My economics professor says the main reason petroleum is so expensive

[matt0611]

I blame dollar weakness mostly, what do you expect with them printing all of that money?

Oil is going up in price for the same reason all commodities are going up in price.
Plus even some more with oil because of political turmoil.

In currencies that have relatively tighter monetary policies like the Swiss Franc, Australian Dollar, and Canadian Dollar, oil has remained relatively stable.
In currencies of countries with relatively loose monetary policy like the US Dollar and Euro, oil has gone up a lot.

Heres a chart with the US Dollar index in blue, price of gold in yellow, and price of oil in red. Notice how the price of gold is almost the mirror image of the dollar index? And oil more or less has been heading up with gold.

 

[sandorski]

It's not just Supply/Demand. The Cost of Extraction is also rising as the cheap and easy to reach Oil is running out.

 

[Atreus21]

My econ professor from a few years ago said it's because everyone in OPEC is finally colluding effectively.

 

[JTsyo]

Anyone have a chart of oil consumption vs price? I bet it doesn't follow for the spikes.

 

[Acanthus]

Anyone have a chart of oil consumption vs price? I bet it doesn't follow for the spikes.

Consumption has fallen significantly over the last two years. However, reserves aren't on the rise because supply is just going to other developing nations.

 

[ayabe]

Commodities speculation has grown tenfold since 2003.

Pretty weak attempts to reign it in so far, he's a recent case:

"U.S. regulators say two well known traders -- one in Oklahoma and one in Australia -- bought up nearly 5 million gallons of oil to create an artificial shortage in early 2008. They then bet on oil prices to fall and sold their hoard of oil at a big profit."

http://marketplace.publicradio.org/...speculators-charged-with-market-manipulation/

Problem as I see it is that this the name of the game and the sole purpose of these kinds of transactions. A few small fish will fry but the big boys will continue as usual, probably even ramp it up.

Yeah, yeah, airlines need to hedge against fuel price spikes - so keep the rest of us out of it. Here's another example where a quasi legitimate need is twisted in order to provide cover for thieves.

 

[ayabe]

"WASHINGTON — When oil prices hit a record $147 a barrel in July 2008, the Bush administration leaned on Saudi Arabia to pump more crude in hopes that a flood of new crude would drive the price down. The Saudis complied, but not before warning that oil already was plentiful and that Wall Street speculation, not a shortage of oil, was driving up prices.

Saudi Oil Minister Ali al Naimi even told U.S. Ambassador Ford Fraker that the kingdom would have difficulty finding customers for the additional crude, according to an account laid out in a confidential State Department cable dated Sept. 28, 2008,

"Saudi Arabia can't just put crude out on the market," the cable quotes Naimi as saying. Instead, Naimi suggested, "speculators bore significant responsibility for the sharp increase in oil prices in the last few years," according to the cable.

What role Wall Street investors play in the high cost of oil is a hotly debated topic in Washington. Despite weak demand, the price of a barrel of crude oil surged more than 25 percent in the past year, reaching a peak of $113 May 2 before falling back to a range of $95 to $100 a barrel."

http://www.mcclatchydc.com/2011/05/25/114759/wikileaks-saudis-often-warned.html

Even the Saudi's know who to blame.....

 

[LegendKiller]

I blame dollar weakness mostly, what do you expect with them printing all of that money?

Oil is going up in price for the same reason all commodities are going up in price.
Plus even some more with oil because of political turmoil.

In currencies that have relatively tighter monetary policies like the Swiss Franc, Australian Dollar, and Canadian Dollar, oil has remained relatively stable.
In currencies of countries with relatively loose monetary policy like the US Dollar and Euro, oil has gone up a lot.

Heres a chart with the US Dollar index in blue, price of gold in yellow, and price of oil in red. Notice how the price of gold is almost the mirror image of the dollar index? And oil more or less has been heading up with gold.

All commodities are up in all currencies, even CHF. The US decline had nothing to do with oil going from $60 to $147 to $39 within the span of 24 months. The USD index didn't suddenly go from 100 to 40 then to 150 and now back to 70 to put oil at 100 in the face of a global recession and gas usage plummeting.

I mean, really, is this too hard for you?

As far as supply/demand, the market is well supplied and can be moreso. Even though extraction costs are up, they aren't up that much. Many have said the real clearing price of oil should be ~60-70. That means speculators are adding 30-40% to the price of oil.

 

[matt0611]

All commodities are up in all currencies, even CHF. The US decline had nothing to do with oil going from $60 to $147 to $39 within the span of 24 months. The USD index didn't suddenly go from 100 to 40 then to 150 and now back to 70 to put oil at 100 in the face of a global recession and gas usage plummeting.

