Pump Gas on April 15th!

Damn.  It is happening again. In this year as in several other recent years, an email is circulating urging people to boycott the mean old oil companies. On one day. Without changing consumption patterns.

I first saw it on Facebook. Many of you may have seen it by now too, or may recall its incarnations in earlier years.

Please don't be suckered into this. It's just another incarnation of the bad old meme that we can solve the world's troubles without, well ... taking any trouble.

If only everyone would just refrain from pumping gas on April 15, we'd tame the oil oligopoly, bring peace to the middle east, and so forth.

Um ... no.  You will accomplish absolutely nothing this day. Look at that notice. It actually encourages you to gas up on the 14th so you won't need to pump on the 15th.

How does that hurt the oil companies???

If you buy gasoline a day earlier than you otherwise would, you've actually done them a favor. They have your money a day earlier, and money has time value. It earns them some interest that extra day!

More generally, the oil companies might worry if you and a lot of other people changed your consumption habits to something that didn't require so much of their product. But that's a more long term and more difficult commitment on your part. It might involve, for instance, moving closer to your place of business.

If your consumption is going to stay the same, then the stream of revenue going to the sellers of the products you consume will be the same, even if you jigger and re-jigger the timing a bit.

"Ah, but they tell us it worked in 1997," you remind me. No, it didn't. What "worked" to bring prices down in 1997 was the oil-for-food program with Iraq. A brief history lesson: after the first Iraq War, during the Presidency of George H.W. Bush, much of the world imposed sanctions upon Iraq in an effort to topple the regime of Saddam Hussein, which that war itself had left standing.

Saddam survived the sanctions, and in 1995, President Bill Clinton, in response to arguments that ordinary citizens in Iraq were being hurt by the continuation of these sanctions, announced a program that would lessen the hardship without, it was hoped, making life any easier for the government. The idea was to allow Iraq to barter sell its oil, but to put the revenues into an escrow account and ensure that they would be available only for foodstuffs and medicines.

Saddam's government signed a Memorandum of Understanding in May 1996 agreeing to participate in their program.

By 1997, then, Iraqi oil was again flowing into world markets. It was this that pushed down the price through that year, not some silly one-day-only boycott.

And, by the way, I challenge any one to show me any evidence from 1997 that any such boycott took place that year at all!  The earliest one I can find any evidence of was two years later. And that had no impact on prices whatsoever.
   
So pump gas, or don't pump gas on April 15th, confident in the expectation that nothing is going to happen that day at the retail outlets across the US or the world that will make any dent on ... anything.

Fracking: Some Links

I'm just going to link farm today.  Subject, fracking, the propagation of fractures in layers of rock in order to draw through the rock the buried petroleum, natural gas, or other valuable stuff.

According to Schlumberger's oilfield glossary, "engineered fluids are pumped at high pressure and rate into the reservoir interval to be treated, causing a vertical fracture to open." Who is Schlumberger?  The "leading oil field services provider," according to the company webpage.

Some residents in Oklahoma reportedly suspect that recent seismic activity there owes something to the practice, but this article in The Christian Science Monitor takes a skeptical view.

Fracking is a more likely culprit for small earthquakes near Blackpool in England recently though.

Earthquakes aside, the usual complaint against fracking involves the potential for water pollution.

The Oil and Gas Accountability Project says bluntly that "our drinking water [is] at risk" due to the practice.

The OGAP cites a white paper prepared by the U.S. Department of Energy's Argonne National Laboratory which described "produced water," i.e. the waste products.  "The many chemical constituents found in produced water, when present either individually or collectively in high concentrations, can present a threat to aquatic life when they are discharged or to crops when the water is used for irrigation."

Joseph Nocera is among those who defends the practice of fracking. He said America "needs the Marcellus Shale," which has 500 trillion cubic feet of reserves, so that we ought to "accept the inconvenience that the drilling will bring" and insist that the drilling be done in ways that address the environmental issues.

