Oil Prices: Is the Fox Guarding the Hen House?

Prices are not determined by the fundamentals in a manipulated market they are determined by oil being an “Asset Class” which is code word or a euphemism for giant Casino in New York instead of Vegas.

...The price of oil, and as such gas is determined not by supply and demand factors, but by whether Goldman Sachs (NYSE: GS) or Morgan Stanley (NYSE: MS) or J.P. Morgan (NYSE: JPM) puts $400 million on Black or Red, the literal Oil Roulette game of the big banks... If Goldman Sachs puts $400 million on Black prices go up, if they put $400 million on Red prices go down, as simple as that, this is actually how the price of oil is determined, nothing more and nothing less. _Dian Chu

In a simpler world of fewer trades, where commodities futures can be monitored closely by a conscientious overseer, manipulating the market would be more difficult. But in the modern, ultra-high volume speed-of-light trading by the giant banks with minimal oversight, the smart money bets on the smart manipulators.

...lets just abolish the SEC and the CFTC, as they are completely useless. Furthermore, since all markets are ripe with manipulation, essentially the wild-west; why not reduce government costs by cutting funds to these two agencies entirely. They serve no real purpose when markets are corrupted everyday with Fake Orders, Dark Trading Pools, High Frequency Trading Algos, and the like except to further government costs & bureaucracy while strictly providing the illusion of fair markets. These organizations are a complete joke, and have been for decades!

... _Dian Chu

If you combine Dian Chu's reasoning above with Andrew McKillop's thinking featured in this Al Fin Energy article, you may begin to see a pattern developing.

Even in an era of relative oil oversupply, markets can be tweaked so as to bring oil prices further upward -- until it is time to let them drop again.

It is difficult to deny that global oil markets have become the equivalent of casinos, with all the big players standing around the wheel, placing bets and exerting small bits of control over the ball, here and there, now and again, over and over again.

As for US government oversight, fuggidduhbowdit! The Chicago outfit only wants to make sure that it gets its piece of the action.

Update: Dian Chu expands her argument on her own site

There are many indicators suggesting that big governments and large intergovernmental agencies are very content managing a world where data transparency is limited to those on the top, politically and economically.

This has generally been the case in Asia and Europe (and for the UN, World Bank, and IMF), but is becoming increasingly the case in the US under the Obama administration, also known as the Goldman Sachs administration.

Oil Price Volatility, the Oil Curse, and A More Abundant Energy Future

This article was first published on Al Fin Energy


In one sense, the price of oil has been very volatile -- boom & bust -- ever since the beginning of the oil age in the late 1800s. The price of oil in US dollars has been particularly volatile. But even when measured against the price of gold, the price of oil has seen some significant peaks and troughs over the years.

Severe oil price swings make it very difficult for countries that are overly dependent upon oil & gas revenues to balance their budgets. Countries such as the MENA oil states, Venezuela, Russia, etc. are finding themselves in a difficult pickle with regard to mounting obligations toward the future.

A new report suggests that Saudi Arabia will need an oil price of $320 a barrel by 2030 in order to balance its swelling government budget.

Russia's fiscal breakeven number varies between about $130 a barrel and $150 a barrel, depending upon who you are asking. Regardless of the exact figure, the number is likely to skyrocket in the future, and Russia is already having trouble making ends meet. What of the future?

Gustafson said that many in Russia's government realize that trouble lies ahead but that consensus is lacking on how to move forward. A reduction in oil revenues could devolve into a power struggle between interest groups over shrinking oil rents... A decline in oil revenues could usher in a major crisis, forcing cutbacks to major spending programs such as pensions and subsidies that underpin the stability of the Putin regime. In such a crisis the state would be forced to confront the difficult choice it has avoided for so long--whether or not to lessen the tax burden on the oil industry and enable it to invest in the next generation of fields and technology. _If Oil Declines, Russia Declines

Putin's agenda of bread and circuses will only suffice to cover up Russia's ruinous corruption and cronyocracy for so long, in the face of stable or falling oil prices.

The chart above reveals that the actual cost of production of oil for these countries is quite low -- in comparison with their fiscal breakeven oil price. The difficulty balancing their budgets in the light of their already huge production profits, points out the depth of oil dependency and corruption so prevalent in these countries.

In the meantime, US oil production continues to grow -- despite the Obama / Salazar / Jackson agenda of energy over-regulation. The vast deposits of Canadian oil sands are also waiting to be developed, and shipped to market. A rapidly accelerating oil production from the huge Iraqi deposits of oil await a suitable environment of stability. And large oil & gas deposits in Iran, Africa, Central Asia, the Arctic, and offshore deposits around the world, await the proper geopolitical and global economic milieu for development.