I mean, really, is this too hard for you?

As far as supply/demand, the market is well supplied and can be moreso. Even though extraction costs are up, they aren't up that much. Many have said the real clearing price of oil should be ~60-70. That means speculators are adding 30-40% to the price of oil.

All countries are devaluing their currencies, I mean, really, is this too hard for you to comprehend?

As far as the "real clearing price of oil" should be, again, see political turmoil.

Here's the dollar index vs a commodity index, notice anything?

 

[LegendKiller]

All countries are devaluing their currencies, I mean, really, is this too hard for you to comprehend?

As far as the "real clearing price of oil" should be, again, see political turmoil.

Here's the dollar index vs a commodity index, notice anything?

The CHF isn't being devalued and many of the swiss businesses are getting crushed. I was reading an article on swiss watches, many luxury brands are getting destroyed, especially domestic sales from foreigners who can get a far better price in their home country, even with discounts.


Yeah, I notice a lot of volatility and even some cases where the indexes track each other. You can spot any trendline you want, especially wrt 2011 movements (ignoring the bulk of the runup).

 

[Portly Penguin]

It's really not a mystery.

Current oil prices have absolutely nothing to do with supply and demand, they are skyrocketing almost entirely because of unregulated speculative activity.

For the finance noobs: a "future" is basically a contract to buy goods at some point in the future at a guaranteed price that is set now. This contract allows buyers and sellers to "hedge" their business against the risk of sudden price fluctuations. The contracts themselves can also be bought and sold by "speculators" who treat them as an investment. For example, If the speculator thinks prices are going to increase in a market in the future, they will buy up a bunch of contracts at the currently low price. Once the prices rise, these cheap contracts are suddenly worth a lot more money. The benefit of the speculative activity (aside from a money making opportunity for the speculators), is that it provides extra liquidity to the market. If you are a farmer and have a bunch of corn to sell but no one wants to buy it, a speculator might buy a future contract because he thinks he can make money on it later, allowing you to get money for your corn now. The important part of all this, is that futures markets are heavily regulated - there is a limit to how many futures you can hold at once. This prevents some rich dude from coming in and buying up all the futures to get a stranglehold on the market in order to fix prices, and otherwise prevent wild price fluctuations caused by over-speculation.

~~~~BUT~~~~~ Over the past 20 years, the US government has secretly handed out commodity futures position limit exemptions to several American financial companies, most notably Goldman Sachs. Removing the limit on the number of long positions a bank can hold allows them to continually buy more and more of the futures, but never sell them (they technically do sell them right before the contract date so that oil doesn't actually show up on their doorstep, but immediately re-buy an equal amount of replacement contracts). This creates a huge amount of completely artificial demand, which continually drives the prices up. The fact that the futures have to be sold and replaced before the contract date means that these transactions are happening constantly (especially thanks to electronic banking), which creates almost perfect liquidity, allowing the cycle to continue. The banks fund the whole thing by turning their futures assets into a commodity index, and selling stakes in it as an investment product to every day people. Because only these companies with the exemptions are legally allowed to do this, they can get away with charging hefty service/processing fees, insuring that they come out ahead no matter what happens in the markets. The whole system is basically an incredibly genius way for banks and investors to make money without anyone actually DOING anything. It's really actually somewhat mind boggling.

Unfortunately, even this simplification of whats happening is too complicated for the average retard American, so the media can't report on it without confusing their readers and causing them to lose interest. So all you get to hear is bullshit sensationalist stories about how oil prices are skyrocketing due to conflict in the middle east.

The government absolutely knows what is causing the skyrocketing prices, but there are far too many influential (rich) people making far too much money for anything to be done about it. Politicians arguing about inconsequential things like offshore drilling is pure misdirection.

America's smartest mathematical minds are now going into finance, instead of science. The level of genius that was once used to develop the transistor or the Internet is now being applied to manipulating our convoluted financial system for monetary gain. Following decades of deregulation, Obama's administration full of ex-Goldman Sachs lackeys are fully complicit in allowing this to continue, so don't expect anything to be done about it soon.

 

[desy]

http://farm4.static.flickr.com/3273/2729271938_750aeeb8b9_o.png

speculation, production contraints, emerging markets etc etc all provide pressure on an in-elastic commodity for all people who need to take some economics in this thread.
hint price/demand isn't relatively proportional

Heres the chart somebody asked for price / miles driven
http://contrarian.ca/2010/05/12/infographics-miles-driven-by-price-of-gas/

 

[werepossum]