There is a spirited discussion in the comments under this post in The Volokh Conspiracy.

A Thought Re: The Crude Oil Boom and Bust of 2008

The price of crude oil rose steadily all through the first half of 2008, hit a peak in July of that year, and headed down for the remainder of the year, right through the election.  Given the rest of the dramatic financial and political events of 2008, and given the general contemporary expectation that the price of oil is tied into everything, this quick spike in crude's price has naturally attracted a lot of attention and speculation. 

Here's a bit more.

In August 2007, voters in Turkey elected Abdullah Gül their new President.  Gül was the first devout Moslem ever to become president of modern Turkey – a country that since it came into existence in reaction to its Ottoman precursors has possessed a determinedly secular political culture.  Indeed, the law at this time prohibited women at universities from wearing of headscarves, for fear of its Islamic implications.  Gül, too, was surely a matter of concern to the world’s oil traders, both those with speculation and those with hedging on their minds. 

Those nasty oil speculators were as usual, following events, not making them.  Early in 2008, Turkey’s parliament passed a law allowing for such headscarves, and it should be noted that the first lady of Turkey, Hayrünnisa Gül, wears a headscarf.

I have impressions and opinions about everything, and of course would be perfectly happy to see women at any university anywhere free to wear whatever head gear pleases them individually.  But such feelings are utterly unhelpful in analysis.  The significance of the issue of the secular or non-secular character of Turkey for the stability of the whole region should not be underestimated.

So a reasonable account of what happened to the oil market in the U.S., and what role it played in the business cycle, might be this.  The market (in accord with what the efficient markets hypothesis we’ve discussed in earlier chapters might lead us to suspect) understood that the U.S. is heavily reliant upon imported oil.  The price of any commodity in an efficient marketplace is forward looking, and events in the Middle East led the market to anticipate further trouble and to build that trouble into its prices.  Those were supply side calculations, i.e. calculations about where the oil was coming from.

Any sign of Islamism in Turkey naturally drew the attention of these market, and this attention may have started that dramatic upward move.

But when the market price started heading down, in July 2008, was this also a supply side phenomenon?  Was the market saying either that sources of supply overseas had been successfully secured or that domestic sources were going to take up the slack?  I doubt either versions of that hypothesis.  No, the most reasonable hypothesis is that in July 2008 the oil market collectively saw that the United States, and with it the rest of the industrialized, oil-consuming world, was headed into a deep recession that would undermine the demand for crude oil and any of its derivatives.     

Energy

Notes toward what will become my chapter 16.

1. speculative bubble in crude oil
a. spring and early summer -- Masters' testimony
b. late summer and fall -- why the bust?
c. what policy consequences?
2. history of ethanol subsidies
a. broad coalition forms by 2010
b. Grover Norquist
3. peak oil? plateau oil? abiogenic oil?
4. realities and fantasies

Back to 1a above.

There was a bubble in crude oil prices in the summer of 2008. Some observers thought this may have tipped the US into the financial crisis of that autumn. Let's discuss this.

One school of thought in May 2008 (expressed by witnesses in hearings that month before the Senate Committee on Homeland Security and Governmental Affairs) was thgat institutional investors and commodity-price indexes had just recently become important factors in the determination of commodity prices, including those for food and fuels.

The chain of cause and effect would then be this. Various Wall Street entities such as Dow Jones, Goldman Sachs, Standard & Poors, created innovative commodity futures indexes. This allowed people or institutions to bet on an increase in commodity prices without actually having to buy something specific like cotton, or to trade even in specific derivatives such as cotton futures. No, the "index speculators" preferred to bet on the whole asset class at once, seeing it as "uncorrelated" with either bonds or stocks, and thus as a valuable addition to the portfolio.

