The Weekly Wrap: May 14, 2011

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.

The trouble with persnicketiness: If all the risky oilfields in the world were shut down today, it is safe to say that few would be very happy. Before long, a lot of stuff to which we are accustomed -- carefree driving and airplane travel, a varied diet, 24-hour electricity -- would pretty much go away. That is why, while many people take as an article of faith that we must "get off of oil," it's simply not a serious proposition in our lifetimes, and probably most of that of our children. There's no ready substitute, nor any on the foreseeable horizon, for the volume of energy produced and consumed every day around the world. Yet, for a variety of reasons we try to move on. There is widespread agreement, for example, that rising temperatures are a bad idea. We would like to emit considerably less carbon into the atmosphere.

As we saw over the last few days week, one of the bits of trouble comes in the trying. With the Fukushima nuclear meltdown as a context, Japanese Prime Minister Naoto Kan abandoned plans to produce half the country's electricity from reactors. Currently, 54 nuclear reactors supply 30 percent of Japan's electricity, and the now-canceled plan was to add 14 by 2030. This decision, if carried through, will add to Japanese demand for dirtier power sources such as gas, coal and oil.

The world's other main user of nuclear power -- France -- doesn't seem to be leaning the same way. Its lower house of parliament voted this week to ban hydraulic fracturing, a method of extracting natural gas from hard shale. The method, known as fracking, has already changed energy presumptions around the world, starting with the United States, where a shortage of natural gas has become a vast surplus; a rush of companies think that the same can happen in Europe. But fracking is controversial - there's concern that it can poison drinking water -- so many people think it will never gain wide adoption in Europe, which generally has a different environmental sensibility from Texas, Oklahoma and Pennsylvania. France's Senate considers the measure next month. Meanwhile, there ‘s no similar move to distance itself from nuclear power.

We see why Kan and France's lower house have acted as they have. But we also see a narrowing of the options for getting off of oil.

 

Frozen cables: It's worth perusing excerpts of new Wikileaks diplomatic cables compiled by the BBC on the race for the next big oil frontier -- the Arctic. While no one will be shocked, the eight states surrounding the Arctic have engaged in various forms of brinksmanship and shadow play in order to better their chances of a greater stake in its estimated 90 billion barrels of oil. U.S. diplomats do not think much of Canada's chest-pounding, viewing it as local politics, but the big shoulders of Russia's Vladimir Putin generate a graver rendering. The foreign ministers of the eight states met in Greenland on Thursday and signed a cooperative agreement to jointly react to oil spills and crashed planes in the Arctic. We've watched as Exxon, Chevron and others have nosed around Greenland, and Gazprom and Statoil in the Barents Sea, but development could happen faster than expected, as suggested by Peter Wadhams, a professor at Cambridge University, who told the BBC that there could be ice-free summers at the North Pole in a matter of two years.

 

The day that Rocky got his due: Sunday is the 100th anniversary of the Supreme Court decision to break up Standard Oil, the powerful monolith created in 1870 by John D. Rockefeller. We did a package to mark the occasion at FP. What struck me while researching the topic was how much Rockefeller's ideas resonate today -- 141 years ago, Rockefeller profoundly understood what it takes to survive and thrive in the brutally volatile oil market. Against the inevitable gyrations of prices that could drive one out of business, Rockefeller controlled costs to the penny, and husbanded huge stores of cash. That made Standard super-competitive against rivals, provided huge profits during good times, and steadied the ship during bad. With all that cash, Rockefeller could scoop up rivals at a steep discount when they were most vulnerable. This continues to be the formula for success at Standard Oil's heir -- ExxonMobil, by far the most successful profit-making enterprise on the planet for decades. The only problem -- whom do we congratulate? Rockefeller? Ida Tarbell, whose journalism helped to bring down his company? The Supreme Court, which acted boldly? Exxon, which has carried on the legacy? Probably all of them.

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