CNNMoney had a couple of articles yesterday about oil prices finally hitting $100/bbl:
Friend of R-Squared, Doug MacIntyre, was quoted at length:
The Energy Information Administration, the Energy Department’s independent statistical and analysis arm, thinks strong demand and limited supply – otherwise knows as “the fundamentals” – is why oil is so pricey.
“Our view is that the market is tighter [than last year],” said Doug MacIntyre, senior oil market analyst at EIA. “We don’t have the inventories now.”
MacIntyre said inventories in developed countries – crude oil stored at refineries, or in tanks at ports, pipeline terminals and other locations – went from 150 million barrels above their five-year average at the start of the year to 10 million barrels below the five-year average now.
“That’s a big difference,” he said. “There’s less slack in the system than there was a year ago.”
Fadel Gheit disagrees, but I think Doug’s explanation is about 80% correct (but with some speculation involved):
Gheit said inventories are declining because high oil prices give people an incentive to sell crude now and wait until later to restock supplies, when hopefully oil is cheaper.
Other than the decline in supplies, Gheit says all the other factors EIA lists have been with us since last year, when oil traded at under $50 a barrel.
“It’s pure speculation,” he said. “What’s changed that we didn’t know in January? Not a single thing.”
Pure speculation? No. Some speculation, but mostly little swing capacity.
The second article talked about the potential impact of $100 oil:
NEW YORK (CNNMoney.com) — The rising price of oil is starting to bite – at the pump, the airline ticket counter and possibly in your home.
Oil hit $100 a barrel Wednesday and gasoline prices could soon top their all-time record from last May of $3.22 a gallon. Gas prices now average $3.05 a gallon nationwide, according to AAA. Many states have had gas over $3 for some time.
In the past few months, drivers have gotten off easy – gas prices hadn’t kept up with the increase in oil prices. The main reason: Demand has been fairly tame. But demand picked up during the holiday season.
At the same time, supplies of gas could get tight as many U.S. refiners are undergoing maintenance, according to Schork. And they stand ready to decrease production if gas prices don’t move higher, according to Kevin Norrish, a commodities analyst at Barclays in London. “The relative price of gasoline is low, and that’s unsustainable,” said Norrish.
As for next spring, when gas prices usually spike on anticipation of increased demand over the summer, Schork noted that in all likelihood we’ll be going into the season with much less in gasoline inventories than last year. “You’re that much closer to $4” a gallon gasoline, he said.
Personally, $4 a gallon gasoline looks very likely to me at these oil prices. It will be interesting to see if that price level finally moderates demand.
What’s changed that we didn’t know in January? Psychology, that’s what. A lot of people must have lost big on short positions in the last year. A lot of people figured that $60 was a temporary aberration, and believed the Yergins of the world that it would soon fall back under $40. Once bitten, twice shy…
I’ve been reading a bunch of econ blogs lately. I think oil and gasoline might go higher in 2008, but not beyond what average folks expect. I don’t think average folks would be too surprised by $4 gasoline. Dismayed perhaps, but not surprised.
On the other hand, I think the credit crunch will be bigger and surprising to plain folks. We may not see any banks fail to the point that the FDIC has to take them over … but I wouldn’t be surprised by some bank-to-bank takeovers and mergers gently encouraged and funded by the Fed.
Recommended:
* The Big Picture
* Calculated Risk
* The Curious Capitalist
* Director’s Blog
* Econbrowser
* Economist’s View
* Greg Mankiw’s Blog
* Marginal Revolution
* Mess That Greenspan Made
* WSJ.com: Economics Blog
Sorry, no time to link them all.
BTW, you see “oil and gold” recommended as flights to quality in the current environment. Some of the “speculators” in the last thread might be “refugees.”
An Anon commenter at the WSJ blog is predicting oil as the next asset bubble. That’s similar to but not exactly the same as a speculation bubble … it contains people just looking for wealth preservation.
Yesterday I said:
Well, Feb 2008 NYMEX crude settled for $99.17 today but traded briefly at $100 around lunch time. I’m wondering how many contracts actually got done at that price. Perhaps somebody just wanted bragging rights.
I hate to say “I told you so” but:
Single trader behind $100 oil
The man behind the record rise in oil prices to $100 a barrel was a lone trader, seeking bragging rights and a minute of fame, market watchers say.
A single trader bid up the price by buying a modest lot and then sold it immediately at a loss, they said.
Vanity trade
Stephen Schork, a former floor trader on the New York Mercantile Exchange and the editor of an oil market newsletter, said one floor trader bought 1,000 barrels, the smallest amount permitted, and sold it immediately for $99.40 at a $600 loss.
I saw the $100.00 come up and thought it too convenient to settle at exactly $100.00.
Wouldn’t that have been funny if he made this trade on Monday at the close of the market and his $600 loss cost Robert $1000.
