods and services becomes more eager
• or, reduce the marginal utility of dollars
• happens either if the supply of dollars becomes more abundant
• or if the demand to hold dollars becomes weaker
• effect of government spending and fiscal policiy
  
• need to stop thinking in terms of "partial equilibrium"
• ie. supply and demand of one item at a time
• think instead in terms of a full or "general" equilibrium imposed by a government constraint
• government spending
• financed through printing paper
• happens in banana republics
• predictably leads to inflation
• in particularly unproductive economies, it leads to hyperinflation
• financed through issuing government bonds
• tempting to think that issuing bonds means that the government is taking something in return for what it spends
• whereas printing money means an increase in spending power
• but: important to focus on the general equilibrium
• regardless of whether government finances its spending by printing money or issuing bonds, the end result is that the government has appropriated some amount of goods and services, and has issued a piece of paper: a government liability
  
• in return, which has to be held by somebody
• both of those pieces of paper – currency and Treasury securities – compete in the portfolios of individuals as stores of value and means of payment
• values of currency and government securities are not set independently of each other, but in tight competition
• particularly true today, when bank balances are regularly swept into interest earning vehicles as often as every night
• whatever the form of the paper receipts, aggressive government spending results in a relative scarcity of goods and services outside of government control, and a relative abundance of government liabilities
• real goods and services are being appropriated by government in return for an increasing supply of paper receipts
• setting a proper marginal tax policy
• on deflation
• e.g. Great Depression
• the marginal utility of “stuff” dropped, while the marginal utility of money soared
• output declined enormously
• but output fell because of a major reduction in demand
• so the marginal utility of goods and services most likely declined during that period even though production itself was down
• in contrast, despite a rapid increase in the monetary base during the Depression, people were frantic to convert their bank deposits into currency
• even the monetary growth that occurred wasn't nearly enough
• the frantic demand for currency, resulting from credit fears, translated into a major increase in the marginal utility of money
• result was rapid price deflation

• Summary:
• inflation results from an increase in the marginal utility of goods and services, relative to the marginal utility of money
• can reflect:
  
• supply constraints
• unsatisfied demand
• excessive growth of government liabilities
• or a reduction in the willingness of people to hold those liabilities
• inflation typically picks up in late-stage economic booms
• not because the economy is growing too fast, but rather because the economy begins to hit capacity constraints and is therefore not able to grow fast enough
• Fed often attempts to cool down the resulting increase in the marginal utility of goods and services
• by trying to make sure that demand growth doesn't outstrip the increasingly constrained level of supply
• apart from commodity prices, which may take a bit longer to reverse, the pressures on marginal utilities are presently on the disinflationary side

• Milton Friedman is widely known for two phrases
• "inflation is always and everywhere a monetary phenomenon."
  
• only half right because a government spending expansion, regardless of the form, will tend to raise the marginal utility of goods and services while lowering the marginal utility of government liabilities
• very true that the major hyperinflations in history have been triggered by currency expansion
• but as long as a government appropriates goods and services to itself in return for pieces of paper that compete as stores of value and means of exchange in the portfolios of investors, you'll get inflation
• "The burden of government is not measured by how much it taxes, but by how much it spends."
• completely correct
  

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The China bubble fuelling record oil prices - FT.com

Summary:
Daniel Gros (director of the Centre for European Policy Studies in Brussels) does believe that fundamentals are to blame for the rising crude oil prices, nor that speculators are driving the price up. It is the owners of the exhaustible resource which is oil that figure it is better to leave it in the ground, as they expect it will be more valuable tomorrow. Production will not increase because today's price is high, once producers expect tomorrow's price to be lower than today's. Equally, China influences the oil price not because of today's demand, but because the demand is expected to be even higher in the future. Another factor disincentivising producers are the negative real interest rates in the US, reducing the return from the dollars they would earn from increasing production. Oil producers are merely limiting their accumulation of rapidly depreciating dollars by limiting the rate at which they extract oil. If there is a bubble, however, it is not so much a bubble in the price of oil, but a China bubble, i.e. speculators and oil producers are gambling on China's sustaining high prices for ever. (Published: 09/07/08)

Notes:

• most economists:
• current sky-high price of crude oil is justified by fundamentals
• high growth in demand by emerging markets, i.e. China
• evidence:
  
• supply and demand seem finely balanced and inventories not increasing
• in spite of very high prices, production has not really increased
  
• Gros disagrees
• observation that inventories are not increasing is irrelevant:
• there is a very convenient way to store oil that is not measured by inventories data:
• just leave it in the ground
• observation that production has not increased is also irrelevant:
• does not take into account the nature of oil as an exhaustible resource
• owner of an exhaustible resource (e.g. King Ab-dullah, of SA) has to make a n inter-temporal choice:
• extract today or extract tomorrow
• extract today, get today's price (minus extraction cost)
• extract tomorrow, get tomorrow's price (minus same extraction cost) discounted at today's interest rate
  
• supply of oil today will thus increase only if tomorrow's price is low relative to the price today
• i.e. supply of oil will increase not when the price today is high, but only if suppliers expect that prices will be lower in the future
• implies that China influences oil prices today not so much because Chinese demand is high today
• but because demand in China is projected to increase so much in the future
• fuels expectations of higher prices
• leads producers to lower their rate of extraction today
• therefore: no mystery that oil supply has not reacted to higher prices:
• rational oil producers are just waiting for even higher prices tomorrow
• another factor limiting oil supply today:
• return to oil producers from the dollars they would earn from increasing production has over the past year been greatly reduced by the US Fed
• US interest rates are now negative in real terms
• therefore: rational for oil producers to limit their accumulation of rapidly depreciating dollars by limiting the rate at which they extract oil
• high oil prices are therefore at least partially a consequence of an expansionary monetary policy in the US
• need to listen more to the suppliers and less to traders on commodity markets to understand oil prices and production:
• King Abdullah: "If additional oil were to be found, I would advise leaving it in the ground because with the grace of God our children might have a better use of it."
• real culprit is the expectation that prices can only go up
• not the trading among speculators
• they are simply betting against each other so that one side's gain is the other side's loss
• regulating oil derivative markets might affect the amount of "speculative" trading, but it will not induce oil producers to increase production
• speculators not to blame = no bubble in oil market?
• not necessarily:
• a bubble starts when past price increases lead to expectations of future price increases
• it could very well be that prices will not increase as much as expected if China's future demand for oil is lower than expected today, or if alternative energy supply sources become as cheap as some suggest
• sky-high oil prices are likely to lead over time to a massive substitution away from oil, even in China
• happened after the first two oil shocks
• but: will take years for this scenario to materialize
• best explanation of oil prices is neither "bubble" nor "China", but a "China bubble"
• i.e. speculators and oil producers are gambling on China's sustaining high prices for ever

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Oil price shock means China is at risk of blowing up - The Telegraph

