Sunday, March 16, 2008

OPEC is right - there is no shortage of oil

I am no fan of OPEC or any cartel, but they are precisely right when they refuse to increase production and insist that there is plenty of oil available in the market. They are ABSOLUTELY correct in their assessment of the supply of crude oil. Sure, global demand for oil is growing, but certainly not at a pace even a fraction of the pace of recent price rises. In fact, the inventory level of crude oil here in the U.S. is quite healthy. As of Wednesday, the weekly U.S. DOE EIA inventory report says that we have 311.6 MILLION barrels of crude oil sitting in storage tanks waiting for someone to use it. Granted, that is 2.8% below the level a year ago, but is still "in the middle of the average range for this time of year." There is simply no shortage of crude oil. Let me say that again: There is simply no shortage of crude oil.

So, why is the price of oil so high? One word: speculation.

Of course, we have always had speculation. So, what is different this time? One phrase: taking delivery. In the past, speculators simply bought futures contracts, held them for days or weeks or months and then sold them at a profit and "rolled" into a new batch of futures contracts. Because they were buying and selling fairly frequently their net impact on the price level was fairly modest, a mere "tax." But now, hedge funds and proprietary trading desks within financial institutions, among other speculators, are actually taking delivery of oil and other commodities. Now, they do not actually have the physical product delivered to their offices, but simply begin paying for storage of oil in a storage tank or gold in a vault or grain in a storage bin or whatever the appropriate storage may happen to be. The point is that since they are no longer selling the futures contracts there is no opportunity for the upwards price impetus when they purchased the futures contract to cancel out with a sale.

In short, there is plenty of oil sitting in storage that could be sold, but hedge funds and financial institutions and other speculators are intentionally keeping product off the market. Even so, OPEC, et al are still pumping more than enough oil to keep the maket fully supplied, but the ongoing one-way trading of oil futures contracts keeps the NYMEX futures market price of oil artificially higher, much higher than actual demand by true users of oil (refiners, chemical companies, transportation companies.)

To put it another way, OPEC is in fact selling a huge amount of oil, but the one-way nature of futures markets is attaching a price to each barrel of oil or other unit of commodity that is completely out of line with the actual supply and demand for actual use of the commidity.

Not all speculators are engaging in taking delivery, but enough of it is going on to keep this pyramid scheme going. Technically what the big speculators are doing is cornering the market. That can work for a while and even for quite a while, but is a very dangerous game to play. If they do not get out before the full speculative demand is met, they will get stuck with losses so massive that they effectively cannot sell their holdings at any price. That is why OPEC is reluctant to increase supply further, because it will only fuel the speculative bubble and cause even greater risk that the market price for oil will completely collapse once speculators realize that "the bubble has burst."

To be clear, OPEC is doing precisely the right thing: Pumping just enough oil to meet real demand by real users of crude oil.

Another factor influencing supply is that the inventory in the U.S. Strategic Petroleum Reserve (SPR) has been rising lately, by 100,000 barrels of oil in the latest week. My suspicion is that the oil companies are pumping oil into the reserve to make room in commercial storage tanks for storage of oil for speculators who have taken delivery.

The bottom line is that "total stocks" of oil and oil products is 0.8% above a year ago and "in the upper half of the average range for this time of year." To say it again: There is no shortage of oil. As far as gasoline, the inventory is 11.2% above a year and and "above the upper limit of the average range." There is no shortage of gasoline.

What I find truly appalling is that not even any of the Democratic presidential candidates are focusing any attention of the massive tsunami of commodities speculation that is continuing to wash over the pocketbooks of middle-class consumers. Let me be clear, the problem is not "big oil companies" or "big bad OPEC", but primarily the self-serving "investment" practices of hedge funds, financial institutions, and other speculators, both large and small. There seems to be very little comprehension among politions of the massive, pervasive, and socially-ruinous qualities of this speculation. Or, when they do know, they have too many deep-pocket contributors who have grown dependent on that speculation.

Finally, it could very well be that profits from this tsunami of commodities speculation might very well be all that keeps Wall Street from complete collapse. That alone may be keeping the regulators at bay, the hope that maybe Wall Street can "profit" its way out of its current financial mess.

To close, I am once again forced to admit that: OPEC is right - there is no shortage of oil and that the causes of high oil prices have to be found elsewhere - namely Wall Street.

-- Jack Krupansky

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