Hurricane Gustav Bludgeons Oil Prices, Spares People

In a great twist of irony, Hurricane Gustav did more for lowering the nation's gas bills than any of our congressmen could muster.  Forget about "evil speculators."  Who knew that the price of oil would surely fall if a tropical storm billed as the next Katrina turned out to be enormously overrated?  The price of oil is down over $7 on the news that Gustav did not do any major damage to the energy infrastructure in the Gulf.  I have yet to read reports of any human casualties, although have heard reports of significant property damage and that parts of the region will be without electricity for days.  Although certainly difficult for the residents of the Gulf Coast region and investors who were long oil futures, the nation just breathed a collective sigh of relief.  We all know who to thank the next time we fill up our gas tank.

Can't the CFTC Find a Bigger Fish to Fry?

The CFTC has taken a civil action against Optiver Holding, a Netherlands-based oil trading firm and three employees for allegedly manipulating crude oil prices.  According to the CFTC's allegations, the traders attempted to manipulate the price of different types of oil during 11 trading days in March 2007.  This manipulation led to staggering profits of $1 million!  Other firms had to be involved given the gargantuan size of the profits.  I'm certain that the CFTC is on the verge of uncovering a collusive oil market manipulation scheme run by many firms that will all split up that $1 million profit.

Given how much attention has been paid to the idea that evil speculators are behind the spike in oil prices, I can understand that the CFTC has to appear as if it is attempting to discipline traders.  Otherwise, it will risk the suffering the same fate as Fannie and Freddie's soon-to-be former regulator OFHEO.  Unless the CFTC gets its act together and starts disciplining the speculator community, Congress with make up a new regulator and replace the CFTC.  So the CFTC pointed its finger at Optiver and its measly $1 million in trading profits.

Maybe a little simple math will help explain how ludicrous it is that the CFTC chose to go after these pea shooters first.  Crude oil futures trade on the Nymex.  One futures contract is equal to 1,000 barrels of oil.  Therefore, if you own 1,000 futures, if the price of oil goes up $1, you make $1 million.  So far today, according to the Nymex website, nearly 51,000 of the September crude oil futures contracts (the current front month) have traded.  The open interest on the September contract is 316,031 contracts.  The total notional amount of the 51,000 contracts that have traded today, using $123.86 as the price of oil, is $6.3 BILLION.  The notional amount of the open interest is $39 BILLION.  Hypothetically speaking,  if you bought all 51,000 of the contracts that traded today, with crude oil down $1.63, you would be looking at losses of $81 million.  Frankly, given the size of the market, I don't understand how anyone could or would attempt to manipulate oil prices to make a measly $1 million.  

The Wall Street Journal has quotes from two congressmen applauding the CFTC's action as some sort of useful measure in clamping down on manipulators.  The irony is that according to the complaint, the traders are accused of "banging the close" or trying to force the price down in the last seconds of trading.  The traders were quoted with saying things like "just whack the oil."  Congress has been beating the drum about manipulators forcing prices higher and the first case the CFTC brings is about traders attempting to manipulate prices to do down?  Perhaps the two congressmen quoted in the Commodities Report section of the Wall Street Journal didn't actually read the allegations before applauding the action.  

A far more interesting story would be to attempt to figure out what happened at SemGroup.  SemGroup declared bankruptcy on Tuesday after posting $3.2 billion in oil trading losses.  The company was short oil futures as a hedge against its physical assets.  Speculation is mounting that the liquidation of its oil futures positions may have led to some of the recent volatility in oil prices.  Here we're talking about billions of dollars in losses taken by a firm that was only trying to hedge its oil production.  Maybe something fishy was going on here?  If I were the CFTC, I'd focus on the billions in losses rather than the $1 million in profit.  Why?  Because if there really is manipulation going on in the oil markets, the manipulators reading the headlines think this is funniest joke they've heard in a long time.

