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That Slippery, Oily Slope?
Jeremy Warner of the Telegraph reports, The uncertainty over oil is a slippery slope:
The last time the oil price lost touch with gravity, which it threatens to again with the price of Brent crude now well north of $100 a barrel, it helped tip the world economy into the deepest recession since the 1930s.
Is history about to repeat itself? Much depends on developments in the Middle East, but things are once more looking perilous.
By adding to energy costs, the effect of high oil prices is to reduce the amount of money for spending on other things, thereby undermining aggregate demand in the wider economy. Eventually a tipping point is reached where confidence collapses. Given what happened as recently as 2008, you would expect OPEC to be acting quickly to prevent any further explosive increase in prices.
The wave of popular protest across North Africa and beyond has put that assumption in doubt. What happens to the world economy is not exactly a priority right now for the autocrats who dominate OPEC. Their focus is instead on survival.
The big producer, Saudi Arabia, looks particularly vulnerable to further contagion in the region.
With nervousness turning to panic among key producers, this is not an environment conducive to the sort of prompt decision-making necessary to prevent the oil price running out of control again.
If the latest instability in the Middle East wasn’t enough excitement for the Energy Institute’s traditionally lively annual conference in London this week, there’s also the unprecedented divergence in benchmark oil prices to ponder.
Go back to the origins of multinational oil in the 1950s and 1960s, and it was big oil companies such as Shell and BP that set the price, with the emphasis very much on the needs of consumer nations they serviced. By the 1970s, OPEC had usurped that role. As a consumer, you either paid up or went without.
The mid-1980s saw the adoption of a more market-related system, with OPEC turning the taps on and off in an attempt to keep prices in a supposedly mutually beneficial range.
Big producers such as Saudi Arabia still sell on their own terms, but they do so by reference to a small number of benchmark prices, supposedly established by arm’s length international trading in oil.
The extent to which these benchmarks are a true reflection of the balance of supply and demand in the world economy is a matter of conjecture. The suspicion is that they owe as much to manipulation, anomaly and speculation as underlying fundamentals.
Like stock and bond markets, oil has become “financialised”. These days, it appears as much the playground of hedge funds, hoarders and financial investors as genuine users and producers. When the oil price took flight three years ago, the Financial Services Authority (FSA) dismissed claims of undue speculative influence as largely nonsense, and on the basis of “the market is always right” dogma of the time, put the phenomenon down mainly to supply constraints against a backdrop of fast-growing demand.
Not for the first time, the FSA was being naive. Price discovery in oil is at best untransparant and inexact, and at worst subject to substantial distortion. The reason this is of such vital importance is because oil plays such a big role in economic activity. To allow oil markets to become subject to the same speculative excesses as sub-prime mortgages would be disastrous. Producer and consumer behaviour are crucially determined by what the price says; when the pricing signal is wrong, economic activity will be affected in highly undesirable ways.
An unduly elevated price will eventually destroy demand, which in turn will undermine sustainable investment in new capacity to meet future demand growth. These cycles are a major influence on the ups and downs of the broader business environment.
A study by Bassam Fattouh of the Oxford Institute for Energy Studies – An Anatomy of the Crude Oil Pricing System – finds the benchmarks that determine world energy prices to be wanting in a number of important respects.
One look at the difference between the two main benchmarks – Brent and West Texas Intermediate (WTI) – immediately tells you there’s something wrong. Historically, WTI has traded at a small premium to Brent, but over the past year, a near record discount of some $15 a barrel has opened up. This in part reflects ample supply in the US Midwest (WTI is an American benchmark) and an equally pronounced squeeze on supplies of Brent. Brent is a waterborne crude, while WTI is a landlocked American benchmark, so the difference might be attributed to the
US economy still being down in the dumps while Asia is booming.
But what do the now quite small quantities of oil still coming out of the North Sea have to do with Asia? The answer is virtually nothing, and yet Brent is used in some shape or form to determine prices for approximately 70pc of internationally traded oil. Markets with very low volumes of production are being used to price ones with very high production elsewhere in the world.
The traditional benchmarks might have more credibility if they were at least solidly grounded in the physically traded product, but they are not. In fact, oil markets are characterised by a complex structure of interlinked spot, physical forwards, futures, options and derivative markets, all of which feed into the benchmark price. The paper market is arguably as important in driving the price as the physical one.