Vast amounts of global energy await the proper conditions for development and distribution. Advanced nuclear energy from unranium and thorium, clean coal technologies of IGCC and liquefaction, efficient and scalable GTL technologies, development of vast deposits of bitumens in Canada, Venezuela, and elsewhere, huge deposits of kerogens, and huge quantities of gas hydrates.

Advanced nuclear energy could supply abundant energy for tens of thousands of years. But until such technologies are developed, fossil fuels can bridge the gap in time.

As for carbon hysteria and climate change? Only a clear and dispassionate knowledge of the global carbon cycle of the land and sea can eradicate those phantom fears. For humans to acquire clear knowledge and wisdom on that and many other crucial issues -- a better leadership and a more honest information media will be needed.

Can Oil Prices Rise Indefinitely Without Strong Economic Recovery in Europe and the US?

Clouds of recession hover over Europe and are threatening the US, unless significant policy changes are enacted from those existing now. Most advanced nations also suffer from both exploding debt and a demographic decline of their core populations.

Unless the world's wealthy nations resume the buying spree of the "economic bubble period" of the 1990s and early 2000s, rapid economic growth in exporting nations of the emerging world and third world nations remains in doubt.

What would be the effect of such a "top-down economic stagnation" on global oil and commodities prices?

The article below, which considers that question in an oblique fashion, is adapted from an article previously published on Al Fin Energy blog

Why are oil prices so much higher now than they were prior to the 2000s? Much of the difference has to do with the steady stealth devaluation of the US dollar, reflecting the US government's massive debt and deficit spending practises.

Compared to the price of oil in 2010 dollars -- or to the price of oil in gold -- prices prior to the year 2000 were not so much lower as we might think. Two price spikes prior to the year 2000 were comparable to -- or higher than -- our current inflated oil prices.

But there is more to the story than the pitiful performance over time of the US dollar. An explosion of demand for oil from emerging nations -- from the late 1990s to the present -- explain a great deal of the ongoing oil price bubble. Particularly when one takes into account government subsidies for oil which hold the cost of oil use artificially low from Mexico to Venezuela to many MENA countries, China, India, and beyond.

This explosion in demand was the natural result of exploding populations in those countries combined with an emerging consumption sense within those populations fed by global media and a subsequent growing sense of entitlement.

Oil in Nominal vs 2010 Dollars

Comparing oil prices in "dollars of the day" vs. oil priced in either standardised 2010 dollar or gold, brings out more aspects of the dynamic than are generally discussed.

Oil in Dollars vs Gold

In addition to the ongoing stealth dollar devaluation and the demand explosion from the emerging world, oil has become a deeply emotional repository of value for many investors -- reflecting a widespread belief in oil scarcity -- or "peak oil". Savvy traders have exploited this superstition by helping to bring about multiple whiplash spikes and troughs of oil price -- which in the aftermath often leave the smart traders richer, and the superstitious true believers that much poorer.

Of the three drivers of higher oil prices mentioned above, the most likely candidate for the "largest" contributor, is demographic change. Let's look at why this "largest contributor" may not end up being the most important long term contributor to changes in oil prices.

We all know that commodity prices depend upon both supply and demand, as well as a number of somewhat arbitrary and changeable government policies, mandates, regulations, taxes, prohibitions, and other caprices of the generally clueless political class.

Demographic change affects both supply and demand, but demand is the more immediate factor affected by the type of population growth we have seen recently. The explosion of both populations and demand in emerging nations shook the ability of national oil companies to respond -- in large part due to a corrupt failure to pay for necessary maintenance and technological upgrades in oil production. And since most conventional oil reserves fall under the control of corrupt national oil companies, the demand explosion was not immediately accompanied by an equivalent explosion in supply. This mismatch pushed oil prices upward.

But population growth without the ability to pay for more commodities, will not necessarily convert to higher demand, and higher prices. If the regions of population growth cannot pay for more commodities, they will either go without or will be the recipient of unearned aid from wealthier countries.

This is what we are beginning to see across Africa, much of Asia, and other parts of the third world and emerging world. As advanced world demand for the products of emerging and third world nations drops, the ability of third world nations to pay for imported commodities likewise drops.

It so happens that the prospects for advanced world economies is looking more and more dim, while the other bubble -- the demographic bubble -- deflates.
More:

Between the Baby Boom of 1945-1964 and the “baby bust” that followed it, the result is a projected ballooning in the relative numbers of the elderly. From 12% of the population today, the proportion of those over the age of 65 is forecast to rise to 25% by 2030 — and stay there for decades afterward.

We are about to be hit by a double whammy, in other words. On the one hand, a rapid escalation in public spending — not so much for pensions, though that is part of it, but for health care. Not only will more of the population be over 65, but a greater proportion of them will be living past 80, 90 and beyond. And the longer they live, the more they tend to cost. _NP

Old people do not typically use as much oil and other commodities, they do not build as many houses, or buy as many cars -- as a rule.