Odo – I would suggest you add http://www.mortgagefraudblog.com to your reading list. It will give you an idea of some of the underlying rot that is causing the problem.
Fraud has certainly contributed to the problem and explains why certain markets (Florida, Las Vegas, California) account for the bulk of foreclosures. I read about a 300 unit condo in Miami that had over 100 units suspected of fraud.
Honest homeowners are impacted by the inflated costs of real estate and then the depressed market and blight that comes from vacant homes in foreclosure.
Off-topic but worth mention: Chinese automaker Dongfeng is researching using hydrous ethanol in their cars
http://www.autobloggreen.com/2008/01/03/dongfeng-investigating-hydrous-ethanol/
Maybe I have to be convinced about the fraud angle. I think that is the icing on the cake, but no more.
I think the main thing, the big national trend, was the decline (disappearance) of the US savings rate, and the coincidental increase in the debt to equity ratio.
Sure, they resorted to “stated income” at the end of the bubble, but a lot of stupid no-interest loans were made without fraud, just with the mistaken assumption that real estate prices could not fall.
BTW, look for similar bad decisions and bad credit management to come home to roost in credit cards and student loans.
heh, i mean interest-only of course.
The “no interest” is another example of failed consumer economics … when people actually believe that there was no interest built into the purchase price of their 0% APR car loan.
I understand that 100% of auto-company loans were sold as investment vehicles to Wall Street, so maybe we have something to see there as well.
Too many folks have been rolling over bigger balances on newer cars (or 14 mpg SUVs). The loan industry has been responding with longer terms. Half of all financings are now over 6 years.
That also, is obviously not sustainable.
I don’t know how much Robert will see this as energy related, but the old recession and oil price linkage is part of it.
On my debt hobby-horse:
“Borrowed funds now equal 138 percent of annual household income, a signal that Americans have taken on too much debt of all kinds.”
Americans have taken on too much debt of all kinds
Of course, it does relate to a successful item in his New Year’s resolutions.
Well, the decline in the savings rate is entirely rational in light of government policy that punishes savers (with taxes) and rewards spenders (with inflation). Interest rates are so low that net of federal and state income taxes you were lucky just to break even with inflation on bank deposits at 5%. Now rates are headed lower and inflation’s headed higher. Savers are slowly losing more ground. The stock market hasn’t been a cheery place to be. The S&P500 was worse than bank deposits in 2007, and in fact an investor in 2000 is still waiting to break even in nominal dollars in this mother of all bear markets. Sure, you might have zigged and zagged in and out of exactly the right investments over that time period, but then again, you might not have. Most people can’t invest in commodities. The next best substitute was housing, now we know where that’s headed. All that leaves is to spend your money quick before it loses more value.
Odo – it is very difficult to know the extent of the fraud problem. It ranges from conspiracies between appraisers, lenders, and buyers to people fudging on their loan applications.
There are parallels to the oil markets. The price of housing exceeded its true construction costs just as oil is trading well above the cost to produce (show me the $100 / bbl oil wells). Restrictive land use provisions in places like California provided a barrier to entry just as the state owned oil companies prevent capital from flowing into E&P development.
But you are right, it is way too easy to get credit. I remember when I came out of college it was tough to get a credit card and interest rates are high. Now it is easy, and interest rates are still high. But it isn’t just Americans. One of my English employees had a $1 million mortgage! You hear of middle income Brits with summer homes in Spain.
Other than our mortgage, we are debt free. I’m trying to pass that on to my kids.
Don’t know how long it’s been since you were in Orange County, but I think (a) builders get what they want, and (b) it’s just that the land seems to have gone. The Irvine fields and various Laguna hills have been pretty much built. By 2006 the move was to in-fill. Small developments of dozen homes or less on small and odd parcels.
Given that the choice was a house in one of the last tracts or a long commute … people went a little crazy.
Seems to me that the builders went two ways at once: ultra-dense but somehow still premium rentals, and then million dollar tract homes on postage stamp lots.
To me single family homes stop making sense when they are on minimum lots, but strangely the market valued a new McMansion with no land higher than an older home on a good lot.
(My dad taught me the same view of debt, mortgage only, and that it’s nice to pay that off. Well see, as Doug says, if this “irrational” path hurts in coming years.)
Well, Feb 2008 NYMEX crude settled for $99.17 today but traded briefly at $100 around lunch time. I’m wondering how many contracts actually got done at that price. Perhaps somebody just wanted bragging rights.
Sorry King, I don’t buy it. The fact that oil was close enough to $100 for one guy to swing it with a 1,000 bbl purchase (and a modest $600 loss) tells me the fundamentals support oil at $100. And then there is this: Price of oil hits record $100 mark again!
Gotta love the Gheit logic. Let’s play that again: What’s changed that we didn’t know in January? Not a single thing (emphasis added).