Summary:
Ambrose Evans-Pritchard believe the outsourcing game for China and Asia is over. It's not just about cheap labour anymore, but distance. Distance now cost money. The manufacturing revolution of China and her satellites has been built on cheap transport over the past decade. Due to the rise in energy prices, however, the cost of shipping a 40ft container from Shanghai to Rotterdam has risen threefold since the price of oil exploded. This monumental energy price increases will be a 'game-changer' for Asia. China's use of energy per unit of GDP also far exceeds that of all other major economies. Energy subsidies merely are delaying the trouble. Low-tech product plants are shutting down and are re-openining in the US. Oil prices may come down, but will only be temporarily. According to Evans-Pritchard, globalisation has passed its high-water mark and the pendulum will now swing back from China to America. The Asian economies will have to reinvent themselves. (Published: 08/07/08)

Notes:

• manufacturing revolution of China and her satellites has been built on cheap transport over the past decade
• great oil shock of 2008: st a stroke, the trade model looks obsolete
• Shanghai's bourse is down 56pc since October
• one of the world's most spectacular bear markets in half a century
• "Asia's intra-trade model is a Ricardian network where goods are shipped in a criss-cross pattern to exploit comparative advantage. Profit margins are wafer-thin."
• Products are sent to China for final assembly, then shipped again to Western markets
• snag is obvious: cost of a 40ft container from Shanghai to Rotterdam has risen threefold since the price of oil exploded.
• Stephen Jen, currency chief at Morgan Stanley
• "The monumental energy price increases will be a 'game-changer' for Asia"
• the region's trade model is about to be "stress-tested".
• energy subsidies
  
• have disguised the damage
• China has held down electricity prices, though global coal costs have tripled since early 2007
• Loss-making industries are being propped up
• This merely delays trouble.
• Stephen Jen: "The true impact of the shock will only be revealed over time, as subsidies are gradually rolled back"
• China's use of energy per unit of gross domestic product
  
• three times that of the US
• five times Japan's
• eight times Britain's
• Stephen Jen: "China's factories were not built with current energy levels in mind"
• outsourcing to Asia
  
• Jeff Rubin, CIBC World Markets:
• "The Asian outsourcing game is over. It's not just about labour costs any more: distance costs money."
• Any low-tech product shipped in bulk - furniture, say, or shoes - is facing the ever-rising tariff of high freight costs
• 2,331 shoe factories in Guangdong have shut down this year, half the total
• North Carolina's furniture industry is coming back from the dead as companies shut plant in China.
• three effects crunching China
  
1. commodity costs
2. 20pc wage inflation
3. sagging import demand in the US, Canada, Britain, Spain, Italy, and France.
• critics:
  
• Beijing has repeated the errors of Tokyo in the 1980s by over-investing in marginal plant
• Communist Party banking system has let rip with cheap credit - steeply negative real interest rates - to buy political time for the regime.
• clear that Beijing's mercantilist policy of holding down the yuan to boost exports share has now hit the buffers
• foreign reserves have reached $1.8 trillion
• playing havoc with the money supply
• declared inflation is just 7.7pc, but that does not begin to capture the scale of repressed prices, from fuel to fertilisers.
  
• Stephen Green, from Standard Chartered:
• "There is a lot more bottled-up inflation in this economy than meets they eye"
  
• "Inflation merely steals growth from the future. It defers monetary tightening until matters get out of hand, which is where we are now. "
  
• Vietnam: has already blown up at 30pc.
  
• India: 11pc
• Indonesia: 11pc
• Philippines: 11pc
• Thailand: 9pc
• oil prices may fall again
• they plunged to $50 a barrel in early 2007 after the Saudis raised production
• the scissor effect of slowing global growth and extra crude later this year from Brazil, Azerbaijan, Africa, and the Gulf of Mexico may chill the super-boom
• US Commodities Futures Trading Commission is on an "emergency" footing, under orders from the Democrats on Capitol Hill to smash speculators
• if it is really true that investment funds have run amok, we will soon find out
• those who claim that derivatives (crude futures) cannot drive spot prices have overlooked a key point:
  
• the Saudis and others use the IPE Brent Weighted Average of futures contracts as their pricing mechanism.
  
• Futures now set the spot price

• But: even if oil comes down for a year or two, the mid-term outlook of the International Energy Agency warns that crude markets will be tighter than ever by 2012

• "Come what may, globalisation has passed its high-water mark. The pendulum will now swing back from China to America. The mercantilists will have to reinvent themselves."

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Crude oil spot and futures markets - Prof. Jayanth R. Varma's Financial Markets Blog

Summary:
Prof. Jayanth R. Varma attempts to clear up the confusion about the relationship between spot and futures markets for crude oil, using Brent crude (BFOE) as an example. The price of physical Brent crude is a futures contract (21 day advance declaration). The closest we get to a spot transaction is the dated Brent crude, i.e. after a buyer has made the declaration. This market has actually very little impact on the price discovery for Brent crude, because of the small quantities of Brent that are actually trade. But Brent is a benchmark for ~65% of the world's traded crude oil. The physical price of this crude is determined by the ICE Futures Brent Index price (plus/minus a differential based on the type of crude), which is the weighted average of the prices of all confirmed 21 day BFOE deals throughout the previous trading day for the appropriate delivery months. i.e. "Futures aren't a paper bet on the direction of prices determined by some independent process. Futures themselves *determine* the price of most physical oil traded today. The futures price (+ or - the differential) literally *is* the price of oil." It follows that Brent futures are far more important and influential than any of the markets for physical crude. The crude futures price is the price of crude. (Published: 04/07/08)
Notes:

• which of the following is correct?
  
• Paul Krugman: "a futures contract is a bet about the future price. It has no, zero, nada direct effect on the spot price"
• Peak Oil Debunked: "Futures aren’t a paper bet on the direction of prices determined by some independent process. Futures themselves *determine* the price of most physical oil traded today. The futures price (+ or - the differential) literally *is* the price of oil."
• Peak Oil Debunked is correct, Krugman's textbook model isn't totally wrong either
• Crude oil markets, e.g. Brent Crude market
• Brent crude = crude coming out of any of four oilfields in the North Sea: Brent, Forties, Oseberg and Ekofisk
• collectively referred to as BFOE
• most important market for physical Brent crude is the cash BFOE market
• is essentially a forward market
• based on 21 days advance declaration
• e.g. in July, a buyer and seller may conclude a transaction for delivery in August without fixing even the approximate date within the month
• the buyer can choose the date later but has to give 21 days advance declaration to the seller
• it is the price of this contract that most participants would regard as the price of physical Brent crude oil
• price discovery does happen in this market, though it is heavily influenced by the futures price
• though this is a market for physical crude, it is a forward rather than a true spot market
• closest we have to a spot transaction is the dated Brent crude market
• when the buyer gives an advance declaration in the cash BFOE contract, it becomes a dated Brent contract
  