Demographics are economics. The advanced countries with the worst demographics problem and the advanced countries with the most uncertain economic futures are often the same. High social spending promised to aging generations that aren't supported by enough young workers leads to the kind of debt crises, economic stagnation, and political upheaval that we can see sweeping Europe -- and might yet lie ahead for a country like Japan. This is ironic, in a way. Two centuries ago, Malthus said that growing populations would tax growing economies. In fact, it's stagnating populations that constrain economic growth in rich countries. _Atlantic

With the contraction of demand from economies in the advanced world, comes a reduction in ability to pay for both luxuries and necessities -- including commodities -- in the emerging and third worlds.

That is not the worst of it. Piling on top of the debt and demographic problems of the sinking nations of the advanced world, is an amazingly destructive dysfunctional energy ideology which threatens to sink many of these nations -- both individually and in groups -- beneath the waves.

Intelligent people understand that the intermittent unreliable energy sources such as big wind and big solar, cannot supply more than a small portion of grid power, without destabilising the grid itself.

Nations of the advanced world -- the ones that thrive -- will discover and develop more sources of energy, and will learn to do more with less at the same time. Improved efficiencies and productivity will contribute to the declining demand for imported commodities which will also be driven by the declining demographic.

Increasing use of robotics and other automation will help to raise productivity, even as core populations decline. But energy will always be key. Newer, cleaner, cheaper, safer generations of nuclear energy will be a long term solution, but we will need to utilise our large supplies of conventional and unconventional hydrocarbons to get us there.

Which is why the energy starvationists -- from Merkel to Obama to Gillard and beyond -- will have to be moved out to make way for a better future.

Oil Prices Fall Below Break-Even for Several Nations

This article was previously published on Al Fin Energy blog

Despite a fall of oil prices below break-even levels for several nations, Saudi Arabia shows no inclination of reducing its high rate of oil production.

 Following is a table of some OPEC producers' fiscal breakeven oil prices:

 
                $/bbl
 Algeria        105
 Iran           117
 Iraq           112
 Kuwait         44
 Libya          117
 Qatar          42
 Saudi Arabia   71
 UAE            84
 Sources: National authorities and International Monetary Fund

_Reuters

The above table is from an article dated 1 June 2012. Scan the graphs below for images of break-even levels from May 2012 and December 2011. Notice that the estimated break-even levels tend to fluctuate. It is likely that most of those published levels are underestimates.

In Russia, for example, the most recent estimate for break-even price level is $117 per barrel. But Russian insiders estimate the true break-even level is closer to $150 a barrel -- particularly with Putin's ambitious new re-building schemes. May 21st 2012
1 December 2011

Citibank expects that Russia will have a very turbulent next five years, given their estimate that Brent crude prices will likely settle close to $85 over that time period.

Oil producers are beginning to feel the future threat of peak demand for oil caused by multiple factors -- including unconventional liquid fuels -- breathing down their necks. For oil to sell in the coming markets, producers will have to price their product to be competitive.

For some quasi oil dictatorships such as Iran, Venezuela, and Russia, reduced revenues to support ambitious government spending could lead to intemperate, perhaps violent, actions, geared to force oil prices much higher. They will require a close watching.

Saudi Arabia Complacent in Age of Inflated Oil Prices

Saudi Arabia does not allow its oil to be traded, nor does it offer its oil without restrictions for resale. The kingdom only sells to final users -- that is, to refiners, who process the crude oil themselves. That means oil may be available, but will remain unsold if refiners do not have a demand for it. _ForeignPolicy

Saudi Arabia could do something about inflated oil prices, and the consequent demand destruction and economic suppression being seen in consumer nations. But there are potential hazards to the oil kingdom, in moving too aggressively to control world markets -- particularly at a time when OPEC is not the all-controlling force that it may once have been.

If Saudi Arabia allowed its crude to be traded -- that is, sold by the original buyer to some other final or intermediate client -- the abundant availability of Saudi oil would drive prices down. But the Saudis are afraid of playing an active role in the market... _FP

Too many bad things could happen to KSA due to the law of unintended consequences, should the kingdom move too aggressively to control prices.

Saudi Arabia's market share and revenues suffered as a result of OPEC's aggressive price setting policy that existed before 1985. In the years prior to that date, Saudi oil production collapsed from an all-time high of 10.3 million barrels per day to a minimum of 3.6 million, in the futile attempt to defend OPEC imposed prices. Ever since that experience, Saudi Arabia has refused to be tied to a rigid price target. _FP

Another unintended consequence of aggressive intervention by KSA could be an oil price crash. The history of global oil markets is cluttered by multiple boom-bust cycles, which proved ruinous to many oil producers over the years. OPEC has inserted some price stability into the picture but markets can be very spooky at times. Trying to control them too tightly can lead to unexpected repercussions.

