Tag Archives: Oil prices

OPEC: Threat or menace…?

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Michael Giberson

… or a clumsy cartel causing excessive volatility in world oil prices, or maybe none of the above. Earlier this week the Cato Institute hosted a discussion of a recent report by Andrew Morriss and Roger Meiners, “Competition in World Oil Markets: A Meta-Analysis and Review.” Panelists included Morriss, FedEx chairman Frederick Smith, and SMU economist James L. Smith. Jerry Taylor coordinated the program.

Of the group of panelists, I think it is J. Smith that has the best handle on the evidence — which unfortunately is all over the map. Yes you can find evidence that OPEC has manipulated oil prices and contributes to instability, but your can find comparable evidence suggesting OPEC has had no real effect. My preferred view is that Saudi Arabia has had an ability to swing prices up or down a bit at the margin–they being the one country willing to maintain excess productive capacity and manage it with an eye to long-run price levels. On J. Smith’s discussion of the evidence, perhaps I should become more agnostic on the matter.

If you, too, have an opinion about the effect of OPEC on world oil markets, then you ought to listen to the program and consider whether your view is well supported by detailed studies of the issue.

ADDED: Mentioned in the discussion is James Smith’s Journal of Economic Perspectives article, “World Oil: Market or Mayhem?“, available free online.

Virginia Postrel on Delta’s refinery purchase

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Lynne Kiesling

Just a quick note to accompany the discussion in the comments on Mike’s post about Southwest Airlines, Delta Airlines, and fuel price hedging: a couple of weeks ago Virginia Postrel had a very good analysis of the reasons why the Delta-Conoco transaction is not a good idea, in her regular column at Bloomberg View. Virginia’s analysis emphasizes the extent to which vertical integration is only profitable when transaction costs make markets and contracting more expensive ways to accomplish the transaction. In this case, markets do not have substantial transaction costs.

But what about fuel price risk? Here Virginia quotes friend of Knowledge Problem Craig Pirrong:

The proposed purchase “doesn’t make a huge amount of economic sense — in fact quite the opposite,” says Craig Pirrong, a finance professor and director of the Global Energy Management Institute at the University of Houston’s Bauer College of Business.

You might think that owning a refinery would at least protect the airline from price fluctuations. But, Pirrong notes, crude oil prices affect the profits of airlines and oil refineries exactly the same way. When oil prices go up, their profits go down. Owning a refinery would simply magnify the effect. “If anything,” he says, “it increases the risk exposure that has bedeviled the airline industry for years.” …

Delta simply seems to be falling for the great fallacy of vertical integration: the belief that the inputs you get from an in-house supplier are cheaper than those you buy in the open market. There’s no markup. You’ve cut out the middle man!

But this story misses the real cost of those inputs.

Basically, if fuel prices are high, Delta will still not fly those costly half-full flights, but will instead sell their fuel in the low-transaction-cost markets. So what’s the point of owning the refinery when it’s not their comparative advantage and refining is such a low-margin business?

Oil speculator witch hunt, 2012 edition

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Michael Giberson

Steve Mufson at the Washington Post reports:

President Obama proposed measures Tuesday to step up oversight of energy markets and boost by tenfold the penalties for market manipulation, in an effort to blunt political pressure over the 20 percent increase in gasoline prices since the beginning of the year. [Links in source.]

Not that the administration has turned up any evidence of problems in the market:

A senior administration official said the president wants to increase the number of “cops on the beat” to stop illegal speculation and market ma­nipu­la­tion…. But neither Obama nor his aides pointed to any examples of such illegal activity or to any evidence that oil speculators had, in fact, been responsible for raising prices recently. The senior official said that oil prices have been rising mainly because of growing global demand and political uncertainty in the Persian Gulf. Obama cited “global trends” in his announcement. Lawmakers on both sides of the political divide have alleged that “speculation” is partly responsible for the jump in oil prices over the past year, but they have not offered any examples, either.

See also: the Wall Street Journal‘s article; the New York Times on the topic; and from The Nation, “Obama Announces Empty Crackdown on Oil Speculation.”

