Couldn't Help Myself: Yet More On Oil

I couldn't just leave well enough along, right?

The reason for the additional post was the fact that I clicked through the Yahoo! Finance front page to this article.

Though I certainly wouldn't mind it if this week's price action was the sound of the oil bubble popping, I'm not primarily concerned with that (on a side note, the title of this article is fairly poor because we aren't told whether it's the biggest dollar drop ever or biggest percentage drop. Given the high price of oil, it wouldn't be nearly as impressive if it was simply the biggest dollar drop ever). What I am interested in, though, is some of the commentary in the article which again brings me back to my "oil is not being driven by supply and demand alone" thesis.

For instance:

"Some brave traders used the week's pullback in oil prices as a chance to buy barrels that suddenly seemed to be on sale. But oil analysts were advising investors to beware."

or

"Still, with oil recording yet another drop on Friday, some industry experts who just days ago thought there was more juice left in oil's meteoric run are reconsidering."

or

"'Buying here is an opportunity if you are a deep believer in $200 (a barrel), otherwise we think that caution would be better applied,' analyst Olivier Jakob of Petromatrix in Switzerland said in a research note."

Do these sound like commentaries on a global commodity market being driven by supply and demand or a frothy financial market that's being closely watched by traders? In fact, I looked up Petromatrix's website and here's a bit from the firm's description:

"After 15 years experience in the commodity trading industry we have created Petromatrix as we found the market lacking independent coverage of the oil markets. At Petromatrix we are not offering any financial or brokerage services, all we care about is reading the market right. ... Our clients include oil majors, trading companies, international banks, hedge funds, down to private individuals. They value our track record, our concise reports, our speed at delivering analysis, our trading focus and experience."

Sounds to me based on this that there are an awful lot of investing / speculative players out there looking for data on oil. Is it possible they're also participating in the market? And I have to imagine that Petromatrix is only one of many firms offering this type of independent coverage of oil price expectations.

Things that make you go hmmmmm...

-AvgJoe

More On Oil Prices

Much to my chagrin, there isn't a whole lot of back-and-forth on my blog (though I'm surely at fault for that with my unreliable posting schedule), but there was a great response to my blog post yesterday about oil prices and I wanted to make sure to highlight it and respond.

I'm not going to pretend that a big part of the reason that I like the response isn't because it happens to agree with my own view. However, I think it does really underscore some of my own thinking. Here's what Michael over at The Macro & Micro has to say:

To answer your question - well you seem to have already done so - S/D have not changed that much... it is the speculation that has changed. While the economist suggests we not 'blame the speculators' (http://www.economist.com/opinion/displayStory.cfm?source=most_read&story_id=11670357), I still find myself disagreeing.

One line in the article "But they do so based on their expectations of future trends in supply and demand, not on whims." is frankly not true. Often speculator 'expectations' may be 'educated whims' - that are wrong. The index funds and the smarter players make a move and everyone else who knows nothing follows - typical herd mentallity.

For example:

1. "On January 17, 2006 crude oil for February delivery rose by USD 2.38 (3.7%) to USD 66.30 a barrel. This was the highest increase since early October 2005." (http://en.wikipedia.org/wiki/Oil_price_increases_of_2004-2006)

2. This jump was a futures market response to the Nigerian violence... in which a temporary 250,000 barrels per day was not produced from Nigeria.

3. According to the 'profit fromthe peak' front flap (I'm seriously considering this book), oil consumption is 86m barrels a day. 250,000 is not even 1 percent of that.. its like .3% - however oil prices rose 3%. less than .5% is barely a drop in the bucket, but the price raise was hardly warranted. It was speculation.


Can I say I couldn't agree more? One of the things I've tried to do is actually sit down and put together some sort of supply and demand curve (the stuff of Econ 101) for oil. Now I understand that it's hard to substitute in many of the places where oil is used, but frankly I couldn't come up with a reasonable graph that would explain the change in the price of oil over the past few years.

As for The Economist, yeah, that was pretty disappointing for me to read. The Economist is easily my single favorite publication ever and I can't help but think they missed the boat on this one. Is all the price action due to speculators? No. But I think there's a healthy margin that is. And as Michael pointed out, it's wrong to assume that all those buying and selling oil futures are fundamental driven investors looking at oil consumption and production statistics. You've got plenty of technical analysts and trend followers out there who are going to be basing their trading on price action and chart patters, not real supply and demand.

So, as I said before, I welcome responses and thoughts -- even if they differ from my own. We're talking about a huge global market here and so I certainly can't claim to have all the answers.

-AvgJoe

The Oil Price Conundrum

Ok, so here's where my brain bends when it comes to oil prices and what's driving the spike. In a market that's driven primarily by supply and demand -- particularly a massive global market, like the one for oil -- I don't think it's crazy to expect relatively orderly price movements. Sure prices can move up or move down, and do either drastically, but if it's really supply and demand driving it either way, I'd expect to see those changes be spread over a period of time.

By contrast, in a market driven by some sort of speculative force, drastic price swings would be expected as speculators anxiously try to read the tea leaves and capture the maximum profit before pulling their parachute right at the top.

Now look at the price action of oil just over the past couple days. Have supply and demand conditions really changed that much to warrant such a big swing in price? And how about the price action of the past year, has supply and demand really diverged that much to cause (roughly) a doubling in price? (Judging by the statistics from BP I don't think so...)

I'd love to get readers opinions on this, so feel free to chime in the comment section below or send me an email and let me know what you think.

In the meantime, I'm about to crack open the review edition of Profit From the Peak that Wiley & Sons was nice enough to send over to me and see if that has the answers I'm looking for. I will be sure to let you all know what I think when I finish.

-AvgJoe