As the revival of oil and gas production in North America and in other parts of the world gains strength, it will be in the interest of all to maintain prices at a level that is neither too low nor too high. A much lower price would nip the expansion of new sources in the bud, while higher prices could abort the fragile economic recovery. Saudi price targets, which lie in a band that hovers around $100 per barrel, are not out of line with the interests of the industrial countries. _FP

To be honest, no one truly wants to lower the price of oil. Instead, most people would like to profit from high oil prices. This is true for KSA, for Russia, for Canada, and for several US states and corporations.

High oil prices spur investment in new technologies of exploration, production, and substitution. A stable regime of high oil prices -- even at today's inflated levels -- may be the best thing to help bring about a more abundant, safer, and cleaner phase of global energy.

But stable energy prices are unlikely in the long run, since greedy, corrupt, and incompetent politicians can never keep their fingers off the golden eggs. As long as weasels such as Putin, Obama, Chavez, and the rest of the usual suspects rule the roost, we are more likely to see a fearful instability.

Oil Price Bubble vs. Demand Destruction and Decline

The following article was first published at Al Fin Energy

The ongoing bubble in global oil prices is fighting for its life against declining demand across the developed world -- and the threat of a near to intermediate-term collapse in demand from emerging nations such as India and China.

Fundweb: Decline in Demand Occurring First in Developed World

...a volatile mix of factors is in play. There is an appetite for risk, he says, but based around demand for a futures position, the buying of paper contracts, not the physical demand for petroleum. Real economic demand for oil, by contrast, is in retreat, and a thin support for current prices.

...More generally, the International Energy Agency (IEA) has forecast shrinking demand for oil from developed nations for 2012, and modest growth in the developing world of 2.8%.

“We are seeing a bit of a bubble, understandably connected to the take on Iran and the embargo,” says Evans.

...The popularity of the Peak Oil theory...has helped to bake-in continually bullish expectations about higher prices. In other words, it has helped create an ongoing foundation for speculation.

Government intervention in the form of monetary policy also seems to have played its role in higher prices. As part of a strategy of “reflation” of asset prices after the 1990s equity collapse and economic downturn, Alan Greenspan, the then Federal Reserve chairman, lowered interest rates to record lows, leading in turn to a new phase of dollar value depreciation from 2002 to the present.

As new capital sought to hedge against a depreciating dollar and inflation, a paradox was created, some argue. As commodity prices rose, capital inflows created the inflation it sought to avoid as a certain amount of passive “buy and hold” money entered the market and rolled over contracts on a regular basis.

...Greater credit there has driven growth, in turn driving up demand for raw materials and commodity prices.

“However, there is a fairly convincing argument that the aggressive loosening of monetary policy everywhere has seen authorities shooting themselves in the foot,” says Neumann.

Consumers in the countries where quantitative easing (QE) has been introduced face higher petrol prices and inflation, for example. More generally, it is not difficult to see why rising oil and therefore petrol, fuel and heating costs, and inflation in general, are causing concern.

With stagnant or declining real wages, and high unemployment in many parts of the developed world, living standards are already coming under pressure. Inflation adds to the cost of living and, of course, has a more serious impact on the poorest of the world in the developing nations.

At the same time, higher oil prices mean higher production costs for a whole range of industries – agriculture, transport, manufacturing, and so on – which, to one debatable degree or another, may be passed on to consumers via higher prices.

Not surprisingly in this context, analysts and economists are trying to quantify the impact of certain oil price levels on economic growth more generally.

...Each type of crude oil – ranging from the heavy varieties in the Middle East, which can be easily extracted, to the lighter North American types – needs to sell for a certain price for profits to be made. The costs of producing a barrel of Canadian Tar Sands oil before profit are thought to be about $40-50.

In this context a higher sale price for oil is likely to have encouraged rising production in America, where production costs are high.

If bullish forecasts are to be believed, America is on the verge of energy self-sufficiency within a decade, given the huge shale oil deposits it has, and the possibility of using the same technology developed for shale gas – hydraulic fracturing, or fracking.

An estimate is that such oil deposits contain two trillion barrels of oil. For comparison, America consumes roughly 19m barrels of oil a day.

...One of the paradoxes about the oil and broader energy market is that, in economic, operational and technological terms, the market has been relatively successful at the basic in supplying half of the world with the energy it has been demanding to raise living standards. The future does not seem too terrible, either, for technological breakthroughs and further development.

According to the US Energy Information Administration, there is enough oil worldwide to meet demand for the next 25 years.

... instability in the [oil] market is...being introduced from the financial and geopolitical sides.

Discussions about reform in the financial area are underway. The US Commodity Futures Trading Commission is considering ways to stop excess liquidity and speculation in futures markets from distorting price discovery and affecting the physical market and real economy.

