Tuesday, June 3, 2008

Don't be a dipstick: it's supply and demand

To those woefully ignorant of basic economics, please read the excerpts of the following essay with as open a mind as you can muster. In fact, you should probably read it in its entirety.


Wishful Thinking, Speculation and Oil (May 30, 2008) by Charles Hugh Smith

Everyone and their sister seems to have jumped on the "oil prices are being driven by speculation" bandwagon, but perhaps that is nothing but wishful thinking. From the very beginning of futures trading--back in the 1600s when traders in Antwerp would buy and sell contracts on the cargo coming from the East Indies--the easiest game in town has been to blame speculators for price movements.

If the price of a commodity is rising, then the villains are speculators. If the price is dropping, it's the short sellers' fault.

Speculators are active wherever and whenever speculation is allowed. It's wishful thinking to expect oil will fall from $130/barrel back to $70/barrel if only those darned speculators would leave the market alone.

Note to hand-wringing, finger-pointing pundits: those darned speculators are the market.


As for the "solutions" to supply:

1. The Iranians have 20 supertankers filled with oil floating around somewhere. Nice, but it's heavy crude, and the few refineries able to process it are already running flat out. Also, 20 supertankers is a drop in the bucket of global demand.

2. Deep abiotic oil is abundant. The Russian have the technology. If the Russians have the technology, why is their production declining so rapidly? Where are the pipelines from their deep wells?

3. It's all the weak dollar. Once the dollar starts rising, the bubble in oil prices will pop. Then how come oil is rising in all currencies and even when priced in gold?

4. Canada and the U.S. have nearly unlimited supplies of shale oil and tar sands. Great, but real-world production will top out at 2.5 million barrels a day, about 10% of North America's consumption, and the process uses vast quantities of natural gas.

5. If only the tree-huggers would let us drill in the Alaska Wilderness. The U.S. consumes 22 million barrels a day or 8 billion barrels a year. The Alaskan North Slope everyone talks about contains about a billion barrels--a whopping 45 days' supply for the U.S. Whoopie.

In other words--it's all wishful thinking, folks: that it's all the speculators' fault, that new supplies will magically come on line and save us--there is simply no credible evidence for either supposition. It's supply and demand. Prices are set on the margin, and as a result a shortfall of a few percent has an amazing leverage on price.

Go ahead and ban speculation, and see what happens then. Prices will not drop, they will simply become more disorderly/chaotic.

As for demand destruction--let me know when China, India, Indonesia, Iran, Venezuela, Nigeria, Mexico et al. stop subsidizing the price of fossil fuels for their hundreds of millions of consumers.

And as for supply, let me know when global production of oil from any source exceeds 90 million barrels and day and keeps climbing as producers take advantage of the high prices.


Those same people who believe this is a contrived crisis for the purposes of extracting the maximum amount of moola from the pockets of Americans often are also the ones who simultaneously detest government intervention and yet want government to do something so that they can continue living their cheap-oil lifestyle. One thing to remember is that "Big Oil" companies actually control a relatively small share of the marketplace relative to several decades ago, approx. <20%. The real players in the market are national oil companies where countries own the oil wealth: Russia, Saudi Arabia, Venezuela, etc. They don't answer to shareholders, so they can do as they please, even if their actions contradict rational economic principles. Couple this with the apparent fact that there just isn't that much easily-pumped crude to meet demand (that's WORLDWIDE demand, not just American demand, which may see demand destruction due to a faltering economy, but there are a lot of folks in India and China who are becoming first-time car owners and each vehicle will need fuel) and you have a recipe for upward-spiraling prices. Don't look for this to change anytime soon, if ever.

Take care.

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