• terms are usually FOB
• dated Brent is a market for a specific cargo (typically 600,000 barrels) to be loaded at the terminal close to Brent during say July 23-25
• the middle day (July 24) is the scheduled day of loading
• the buyer can usually bring the vessel to the terminal at any time within the three day period (known as laydays)
• dated Brent contracts are actively traded between oil industry participants
• dated Brent market probably has very little impact on price discovery for Brent crude
• because these transactions are concluded on a differential to the (forward) cash BFOE price
• the dated Brent for July 23-25 might e.g. be traded at August cash BFOE plus 10 cents
• most important price of Brent crude is the Brent crude futures at ICE
• ICE Brent Futures is a deliverable contract based on EFP delivery with an option to cash settle against the published settlement price
• i.e. the ICE Futures Brent Index price for the day following the
  last trading day of the futures contract
  
• ICE Futures Brent Index is the weighted average of the prices of all confirmed 21 day BFOE deals throughout the previous trading day for the appropriate delivery months
  
• i.e. is based on the cash BFOE market
• i.e. the underlying for the Brent futures is the cash (21 day) BFOE market
• things get more complicated
• long term contracts for crude in regions far away from the North Sea are based on Brent futures plus/minus a differential
• the Brent contract is used to price over 65% of the world's traded crude oil
• note:
  
• West Texas Intermediate (WTI) used as benchmark for oil sold to North America
• Brent benchmark for oil sold to Europe and Africa
• Dubai-Oman benchmark for Gulf crude sold in the Asia-Pacific market
  
• on the other hand, BFOE is only a miniscule part of the total crude oil production in the world
• the point Peak Oil Debunked is making:
• "very little trading occurs in physical BFOE (or other benchmark crudes) [...] because this makes the process of price discovery very difficult [...] a futures market (based on the average of all future price quotations that arise for a given contract) is currently the basis for oil pricing."
  
• "Unlike the spot market, the futures market is highly liquid which makes it less vulnerable to distortions. In addition, the futures price is determined by actual transactions in the futures exchange and not on the basis of assessed prices by oil reporting agencies. "
• i.e. "Futures aren't a paper bet on the direction of prices determined by some independent process. Futures themselves *determine* the price of most physical oil traded today. The futures price (+ or - the differential) literally *is* the price of oil."
• i.e. Brent futures are far more important and influential than any of the markets for physical crude
• most price discovery happens in the futures market and the physical markets trade on this basis
• i.e. the crude futures price is the price of crude

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Bearish battalions - The Economist

Summary:
Economists warns that a lengthy period of gloom in store for the stockmarkets: almost everything that could go wrong is going wrong for world stock markets: falling profits, slowing economic growth, rising inflation and interest rates. All made worse by the credit crunch. Problem for financial markets is that the virtuous circle which pushed asset prices higher (lending on housing collateral) in the middle of this decade is turning vicious. Investors might have coped with the credit crunch if it were not for the high commodity prices, and vice versa, and do not know whether to fear inflation or recession more, but they know that both at once are unpleasant. Best investors can do is hope that something will turn up (e.g. collapse in oil prices). (Published: 03/07/08)

Notes:

• June 2008: US stockmarket had its worst month since 2002
• down >20% from peak
• definition of bear market
• global stockmarkets fell by $3tr
• 10% decline in emerging markets
• Four forces impel stockmarkets
1. economic growth: slowing
   
2. profits growth: slowing
   
3. interest rates: rising
   
4. inflation: rising
• soaring oil and food prices
• high commodity prices
• have acted as a terms-of-trade shock for consuming countries
• the things they buy from abroad cost more compared with the the things they export
• has made them poorer
• questions
• will workers suffer by seeing their wages rise more slowly than inflation?
• will companies have to compensate their workers by raising wages, sacrificing their profit margings?
• will central banks treat high commodity prices as a blip, and leave interest rates low, penalising savers?
• will they raise interest rates and riks pushing the economy into recession?
• all made worse by the credit crunch
• effects can be seen in
• sharp falls in mortgage approvals in both US and Britain
• data produced by the Fed which show that loans made by banks have fallen over the past three months
• thightening in credit has taken long time to show up in the numbers because of the way that banks were operating before the summer of 2007
• had pushed much of their lending business off-balance-sheet
• loans were bought by specialist entities like structured-investment vehicles (SIVs) and conduits
• when the market for subprime loans collapsed, lot of these loans came back on to the banks' balance -sheets
• banks had made back-up commitments to businesses to lend money if needed
• with the collapse in other debt markets (e.g. asset-backed commercial paper), corporate borrowers cashed in those chips
• as a result banks found their loan books expanding
• now banks more careful
• chastened by the huge amounts of capital they have had to raise to strengthen their balance-sheets
• problem for financial markets is that the virtuous circle which pushed asset prices higher in the middle of this decade may be turning vicious
• banks lend money against the collateral of assets
• most notably in the form of housing
• as house prices increase, collateral raises in value and banks are willing to lend more
• enables buyers to bid up prices even further
• when banks stop lending, buyers unable to purchase assets
• some investors forced to sell to pay of loans
• value of collateral fals
• making banks even more reluctant to lend
• markets freeze up, as neither buyers nor sellers have the confidence to do business
• cfr. Finland, Sweden in early 1990s
• house prices fell
• personal-savings rates jumped by 12-14%
• similar move in US or Britain would have a devastating effect on consumer demand, and thus GDP growth over the next couple of years
• as yet, has been more of an effect on consumer sentiment than actual retail sales
• although individual retailers (e.g. M&S) are suffering
• companies: with consumers depressed and banks unwilling to lend, why should they invest?
• market's sorrows have come in batallions, not single spies
• investors might have coped with the credit crunch if it were not for the high commodity prices, and vice versa
• do not know whether to fear inflation or recession more, but they know that both at once are unpleasant
• lengthy period of gloom in store for the stockmarkets
• best investors can do is hope that something will turn up
• e.g. a collapse in oil prices
  

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Oily Speculations - The New Yorker

Summary:
James Surowiecki believes speculators are being used as the scapegoat for high oil prices because the real reasons are either out of their control or are not palatable in an election year. Speculators could in principle directly distort oil prices by turning their futures contracts into oil and then taking it off the market to drive up prices, but a look at oil inventories shows no sign that this is happening. The real reasons are simple: boom in global demand, the inaccessibility of certain oil fields, prospect of war in the Middle East, our dependence on foreign oil and the weak dollar. In addition, "shortage psychology" plays a role: the price of oil isn’t based solely on current supply and demand, but also on people’s expectations about future supply and demand. This is not sinister speculation, but people's current reading of the future. (Published: 07/07/08)
Notes:

• Senator Joseph Lieberman: "Excessive market speculation has inflated the price of oil and other commodities beyond reason"
• Curb speculation, as a raft of proposed laws intend to do, and oil prices will soon return to earth.
• but: speculation has been a favorite target of politicians looking to mollify anxious voters since the time of ancient Greece
• orator Lysias protested that wheat traders had reduced Athens to a “state of siege.”
• suspicion not unreasonable: the past century is full of examples of avaricious selfishness leading to the manipulation and corruption of market
• In the twenties, speculators banded together in “stock pools,” trading a particular stock among themselves to create the illusion that its value was rising
• in March, 1929, a stock pool succeeded in pushing up RCA’s stock price by almost fifty per cent in less than two weeks—and then dumping the stock when outside investors bought in
• In the late seventies, a speculators’ pool led by the Hunt brothers mounted an attempt to corner the world’s silver market
• at one point controlled an amount equivalent to an entire year’s global production
• However: there’s little convincing evidence that the oil market is being significantly manipulated
• Whatever chicanery is occurring—and we can assume there is some—has only a marginal effect on prices at the pump.
• Congress is not just attacking illegal market manipulation, it’s also taking aim at perfectly legal speculation
• i.e. the buying and selling of futures contracts, which are effectively bets that oil prices will go up (or down)
• Futures contracts: oil sellers and buyers
  
• futures contracts can be used by oil sellers (like OPEC ) or oil buyers (like the airlines) to hedge their risks by agreeing to sell or buy oil in the future at a set price.
  
• Futures contracts: speculators
• mostly use futures contracts to gamble on oil prices, and have no interest in buying or selling real barrels of oil
• These gambles can be tremendously lucrative, but they don’t directly determine the real (or “spot”) price of oil.
  
• That’s set by the people who are buying and selling actual barrels of petroleum.
• Although speculators could directly distort oil prices by turning their futures contracts into oil and then taking it off the market to drive up prices, a look at oil inventories shows no sign that this is happening.
• If speculators aren’t at fault, why have oil prices spiked so high?
  
• Fundamental reasons not hard to find:
  
1. Between 2000 and 2007, world demand for petroleum rose by nearly nine million barrels a day, but OPEC has been consistently unable, or unwilling, to significantly increase supply, and production by non-OPEC members has risen by just four million barrels a day.
   
2. The prospect of military action against Iran, which would disrupt global supply, seems greater than it did a few years ago.
   
3. And the plunging value of the dollar has meant that the cost of oil has jumped more in the U.S. in the past year than it has in countries with healthier currencies.
• Another reason: “shortage psychology” (oil guru Daniel Yergin)
• The price of oil—more than that of many other commodities—isn’t based solely on current supply and demand.
  
• It’s also based on people’s expectations about future supply and demand,
  
• because those expectations determine whether it makes sense for oil producers to sell their oil now or leave it in the ground and sell it later
• Currently, the market is assuming that oil will become scarcer, and that global demand will keep rising,
  
• especially in rapidly developing countries like China and India. As a result, producers are asking very high prices to pump their oil.
  
• it could be that these assumptions are all wrong
• i.e. that the supply of oil will not be constricted going forward, that concerns about the Middle East are exaggerated, and that higher prices will lead people to cut back on energy consumption, shrinking demand.
  
• In that case, oil would turn out to have been hugely overpriced.
  
• But that won’t be because of sinister speculators;
  
• it will be because oil producers and oil users collectively misread the future.
• difficulty for Congress is that none of the problems that have driven up the price of oil lend themselves to a quick fix
• most, like the boom in global demand and the inaccessibility of certain oil fields, aren’t under our control at all
• makes speculators a perfect target:
  
• by going after them, Congress can demonstrate to voters that it understands their pain, and at the same time avoid doing anything that might require real sacrifice from Americans.
• Our dependence on foreign oil, together with the fiscal fecklessness that has helped reduce the value of the dollar, means that there is no easy way out of where we are.
  
• in an election year that’s hardly a message that anyone in Washington is going to deliver

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Beating the Oil Barons - Thomas Palley Blog

Summary:
Thomas Palley disagrees with economists like Paul Krugman (faith in markets) that the high price of oil is due to fundamentals and believes speculation is to blame. The inventories argument ignores the extreme price insensitivity of oil. The only way demand can be lowered is by reduced economic activity (no recession yet). Furthermore, inventories should be down (incentive to sell), whereas they are up slightly. Financial markets' ability to mobilize tens of billions of dollars for speculative purposes has enabled traders collectively to hit upon a strategy of buying oil and quickly re-selling it when end users accommodate higher prices. Current oil price spike will be broken only by a recession that exhausts consumers’ capacity to buffer higher prices. Calls for new licensing regulations limiting oil-market participation, limits on permissible trading positions, and high margin requirements where feasible. (Published: 24/06/08)

Notes:

• proving that speculation is responsible for rising oil prices is difficult
• because speculation tends to occur during booms
• price increases easily masquerade as a reflection of economic fundamentals
• most economists dismiss the idea that speculation is responsible for the price rise
• reflects their faith in markets
• argue that if speculation were really the cause, there should be an increase in oil inventories
• because higher prices would reduce consumption, forcing speculators to accumulate oil
• the fact that inventories have not risen supposedly exonerates oil speculators.
• see e.g. Krugman
• picture is far more complicated than that
• because oil demand is extremely price insensitive
• In the short run, it is technically difficult to adjust consumption.
  
• e.g. the fuel efficiency of every automobile and truck is fixed
• most travel is non-discretionary.
• fundamental point: in the short run, reduced economic activity is the principle way of lowering oil demand.
  
• Thus, absent a recession, demand has remained largely unchanged over the past year.
• furthermore: relatively easy to postpone lowering oil consumption
• Consumers can reduce spending on other discretionary items and use the savings to pay higher gasoline prices.
  
• Credit can also temporarily fill consumer budget gaps.
  
• Although the housing boom in the United States – which helped in this regard – ended in 2006, consumer debt continues to grow
• America’s Federal Reserve has been doing everything it can to encourage this.
  
• Consequently, for the time being the US economy has been able to pay the oil tax imposed by speculators.
• contrary to economists’ claims, oil inventories do reveal a footprint of speculation
• inventories are actually at historically normal levels and 10% higher than five years ago
• with oil prices up so much, inventories should have fallen, owing to strong incentives to reduce holdings
• Wall Street Journal has reported that financial firms are increasingly involved in leasing oil storage capacity
• root problem is that financial markets can now mobilize tens of billions of dollars for speculative purposes
• has enabled traders collectively to hit upon a strategy of buying oil and quickly re-selling it when end users accommodate higher prices
• situation that has been aggravated by the Bush administration, which has persistently added oil supplies to the US strategic reserve
• further inflating demand and providing additional storage capacity
• Absent a change in trader beliefs, the current oil price spike will be broken only by a recession that exhausts consumers’ capacity to buffer higher prices
• or when the slow process of substitution away from oil kicks in
• thus, economic fundamentals will eventually trump speculation, but in the meantime society will have paid a high price
• whereas oil speculators have gained, both the US and global economies have suffered and been pushed closer to recession
• This sobering picture calls for new licensing regulations limiting oil-market participation, limits on permissible trading positions, and high margin requirements where feasible.
• Sadly, given the conventional economic wisdom, implementing such measures will be an uphill struggle.
• some unilateral populist action is possible
• a major form of gasoline storage is the tanks in cars.
  