As Michael W. Master, managing member of a long/short hedge fund, told the Homeland Security Committee, what was new about the index speculators was that they weren't concerned with traditional notions such as price per unit. They had made a portfolio allocation decision, and would "buy as many futures contracts as they need[ed], at whatever price [was] necessary," until all of the portion of their money that they had allocated to the commodities asset class was at work there. Thus, this was a form of demand separate from physical or commercial demand/supply calculations.

On January 2007 the Commodity Futures Tradings Commission changed the way it broke down its "commitment of trader" numbers, creating a new category for the newly-prominent index funds.

It is possible, then, that the sharp rise in certain prices beginning that spring owed something to the new indexes and to the rise of a new class of index speculator.

It is also possible, and I suspect probable, that the sharp rise combined a small effect from the rise of index speculators and a larger rise from old-fashioned directional speculators who thought that the index speculators would be a huge factor and who wanted to be on the same side as them.


But ... what about the sudden decline?

Contango: 2011 Edition

Regular readers may remember that every year at this time I do some basic arithmetic regarding contango.

As a refresher, contango is the discount you can get on a non-perishable commodity by virtue of your willingness to accept delivery at once, or (stated inversely) the extra payment you make if you want the seller to hold it for you for some interim.

One would naturally expect this discount to be closely related to the costs of storage space. After all, if I buy crude today and tell you to deliver it six months from now, you have to keep it somewhere during the interval, and pay the maintenance on the storage facilities. If I take delivery now but I don't use it over the six months, then the cost of storage falls on me.

So: a year ago I simply measured the per-barrel price for March delivery (which was $74.14) against that for August delivery ($77.08) and extrapolated that into an annual rate. The five month delay in delivery cost the buyer $2.94 at that time, which extrapolated into an annual figure would have been $7.06 or about 9.5% of the price of the barrel.

Checking the figures a year later ... the price of a barrel was $89.58 for March 2011 delivery last time I checked. Never mind the question of why that has gone up. I'm focusing on just one piece of the puzzle now. The price for August delivery was $94.49. That's a difference of $4.91 for storage. This annualizes to $11.82, which is roughly 12.5% the price of a barrel.

Why is contango on the increase? I might like to suggest that this confirms that the market is signalling a recovery soon. People are willing to pay to store the crude NOT because the costs of carry have gone up dramatically but because speculators would rather have crude oil several months from now than now. And they'd rather have in six months from now because they are getting signals that people are going to be driving more, the wheels of industry are going to be turning ... good times will be back. At least to some degree.

But then ... I'm still uncomfortable. After all, forgetting speculation, the simple cost-of-carry sort of contango might have increased to 38% annually. Why not? Maybe all the easy storage spaces are all used up, and it takes extra expense to bring new storage space on line (marginalism, anyone?) and THAT is leading to a sizeable discount for anyone who will take the stuff out of the marketers' hands quickly.

All this is making my head hurt. Enough!

Tojo's Fall From Power

Today, July 18, is the anniversary of a memorable shake-up in the Japanese government. On this day in 1944, under the stress of a failing war effort, the loss of Saipan in particular, Hideki Tojo, the man who had been Japan's prime minister since October 1941, resigned that post.

Tojo's rise to that position is in its way revealing of the pathology of Japanese decision making at the time.

It involved what one might call a love/hate relationship between Tojo and Fumumaro Konoye.

In November 1938, Tojo, now vice-minister of war, spoke to a group of industrialists and spoke harshly about a list of actual and potential enemies, including the Chinese, the British, the Americans, and the Russians.

The speech received a good deal of attention, and seems to have set off a sharp drop on the Japanese stock exchange. It also worried Konoye, who was prime minister at this time. Konoye was was no pacifist. He was perfectly content to lead a government in an endless war in China, but he wasn't eager to expand Japan's war by attacking, even rhetorically, the US and UK and the Russians.

Konoye quietly re-assigned Tojo to a position where he'd be less visible, give no speeches, and so do no further harm.

Konoye himself resigned in January 1939, complaining that he had become merely a "robot" for the military. Hiranuma Kiichiro became the new prime minister.