What he says is substantially true but not the entire picture. Some will say the current run up is all speculation but they are incorrect.Others have tried to break down how much the oil increase is real demand vs speculation but as an example:

I sell 80 syringes/day of a medicine that 80 people need. If they do not get this they die by sunset. It doesn't cost me much to make and my 80 customers pay about $5/day for it. Tomorrow I drop a syringe by mistake in my lab and I have only 79 doses. Somebody is going to die. What do you think of those 80 people they'll be willing to pay? This is what happens with oil. There is _very little_ excess production (2-3M/day in a market that drinks 80M+/day), so anything that lowers it or increases demand can impact prices substantially until the demand and production are back in balance again.

This is exactly spot-on. Production is managed to keep even with demand. People with oil contracts to sell know that 100% of their oil will be sold, so they have a lot of leverage to drive up the price. This could be offset to some degree if we increase production, but other oil producers will fight it, lowering production to keep prices high. It's in their interests to keep prices high, balanced by their competing interest in keeping the market buying their product. This is also partially in our best interests as well, because by keeping prices high and thus discouraging consumption and encouraging development and utilization of alternative energy sources, we'll use less oil and therefore have oil for a longer time period. Unfortunately the high prices also drive down our economy at a time we can least afford it.

The OP's professor has a valid point though. The increasing industrialization and wealth of China and India will continue driving up demand, which will keep prices from falling to normal historic levels until we have a satisfactory replacement.

 

[brencat]

For those just tuning into this thread now, read Portly Penguin's quoted post above about commodity index speculation and the position limit exemptions given to Goldman and other select banks over the past 25 years. This is in a nutshell what I have been saying on this forum for months (and what was discussed in Matt Taibbi's book 'Griftopia'), but Penguin managed to articulate it well in a neat and concise format.

 

[manimal]

Thumbs up to portly penguin!


welcome to the forums btw!!

 

[desy]

Yes that articulates the speculation part but doesn't address the production/demand constraints which is the other major driver.
ITS not just one thing

 

[Blackjack200]

It's really not a mystery.

That makes no sense. Speculators do not create "demand". They have to sell before the contract date which would cause huge downward pressure on prices.

Think of the life of a single barrel of oil, say November 2012 delivery. Let's say the future contract on that barrel is sold by the producer in November 2011. The producer is going to sell to the highest bidder on that contract, so he's probably going to get something pretty close to today's market price. The speculator will then hold the contract (or trade it with other speculators) for the next twelve months. As the contract date approaches, he must sell it at market price, as he has no ability to refine and distribute the oil himself.

Every time the price of oil spikes, I hear about speculators, but I've never heard a satisfactory explanation for how they are able to manipulate the price.

I'm certainly no expert on this, but if I had to guess what was causing the current high price it would be the extreme inelasticity of the price of oil combined with economic growth in BRIC (mostly 'C', whoever said China is the same now as in 2007 doesn't understand the impact of 10% annual growth).

 

[manimal]

Yes that articulates the speculation part but doesn't address the production/demand constraints which is the other major driver.
ITS not just one thing

no its not just one thing. The low hanging fruit however is the speculation and the single biggest contributor to the current climate. If your inferring the moratoriums on drilling here in the US the overall impact on global prices is negligible...


Remember oil is fungible commodity sold on the open market...more drilling here will barely affect overall barrel pricing....

 

[brencat]

ITS not just one thing

That's right. It's also cheap money which has made investments like commodity indexing, CDOs, and other leveraged financial engineering viable vehicles among institutional investors 'searching for yield' because the people I work with 'don't get paid to hold cash'.

 

[MagnusTheBrewer]

Your economics teacher should know that speculation as well as OPEC have ALWAYS had more to do with the price of oil than supply and demand.

 

[LegendKiller]

That makes no sense. Speculators do not create "demand". They have to sell before the contract date which would cause huge downward pressure on prices.

Think of the life of a single barrel of oil, say November 2012 delivery. Let's say the future contract on that barrel is sold by the producer in November 2011. The producer is going to sell to the highest bidder on that contract, so he's probably going to get something pretty close to today's market price. The speculator will then hold the contract (or trade it with other speculators) for the next twelve months. As the contract date approaches, he must sell it at market price, as he has no ability to refine and distribute the oil himself.

Every time the price of oil spikes, I hear about speculators, but I've never heard a satisfactory explanation for how they are able to manipulate the price.

I'm certainly no expert on this, but if I had to guess what was causing the current high price it would be the extreme inelasticity of the price of oil combined with economic growth in BRIC (mostly 'C', whoever said China is the same now as in 2007 doesn't understand the impact of 10% annual growth).