• If people would stop filling up and instead make do with half a tank, they would immediately lower gasoline demand.
  
• Given lack of storage capacity, this could quickly lower prices and burn speculators

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Exploding commodity prices, lax monetary policy, and sovereign wealth funds - VOX EU

Summary:
Guillermo Calvo (Columbia) argues that the high commodity prices are not the result of speculation, but of fundamentals. Disagrees with Krugman however on the nature of these fundamentals, and instead believes it is due to a portfolio shift against liquid assets by sovereign wealth funds, partly triggered by lax monetary policy, especially in the US. This could be a harbinger of higher CPI inflation if interest rates stay low. An effective anti-inflationary battle will involve a sharp rise in interest rates, which will enhance the risk of deepening recession. Policy makers should start worrying about inflation and stop chasing imaginary destabilising speculators. (Published: 20/06/08)

Notes:

• rise in oil, metals and food prices
• hard to rationalise on the basis of world output growth
• not even on the basis of China's and India's fast growth, let alone the expected global slowdown
• phenomenon has been accompanied by much higher transaction volumes in the forward markets
• analyst and policy makers pointing accusing finger at speculators
• Calvo's thrust:
• we are not going through another self-fulfilling bubble
• today's explosion of commodity prices is the result of a very real financial storm associated with large excess liquidity in several non-G7 countries and nourished by low G7 central banks' interest rates
• this price explosion could be a leading indicator of future inflation driven by fundamentals
• Wolf, Krugman: absence of substantial increase in physical commodity inventories is evidence of absence of speculative activity
• Calvo: this is not valid
• incentives to stockpile commodities stem from the combination of low central bank interest rates (esp. in the US) and the growth in sovereign wealth funds
• SWFs have been created partly with the intent of switching the composition of government wealth from highly liquid but low-return assets to more risky but much more profitable investment projects
• Fed's rate has been sharply lowered and market does not expect expect that it will be raised with equal impetus within a year
• must add to SWF's determination to switch away from US treasury bills
• portfolio switch implies higher prices
• not all prices have same degree of flexibility
• commodity prices are at the high end of the flexibility spectrum
• wages at the low end
• i.e. price rise phenomenon will bring about a change in relative prices in favour of commodities
• however: eventually the slow-moving prices will catch up and these sharp differences across prices will disappear
• a much more uniform price rise phenomenon will materialise
• when analysed from the perspective of some future time, this whole episode will look very much like a bubble in the commodity market, even though what is behind it is a fundamental factor
• i.e. lower demand for liquid assets by sovereigns like China, Chile or Dubai
• conclusion
• high commodity prices are not the result of speculation, but of fundamentals
• namely a portfolio shift against liquid assets by sovereign wealth funds,
  
• partly triggered by lax monetary policy, especially in the US.
  
• this could be a harbinger of higher CPI inflation if interest rates stay low
• an effective anti-inflationary battle will involve a sharp rise in interest rates, which will enhance the risk of deepening recession.
  
• Policy makers should start worrying about inflation and stop chasing imaginary destabilising speculators

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The Oil Nonbubble - New York Times

Summary:
Paul Krugman denouncing the idea that speculators are behind the rise in oil prices. Evidence for this is that there is no physical hoarding: inventories have remained at more or less normal levels. Instead, it’s the result of fundamental factors, mainly the growing difficulty of finding oil and the rapid growth of emerging economies like China. Doesn't mean that prices won't fall again (they probably will, as demand adjusts), but era of cheap oil is over. The claims that speculation is the cause is largely wishful thinking on the part of the political right, i.e. that we can somehow return to the good old days of abundant oil. (Published: 12/06/08)

Notes:

• many voices declaring that rising oil price is a bubble, unsupported by the fundamentals of supply and demand
• two questions:
  
• Are speculators mainly, or even largely, responsible for high oil prices?
  
• If they aren’t, why have so many commentators insisted, year after year, that there’s an oil bubble?
• speculators do sometimes push commodity prices far above the level justified by fundamentals
• but: when that happens, there are telltale signs that just aren’t there in today’s oil market
• what would happen if the oil market were humming along, with supply and demand balanced at a price of $25 a barrel, and a bunch of speculators came in and drove the price up to $100
• would have major consequences in the material world
• Faced with higher prices, drivers would cut back on their driving;
  
• homeowners would turn down their thermostats;
  
• owners of marginal oil wells would put them back into production.
• As a result, the initial balance between supply and demand would be broken, replaced with a situation in which supply exceeded demand.
  
• This excess supply would, in turn, drive prices back down again
• unless someone were willing to buy up the excess and take it off the market
• i.e. the only way speculation can have a persistent effect on oil prices, then, is if it leads to physical hoarding — an increase in private inventories of black gunk
  
• this actually happened in the late 1970s, when the effects of disrupted Iranian supply were amplified by widespread panic stockpiling
• stockpiling hasn't happened this time:
  
• all through the period of the alleged bubble, inventories have remained at more or less normal levels
• tells us that the rise in oil prices isn’t the result of runaway speculation;
  
• it’s the result of fundamental factors
• mainly the growing difficulty of finding oil and the rapid growth of emerging economies like China.
  
• The rise in oil prices these past few years had to happen to keep demand growth from exceeding supply growth.
• Saying that high-priced oil isn’t a bubble doesn’t mean that oil prices will never decline
• a pullback in demand, driven by delayed effects of high prices, may send the price of crude back below $100 for a while
• it does mean that speculators aren’t at the heart of the story
• Why, then, do we keep hearing assertions that they are?
• Part of the answer may be the undoubted fact that many people are now investing in oil futures
  
• feeds suspicion that speculators are running the show, even though there’s no good evidence that prices have gotten out of line
• also a political component
• Traditionally, denunciations of speculators come from the left of the political spectrum.
  