Add to that the fact that no one really knows what’s going on in the world’s fastest growing oil market, China, and all the ingredients are there for a mispricing disaster.
The conclusion drawn by Mr Fattouh is that new benchmarks may be needed to reflect the emergence of Asia as the main source of growth in demand for oil. Perhaps unfortunately, we seem most unlikely to get one. As monopoly, state-owned suppliers that won’t auction their oil, the main OPEC producers are even less capable of generating credible price discovery benchmarks than Brent.
Of course, these musings may soon be largely irrelevant. It may be true that whatever the regime, the oil will keep flowing, but with Pandora’s Box now well and truly opened across great swathes of the Middle East, there’s no knowing where it will end. Short-term supply, future pricing, ownership and preferred trading partners – all these things are again up in the air.
Back in 2005, I attended a conference on commodities in London and was amazed at how much money pensions were shoving into so-called "commodity indexes" (even if they were made up of 76% oil futures). It's ridiculous to think that there is no speculation going on in oil markets. Go back to read Michael Masters' excellent testimony to the Committee on Homeland Security and Governmental Affairs. It's all happening again except this time we also have geopolitical eruptions spurring on further speculation.
The price of oil makes me nervous for one simple reason: if it shoots up, it can easily destabilize the fragile recovery taking place right now. And here is something else to ponder: higher oil price increases deflationary pressures:
...while jumps in the oil price cause inflation to rise at the headline level, it also has an adverse impact on economic activity, reducing demand which naturally serves as a deflationary force. This happens in a number of ways as higher fuel costs hamper a firm's production, which in turn forces it to lay off workers while also reducing wage pressures.
Analysts at UBS believe a $10 hike in the oil price would push up European inflation by 0.2% over one year and 0.1% over two years. They do not believe further oil prices would necessarily translate into significant inflation because of the countering deflationary forces.
According to the investment bank's simulations a jump in oil prices pushes up the energy component of the inflation index but depresses core inflation, which excludes volatile food and energy prices.
Analysis from the bank shows that a 10% increase in crude reduces core inflation by 0.1% a year after with the deflationary effects of oil shocks seem to take longer to disappear with projected core inflation still well below the non-shock level. This is because the shock is estimated to reduce economic activity for more than two years. In a extreme case scenario where the price of oil rises by as much as $50 core inflation subsequently drops by 0.25%.
For this reason UBS does not expect European central banks to be knee-jerked into action if the oil prices continue to rise amid the Middle East tensions.
'An eventual oil shock would hit the EU economy in an environment of low inflation expectations and wage deflation,' UBS says. 'For this reason we think the ECB would not be too worried about second-round effects, and would therefore not be forced to hike rates earlier.'
So while the oil shock may not result in central bankers becoming overly hawkish it could in fact have an opposite deflationary impact and reduce the need for an aggressive tightening campaign on rates.
Whether this could drag the global economy back into recession remains to be seen.
I'm not so sure the ECB (aka the Bundesbank) really cares about anything else except for what's going on in Germany. It wouldn't surprise me if they do start hiking rates, killing the periphery economies and adding further fuel to deflationary forces. I hope I'm wrong but they never cease to amaze me.
As for the global economy, it still runs on oil. If oil prices shoot up, expect more riots, more instability, and more volatility in financial markets. The way things are going, we might be back to a time where everything is correlated to oil. This unstable environment is great for arms manufacturers, but it will wreak havoc on the global economy. Hedge accordingly.
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In 1950 gold was $35/Oz, while oil was $2.77/bbl. Gold was 12.6x more valuable.
Now, gold is $1400/Oz, while oil is $100/bbl. Gold is 14x more valuable.
Oil is slightly cheaper relative to gold, then it was in 1950.
Is this a Chicken Little end-of-the-world scenario? Is the Earth devoid of oil? Has human innovation ceased? Has demand elasticity ceased to operate?
Or is this simply the typical effects of money suppy inflation?
Any market dominated by speculation is going to be volatile. Specs buy and specs sell. The market goes up, the market goes down. But, if the price of oil gets too high, I would expect producers to start delivering on contracts. Where is the supply? If supply was limitless, oil prices would be lower.