It plans to implement “position limits” in the futures markets, for example. Ex-futures traders are some of the most strident critics of the system. In his book, Oil’s Endless Bid: Taming the Unreliable Price of Oil to Secure Our Economy, Dan Dicker, an energy analyst and ex-oil trader, explores how financial markets have become more divorced from the practical and productive activities in the physical oil industry.

The problem might be broader still. A further analysis might look at what is happening with broader money creation, the excess liquidity and price instability problems stemming from the central bank objectives of “reflation”, and their impact on the oil market. _Fundweb

Read the entire article linked above for much more detail, provided in a relatively even-handed and broad overview.

The article fails to consider what will happen if propped-up and subsidised demand from emerging nations such as China and India should decline -- either gradually as in the developed world, or abruptly in the form of demand collapse.

Global demand for energy is increasing at the same time that demand for crude oil -- at its currently inflated prices -- seems to be declining. Europe, Russia, and parts of East Asia are experiencing demographic implosion, which can only lead to a future drop in demand for oil. The only parts of the world still exploding in population are the parts of the world that can least afford to buy expensive commodities -- but are instead more likely to sell their birthright commodities in order to supply corrupt leaders and their families with European townhouses and extended vacations.

Global energy markets involve far more than crude oil. Rapidly improving technologies of fuel and energy substitution are likely to further diminish the importance of crude oil as a controlling influence of national and international economies by the 2020s.

If you don't mind losing your shirt again and again, the peak oil religion may be appropriate for you. Otherwise, a bit of nuance may be called for.

Another Brief Look at Oil Prices

Saudi Arabia is ramping up oil production in response to appeals from European governments to moderate oil prices. But it may be that no matter what Saudi Arabia does, oil prices will remain well above the level that ordinary market mechanisms of supply and demand would place them. Here is more on the Saudi move, followed by further excerpts from the FT article which reveal a deeper dimension to how oil prices are set.

Speaking to reporters in the Qatari capital Doha, Mr Naimi [the Saudi oil minister] said he wanted to “dispel this pessimism in the market” and the widespread fear that the world could see a repeat of 2008’s oil price increase which was a harbinger of the global recession.

“I think high prices are unjustified today [on] a supply-demand basis,” he said. “We really don’t understand why the prices are behaving the way they are.”

Supply was “much more firm today than in 2008” when crude rose to $147 a barrel, he said, with global supply now exceeding demand by 1m-2m barrels a day.

Saudi Arabia had 2.5m b/d of additional production capacity, which it could bring online if necessary, he said. The kingdom is likely to be producing about 9.9m b/d of oil in April and exporting roughly 7.5m-8m b/d of that, he said.

Asked if it could ease prices by exporting more oil, he said customers were not asking for additional crude. “We are ready and willing to put more oil on the market, but you need a buyer,” he said.
_FT

The statements of the Saudi oil minister are interesting enough, suggesting that the Saudis are still capable of achieving a 25% increase in oil production. Continue reading, to understand why even a 25% boost in Saudi oil production might not knock oil prices off their pedestal:

...the relatively modest move in the oil prices was a sign of some scepticism in the market.

“I don’t think it’s much of change for the market,” said Mike Wittner, head of oil research at Société Générale [investment bank] in New York. “The problem is the more they produce the less spare capacity they have. If they want to try to bring down prices not only do they have to keep on producing at very high levels they need to show the world that they are bringing on extra spare capacity.”
_FT

Can you see the hidden assumptions in Mr. Wittner's comment above? Mr. Wittner thinks that he knows the "true" spare capacity of the Saudi's oil production sector. Speaking as an investment banker and oil speculator, Mr. Wittner is as much as saying that the uber-investors will not allow oil prices to come down until insider (and public) assumptions about spare capacity can be beaten down with a big stick of reality.

This is the self-fulfilling peak oil mentality writ large, currently installed at the highest levels of New York investment banking. No matter how much oil OPEC decides to pump, Mr. Wittner and his cohorts think that they can set the global prices of oil based upon their beliefs in OPEC "spare capacity."

A very interesting prelude to financial disaster, once again, for pension funds, university endowments, and the life savings of countless numbers of retirees and near retirees. But a huge windfall for the top investment bankers and uber-investors.

Up until now, Saudi Arabia has kept silent on the price rally, although it is pumping oil at 30-year highs. But a statement issued by the Saudi cabinet on Monday could signal a more active policy. The cabinet said that it had noted the risk high oil prices posed to economic growth and the kingdom would work individually and with others if necessary to “return oil prices [to] fair levels”.

When asked, however, Mr Naimi declined to specify what specific measures Saudi Arabia could take to moderate prices.

The minister, who was in Doha for a meeting of the Gulf Co-operation Council, acknowledged that he had been approached by a number of ministers from European and developing countries complaining about the effect of high oil prices on their economies.

