The Oil Market QE Premium Is Coming out of Price

EconMatters's picture

By EconMatters


The Fed Giveth & Taketh with Policy


The Fed may pat themselves on the back for creating the ‘wealth effect’ in stocks, and hope like heck that some of this wealth trickled down and through the rest of the economy, but it is quite evident what the Fed giveth on one hand they taketh away on the other hand in terms of higher oil and commodities prices like gasoline prices.  


EIA Fundamental Analysis


Remember last year when the EIA`s average price for the year was supposed to be by the fundamentals at around $93 a barrel, and oil basically stayed most of the year above $100 a barrel, and gasoline prices stayed elevated way beyond the fundamentals of weak demand and robust supplies. Well consumers have the Federal Reserve to thank for this market outcome as it is obvious looking now as QE is winding down so is the price of oil, as the QE premium comes out of the market, prices are going back to where they started before the injection of $85 Billion of asset purchases that ended up injecting $20 a barrel premium in the price of oil, and the resultant carry over higher prices in gasoline for consumers.


The Oil Market Acted Strange after Fed $85 Billion Monthly Asset Purchases


Right before QE oil was trading in the $82-87 range and pegged pretty sleepily at $85 a barrel, then QE starts and boom, the oil markets head to $100 and basically will not go down for the entire year confounding the EIA and many other analysts. And don`t go to the more supplies card or more geopolitical concerns as all in all Libya is probably producing just as poorly right now as they were last year, and US supplies on the whole are in the same ballpark in terms of robust production – if anything the increase in US Production of last year compared to the prior year was more dramatic and should have been a headwind for price last year. Welcome to the Fed Effect on Oil Prices, that $85 Billion of stimulus goes into a lot of places the Federal Reserve doesn`t realize, and oil and gasoline markets get juiced a hefty margin beyond the fundamentals of the market.



Discretionary Income Choices for Consumers


This is one of the factors behind tepid retail store sales numbers as consumers` discretionary income has gone to purchasing gasoline and away from purchasing clothes, purses and mall type items. The other factor hurting retail store numbers is the migration to online purchases and these numbers are hard to capture in the outmoded data reports. Imagine how much more discretionary income could be infused into the consumers` pocketbooks without the QE induced higher gasoline prices of the last “Infinity QE Program” as $85 Billion of asset purchases has to go somewhere. The Fed really needs to think about the side effects of policy decisions: What does better for the economy higher stock prices for 5 to 10% of the US population or lower fuel costs by the entire population? If they actually thought in a balanced manner, and considered all aspects of policy decisions including the unintended consequences of the negative effects of excessive QE Purchases on gasoline prices derivatively from juiced up oil prices, they might actually make smarter decisions and help the economy reach potential faster. 


Lower Oil & Gas Prices Boost for Economic Growth


Watch as the QE Premium comes out of the Oil Market how this spurs economic growth for the second half of the year in the retail sector of the economy. The lesson here is stay out of markets, Federal Reserve.  Fed policies not only don`t help the economy near as much as they think, they actually hinder economic growth in many areas through having markets diverge from the fundamentals, and promote inefficient uses of capital. As Jackson Hole approaches the Federal Reserve needs to seriously rethink Policy, and just get the heck out of markets and stay out for good. Your only job should be to move the Fed Funds Rate between 3% and 5.5%, and monitor excessive risk taking and unsafe practices of leverage by the big banks, and that is it. There should be no more Asset Purchases or Zero Percent Fed Funds Rates forever, this should be outside of their jurisdiction, and if they cannot manage to keep their hands out of financial markets, then legislation needs to be passed to reign in their power, and keep them from continually meddling in markets which are supposed to be about “Price Discovery” and not manipulation by a government body.



Federal Reserve Destroyed Price Discovery in Markets


To sum up, Fed Officials need to look inwardly at the damage that their policies do to the economy, as it is obvious we all paid far too much for gasoline the past year by a substantial amount given the fundamentals of the oil market. Yes EIA, your analysis needed to include the ‘Fed Effect’ on oil prices and an annual average price of $93 a barrel went out the window as soon as the Fed started buying bonds. Message to the Fed -- get out of markets, and let price discovery begin all over again as you have destroyed financial markets like a creeping cancer by interfering with outright asset purchases.  And it will take at least a decade to fully recover and get back to their original purpose of setting a market price for assets based upon actual marketplace of non-government buyers and sellers!


Oil Forecast & Outlook


Now I don`t know how low oil prices are going in this recent weakness in the market, and the Federal Reserve will not be fully out of the Asset Purchase business until November starts. The economy is growing better than last year, and should get stronger in 2015. Furthermore, this is the weak part of the year for oil prices as the summer driving season winds down, and traders can push down markets pretty hard on forced liquidation moves. Is $85 a barrel in the cards? Sure it is! Last year they managed an $86 handle on a low for the year. However, an uptick in inflation countered by a stronger dollar and an uptick in Cap Ex spending will all play out in setting prices going forward. But the one I know for sure is that oil prices should and would not have performed at the elevated level they did last year without Fed intervention – the average price last year was out of whack with the fundamentals of the marketplace thanks to the Federal Reserve.