But the suppliers, who are mostly sovereign entities, are guarding their supplies. They know what the future holds.
High oil prices kill debt-based economies because high oil prices threaten inflation. Interest rates rise, debt contracts.
Look back at a chart of the UST from '07. Just as bonds threatened to drop out of a long term top, the housing market bubble popped. And the stock market topped. Now they are threatening the same drop.....same with the dollar.
gh
what a crack in the bicycle spokes! It sounds like it needs a dynamo.
Except those full of certitude, in the magical beans that US corporates hold for digging themselves out of their own s*** hole. Jack in the bean stalk time ahead looking for the goose with the golden egg. Methinks, Humpty Dumpty not fare away...
this is why we need high speed rail as proposed by president obama. he sees the problems with oil/gas and his idea of an interstate freeway system of highspeed rail for people is now a must have. too bad its about 5 years too late even now and nobody wants to sit next to smelly people. individual cargo units would be good but drilling here in the USA, unleashing science to get clean coal so we can isolate ourselves from these shocks would be great, solar is a bust because you need water to convert the heat build up and giant solar farms in the desert - there is no water, windmills freeze in cold weather and that's that. Natural gas, coal, and our own oil need to be reawakened NOW. Not ethanol as we need to eat the corn. Keep prices down for food means keeping input pricing down, transport costs down, and we stop importing raspberries from chile in february.
Good idea Leo. We are all venting and seekers of truth but individually powerless in making an impact beyond conjecture.
Leo , So far, today the market is tanking because of news from ME and so far buyers are not coming in to cause a rebound. Its still early but more and more talking heads are calling for beginning of correction based on consumer resistance to oil prices. Ben cannot control world events,so QE III will not help if situation deteriorates further in ME. Result is uncertainty which will spook markets for forseable future
Are you serious? One day, one week, one month does not make it a bear market. Let's all take a deep breath and chill...should be an interesting week.
When everyone is gaming the system with synthetic instruments and leveraging with cheap capital the inevitable black swan will reappear--especially in a world of limited resources and mass disparity in wealth.
Dont have any solutions but instinctively know we are going in the wrong direction and are reaching the choke point ala Middle East , energy, unemployment ,civil unrest and all other reasons expressed on ZH
That is about as good as a two sentence summary as you can come up with....
I don't discuss solutions as it is clear that the majority do not recognize the problem yet. Once we are there, we can discuss approaches as there are no solutions that allow BAU.
OMG. Nothing can be solved until everyone believes that natural gas is dinosaur farts?!?!?!?!
Get lost.
The only one mentioning dinosaur farts is you....I fail to see any connection with the issue at hand....
So far, there is little to justify panic. Compared to a Gulf hurricane, a corroded pipeline or a major oil spill what's really happened to affect supplies? The disruption in Libya is almost SOP for Nigeria.
The threat, if there be one, would have to be this Shia/Sunni problem in Bahrain. Allow that to intensify and there would be REAL threats to supply. Fortunately, we have The Rodhamster as SoS and this immensely talented woman with her years of experience in bimbo eruptions, cattle futures trading, rural land sales in Arkansas, failed public healthcare policy initiatives and hiding subpoenaed billing records from the infamous Rose Law Firm, equip her with the expertise she will need to sort out the tribal, religious and geopolitical issues now tearing the Arab world apart.
Leo believes in Hedgies as a good way to manage diversified pension funds but also cites Hedgies as distorting commodity prices {oil}. So are Hedgies also partly responsible for driving up price of oil and therby destroying consumer demand and also ending this wonderous recovery. Just wondering
Hedgies are not the major players in commodity indexes, global pensions are. Hedgies are important speculators but they also hedge their positions. I do believe in investing in hedge funds as part of generating alpha but realize that the majority of hedge funds are selling beta as alpha. There are enough of them, however, that earn their 2 & 20 and align their interest with those of their investors.
Leo believes we are in some sort of recovery. I wish he would go sector by sector and point out all the green shoots, you know like construction, retail, durables, etc. I bet Leo swallows whole the BS economic statistics from the Ministry of Disinformation which, IMO, would be totally unnecessary if we were really in a recovery.