Kiichiro's government wanted a treaty with Germany, and it wanted that treaty to be especially aimed at what Kiichiro saw as the common enemy of Germany and Japan: Soviet Russia. When Hitler and Stalin entered into their own treaty in August 1939, the bottom fell out of Kiichiro's plans.

The political maneuverings of the following months are complicated and would be tiresome to relate. Suffice it to say that Konoye returned to the office of prime minister -- apparently no longer scrupulously refusing to be a robot -- in the summer of 1940. Konoye, who had once demoted Tojo to an invisible position, now promoted him to a highly visible one, making Tojo his War Minister.

It was under Konoye, too, that Japan entered into the Tripartite Pact with Italy and Germany. Therafter, Hitler attacked Russia and Japan moved its military ambitions southward, into Indochina. This precipitated a U.S. cut-off of oil sales to the Japanese. Konoye was still reluctant to do anything that would involve a direct confrontation with the English-speaking powers. And in September 1941, Konoye told the US ambassador that he would like to meet with Roosevelt personally in an open-ended summit.

Roosevelt and Cordell Hull were leery of a summit. They suspected (accurately) that Konoye would expect them to acknowledge Japanese pre-eminence in its sphere of influence.

At any rate, Konoye resigned in October when he saw that the armed forces were pressing for a war with the western powers and he didn't have the support to stop them. Tojo became prime minister at this time, in this context.

So today we mark the day of his downfall. I don't have any cosmic lessons to draw from any of this, but various fascinating alternative histories suggest themselves.

Contango: Another Year

Last year at around this time I wrote a fairly extensive blog entry about crude oil and contango.

As a refresher: Contango is the discount you can get on a non-perishable commodity by virtue of your willingness to accept delivery at once, or (stated inversely) the extra payment you make if you want the seller to hold it for you for some interim.

One would naturally expect this discount to be closely related to the costs of storage space. After all, if I buy crude today and tell you to deliver it six months from now, you have to keep it somewhere during the interval, and pay the maintenance on the storage facilities. If I take delivery now but I don't use it over the six months, then the cost of storage falls on me.

So: a year ago I simply measured the per-barrel price for March delivery (which was $46.47) against that for August delivery ($53.81) and extrapolated that into an annual rate. The five month delay in delivery cost the buyer $7.34 at that time, which extrapolated into an annual figure would have been $17.64, or about 38% of the price of the barrel.

Checking the figures a year later ... the price of a barrel is now $74.14 for March delivery, and $77.08 for August. That's a difference of $2.94 for storage. This annualizes to $7.06. That's roughly 9.5% of the price of the barrel.

Why has contango fallen so drastically over the course of the year? People were noticing the drop as early as May. But I can find very little blogospheric commentary that addresses the reason for the drop. Could storage space have gotten less expensive?

Let us go back to basics. Supply and demand. There could be more supply (available space) if the owners of storage facilities haven't been re-filling them as rapidly as they've been pumping the oil out toward the refineries and its trip toward retail use. Or perhaps the large contango of a year ago inspired entrepreneurs to invest in the creation of new storage facilities. Those facilities have since been coming on line, and that has driven the contango down, just as it should according to the textbooks.

Or it could be a demand issue. Anyone who wants to join in with some helping hypothesis ... I'm all ears.

Bernanke

The Chairman of the Federal Reserve seems determined to pursue an easy-money policy, one that risks consequences reminiscent of the 1970s.

Ben Bernanke gave a speech in Atlanta over the weekend in which he maintained that monetary policy didn't cause any bubble in housing prices. The financial crisis of 2008, which was precipitated by the subprime crisis of 2008, which on most views was the result of the housing bubble in the years leading up to that ... has "regulatory" causes, says Big Ben. The money supply is an irrelevance.

He showed off various graphs designed to make this point. And I'm sorry if this sounds populist, but this is the sort of non-sense only an academic over-impressed by his graphs can believe.