© EconMatters All Rights Reserved | Facebook | Twitter | Email Subscribe | Kindle

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
GooseShtepping Moron's picture

The high price is probably the result of all the gas fumes this guy's been huffing. Anyone who expects a retail recovery in Q3 is out of his mind.

himaroid's picture

Fed's got nothing to do with it. Lack of demand will cause a larger drop than author is thinking. Will be good for long tbond holders. 

Cost of production drops along with demand.

Bemused Observer's picture


How can oil prices come down in any meaningful way? The cost of extracting that oil is going up, fast. Does this writer think those drillers will just do all that fracking and deep-water drilling for 85 dollars a barrel?

Sure, demand will go down, but that doesn't make the extraction cheaper, it makes it more expensive.

And, unlike the gold and silver markets, oil is needed in its actual form to run your machinery. A manipulated 'paper market' in oil isn't going to keep industry humming. At some point, someone has to go and get it. And they are going to expect to be paid.

So, you'll pay the price, and it won't be 85 dollars a barrel. And if you refuse to pay, someone else certainly will, and you'll be without it.

disabledvet's picture

Does it include actual delivery of the physical? Oil isn't something you simply "hide in your swimming pool." You need literally tons just be in the sure, there is a ton of leverage in the oil market...but there is also a massive quantity too.

The differences between expectations and actual results reported by the EIA is really you don't want to trade on that information. You can however trade on actual price though since trying to move the needle ala 2005-2008 isn't so easy now that there USA massive production boom well underway in the USA.

So sure...speculate in refined product then...but take a look at corn prices then as well and ask "how cheap for fuel?" My view is ten cents a gallon.

The only reason oil prices are so high is because the Federal Government uses so much. Federal spending in the fuel space peaked many years ago. Prices will now correct. Downward in my view.

Bossman1967's picture

The pn
Y reason that oil os now 97 and going to 85 is that Putin needs 100 or more. Manipulation here gold silver as i watch its amazing

disabledvet's picture

Well...natural gas prices peaked "just in time for the Olympics." Once President Putin decided to invade Crimea natural gas prices got hammered...not the first time this has happened either (Russian invasion of Georgia)...yet no one talks about this obvious connection "going on all year now."

GFORCE's picture

Is it coincidence that oil is dropping as the U.S. is trying to squeeze Russia? Anyway, this post will mark a bottom.

Jack Sheet's picture

The chairman stood up, made a loud report, and let the econmatter drop.

IMO naive to believe that the Fed is the only player influencing the oil price. I have yet to see a convincing explanation for the precipitous price drop from 150 to 35$ within a few months back in 08/09. Then, there was talk of tankers filled up to the yingyang with crude oil parked all over the globe.

If there is a paper price divorced from the physical price of any substantial quantity in gold, why not in oil. Peter Warburton wrote back in 2000 in his paper on "inflation, but not as we know it" that an essential condition for the functioning of a commodity as a numeraire is the absence of a futures market.

GooseShtepping Moron's picture

Interesting. I believe I independently came to a similar conclusion as Peter Warburton. Here is the paper (I think) you are refering to, for those interested.

lasvegaspersona's picture

It will be interesting to see how oil prices are kept below the cost of production for any period of say...more than a month!

We now frack and drill in the middle of the ocean. I do not think that absence of QE will bring down the price. I'm not even sure that QE will stop, it will likely come in some other form. Support of the dollar and of the US government will not stop just because 'QE didn't work'. They will (in some way) print because they need to, not because it is helping the economy. Not to do so would mean the government has no influence on the dollar...that is just plain silly.

All purely fiat currencies break in the end in this way. The Fed is just playing the role Dr Gideon Gono played in Zimbabwe and Dr Rudy Havenstein did in the Weimar. Same play, different actors. Same human demands.

Jack Sheet's picture

true but IMO you also have to know how much oil is stored globally and kept off the market .

MalteseFalcon's picture

The Oil Market QE Premium = unnecessary mark up due to speculators.

Eat sh!t and die speculators.

Coast Watcher's picture

$85 a barrel WTI at Cushing would destroy the fracking industry. Way too low for new wells to attract investors, and the old wells deplete so fast that overall production would start dropping almost immediately. That also puts Canada tar sands oil in the red. So will the Saudis make up the difference? Gee, another oil war?

