Speculators argue that they do not affect oil prices -- we are paying more at the pump, and businesses far more to make their products, because this is the natural state of things: Oil supplies are static while demand is rising, so next year we will be back to the ultra-tight market of 2008, when oil prices sky-rocketed to $147 a barrel. In fact, Goldman Sachs says that is precisely where we are headed -- an average of $140 a barrel next year, the bank said in a note to clients this week.
These are geopolitical prices -- such levels weigh heavily on the economies of oil-consuming nations, such as the United States and Europe, and make producers such as Russia and the OPEC nations fat and mean.
Only, is the Goldman Sachs account of reality true? Let’s start with the 2008 runup -- yesterday, the Commodity Futures Trading Commission charged Parnon Energy, a big U.S. trading house, and two of its European affiliates with oil price manipulation. They bought up and stored a huge percentage of the available oil in Cushing, Oklahoma, in January and March 2008 with the aim of cashing in when the market perceived a drastic shortage of crude, the CFTC alleges. During the whole of these events, Goldman Sachs and other investment banks -- attempting to stave off tighter regulation -- paraded repeatedly before CFTC hearings, congressional committees and public cameras claiming that such activity was almost impossible. The surge was a reflection of fundamentals, and traders were innocent of any impact, they testified. Were they correct? Not if the CFTC case is accurate.
Let’s look at the bigger picture. Spare capacity is an indisputable fundamental factor in oil prices, but it is only what gets the whooping-and-cheering Goldman Sachs, Morgan Stanley and their clients to the casino table. Once they are there, they are standing alongside traditional traders, and pouring their extremely high net worth into the same pot. It’s that piling up of the cash on the table that pumps air into the oil price. Should we ignore that pile while the investment banks divert our attention to the nice flowers and pretty birds? No, we shouldn’t.
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Oil price spiral, interrupted: Rex Tillerson, the CEO of ExxonMobil, said this week that the purely economic value of oil is $60-$70 a barrel, or about 29 percent lower than the price at which it closed Friday. Tillerson (pictured at right above) was talking about the cost of producing new crude oil, not the stuff that is already in tankers headed to refineries or in storage. You'd add reasonable profit on top of Tillerson's estimate, but he doesn't claim that this explains the divergence of the price to above $100 a barrel in the last couple of months. He is mystified along with the rest of us.
He was speaking at a Senate Finance Committee hearing that was just one tick in a highly newsy week in oil. The CME Group, which owns the Nymex exchange where speculators trade U.S. oil futures, took some air out of the market by significantly raising the cost to bet on oil -- by a whopping 25 percent (while that's a lot, it's nothing compared with an 84 percent increase this week in the price for betting on silver). Why did CME act? One reason is that speculators are pushing the oil price all over the place. Traders became so overheated Wednesday, for example, that CME actually called a temporary halt to the betting action.
One factor that's played havoc with the market has been two years of government stimulus. Governments around the world -- in Europe, Asia and the United States -- have so feared a catastrophic and prolonged depression that they have lavished public spending on their economies, and maintained super-low interest rates. The U.S. Federal Reserve has even engaged a trick called quantitative easing, which does the same thing as stimulus by putting more cash into the system. All this money staved off the worst for a while, but it had to go someplace, and guess where that is? A lot of it has become "hot money," sizzling up developing markets around the world -- and commodities such as oil. To make things much simpler, the money has gotten into the hands of traders, who have driven up the price of oil (among other commodities including silver). Don't ask me how specifically it got into their hands; that's one of the tricks of speculator types -- they somehow, in every period of economic bubbles, end up at the delivery end of cash faucets.
What importantly isn't often taken account of is that robotic traders are sitting right next to the live players at the casino. These really are robots -- not the kind with artificial intelligence that futurist Ray Kurzweil forecasts will take over our lives in a few short decades, but computerized traders: robotic robots that automatically buy or sell when certain price thresholds are crossed. That was the major cause of the huge price dives over the last 10 days or so. As Reuters reports, there was a perfect storm, and the robots went wild.
As a coda, I have often wondered why this type of what I think is fairly sensible talk makes some people uncomfortable, and I think I've discovered why -- they think that if you point out the role of speculators, you are calling for their abolition. But why would that be so? If one suggested for example that the presence of wild quantities of trout results in a spurt in the issuance of fishing licenses, would you fear the eradication of fishing? I think the speculation deniers should relax. We all know that trading (speculation) has a healthy function in markets. Yet we also know that it can move markets. It is the latter factor that is under discussion.
For those who want it from the horse's mouth, here is a video of Tillerson at Thursday's Senate hearing.
Read on for more of the Wrap.
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Oil prices and speculator-haters: For months, this blog suggested that oil prices would moderate in the $85-a-barrel range and lower. So what happened? Why did the price close at $113.93 a barrel today, or 39 percent higher? Chinese demand is one unsurprising reason. The remarkable upheaval in the petroleum-vortex of the Middle East is another, inserting a premium into the oil price of at least $15-$20 a barrel, and generating serious concern of a drag on global economic recovery.