As Wesbury rightly says, in his column on Bernanke's speech (see the above link) what is "disconcerting" about this is not the revisionist history as such, but the fact that "with interest rates at essentially zero, and with the economy and inflation picking up steam, he makes a speech defending extremely loose money."

On a related point, here is a discussion of the internal politics of the FOMC. However often I see it, the use of "hawks" and "doves" in this context (where "hawks" are for tightening the money supply and "doves" for easing it) always strikes me as odd. Heck, the use of those avian metaphors for issues of war and peace is hard enough to get used to -- but this is a metaphorical stretch too far.

A refresher on contango

Contango is the discount you can get on a non-perishable commodity by virtue of your willingness to accept delivery at once, or (stated inversely) the extra payment you make if you want the seller to hold it for you for some interim.

As I noted in a post on the subject I wrote here in January, the per barrel price of oil at that time was $46.47 for March delivery. That is as immediate a delivery as Nymex listings will get you. Going out further, a barrel for August 2009 delivery went for $53.81. So the contango for that five-month period was $7.34, or $17.64 annualized, or 38% annualized and stated as a percentage of the value of the barrel. That seemed historically very high and I wondered about the reasons in that January post.

Six months later, the price is up, however one measures it. But let's maintain our focus on contango. Crude oil for July delivery (essentialy the spot price) is at $72.68 a gallon, looking at the "most recent settle" at Nymex. Going out five months, a barrel to be delivered in December costs $76.12. This is a contango of a modest $3.44, or $8.26 (11.4%) annualized.

Why has the contango dropped so drastically?

Presumably this means that in January oil was being held offshore in tankers, and now it is being released into the market. That would make the on-tanker storage space less valuable and bring down its price.

That's the theme of the Izabella Kaminski blog entry to which I've linked you, and she has further facts and numbers.

It doesn't sound as if the recent price incraeses are the result of price machinations. It seems as if the refineries ran through their backlog and are now closer to being current than they were in January, yet demand or anticipated demand is great enough to move prices up even while crude is moving onshore.

That would be good news in terms of a recovery, although as I've indicated before the recovery in question is the inflation-stoked and inflation-soaked sort that will bring more than its own share of problems.

Crude oil and contango

There are worlds of stuff I don't know, so bear with me. The price of a barrel of crude oil on the New York Mercantile Exchange at the end of trading Thursday was $43.26. It is heading back up from its lows in the 30s.

On Friday, a barrel for March delivery sold at the close for $46.47.

Could it be that the cold winter is pushing up demand? No. Markets look ahead. We're at the worst of the winter in the northern hemisphere, so you would have expected that meteorology would be fully discounted by now. Indeed, you might see the markets looking ahead to spring, which would indicate a lowering of demand for crude.

The market could be looking ahead in another sense, to the greater quantity of driving that generally comes with spring. But that would seem to be countervailed by the recession.

Or ... the market could be telling us that things are turning up. The optimistic reading of the price increase is that it results from speculative demand increase which in turn results from signs (seen by the speculators, if not by you and me) that the economy is about to turn around.

But let's not rush to that conclusion. Think first about contango, a word that appears to have nothing to do with Argentine dancing. [Yes, I had to get that one out of the way].

Contango, the word seems to be derived from "contingent," is the discount you can often get on a commodity by virtue of your willingness to accept delivery at once. Suppose I have a barrel of oil and I want to sell it. You want to buy ... but you want me to deliver it to your place of business six months from now. Why would you have to pay more?

Because the oil isn't doing me any good in the meantime! It is taking up space and there are maintenance costs associated with storage. So I make you pay for that. What you pay for my storage (or, looking at it the other way around, the discount you get for accepting the oil immediately) is your contango. This elemental reason for contango is called "cost of carry."

I've heard from no place worth mentioning that a good guess for costs-of-carry historically is about 14% a year. So if contango is greater or less than 14% there should be explanations other than "where the heck do I put the stuff."