So Leo are we to infer from your article selections that you subscirbe to the notion that Hedgies and their kind have a measurable impact on the price of oil? Schork was on Bloomberg this AM and suggested that the gap between WTI and Brent is due to a storage bottleneck in OK and excess refining capacity. Interestingly he suggested that it was hedging that was in effect keeping WTI below Brent, which he sees (Brent) as closer to true market price. Current US gas prices he suggests are reflecting $100 oil and that $3.50 average/gal is baked in for this coming summer.
Read Mike Masters' testimony (link is in my post). There is a real danger that these commodity indexes and speculative activity are having a significant impact on the price of oil. The bad news is that we'll find out about it after the fact, when all hell breaks loose.
As always. At least you tried, Leo.
I often wonder why I bother posting here, but I like to read some of the comments, at least the intelligent ones.
Are you ready to call a next leg down yet? Seems to me that would put the "recovery" squabble behind you.
No, I'm not ready to call the next leg down. I continue to believe each pullback will be bought and stocks are heading higher. What I'm looking at now is oil and policy mistakes by central banks. We'll also see how the vote in Ireland plays out and whether Euro banks take another haircut.
I see flocks of black swans waiting for a stray wind to cue them to flight. I think you have too much faith in the Masters. We'll see.
Have faith in what Mike Masters warned us of in the past.
I am on the road now with some time to kill and dont have easy access to my list of links... The peak oil deniers are loosing the battle on this site thanks to the efforts of a few. They spew their crap and retreat when confronted, hell, tmosely had a epiphany recently...
The battle is over. Natural gas = dinosaur farts has been disproven.
Oh No !
Bicycle, the definitive, conclusive intellectual petard has been thrust upon us.
If you don't agree with the Big Oil companies's Shill, the Flakmeister, then you are a DENIER !
Oh my oh my. Now that is an Al Gorism.
You sir, are a DENIER !
Time to go FLAK yerself Flak.
Go and read
http://www.theoildrum.com/node/7460
Get back to me and we can have a real discussion if you like.
Also explain why CHK just sold one of their "hot" shale gas plays (the Fayetteville) to BHP. If CHK thought they could make money on it, do you think that they would sell?
http://tmx.quotemedia.com/quote.php?qm_symbol=CHK:US
Does that qualify as "cut and paste"? The oildrum is a large collection of trivia. No thanks.
CHK cannot make money, because there is too much natural gas. There is a glut, and prices have been dropping. Worldwide.
You've been completely brainwashed.
you use price to prove a glut of one thing but deny that as evidence for the shortage of another
I think that there are dangers if the oil price spike becomes more prolonged. I was reading some research earlier on the impact of a rise in the price of crude oil by ten US dollars per barrel. After the analysis this suggestion was pointed out by the economist Shaun Richards.
Anybody know any economies in that type of situation?
Peak oil, my ass. The market is completely manipulated. And there is an over abundance of cleaner natural gas. Hubert's (sic) peak? I doubt Hubert (sic) ever heard of natural gas.
Well thankfully America has a fleet of NG cars on the road today and all the infrastructure needed to fuel them! Phew,I was worried there for a second. Lucky for us,we can use allllll that NG for...