Some people are getting angry -- gasoline prices are going up along with oil. But what gets them really angry -- madder still than the $60 ringing up on the meter at the gas pump -- is the notion that speculators (spit, spit) may be largely behind the runup. The only thing that gets some people even angrier than that is the accusation that speculators (spit, spit) are largely behind the runup.
Phil Flynn, among the sharpest trading commentators around, is firmly in the latter group. He is spitting mad at the defamation to which energy traders are being subjected. Fatih Birol, chief economist for the International Energy Agency, doesn't look spitting mad, but he does think the speculator-hater crowd has it wrong -- speculators may be driving up prices, but only in response to supply and demand signals, Birol tells Dow Jones Newswires. Of course, President Barack Obama himself helped to raise the temperature a week ago or so by pointing out the role of speculation in the price rise.
But once you get past the demonizing and the defensive rhetoric, the argument that traders have played no or hardly any role in the oil price rise is absurd. As Reuters points out, the number of net longs -- traders betting on a rise in oil prices -- has surged in tandem with the turmoil in the Middle East. On the Nymex exchange in New York, the number of long bets is up by 85 percent since mid-February; in London, the number is more than double. No judgment there. These bets simply push up the price.
Politics and war among the gas-guzzlers Oil has always been a multi-use commodity. One of its perennial benefits has been as a political football. As political leaders in Shanghai learned when fuel prices were raised on truckers last week, almost anywhere there is oil around the world, it becomes a potent political foil. So it is now in the United States as the 2012 presidential race gets under way. President Obama has suggested that the oil industry forgo $4 billion in tax deductions permitted in the exploration process, and has attracted some unlikely support for the idea. Yet most of his opponents accuse him of economic malfeasance and worse.
So far, it's not clear where this one will come out. But in terms of pure politics, coinciding with ExxonMobil's report of a $10.7 billion quarterly profit, along with large returns for the rest of the oil industry, Obama seems to be in the driver's seat for now on the tax issue. Similarly (and counter-intuitively), he may also be less vulnerable than might seem the case on gasoline prices, which have crossed the symbolic $4-a-gallon mark in large parts of the country. Nate Silver trots out studies suggesting that, when it comes to presidential popularity, there is very little voter response to high gasoline prices in isolation.
Shale gas: the mountain moves Until now, U.S. shale gas drillers have been implacable -- against warnings that they are inviting federal regulation and spooking potential future European suppliers to boot, these fellows have kept their heads in the 1940s, and suggested that this too shall pass. The trouble is over hydraulic fracturing, or fracking, the method by which gas is dislodged from hard shale. People whose homes abut such operations worry about the quality of their air and drinking water, and are raising a ruckus about it. Basically, if the industry wants to keep fracking, it needs to be much more pro-active in explaining itself, and to apply serious peer pressure on bad actors to clean up their practices. Why? Because it's not the 1940s. It is much harder to tough out such complaints since the 1970s environmental movement forced a gleamier look on the industry. This is no small issue -- shale gas has utterly shaken up energy and economic assumptions, and undermined Russian influence in Europe. If handled well, this bonanza of shale can have a big, positive economic, environmental and geopolitical impact in the United States and stretching all the way to China.
As it happens, there are signs of cracks in the industry edifice. A handful of drillers has gotten behind a website called fracfocus.org, where they have begun to post data sheets on some 330 of the 14,800 fracking wells in the U.S., along with the chemicals used in the process. Such disclosure has been a minimum demand of fracking critics. What changed their minds? Perhaps the Environmental Protection Agency, which this week moved against drillers who use diesel fuel in fracking. Perhaps it's President Obama, whose administration is newly calling for "common sense" regulation of the industry. Perhaps it's the relentless negative press, including a serious accident this week in Bradford County, Pennsylvania.
Yet, hold the champagne. First, 330 is not many wells. In addition, Cabot Oil & Gas, a serial environmental violator that this time last year was banned from any drilling in Pennsylvania over water contamination, isn't part of fracfocus.org. And ExxonMobil, the largest natural gas driller in the U.S., which is one of the early joiners at fracfocus, among others seems still to have a tin ear. Speaking to reporters yesterday, Exxon vice president Ken Cohen denounced the Mounties for stepping on his lawn while ignoring the horse thieves that brought them there. "[P]olitical overreaction to a small number of isolated environmental issues could jeopardize this emerging industry and the benefits it provides," Cohen said. He said, "Government policies did not cause the shale gas revolution in this country, but they could stop it in its tracks." Perhaps Cohen should share similar sharp language with Cabot.