The above barrel price, $46.47, is as I said for March delivery. That is as immediate a delivery as Nymex listings will get you. Going out further, a barrel for August 2009 delivery goes for $53.81.The present difference in price between March delivery and August delivery then is $7.34. That would work out to $17.64 annual. As a percentage of $46.47? About 38%. That's one mean contango.

I might like to suggest that this confirms our earlier suggestion: that the market is signalling a recovery soon. There is such high contango NOT because the costs of carry have gone up dramatically but because speculators would rather have crude oil six months from now than now. And they'd rather have in six months from now because they are getting signals that people are going to be driving more, the wheels of industry are going to be turning ... good times are back.

But then ... I'm still uncomfortable. After all, forgetting speculation, the simple cost-of-carry sort of contango might have increased to 38% annually. Why not? Maybe all the easy storage spaces are all used up, and it takes extra expense to bring new storage space on line (marginalism, anyone?) and THAT is leading to a sizeable discount for anyone who will take the stuff out of the marketers' hands quickly.

All this is making my head hurt. Enough!

Be Sure You Guess Right

At a message board where I regulartly go to vent, one of the other venters asked us all the question: "Do you wish you were an oil speculator right now?"

I do. Oil's gone from the mid-high 140's to 115. Someone's getting really rich off of this.

The big swings is always where the biggest money is made.

I think this thread has the potential to be a lot of fun. How many of you reading this thread right now didn't know that commodities speculators make money when the price goes down?

This shows a wonderful naivete that thinks of itself as sophistication. Speculators make money when the price goes down? Wow, man, you're blowing my head.

I had to reply. And I enjoyed my reply so much that, in lieu of other inspiration, I'll reproduce it here.

Oil speculators make money when the price goes down only if they knew in advance that it would, or just guessed well.

Personally, I don't believe that the average oil speculator right now knew anything in advance. It seems to have been a paradigm 'random walk' of late, both up and down. So the successful ones have been guessing right.

No ... I wouldn't want to be a speculator right now for the same reason that I don't spend a lot of time in casinos.

People who DO spend time in casinos are performing a socially useful function (somebody else will probably make better use of their money than they know how to do). Likewise, people who speculate on commodity prices are performing a socially useful function. They create a market in which other parties, commercial entities, can hedge against risks.

But I wouldn't want to be the one performing that function, no. When oil was above $140, the general guess was that it would keep going up, maybe to $200, before heading down in a big way. What [do you] believe has happened to any speculator who acted on that bit of wisdom?

Yesterday's crude oil excitement

Crude oil prices rose yesterday by more than $10 a barrel. As you can see from the attached chart, from the New York Mercantile Exchange, prices were trending down Tuesday and Wednesday. They were flat through Thursday morning in the neighborhood of $122 a barrel. Then, Thursday afternoon, came the start of the spike that continued until Friday afternoon.

So ... what happened? Trading at the New York Mercantile Exchange may have been driven (I say "may" because I'm guessing) by a combination of news items that together suggest further violence in the Middle East and, accordingly, more supply disruptions.

Item: On Thursday, the Turks and Iranians announced that they had launched co-ordinated attacks against Kurdish rebels in the north of Iraq. Condi Rice met with Turkish officials on the subject and released a statement that didn't mention the Iranian role at all, but did say that the Turks and the US are "on the same page" as against the rebels.

Item: a deputy prime minister of Israel said: "If Iran continues its nuclear weapons program, we will attack it."

Item: There's been a new outbreak of violence in Sri Lanka in recent days, including two bus bombings in the capital city Friday. The guerillas, a/k/a/ the Tamil Tigers, demand a separate homeland in the north of the island nation.

Consequence? The rise in the price of a barrel Friday (forget the start of the run-up Thursday) was the equal of the WHOLE price of a barrel in 1998.

If the sense of imminent doom passes over this weekend and things calm down a bit, contracts will lose some of this value in trading again next week.

But I'm still just guessing.