I think what you're really hitting at is whether speculation in the futures market can affect the price in the spot market. It absolutely can. While the futures market is a zero sum game (somebody has to go long and somebody has to go short for the same amount, short sells the contract to the buyer/long), the price of oil at a futures price can effectively come back to influence the spot. Say, for example, we have a new futures price of $140 for delivery in August 2011. This gives us an expectation of what oil MAY be in August, according to the "market", but oil is at $100 right now. That means in 3 months somebody thinks oil is going to $140.

What happens if, because of that "expectation", somebody puts a new price target for oil to hit $140 by august, say Goldman. That means that people say "oohh wow, oil is going to $140 by august, I need to get in on the action". That also means that people will be willing to buy the oil now at $100 and store it, provided storage costs less than $40/bbl during the holding period. Now, you'd see oil inventories going up in this case, in 2008 there were many oil ships off coasts holding oil. In other cases you heard/saw tanks being full.

Now, what happens if nobody is collecting physical but the expecation is that spot will hit $140 by August. The futures pricing takes into account time-value, margin requirements and the fact you don't have to store anything, thus, once you subtract those out, that's what spot should be. What happens if there's a lot of conviction in the futures, say, tons of money flowing into futures? The stronger the conviction, the more the physical market can react to the conviction. Why sell oil now for $100 when it's actually worth $140 - TVM - storage - margin costs = $135.

So the new spot for oil should be $135. As others have mentioned, these futures offer huge leverage opportunities, you only need a small amount of capital to get a big contract.

Obviously people say that futures do not create spot demand and cannot influence the price of the supply/demand of the spot, but I disagree.

It doesn't help when people trumpet $200 oil, like T. Boone Pickens.

 

[Blackjack200]

Say, for example, we have a new futures price of $140 for delivery in August 2011. This gives us an expectation of what oil MAY be in August, according to the "market", but oil is at $100 right now. That means in 3 months somebody thinks oil is going to $140.

This is the part that I don't understand. That $140 figure is the product of anylists at GS etc., and they must be looking at projected demand based on economic growth projections of the big oil consumers (US, EU, BRIC), projected supply based on conflicts in the ME or weather events on offshore rigs/refineries etc.

Or are you saying that the GS analyst (or any other analyst, not just picking on GS here) would throw out intentionally high projections to generate momentum in the futures market?

I do understand what you're saying about speculators being able to store oil and keep it off the market if they believe the price will go up, but I'm just surprised that that would work for more than a very short period of time.

 

[Atreus21]

Why is OPEC taking a back seat to the list of usual suspects in this?

Isn't their express purpose to raise the price of oil?

 

[QuantumPion]

You demonstrate a vast ignorance of the elasticity of prices. It doesn't require a doubling of demand to double prices. Ignoring the effects of speculation, all that's needed to produce a price spike is for the increase in demand to exceed the ability to increase oil production.

US produces 2% of world's oil and consumes 25%. So increased production is not going to help us. Even if we double our production, it's just going to turn our 2 drops in the bucket into 4. Cutting our consumption can have a much bigger effect on oil prices.

so if demand goes up a teeny bit prices can skyrocket, but if supply goes up a teeny bit prices won't change at all? k. liberal logic makes perfect sense to me lolololol :whiste:

 

[werepossum]

That makes no sense. Speculators do not create "demand". They have to sell before the contract date which would cause huge downward pressure on prices.

Think of the life of a single barrel of oil, say November 2012 delivery. Let's say the future contract on that barrel is sold by the producer in November 2011. The producer is going to sell to the highest bidder on that contract, so he's probably going to get something pretty close to today's market price. The speculator will then hold the contract (or trade it with other speculators) for the next twelve months. As the contract date approaches, he must sell it at market price, as he has no ability to refine and distribute the oil himself.

Every time the price of oil spikes, I hear about speculators, but I've never heard a satisfactory explanation for how they are able to manipulate the price.

I'm certainly no expert on this, but if I had to guess what was causing the current high price it would be the extreme inelasticity of the price of oil combined with economic growth in BRIC (mostly 'C', whoever said China is the same now as in 2007 doesn't understand the impact of 10% annual growth).

In a way, speculators do create demand. Some of them, like airlines, actually buy contracts as a hedge to make sure they have fuel available in the future at a price they can pay, even if they are hoping for lower prices (and thus the loss of their speculation.) Others buy futures only in the hope that the price will go up to a point that they can make money. But everyone selling those contracts has to be able to fulfill them; if a contract is sold, then that oil is tied up. If more money goes into speculation, demand has risen.