That’s typical analysist logic: Don’t worry about that hurricane heading for your house – the weather channel has been predicting that it would do so for a week. In other words, the fact that you knew about it somehow makes the event less severe.
Of course, the knowledge would allow you to make some much-needed preparations, but the knowledge but itself does not affect the underlying fundamentals.
Also Gheit seems to completely miss this important factor: EIA attributed the decline to OPEC production cuts of about 1.5 million barrels a day beginning at the start of 2007, when inventories were so high and oil prices briefly dipped below $50 a barrel. The cuts came despite continued strong worldwide economic growth, which EIA said caused oil demand to rise by 1.3 million barrels a day over the last year. Now that’s what I call fundamentals!
Anyway, Gheit seems married to a particular point of view. When was the last time he predicted future direction of oil prices accurately?
show me the $100 / bbl oil wells
Seems like James Burkhard, managing director of the Global Oil Group at CERA, disagrees with you: An oil price of $90 [a barrel], which a few years ago would have been a clear, unambiguous signal to invest more and more, [does not necessarily have that effect] today. Because of higher cost and higher state take, the investment equation is not that simple.
Odo – you are right, the last time I was in Orange County was 2001. What I was referring to was this analysis: A Tale of Two Townhouses , which estimated the “right to build” costs. In seven years the non-construction costs to build (not accounting for the cost of the land itself) account for $400,000 for a house in Anaheim. This is government limiting supply and driving up prices.
Optomist – what I meant is that there is no marginal production at $100 that isn’t already producing. Much of the growth in crude demand comes from China and the Middle East, where oil prices are subsidized. Look at Venezuela, gasoline is 25 cents a gallon. New Hummer dealerships are opening in Caracas. In China, power producers run on subsidized fuel oil. Such subsidies distort the market and are expensive to maintain.
A credit crunch induced recession will take out Indian and Chinese crude buyers and we could see $40 crude again.
Heh – I’m not saying being debt-free is irrational. I’m firmly in the same camp. But, as a saver, I’m painfully aware of how my frugality is being abused by the economic system we’ve got. I’d like to see government policy change so that savings is actually encouraged. Here’s an idea: eliminate the income tax levied on the portion of interest income that is just inflation – tax only the real inflation-adjusted gain. Here’s another: keep interest rates above the rate of inflation.
There are some weird projects in Anaheim. It’s one of the places developers have gone high-rise.
High rise in OC might be because the flat land is taken, as I said, or it might also be because things went a little crazy.
Is high rise actually justified in OC? Time will tell.
Much of the growth in crude demand comes from China and the Middle East, where oil prices are subsidized. Look at Venezuela, gasoline is 25 cents a gallon. New Hummer dealerships are opening in Caracas. In China, power producers run on subsidized fuel oil. Such subsidies distort the market and are expensive to maintain.
King, I agree, market distorting policies complicate matters much – as well as add instability. BTW, I believe the Indians are also subsidizing oil.
I also maintain that to get to $40/bbl we’ll need to see much economic pain (which would go around the world thanks to the global economy). So much that I would rather see $140/bbl than $40/bbl.
In China, power producers run on subsidized fuel oil. Such subsidies distort the market and are expensive to maintain.
One wonders how long those subsidies are sustainable. And yet, everything I hear about China says that they’re sitting on a colossal pile of dollars (or is it dollar-denominated debt?), which makes it sound like they could continue subsidizing (and thereby supporting $90+/bbl prices) indefinitely. I wonder if anybody is able to (or already has) put any kind of numbers to that, however speculative…
Odograph – high rises in Tustin? Boy it has been a long time since I’ve been there.
If the “right to build” is high, it makes more sense to build a high rise were both the permitting costs and land are spread over more units.
The point is, setting aside the land (which the Atlantic article does), homes shouldn’t cost much more in Anaheim than they do in Dallas. It is government policy that makes it so, and a change in policy could correct the problem. So the value of homes is NOT simple supply and demand because the government restricts the supply. Just as the governments of Saudi Arabia, Venezuela, and other states restrict the supply of crude by not allowing foreign participation.
Mike C. – They hold US bonds. China’s thing is to try to maintain full employment, particularly in the interior provinces. They run a mercantilist trade policy and are loathe to use their export dollars to purchase anything outside of China. They will subsidize oil only as long as they need the electricity to run the factories. I would guess they will transition to domestic coal and hydro power to avoid exporting dollars and jobs overseas. In 2009 when 3 Gorges comes on, they may not need so much power.
I think the Story you have with rights to build is stronger than Fact.
And certainly there are going to be higher costs to approve a 15 story high rise condo than would-be for a one-story townhouse cluster.
Don’t tell me YOU’D approve both plans and integrate them to your towns service grids for the same price?