• In the case of oil prices, however, the most vociferous proponents of the view that it’s all the speculators’ fault have been conservatives
  
• people whom you wouldn’t normally expect to see warning about the nefarious activities of investment banks and hedge funds
• explanation of this seeming paradox is that wishful thinking has trumped pro-market ideology
• realistic view of what’s happened over the past few years suggests that we’re heading into an era of increasingly scarce, costly oil
• but: they want to believe that if only Goldman Sachs would stop having such a negative attitude, we’d quickly return to the good old days of abundant oil

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Oil prices: risks and opportunities - VOX EU

Summary:
Francesco Lippi argues that the current rise in price of oil is due to a demand shock, not a supply shock. Effects of a demand shock on the US economy are very different from a supply shock. A demand shocks tend to lead to an increase in industrial production, due to the booming of emerging economies. America’s specialisation in the production of goods not supplied by emerging economies is key to this result. It is the ability – or lack thereof – to innovate and produce goods that are not easily substitutable that determines whether the new challengers represent a risk or an opportunity for industrialised countries. (Published: 11/06/08)


Notes:

• Most analysts attribute the increase in the price of crude oil to growing demand from Asian economies.
• Economic theory suggests that the real effect of an oil price increase depends on its underlying fundamentals. If it stems from
  
• a change in supply conditions: the resulting price increase depresses economic activity, as energy inputs are more expensive
• case with the Iranian revolution, the first Gulf war, or policy tightening by OPEC
  
• an increase in demand by emerging economies
• production in other economies like the US is subject to both a negative effect
• due to the higher price of energy and
  
• a greater demand for US goods and services by the growing emerging economies
• i.e. effect on the US is positive
• weak relationship between oil prices and the US business cycle in recent years reflects oil demand shocks
• while the episodes in the ‘70s and ‘80s can be ascribed to oil supply shocks
• study identifying the oil demand and supply shocks underlying fluctuations in oil prices (deflated by the US CPI)
• allows estimation of the effects of these shocks on the US business cycle
• identification strategy assumes that oil production and price move in opposite directions following a supply shock, while they move in the same direction following a demand shock
• analysis focuses on the real effects of the shocks, disregarding the inflation effect, which depends to a large extent on monetary policy

• A historical decomposition of the oil price time series shows that demand shocks emerge as a main cause underlying the current increase.
• oil supply shocks account for less than half of oil price fluctuations over the last 30 years.
  
• More than half are due to oil demand shocks.
  
• effects of oil demand and supply shocks on the US economy are markedly different
• after a negative oil supply shock (that reduces production and increases the oil price), US industrial production falls with an estimated probability of about 80% one year after the shock
• after an oil demand shock (causing a comparable increase in the price of oil), industrial production increases with an estimated probability of about 70% one year after the shock

• Despite the “negative” production effect stemming from the higher oil price, the booming emerging economies ultimately lead to an increase in US industrial production the majority of the time.
• emergence of new players in the global economy makes some resources scarcer, increasing their cost, but it also offers new trade opportunities
• positive correlation between the price of oil and US industrial production shows that the US economy enjoys a net output gain from these developments
• America’s specialisation in the production of goods not supplied by emerging economies is key to this result
• It is the ability – or lack thereof – to innovate and produce goods that are not easily substitutable that determines whether the new challengers represent a risk or an opportunity for industrialised countries.

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Let the markets solve the energy crisis - FT.com

Summary:
Tony Hayward (BP's Chief Executive) argues that three of myths about the current oil prices are standing in the way of finding the right solutions to energy security and climate change. These myths are: 1) prices are due to speculation; 2) the world is running out of hydrocarbons; 3) we can switch to alternative sources of energy quickly. The solution to the crisis is to let the markets do the work: consumer will temper their consumption in response to high prices, while it will encourage the oil companies to invest in means of increasing output. Governments can help by removing barriers to that investment, improving access to resources and modernising the tax structure businesses work in. (Published: 10/06/08)


Notes

• some myths that need to be put to rest if we are to find the right solutions to big global problems such as energy security and climate change
1. prices are caused by technical factors, e.g. speculation
• may have an impact on the margins
• but: the data clearly show that high prices are really caused by economic fundamentals: supply and demand
  
• demand:
• global energy demand growth in 2007 was above average for the fifth year in a row
• driven by the fastest period of economic growth since the early 1970s
• demand growth is concentrated in those emerging nations that also subsidise fuel prices, such as China, India and - increasingly - the oil-producing nations themselves
• supply:
• energy supply has struggled to respond
• production by the OPEC fell by 350,000 barrels of oil a day last year
• production situation is even more challenging in the market-oriented nations of the OECD (e.g. UK)
  
• many existing basins are maturing fast
• last time oil prices surged to this kind of level, 30 years ago, new production from the North Sea helped bring prices down
• this time, new OECD production will have to come from frontier provinces such as the Canadian oil sands, the Arctic and the deep waters of the Gulf of Mexico
• production in Russia has begun to decline
• fact: until now, the growing demand for oil from China and India in recent years has been met almost barrel for barrel by rising supply from Russia
• access to resources for international oil companies remains very restricted
• resource nationalism is on the rise
• important because it is the oil majors that have some of the best technology for bringing difficult resources on-stream
2. world is running out of hydrocarbons
• world has ample resources:
• more than 40 years of proven oil reserves
• 60 years of natural gas
• 130 years of coal
• problems in bringing on new production are not so much below ground as above it
• not geological but political
  
3. we can switch quickly to a low-carbon economy
• biofuels, wind and solar energy
• growing rapidly
  
• but: comprise a tiny share of global energy production
• <>
• humankind remains dependent on fossil fuels
• coal is the fastest-growing of all the main fuel types
• carbon emissions will continue to rise
• all need to work harder if we are to tackle the threat of climate change.
  
• how to secure the energy needs of the world in the 21st century?
  
• evidence is that where markets are allowed to operate, they do work
• that is the real source of hope for the future
• consumers in Europe and north America are already responding to high prices by moderating demand and beginning to embrace energy efficiency
• where investment is allowed to take place, energy production responds positively
• last year, US oil and natural gas production increased - in the case of oil, for the first time since 1991
• conclusion:
• producers and consumers should be encouraged to respond to the market's signal
• High prices are saying that we need more investment
  
• in energy efficiency, new production, new technology and new energy sources such as wind, solar and nuclear
• in order for that to happen, businesses and governments must act together
• companies know that they need to invest more
• governments must do their bit too
• removing the barriers to that investment
• improving access to resources
  
• modernising the tax structures we work in

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Act now to prick the oil price bubble - FT.com

Summary:
Meghnad Desai (LSE) argues that high price of oil is due a speculative bubble, not related to supply and demand. No macro-economic factors to explain sharp rise in prices. Index and pension funds treating oil as an asset rather than commodity, with no intention of using it. Market not driven by supply and demand but simply by price expectations. Needs to be made less profitable in order to discourage this. Up to Group of Eight leading industrialised nations leaders to urge Nymex to implement this policy. (Published: 05/06/08)


Notes:

• latest price rise has baffled many: what has happened to supply and demand to cause such a steep and sudden price rise?
• Gordon Brown: "the cause is clear: growing demand and too little supply"
• China and India are buying more oil.
  
• Costs of exploration and extraction are going up.
  