Solvents
Diesel fuel
Motor Oil
Bearing Grease
Ink
Floor Wax
Ballpoint Pens
Football Cleats
Upholstery
Sweaters
Boats
Insecticides
Bicycle Tires
Sports Car Bodies
Nail Polish
Fishing lures
Dresses
Tires
Golf Bags
Perfumes
Cassettes
Dishwasher parts
Tool Boxes
Shoe Polish
Motorcycle Helmet
Caulking
Petroleum Jelly
Transparent Tape
CD Player
Faucet Washers
Antiseptics
Clothesline
Curtains
Food Preservatives
Basketballs
Soap
Vitamin Capsules
Antihistamines
Purses
Shoes
Dashboards
Cortisone
Deodorant
Footballs
Putty
Dyes
Panty Hose
Refrigerant
Percolators
Life Jackets
Rubbing Alcohol
Linings
Skis
TV Cabinets
Shag Rugs
Electrician's Tape
Tool Racks
Car Battery Cases
Epoxy
Paint
Mops
Slacks
Insect Repellent
Oil Filters
Umbrellas
Yarn
Fertilizers
Hair Coloring
Roofing
Toilet Seats
Fishing Rods
Lipstick
Denture Adhesive
Linoleum
Ice Cube Trays
Synthetic Rubber
Speakers
Plastic Wood
Electric Blankets
Glycerin
Tennis Rackets
Rubber Cement
Fishing Boots
Dice
Nylon Rope
Candles
Trash Bags
House Paint
Water Pipes
Hand Lotion
Roller Skates
Surf Boards
Shampoo
Wheels
Paint Rollers
Shower Curtains
Guitar Strings
Luggage
Aspirin
Safety Glasses
Antifreeze
Football Helmets
Awnings
Eyeglasses
Clothes
Toothbrushes
Ice Chests
Footballs
Combs
CD's & DVD's
Paint Brushes
Detergents
Vaporizers
Balloons
Sun Glasses
Tents
Heart Valves
Crayons
Parachutes
Telephones
Enamel
Pillows
Dishes
Cameras
Anesthetics
Artificial Turf
Artificial limbs
Bandages
Dentures
Model Cars
Folding Doors
Hair Curlers
Cold cream
Movie film
Soft Contact lenses
Drinking Cups
Fan Belts
Car Enamel
Shaving Cream
Ammonia
Refrigerators
Golf Balls
Toothpaste
Gasoline
you're right, peak oil will have your ass
Who are those people who find all the fields for you again? Geologists? What was Hubbert's profession? Geologist. Where did he work? Shell.
Now go blow an Exxon executive for your dinner, troll.
Nice attempt to limit the discussion to Shell versus Exxon.
You are truly lost.
It's over, assholes. Give it up.
I detect a hint of self reflection... there may be hope for you after all
I detect more than a hint of desperation. Tell your buddy Al Gore and the oil companies, it's over.
You realize that every time you open your mouth you come across as even a bigger fool?
Outside of insults, you have nothing but old, debunked propaganda.
Debunked by who and where, please elucidate
You just demonstrated you complete lack of intellect regarding anything to do with energy
Chinese solars, Leo?
"Governments, investors and even the World Bank are rushing for the exits in the Great Escape from the green energy bubble.
Solar energy appears to be the worst affected sector so far. Dow Jones reports on a startling U-turn by Britain’s ultra-green government has caught investors off guard and shock waves across the markets will likely precipitate the further rush from green energy projects to shale gas.
The UK’s Department of Energy and Climate Change made the shock announcement as it revealed a comprehensive review of its Feed-in Tariff (FIT) program. Indications from data provider, Prequin are that over $1bn in earmarked funds may be lost as Britain now promises it will only hold tariffs until April 2012.
Green Investors Feeling Betrayed by European Governments
Britain’s decision is another nail in the coffin for Europe’s tottering green energy market. Last year the first of several crushing body blows was dealt to environmentalist dreams when the Spanish government retrospectively cut the value of its tariffs in its own U-turning energy review.
The devastated Spanish Solar Photovoltaic Industry Association, with mass bankruptcies on the cards, is accusing their government of utter betrayal is yet to carry out a threat to sue over the ruling.
As the green house of cards collapses Netherlands-based investment manager DIF and BNP Paribas and venture capitalists such as Future Capital Partners are rumored to be extremely fearful of further repercussions coming at a time when European public opinion is bored and fatigued after two decades of endless global warming hype.
UK Energy Minister Charles Hendry made the starkly ominous admission, “one third of Britons think the science on climate change has been exaggerated.”
Not helping the green cause has been a succession of brutally cold Northern hemispheric winters which an increasing number of scientists fear may be the harbinger of the onset of a mini-ice age.
Abundance of Shale Gas Deflates Green Energy Bubble
Causing green lobbyists and environmentally focused investors to cry bitter into their carrot juice comes the news that China is making its move to become pre-eminent in shale gas investment.
Peter Foster in the Financial Post (February 11, 2011) reports that energy company Encana is to get a proposed $5.4-billion investment by PetroChina in its shale gas operations. The move he says “confirms the soaring importance of a resource that 10 years ago was hardly on the commercial map.”
The market obviously liked the news of the Chinese investment as Encana shares jumped 4.5% to close at $32.02.