The weak global economy was tempering demand for oil, he said. Europe’s economy was “iffy” and growth was moderating in Asia. “I don’t think an economy that’s sick today is all of a sudden in the third and fourth quarter going to turn around,” he said.
_FT

Under an oil-pricing regime where top investors can manipulate spot prices via the futures market -- using leased storage facilities as well as a backward-propagating manipulated shortage of market supplies when futures prices are bid up -- it takes far more oil production to overcome artificially inflated prices caused by the intercession of big money investors.

It is rare for investment banks to admit as much, but if you listen closely you can hear their confessions. But the investment banks, in their quasi-Peak Oil fervour, are deluding themselves about "spare capacity." Spare capacity is not worth anything to oil producers until it is needed. In fact, spare capacity can be a huge economic drain, if it is maintained when not needed, particularly in an oil kingdom with a massively corrupt extended royalty, and a need to placate the unruly masses.

Are high oil prices "bad?" No, if high oil prices would only stay high, the proper investment in substitutes and unconventional fuels would be made, and we would enter a new era of liquid fuels supplies (and a higher use of nuclear power) -- at a stable but higher level of fuel prices than we have been used to. But such a transition requires a huge investment, which will not be made until it is clear that it is necessary. Capital intensive industries such as CTL, GTL, KTL, BitTL, BTL, etc. can be easily wiped out by the type of oil price drop that occurred in 2008 / 2009.

That huge price drop of oil in late 2008 and early 2009 was no accident. It was the natural aftermath of the same investment bank policies which are being used currently to artificially boost prices, but which are unsustainable due to significant changes which are beginning to occur on both the supply and demand sides.

Smart investors and investment bankers can ride these artificially generated waves to high profits. But the majority of investors and investment brokers are not that smart, and will lose huge amounts of money once again.

Previously published at Al Fin Energy

Supply and demand are enormously important in setting the price of oil on global markets. But we need to remember that public impressions of supply and demand can be manipulated by powerful players -- both in governments and in finance.

A Word About Oil Prices

There is a great deal of discussion about why global oil markets are engaged in yet another price feeding frenzy. Some claim it is simply supply and demand. Others point out that both "supply" and "demand" can be manipulated in many ways. Others point to international tensions in the middle east, particularly Iran. Yet others point to Wall Street and blame the bankers. And not just a few in the US are pointing fingers at Barack Obama's broad agenda of energy starvation as being a significant factor in price increases. But where does the truth "lie?"

A speculator purchasing vast futures at higher than the current market price can cause oil producers to horde their commodity in the hopes they'll be able to sell it later on at the future price. This drives prices up in reality -- both future and present prices -- due to the decreased amount of oil currently available on the market.

Investment firms that can influence the oil futures market stand to make a lot; oil companies that both produce the commodity and drive prices up of their product up through oil futures derivatives stand to make even more. Investigations into the unregulated oil futures exchanges turned up major financial institutions like Goldman Sachs and Citigroup. But it also revealed energy producers like Vitol, a Swiss company that owned 11 percent of the oil futures contracts on the New York Mercantile Exchange alone [source: Washington Post].

As a result of speculation among these and other major players, an estimated 60 percent of the price of oil per barrel was added; a $100 barrel of oil, in reality, should cost $40 [source: Engdahl]. And despite having an agency created to prevent just such speculative price inflation, by the time oil prices skyrocketed, the government had made a paper tiger out of it. _HSW: Oil Speculation and Oil Prices

Inflation Adjusted Crude Oil Prices
As you can see from recent history, oil price shocks are nothing new to global markets. In fact, as you can see from the chart above, oil prices are not yet back to last April's (2011) highs -- the most recent price scare.

What about oil futures and oil prices? Many people suggest that if oil futures speculators do not take delivery of oil contracts, that they cannot influence the real price of oil. But that is not necessarily the case:

A speculator betting on a single futures contract will have no effect on the market. A speculator with a sizable amount of capital to put to work however, can purchase a stake that is sizable enough to sway the market, and is considered the major factor in how oil futures raise prices.

As speculators purchase on rumor rather than fact, a speculator purchasing a large amount of futures at a price that is higher than the market value of oil currently can lead to the hoarding of the commodity by producers in the hopes that the commodity can be sold for a higher price in the future.

As the supply of oil is reduced by these actions on the part of the producer, this leads to a realized increase in the price of the commodity both in the present as well as the future. An investment firm as well as oil producers stand to make a huge profit, as an estimated 60% of oil’s per barrel price is the result of speculation on the part of investment firms and other major players. _HowtoTradeStocks

Large scale, coordinated oil speculation would appear to be one way in which "oil demand" can be manipulated so as to drive up prices. There are several other ways in which this can be done, and we will look at some of those in later postings.

Those who think that oil speculators do not actually take delivery of oil may be in for a bit of a shock to discover that speculators have periodically stockpiled oil -- then strategically released stockpiles -- for some time.