• Nigeria and Venezuela are causing anxieties about supply.
• But: none of this is new
• Nothing has happened in the real oil economy to justify such a sharp and steep rise in its price.
• latest sharp upsurge in the price of oil most likely a speculative bubble rather than an outcome of market fundamentals
• Soros: commodity index funds treating oil as an asset rather than a commodity to be bought and sold for use, thus creating a bubble
• index funds and pension funds are investing in oil futures, not for direct use but as financial assets for profit
• index funds and pension funds are neither buying oil nor selling it: they are passive investors in commodities
• have invested $260bn (C169bn, GBP133bn) in commodity markets, compared with $13bn just five years ago. Much of this money is in oil.
• this paper market is not driven by the pressures on demand and supply but entirely by price expectations
  
• global economy is likely to be forced into a serious crisis if we do not explore the possibility that this is a bubble that needs to be burst quickly
• best way to counter speculation is to make it less profitable.
• protect the regular traders in the real oil economy
• ie. those who intend to close their positions by making or taking delivery of oil)
• charge them a lower margin than those who have no intention of plying the oil trade
• purely financial traders must be made to pay a proper price for their speculation
• can be done simply by increasing the margin that they have to put down to trade as open interest, from the current 7 per cent to about 50 per cent
• up to the Group of Eight leading industrialised nations leaders to urge Nymex to implement this policy
• no need for western governments to go down on their knees to Arab oil sheikhs, or to ration oil to the increasingly cash-strapped and angry consumers
  

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Summary only...

Solving Pump Pain - New York Post

Summary:
Jerry Taylor (Cato Institute) suggesting four things the US Congress could do in order to bring down the price of oil: 1) Opening up key areas for oil and gas exploration and development; 2) Opening up the West to oil-shale development; 3) Emptying out the Strategic Petroleum Reserve; and 4) Suspending (or ending) federal rules that force refiners to use only low-sulfur oil to make gasoline and diesel. (Published: 02/06/08)


Notes:

• skyrocketing energy prices:
  
• gasoline price at pump, now: $3.94/gallon; 5 years ago: $1.43/gallon
• home electricity, now: 10.31c/kWh; 5 years ago: 5.43c/kWh
• "we'll keep on finding ways to save as prices stay high"
• driving less, buying fuel-efficient cars, ...
• demand side: should government mandate more conservatism?
• No
• too much" conservation is as economically harmful as "too little"
• only thing government should do is ensuring that prices are "right"
  
• ie. reflecting total costs
• mainly an issue for electricity, where retail power prices typically bear little relation to wholesale prices
• governments need to encourage real-time pricing of electricity - so that consumers will get the signal to, for example, run the clothes dryer at night, when power is cheaper.
• supply side: four things government could do:
1. Open up key areas for oil and gas exploration and development.
• Arctic National Wildlife Refuge and 85 percent the outer continental shelf are currently stated "off-limits" by Washington
• absurd and hypocrytical for our politicians to fulminate about the need for more oil production from OPEC when they won't lift a finger to increase oil production here at home
• will take years to get these fields on-line: all the more reason to start now
  
• by the time those new fields would be producing, global oil production will probably be about 100 million barrels per day
• optimistically, the fields would yield about 3 million more barrels a day - for a long-run cut in the price of crude of about 3 percent.
• however, will do more for natural-gas prices than for oil
• gas prices are highly sensitive to regional (rather than global) supply and demand issues, so we'd likely see far greater reductions in electricity prices
2. Open up the West to oil-shale development.
• US has three times more petroleum locked up in shale rock than Saudi Arabia has in all its proved reserves
• costly to extract
• oil prices need to be at at about $95/barrel to allow a reasonable profit from extracting oil from Rocky Mountain shale
• probably profitable now
• problem: mostly on federal land; Washington has so far said, "Hands off!"
• Environmentalists object to both these first two ideas
• insist that the wilderness that would be despoiled by energy extraction is worth more than the energy itself
• nonsense - faith masquerading as fact
• How much something is worth is determined by how much people are willing to pay for it
3. Empty out the Strategic Petroleum Reserve.
• holds 700 million barrels of oil
• draining it could add add up to 4.3 billion barrels of crude a day to the market for about five months
• if the theories of a speculator-created "oil bubble" are true, it would pop the bubble and send prices tumbling
• national-security risk is myth
• as long as we're willing to pay market prices for crude oil, we can have all the oil we want - embargo or no embargo.
4. Suspend (or end) federal rules that force refiners to use only low-sulfur oil to make gasoline and diesel.
• best short-term fix for high gas prices
• refiners once relatively free to use heavy crude to make transportation fuel
• today: environmental regulations make it difficult and costly
• there's a (relative) glut of heavy crude right now
• light-crude oil markets are incredibly tight, with no real excess production capacity.
  
• heavy-crude markets are robust, with plenty of crude going unsold for lack of buyers
• suspending low-sulfur rules would bring those heavy crudes into the transportation fuels

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Exxon Rejects Proposals Backed by Rockefellers - NYTimes.com

Summary:
Report of a "robust debate" among shareholders at an Exxon Mobil annual meeting concerning the company's policy toward renewable energy and global warming. A significant portion wants the company to invest more profits in alternative sources of energy. This appears to be a case of shareholders calling for more Corporate Social Responsibility, at the expense of profitability. Shareholders putting pressure on world's largest independent oil company to invest in renewable energy. (Published: 29/05/08)


Notes:

• "The vote was announced after a robust debate among shareholders, those who defended management as a great engine for profits and those who argued that a narrow focus on developing oil and gas as energy sources would threaten the global environment and ultimately the company's financial health."
• "Exxon Mobil is acting like a dinosaur, not adopting to a changing environment" - New York shareholder
• "We're faced with a profound moral and business challenge" - New Jersey shareholder
• Exxon's CEO, Rex Tillerson: "We're focused on safely and reliably meeting the growing energy demand while working to reduce our impact on the environment. [...] A lot of climate policy is still up for debate. [...] Society must be realistic about the economic impact of policies aimed at curbing the burning of fossil fuels. [...] Exxon has to keep focused on its mission of developing more oil and gas reserves [...] Oil and gas will remain the primary fuel source for decades to come. [...] But ... Exxon Mobil will be at the forefront of technological change in producing alternative energy sources."
• While Exxon has invested more in renewable fuel research [under Tillerson, as compared to under Lee Raymond], it is far less public about those policies than major rivals like BP, Chevron and Royal Dutch Shell.
• Calls for role of CEO and Chairman to be separated
• Peter O'Neill (Rockefeller descendant and PE investor): an independent board led by a chairman who was not chief executive would help the company "keep an open mind" and "take long-term steps" not only to work for a cleaner environment but also to take important risks to find more oil reserves.
• Rockerfeller family members: company needs to show more leadership in developing alternative fuel sources that will combat global warming
• Others backed and have co-sponsored three other resolutions that Exxon study the impact of global warming on poor countries, reduce company emissions of greenhouse gases and do more research on renewable energy sources like wind turbines and solar panels.
• Neva Rockefeller Goodwin: "These increased concentrations of CO2 in the atmosphere will cause weather disasters that will work against everyone's best hope for robust development in emerging countries while also increasing the vulnerability of the poor in the rich countries. It will also impact the global economy."
• Under Exxon rules, proxy resolutions are non-binding unless they have the support of the board. But company executives say they must take the opinions of shareholders seriously, especially when they represent a majority of votes taken.
  