Savvy shale gas investors are also looking most eagerly at Canada where the discovery that Quebec has considerable shale gas potential has dealt another blow to the idea that the world’s energy resources are anywhere near a so-called “peak.”
A strident Quebec Oil and Gas Association has hired former Parti Quebecois premier Lucien Bouchard to help lobby for provincial development to exploit the unexpected huge find.
With so many known large deposits of shale gas in countries such as Poland, Germany, France and the U.K. economic strategists are finally waking up to the fact that this monumental new resources could help free Europe from the threat of disruptions from its main natural gas supplier, Russia.
Andrew Orlowski reporting for ‘The Register’ (February 10, 2011) reveals Holland has also joined the rush away from green by becoming the first country to abandon the EU-wide target of producing 20 per cent of its domestic power from renewables. The Dutch are now putting their long-term faith in nuclear. Netherland’s only nuclear reactor, the Borssele plant, scheduled for closure by 2003 is now planned to operate at least until 2034.
World Bank Joins Rush Away from the Green White Elephant
Top line international bankers also appear to be abandoning ‘big green’ according to a report by climate scientist Roger Pielke Jr. who highlights two recent research papers published by influential thinkers inside the World Bank.
Economics papers by Robert Mendelsohn and Gokay Saher (here in PDF) and Medelsohn, Kerry Emanuel and Shun Chonabayashi (here in PDF) chop the legs from under the pro-green Stern Review (2007) and affirm that no human impact may be inferred on global climate.
With economists plainly joining an increasing number of scientists in global warming skepticism its little wonder there’s now a mass flight away from ‘renewables;’ such that both investors and governments are compelled to follow suit in the clearest indication yet that green energy won’t live up to its promises.
The key to long-term economic success now appears to be safely premised once again on solid market innovation, not ideologically driven government subsidies; such subsidized ventures have a long and notorious history as lame duck enterprises. It seems Green renewables' has become the latest of these white elephants."
So your name is John O'Sullivan...and you're Exxon's buttslutt.
I know, I know...you "needed the money". A tragic story as old as time.
Leo, allow me to call you and all your deluded keynesian economist pals out on one point (for this post, at least). Old style deflation caused the overall price levels to decline. Not for a week, not for three months, not for as long a the BLS wants to lie about it, OVERALL PRICE LEVELS DECLINE and are visable in historic perspective, i.e. looking back at a chart of the last three years. Period. It is not deflation when bad debt nearing default declines in price. It is not deflation when the property securing bad debt declines in price. Deflation takes down food prices, gas prices, the price of blow, the price of hookers, and the price of used Rolexes. EVERYTHING. Tell me when this has happened for more than a few months since the great wake up call in 2008? Now soak your imaginary deflation in some slippery KY and hold your breath until you guess what to do with it.
You're thinking near term. If you have another crisis and unemployment shoots up, deflation in the US is a real possibility. And one more thing, Keynes was a genius, among the greatest geniuses of the 20th century. To ridicule him or lump him together with neo-Keynesians just shows how ignorant you truly are of the man, his work, and his stature. If you want to read delusional economists, go read all those Nobel-prize winners at the Chicago school. Those market maniacs were much more influential and managed to screw up your country's economic policy for years.
"And one more thing, Keynes was a genius, among the greatest geniuses of the 20th century."
I knew if I waded far enough out into the effluent lake that are your posts I would find you saying something like this.
Keynes was a socialist with a zeal for fascism Leo.
He admitted in the foreward of his book published to the German speaking people his "theory" worked best in a authoritarian state.
How many of your customers know this about you?
Yes, those "market maniacs" never amounted to much. I guess that's why Chile's economy, designed by the "Chicago boys", is the healthiest and most productive in South America.
Before you wax too poetic on our affected friend Mr. Keynes, it's good to remember that he amassed his personal fortune by essentially ignoring or acting counter to the advise he dispensed to the fawning political elites that held him is high esteem.
Won't be long before the Chicago boys screw up Chile's economy. To be fair, Milton Friedman was a great economist, but I just never bought into a lot of the theories his disciples conjured up (just like apart from Tobin, I don't like what ''neo-Keynesians'' are coming up with). Having too much faith in the market or in the state is a recipe for disaster. As for Keynes making money speculating, good for him. He figured out the psychology of markets and profited from his insight.