Memoirs of a middleman: The word on the street is that James Giffen, the New York lawyer who wheeled and dealed for three decades in Moscow and then Almaty, is looking for a ghost writer to help with a memoir. As is the case with most such works, the interest will lie in how candid Giffen chooses to be. Given his penchant in those days for womanizing and drinking, one would expect much in the way of bawdy story-telling of the closing years of Mikhail Gorbachev's rule and beyond, and that will be interesting. But will he illuminate the darker side of politics and business in the former Soviet Union, material that would be of genuine literary and historical merit? Here one has reason for doubt. In November, Giffen was exonerated of charges of foreign bribery regarding U.S. oil company payments that ended up in the coffers of Kazakhstan President Nursultan Nazarbayev. His successful defense was that he was serving as an asset of the Central Intelligence Agency, a tall tale that nonetheless got Judge William Pauley nearly to weep and give him a bear hug. Will Giffen back off of claims of single-handedly bringing down the Soviet Union and bringing democracy to Kazakhstan? Perhaps. But that would not be in the character of a middleman.
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TNK-BP: Clutch play by Dudley puts momentum back with BP? Counter-intuitively, the momentum may have shifted back to BP in its latest high-wire negotiations in Russia. BP's Bob Dudley (pictured above), attempting to turn around the company's fortunes after the costly Gulf of Mexico oil spill a year ago, in January dived into a highly tenuous tie-up with Russia's state-owned Rosneft, with whom it hoped to explore the oil-rich Arctic Sea. The tenuous part came because BP's long-time Russian partners, the grouping of four oligarchs known as AAR, blocked the partnership through tribunal rulings in Europe. As late as yesterday, BP and Dudley seemed to be in deep trouble -- BP had offered to buy out AAR's 50 percent of their Russia-based partnership for $27 billion; AAR apparently counter-offered with an ask of $35 billion, part of which would be paid through 10 percent share holdings of both BP and Rosneft. Dudley balked at the shareholding part, and possibly the money too. But just when hope seemed lost, Dudley got Rosneft to extend what had been a drop-dead deadline yesterday for completing their tie-up. Now BP has until this time next month.
Now a curious thing has happened. In a statement issued today, AAR CEO Stan Polovets advises BP to find a way to honor their partnership agreement faithfully. "We trust that BP will use the extension it has got from Rosneft to ensure that both the Arctic opportunity and the share swap are pursued through a structure consistent with BP's obligations under the TNK-BP shareholder agreement," he said. It's curious because Polovets said almost the identical thing yesterday.
If one is in the catbird seat, one generally remains sphinx-like. Hence, the signal that AAR is a bit uncertain. BP now has time to turn the tables. Chris Weafer, an analyst at UralSib, thinks that the long time extension suggests that the Kremlin intervened at the last minute to keep the deal alive.
Even if he was miserly with the cash -- $35 billion does not seem like too much money for the unlisted company -- Dudley was right to refuse AAR's share demands. He would be a fool to hand over 10 percent of BP -- and hence a board seat -- to the litigious and shark-like AAR, who have shown over the last 15 years a zest for a bloody brawl. Nothing personal, of course.
Should the shale gas tent be folded up? If Cornell Professor Robert Howarth and a couple of his colleagues are correct, there is precious little hope -- very close to none -- of getting greenhouse gas emissions under control and preventing some of the less-pleasant repercussions of climate change. This week, the Howarth team published a paper disputing one of the main assumptions accompanying the U.S. boom in shale gas drilling -- that it is a positive development because natural gas emits half the greenhouse gases of coal, and a third less than oil. Gas, it has been said here and elsewhere, is a "bridge fuel" until an as-yet undetermined non-fossil fuel technology is scaled up to propel the global economy along with the world's private vehicles. But Howarth says that, when one takes into account the methane released during shale gas production, coal in fact comes out cleaner. Given the hoopla surrounding shale gas, Howarth's paper has attracted much attention, including prominent display in the New York Times. But is he right?
Over at the Council on Foreign Relations, Michael Levi isn't so sure. There is no dispute regarding the hazards of methane -- this gas is pernicious. But Levi takes Howarth to task for relying on "isolated cases reported in industry magazines" along with the performance of notoriously bad Russian pipelines for his conclusions regarding how much methane escapes into the atmosphere during hydraulic fracturing, the method by which shale gas is extracted. Levi is at his most brutal in an apparent scientific gaffe -- Howarth used comparative gigajoules in order to measure the methane emissions of shale gas against those of coal. The problem is that gas produces a lot more electricity than coal gigajoule-by-gigajoule, something that Howarth doesn't take account of. For that reason, Levi favors kilowatt-hours for comparison purposes, and regards Howarth's failure to do so as "an unforgivable methodological flaw; correcting for it strongly tilts Howarth's calculations back toward gas, even if you accept everything else he says." Ouch.
Howarth explicitly states his data are thin and that more research is necessary -- methane is under-examined. Levi agrees with him there.
Here is where we return to one of the industry's own big failures to get out in front, figure out its weak points before critics do, and fix them. We have previously suggested that the error-prone shale gas industry ought to police itself, put peer pressure on its own bad actors to straighten up, and openly disclose the content of its fracking fluid. Now a new front has opened up. It could be too late to recover entirely -- the industry is headed for serious federal regulation, the very thing it has sought to avert.Read on for more of the Wrap
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Steve LeVine is the author of The Oil and the Glory and a longtime foreign correspondent.