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The Coming Energy Wars - Newsweek

Summary:
Rana Foroohar on what the effect will be of $200 oil on the global economy. No industry will be unaffected. Long-term demand will continue to grow while supply threats aren't going to go away rightaway. $200 in 6 to 24 months (Goldman Sachs estimate) is to fast for economies to cope. China and India have kept inflation down with cheap goods, but will be exporters of inflation once energy subsidies are reduced or stopped: end of cheap goods. Shift toward regional trade (regionalism), even major reversal of globalization itself, due to rising transport costs. Increase in corporate failures, and a lot of M&A; emerging-market firms swooping up ailing Western firms on the cheap. Effects will be worse for poor people in developing economies. Number of oil states rising as prices climb, ill-equiped to cope with corruption that oil-wealth brings. Shift in balance of world power, conflicts increasing. (Published: 31/05/08)

Notes:

• $4/gallon oil has already made an impact on American lifestyle
  
• driving less, using mass transit more, buying fewer gas guzzlers, shopping less wantonly
• energy revolution
  
• however: more and bigger changes in store
• Asian developing countries: currently protected from spiking price of oil buy subsidies
• if oil continues to rise and Asian energy subsidy dam eventually breaks, energy revolution will spread
• $200/barrel oil would have enormous global consequences
• year ago, no one was talking about $200/barrel oil, now everyone in the market is
• oil prices climbed from $10 in 1999 to $95 without slowing the surging world economy
• in large part because markets believed spike was at core driven by rising demand
• particularly from China and Inda
• feeds growth
• there was concern over supply, but nothing like in 1970s
• not until recent months
• with futures reaching $135, consensus began shifting to a new, more gloomy view:
• long-term demand, led by China and Inda, will continue to grow
• supply threats aren't going to go away any time soon
  
• increasing conflict, falling investment, industry bottlenecks and downward estimates of big field reserves in major oil fields
• Goldman Sachs: $200 barrier could be hit within next 6 to 24 months
• way too fast for comfort
• even for those who welcome hight gas prices as a way to induce energy conservation and fight global warming
• already causing real pain for ordinary people, threatening global growth and reviving spectre of inflation
• price pressure now particularly acute in emerging markets like China and India
• China and India
• have dampened global inflation by exporting cheap goods and services
• now they threaten to become exporters of inflation
• particularly if energy price controls give way
• Americans now making up for their losses at the pump by flocking to Wal-Mart for cheap Chinese goods
• will be out of luck
• oil drives so much of the global economy it's almost difficult to fully imagine the world of $200 oil
• will force nations to greener much faster than now
• conserving energy and developing and adopting new non-fossil fuels
• but: none of this can happen full stop in 6 to 24 months
• some analysts: shift toward regional trade, even major reversal of globalization itself
• rising transport costs will make it too expensive to ship many of goods long distances
• major acceleration in transfer of wealth from oil consumers to producers would alter the world balance of power
• Morgan Stanley: at $200/barrel, the proven oil reserves of the 6 Gulf nations would rise in value to $95 trillion
• twice the size of public equity markets
• corrupting curse of oil wealth
• Michael L Ross (UCLA): percentage of the world's wars that take place in oil states is growing
• number of oil states rising (Cambodia, East Timor, ...) with more likely to follow as prices climb
• many of these newcomers are small and ill-equipped to cope with the corruption that often wastes the windfall
• no industry will be unaffected by $200 oil
• death of at least one of the Big Three in Detroit
• airlines vulnerable
• Jean-Cyril Spinetta (Air France-KLM, CEO): $200 oil would represent a far bigger shock than 9/11 or SARS (2003); it's more than a change, it's a revolution, a new industry in fact; lot of bankruptcies very rapidly in Europe, US and Asia; restructuring of networks, cutting routes, cutting capacities
• as food and energy go up, spending on everything else will go down
• big-box stores like Wal-Mart are already having record quarters while middle-market chains are suffering
• trends will hit Europe too
• the more Europeans spend on gas, the less they will spend on furniture, clothing and white goods; sales in all those categories are already down
• Richard Reid (Citibank): expect an increase in corporate failures, and a lot of M&A; might well see flush emerging-market firms (e.g. Tata) swooping up ailing Western firms on the cheap
• American automakers
• were moving slowly to smaller cars before the spike
• but: sales of SUVs and pickups are now falling so fast that they appear to have been caught flat-footed
• Philip Verleger: at $200, GM tanks; they just don't have time to fix their fleet
• Alan Mullaly (Ford CEO), 2 weeks ago: no longer expects a return to profitability in 2009; believes gas-price shift is permanent
• Nissan: unveiled a $115m new plant designed to build lithium-ion/fuel cells
• Richard Berner (Morgan Stanley): "If you think things won't be pleasant for industrial nations, think about developing economies, where people spend 50% of their income on food and fuel"
• concern that as higher oil prices force many Asian economies to reduce or even cut their generous fuel subsidies, growth will slow sharply, and there could be social unrest as the world's poorest become more desparate
• political ramifications of this (moving away from free-trade), combined with ever-rising cost of doing business as usual, could force a retrenchment from globalization
• Jeff Rubin (CIBC World Markets): "It's a harbinger of the reversal of globalization; at $200 a barrel, you'll see transport costs rise so much that they will effectively reverse the trade liberalization of the last 30 years"
• regionalism: world will realign itself regionally
• Japan may continue to ship in goods from China, but the US will increasingly import from Latin America
• same thing happened from 1973 to 1979
• regionalism won't stop at trade
• Sovereign Wealth Funds will continue to buy big chunks of Western banks and blue-chip companies
• possibility of worse conflicts
• Scott Nyquist (McKinsey): "As areas like the Mideast and Africa, Russia and Venezuela continue to rise, you're going to see increasing energy greed, aggressive behaviours and neocolonial actions on the part of various countries."
• Western ideas about civil society, the environment and women's rights could be displaced with new sets of values
• lack of any spare capacity in the global pipeline makes it difficult to solve such situation with sanctions
• taking any oil off the market would at this point merely ignite an already explosive situation
• megatrends fueling the global supply shortage tend to feed on one another
• higher prices fuel the growing tendency of oil states like Russia and Venezuela to re-nationalize fields
• often leads to lower output due to the inefficiency of most state oil companies
• publicly traded companies have to go where they can
• fields in peaceful places tapped out
• hunt for new oil has moved into conflict zones (Nigeria, Angola) and geologically extreme territory (Siberia, deep sea)
• policy makers need to
• stop grilling big oil companies about why prices are so high
• they now control only a small percent of known reserves, out of their hands
• support smarter green initiatives
• wind and solar credits rather than ethanol boondoggles
• stop pandering to voters with subsidies and gas-tax cuts
• ignores the new reality: oil is a finite resource, more people want more of it, and the profligacy with which we've used it is going to change
  

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