Gail Tverberg has an interesting take on the impact of lower oil prices at:

Bossman1967's picture

Ah a ha thats what they want isnt it that will hide the crash blame

delivered's picture

CW. Agreed as the fracking industry is heavily dependent on debt to finance new wells and development. I have yet to see a worthwhile report/article on the real economics of the fracking industry as it relates to required production levels needed to support future debt service requirements and at what price. When the price decreases, the average production level needed to support the debt service begins to increase and in some cases, significantly. So if new fracking wells aren't coming on line quick enough, production from the existing wells must be used to support the debt service and knowing that depletion rates are much higher for fracked wells than conventional wells (after year one), combined with lower prices, this paints a very dark picture for the weaker fracking companies. 

My guess is that the large fracking companies have been "massaging" their financial reports and masking real profitability by capitalizing well development costs and not depleting these costs in a timely manner. The two easiest places in financial statements to manage (or in this case, engineer) operating results are with other/long-term assets and other/long-term liabilities. Both areas are heavily dependent on the use of "estimates" to properly account for reductions in values of long-term assets (e.g., depletion for mineral operations, amortization for intangible assets, etc.) and potential outstanding liabilities for contingencies and committments. To make matters worse, if the fracking industry has to begin to properly account for potential long-term environmental damage (which is obviously being swept under the rug right now), it will be game over.

So the real question is what financing group is the most heavily invested/committed to the fracking industry and has excessive exposure on the debt side? If the price of oil does continue to fall, the real pain is going to be felt in the banks/finance groups that backed fracking as the debt will no longer be able to be serviced and a wave (and in some cases, a panic) of asset sales take place in order to cover the outstanding debt. 

Agreed with the assessment that the larger, very well capitalized oil companies will stand to benefit from picking up mineral properties at fair market prices when the price of oil is finally set by real supply and demand factors. Not sure if the Fed has really thought through all of the scenarios but in the end, they simply can't have their cake and eat it to. Either let market forces set the price of oil and watch it decrease (thus hammering the fracting industry and eventually leading to lower US production) benefiting the consumer or continue to manipulate the market, support domestic production, but at the expense of the consumer.

Time for the Fed to pick their poison. 

El Vaquero's picture

Shell had to take on more debt so that it could pay dividends to its shareholders.  The frackers are long term fracked at these prices.  Bring it down to $85, and shit'll get dicey if the trends in HY credit that the Tylers were harping on a week or so ago keep up.  

MalteseFalcon's picture

Ask Gail if there will be any oil after 2020.  TIA.

DOT's picture

There is a great difference between what the Fed should do and what they will do.

My take is that any QE Supporttm that has not been taken out will be replaced with a risk premium due to global conflicts around producing regions.

Retail investors are being pushed upstream and the un-"qualified" investors are buying into wells. Midstream is about to get pummeled for a while so a price drop makes it easier for the large caps to aquire more assets at a lower price during a consolidation phase.

Hey Honey! I was just on Yahoo and found this great stock in an energy company !   Pays a 6.5% dividend too. What are we getting from the bank?

disabledvet's picture

It is possible that the Fed was buying gasoline futures with the 85 billion )a month.). More likely diesel futures as those prices have always been higher than gasoline...going on like ten years now-which makes absolutely no sense btw...anywho, who knows?

Fact remains the economy is the denominator and gasoline demand has never recovered from the collapse of there is something to be said for the Fed buying gasoline futures.

Since we still don't have a recovery worthy of the name and now have a production explosion in oil and natural gas PLUS two all electric vehicles with double digit sales growth...hard to see how that price support gets maintained.

Gasoline is not expensive to make...there are "wildcat refineries"...not hard to see a price collapse coming especially when merged with the ethanol mandate and flex fuel vehicles.

Peak Finance's picture


PLUS two all electric vehicles with double digit sales growth.

Fuck electric cars:

KansasCrude's picture

DV what you may not understand about diesel is that it has quite a bit more energy per gallon than gasoline.  Thats why it costs more...yeah 10 years or so prices were lower due to technology not quite there for cleaner burning and not the cars and trucks out there burning diesel to overcome the market more.  Demand has grown and now diesel is priced pretty close to the extra energy per gallon versus gasoline.  We import alot more gasoline due to its availability as diesel demand is greater in the ROW versus gasoline.

disabledvet's picture

The Diesel engine works on compression not combustion. You can throw "bunker fuel" (unrefined oil coming out if the ground) and that will run a Diesel engine. True also of a turbine engine as well actually.

Not true of engines running on gasoline though.

Apply Force's picture

Forward Fed policies have nothing to do with geology, EROEI, and embedded inflation (embedded in costs to procure & then produce useable fuel).  This cake is baked.  Lower oil prices will mean less fuel available, and hence less "growth"

disabledvet's picture

Less SPECULATION. "The market is shrinking" (price and physical volume) so simply "going long" won't work.

If you have to sell product in the cash market in this economy the price will fall.

Tha used called a good thing "back in the day." (A lower energy bill.)