Tensions in Nigeria Negate Saudi Promises To Increase Oil Output

Saudi Arabia promised to increase output by 200,000 barrels to 9.7 million barrels a day.  The Saudi's reassurances of supply increases put nary a dent in price of crude.  Problems in Nigeria,  where attacks last week on Chevron and Royal Dutch Shell pipelines knocked out 375,000 barrel a day of production, have negated the affects of the Saudi increase.  According to the Financial Times, Nigeria now pumps less than 1.5 million barrels a day, its lowest level in 25 years.  This production level is a million barrels less than Nigeria's capacity.  Nigeria, once Africa's largest producer, is now in second place behind Angola.  Once known only for being experts at fighting a never-ending civil war, Angola was granted membership to OPEC in December 2006.  Being the number one African producer of oil should finally give the Angolans something to cheer about.  Let's hope they use the proceeds wisely. 

In addition to declines in Nigerian oil production, production from Russia, Mexico, and the North Sea has fallen by 1.5 million barrels a day since the beginning of 2007.  When put in context of declines in other major oil producers' production capabilities, the Saudi increase appears to be for public relations purposes alone.  Furthermore, skeptics wonder whether Saudi Arabia actually can pump more oil.  As I noted in my last story about soaring crude oil prices , "peak oil" theorists believe that the world's production capabilities have peaked and that the major oil fields, particularly in the Middle East, are in decline.  Continuing evidence of production declines are troubling to say the least and lend support to the argument.  The price of crude remains stubbornly high, despite many sophisticated investors' cries of a bubble (see Barron's and George Soros.)  In fact, according to the Commodity Futures Trading Commission,  the net speculative position in WTI crude futures is actually short.  This is contrary to all of the cries currently bandied about accusing speculators for the high price of oil.  If speculators are shorting oil, how much higher would the price be without their sales?  "Peak oil" believers, who until very recently were considered a bunch of kooky alarmists, are being joined by more mainstream market participants in fearing the worst.  

Record Crude Prices Blamed on Hurricanes, Traders, OPEC...Etc

According to Bloomberg, crude oil prices rose near record levels again because the National Oceanic and Atmospheric Administration warned of a more severe hurricane season than originally forecast. This story is quickly followed by another blaming crude's rise to $135 on traders who have been forced to cover losing short bets. Meanwhile, Congress has unearthed this mysterious orginization called OPEC, who unexpectedly formed a cartel with the evil plan of cornering the crude oil market. Who are these people called OPEC? Too bad they weren't around when oil was trading $10 a barrel. We could've sued them back then when the price of oil was obviously too low. The House of Representatives, fulfilling their duty to always pass useful legislation aimed at resolving our country's issues, voted this week to sue OPEC. Who will this legislation benefit the most? Possibly class action lawyers, who can now begin to gather plaintiffs for a huge class action lawsuit on behalf of every American to reclaim their God-given right to cheap oil from the Middle East. There are plenty of lawyers on Capital Hill so maybe one or two of them can explain to me how we can force countries outside of our jurisdiction to follow our anti-trust laws. More importantly, how do legislators expect to hold the Middle East responsible for our insatiable consumption habits? What I know for certain is that this legislation won't and can't lower the price of oil.
There are two and only two culprits that explain the rise in crude prices: supply and demand. On the demand side, we have the United States who refuses to change its consumption habits. Then we have China and India growing at 10% a year, giving rise to a new segment of demand that never existed before. Certainly there are "speculators" who have entered the commodities trading arena because it is "hot" now. But if you drive a car and heat your home and you're buying into an oil fund, then you are not really speculating, you are hedging your future consumption needs. The fact remains that a high price is being supported by a significant increase in demand as parts of the world rise out of poverty and demand cars and heat, luxuries that are no longer out of their reach. One can even make the argument that the price of energy has been too cheap and that consumers will only change their oil consumption habits when it gets too expensive to make economic sense. We are finally starting to get to that point as consumers are finally beginning to tire of driving large gas guzzling vehicles.
In terms of the supply side, there is the serious question of how much oil is left in the ground. The large, cheap oil fields are in decline and few new discoveries have been made. People are beginning to believe the "peak-oil" theory, instead of chalking it up to a bunch of alarmists looking for attention. Apparently, even the International Energy Agency is conducting a survey to assess the condition of the top 400 oil fields. The results will be available in November. Be sure to check back for an update then. In the meantime, there's a class action lawyer I need to call...