The oil-storage trade is a trading strategy where oil tank owners and companies that lease storage buy oil for immediate delivery and hold it in their storage tanks, then sell contracts for future delivery at a higher price. When delivery dates approach, they close out existing contracts and sell new ones for future delivery of the same oil. The oil never moves out of storage. Trading in this fashion is only successful if the forward market is in "contango", that is if the price of oil in the future also known as forward prices are higher than current prices or spot prices. Storing oil became big business in 2008 and 2009,[1] with many participants—including Wall Street giants, such as Morgan Stanley, Goldman Sachs, or Citicorp—turning sizeable profits simply by sitting on tanks of oil.[2]

It has been estimated that one in twelve of the largest oil tankers are being used for the storage, rather than transportation of oil,[3] and that if lined up end to end, the tankers would stretch out for 26 miles. _Wikipedia

The actual proportion of tankers and oil depots used for speculative purposes is likely to fluctuate over time, according to prices and price-manipulating opportunities.

There is a great deal riding on oil prices. Hedge funds, pension funds, university endowments, foundations, big money NGOs, and more, are betting on oil prices going higher. The risk involved is significant, but with the deteriorating value of the dollar and the general stagnation in global economies, opportunities for significant returns on investment seem to be few and far between, the past few years.

While many analysts are scratching their heads as to how oil prices could increase in the absence of any clear increase in natural (as opposed to artificial) demand, Al Fin energy analysts believe that several concurrent factors are in play:

1. Russia is far more than a bystander in the current price runup More here
   
   International tensions tend to create a "defensive demand," a type of artificial demand which involves stockpiling oil in anticipation of future reductions in supply. Russia is best situated of all nations to both ramp up international tensions -- either directly or via proxies -- then to profit in several ways from a runup in energy prices.
2. OPEC has an interest in driving up the global price of oil as high as can be sustained by the markets.
3. National oil companies in many oil-producing countries neglect their oil production equipment and their oil fields, leading to artificial reduction in production and supply due to Oblomovism.
4. Official policies of "energy starvation" on the part of the US Obama administration and other western nations, leads to artificial reduction of supplies.
5. The rapid buildup of the "infrastructure to nowhere" better known as the "Great China Bubble" has led to an artificial demand surge. The Chinese government appears to be engaged in "doubling down" on this policy, despite early warning signs of impending turbulence.
6. The progressive decline in the value of the dollar creates an inexorably upward trend in oil pricing.

There are many more factors involved, of course. But it is enough to understand that the causes of the current oil price runup are many and varied.

What are the counter-vailing forces, seeking to drive oil prices downward again? The most significant force in the short-term is the desire of speculators to take profits. Once investors decide the house of cards is due for yet another inevitable collapse, the rats will get out while the getting is good.

In the intermediate term, demand destruction eventually sets in -- even in emerging nations, BRICs, and third world nations. But demand destruction in the advanced worlds of the North America and Europe never truly went away after the price runup of 2007-2008. And such demand destruction in North America and Europe is likely to add to the general economic doldrums both there and in exporting nations such as China.

In the longer term, high oil prices stimulate increased production of oil, increased exploration for new oil, better technologies for recovering more oil from existing fields, and better technologies for producing economical substitutes for crude oil. All of these price-stimulated supply increases put downward pressure on oil prices.

The entire dynamic is complex, with several opposing and reinforcing factors in play. It is best to expect to be surprised, and to be prepared, in case you are.

Cross-posted to Al Fin Energy

More: Gas Prices - Much Ado About Nothing?

Price of Oil: Economic Breakeven vs. Political Breakeven Prices

The following table provided by the Bank of Kuwait gathers current reported break-even prices of major oil producing nations:

Oil Break-Even Prices
Nation	US$/Barrel
Bahrain	40
Kuwait	17
Saudi Arabia	30
U.A.E.	25
Oman	40
Qatar	30
Canada's oil sands	33

Based on the formula, profitability of these countries' oil operations are in order:

Profitability at $100/barrel oil
Nation	Break-Even Price	Profitability
Kuwait	17	488%
U.A.E.	25	300%
Saudi Arabia	30	233%
Qatar	30	233%
Canada's oil sands	33	203%
Bahrain	40	150%
Oman	40	150%

__Source

The tables above present rough estimates for economic profitability for oil production in various nations. Such numbers create a "price floor" of sorts for oil markets. But a lot more is involved than mere economic profitability. When entire nations base their budgets upon oil & gas income, another type of "breakeven" enters the4 picture: political breakeven.

Here you can see the political breakeven prices, which countries must receive for their oil in order to meet their fiscal budgetary demands. The political breakeven prices are rising almost every year now. Several oil producing nations are now dependent upon $100 per barrel oil prices now, and others are pushing to keep prices at that level just to maintain a safety margin for their governments.

Fareed Zakaria used the above logic in his predictions that oil prices must stay high -- that they cannot possibly fall much below current market prices.

But he and many others of like mind are ignoring the shadow side of global energy markets: shaky demand caused by the threatened stumbling of economies in Europe, the US, and increasingly, China. If global demand crashes, political breakeven becomes essentially irrelevant.

Peak oil theorists have generally neglected the demand side of the equation, always insisting that demand will grow exponentially, no matter what. We may soon discover whether they were right, as political peak oil threatens to show its ugly nethers yet again.

The whole house of cards is currently built upon a trumped-up demand, which originates largely in one specific country:

If something happens to collapse the bubble of demand in that country, a cascading collapse of commodities demand could very well set in around the globe. Interesting times, as they say.

More: Marginal oil, with its greater risks and higher cost of production, will exert more influence on oil prices as it moves to becoming 10% of global supply by 2035.

Of course, improved technologies will make marginal oil more affordable over time -- to the point that "marginal oil" will probably become more profitable than conventional oil in many of the oil states that have allowed their oil field infrastructure to decay, without investment or upkeep.

Week ending close of oil price at NYMX from 2006 to present

Making sense of such a fluctuating trend requires a lot of background information, along with a finely tuned intuitive sense. Several forces are at work: political, speculative, technological, supply :: demand economics, demographic trends, human nature, and even criminal interests. The balance is subject to rapid and catastrophic shifts.

Anyone who makes confident predictions in such an environment has either vested interests, solid gold insider information, or a declining mentation.

Seeking the True Shape of Peak Oil

The most simplistic graphic description of peak oil is shown above. The curve moves smoothly upward to the peak, then drops quickly to negligible levels. This is how unsophisticated peak oil doomers typically see the "peak oil" phenomenon.

A more sophisticated observor of oil and liquid fuels production is likely to be aware of the economic "recruitment" of new oil supplies and substitute fuels, as the cheaper, low-hanging fruit is plucked and prices trend upward. Notice the unsophisticated peak oil curve in dotted orange, labeled "Peak oil--Campbell."

Sine / Cosine Graph Simulating Out of Phase Oil Price and GDP Curves
But that is not to say that all peak oilers and peak oil consultants are as unsophisticated as Hubbert, Campbell, or Simmons. A new breed of more economically informed peak oil consultant is beginning to describe "peak oil" as more of a cyclical phenomenon, driven by the interaction between oil prices and economic growth.

Peak Oil is, in fact, a complex but largely an economically driven phenomenon that is caused because the point is reached when: The cost of incremental supply exceeds the price economies can pay without destroying growth at a given point in time. While hard to definitively prove, there is considerable circumstantial evidence that there is an oil price economies cannot afford without severe negative impacts.

The corollary is that if oil prices fall back to and sustain levels that do not inhibit growth, then economic growth will resume, with both recoveries and downturns lagging oil price changes by 1-6 months. _ChrisSkrebowski

You can easily see in the above definition of "peak oil," the driving forces of a co-cyclical pattern involving oil prices and economic growth, simulated by the out of phase sine and cosine curves.

But for peak oil to mean anything at all, it must incorporate an element of doom, catastrophe, and collapse. The above graphic simulates a cyclic economic pattern with attenuation, damping to very low levels of economic activity. This graphic might best depict the new, more sophisticated economic / geologic synthesis of peak oil doom consultants, as described by Skrebowski, when economies do not have enough time enough to fully recover from the previous crash before the next oil price hike hits the system. Each successive cycle leads to a worsening economic picture, in this scenario -- since the economy is thrown too far off balance to develop substitute fuels or power sources in time to prevent collapse.

Now, contrast the "peak oil plateau" graphic that is the second image from the top, with the damped sine wave depiction of peak oil collapse in the lowest graphic. In the case of the "complex plateau," there would seem to be time for advanced societies to move to safe, clean, advanced nuclear sources for power and industrial heat. But in the case of the damped sine pattern, it is not clear that societies could recover from the downward spiral.

A thinking person might perceive that different nations possess different resources -- both natural resources and human resources. Logically, the response curves to "peak oil" for different nations and societies would not be identical to each other. Rather, the response to "peak oil" -- no matter how it is defined -- is likely to vary widely between different economies, depending upon the available resources and the competence of national leadership. In other words, collapse is more likely to be regional in all but the worst price-shock cycle scenarios.

A careful reading of the Skrebowski piece linked above, will reveal that government policies will have a great deal to do with how a society weathers high energy costs. If governments pursue policies of energy starvation -- such as the Obama government and certain European governments are doing -- economic hardship within the society will multiply.

More:

Two sides to peak oil
An interesting historical look at the evolution of viewpoints toward oil resources and peak oil.

How an excessively gloomy view of peak oil might distort markets and cause unnecessary disruption and hardship

Cross published at Al Fin Energy