The Nation‘s piece is interesting, essentially claiming that the President is right on the merit of his proposals, but just pandering to the public with symbolic gestures since five out of six of his proposals require Congressional action the President knows he won’t get, and the President refuses to do the one thing he can do that would work (in the author’s view): telling the attorney general to start subpoenaing oil traders and begin actually uncovering oil market manipulation.

Of course you may recall that a year ago the President did tell his attorney general to constitute an Oil and Gas Price Fraud Working Group. Last month the Attorney General reported on its many great successes.

Just kidding, they’ve got nothing. Here is what the Attorney General actually said on March 9, 2012:

Since last April – when I established a new part of the Task Force known as the Oil and Gas Price Fraud Working Group – we’ve also been focused on identifying civil or criminal violations in the oil and gasoline markets, and ensuring that American consumers are not harmed by unlawful conduct.   This Working Group’s latest meeting was held at the Justice Department just this morning – and its members discussed a variety of topics, including the role of speculators in the market; recent reports and enforcement matters by various Working Group members – such as the FTC and the New York State Attorney General’s Office; as well as ways to improve information sharing between Working Group members and partners; and where we go from here.

I can also report that one of the Working Group’s members – the Federal Trade Commission – is currently conducting an investigation, with assistance from other Working Group members, into whether gas prices have been affected by any antitrust violation or market manipulation by refiners, oil producers, transporters, marketers, physical or financial traders, or others.  Working Group members stand ready to act if the FTC learns anything that implicates the laws they enforce.

So in short, they’ve held meetings, talked about stuff, and are working on better “information sharing” (always a popular task for interagency task forces because you get to have new processes requiring new paperwork so you can justify new staff to handle the added work load). Oh yeah, the FTC is conducting an investigation. (Which has been known since at least last December and so far no results. More from McClatchy on the OGPFWG. A blogger at Think Progress is seriously disappointed in the administration’s lack of commitment to rooting out oil market manipulators.)

Like before, a shameful, pandering witch hunt in search of short-term political advantage. (And by the way, the GOP is no better in their beating of the political drums trying to pin high gasoline prices on the President’s failure to approve the Keystone XL pipeline and reductions of oil output from federal lands.)

Hamilton on the main reason oil prices are high

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Michael Giberson

Saudi oil minister Ali al-Naimi said  there was “no rational reason” for current high oil prices, since there were enough supplies and all consumers were getting oil.

James Hamilton rises to object, “if oil prices were lower, the world would want to consume more than is currently being produced.” Hamilton examines what the quantity demanded might be at lower prices and concludes we’d need about an additional 15 million barrels a day in supply to meet consumer demand at oil prices of a decade ago.

So the higher price is encouraging some consumers to reduce their consumption while urging suppliers to increase, if they can, the amount of oil they bring to the market.

The WSJ’s confused story on gasoline prices and crude oil prices

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Michael Giberson

Caption: Change in retail gasoline prices vs. prices of two benchmark crude

WSJ Image: Change in retail gasoline prices vs. prices of two benchmark crude

The story in yesterday’s Wall Street Journal on the link between gasoline prices and crude oil prices was a bit frustrating. The article does a reasonable job explaining key pieces of the puzzle, but then fails to assemble the puzzle into something resembling reality.

The story is headlined, “Gas Stays High as Oil Drops: Prices at the Pump Have Yet to Reflect the Substantial Decline in Crude Futures,” and the first sentence repeats the theme: “U.S. crude-oil prices have hit the skids, but drivers aren’t feeling the impact.” The next couple of sentence fill in some details. In brief, the story says, the benchmark crude oil price is down nearly one-third since April, but U.S. gasoline prices are only down about 13 percent.

The mystery of the just-down-13-percent gasoline prices is almost entirely created by trying to treat the NYMEX price as the relevant benchmark, but it isn’t. (As noted here in February.) Currently the Brent price is a better indicator of the world oil market price for crude oil. Our story here, then, is that world oil prices have dropped 18 percent since April while average gasoline prices dropped 13 percent. Hardly a different warranting a headline.

The reporter fully recognizes this point, as he explains, “gasoline prices on the East Coast and even in the Gulf Coast track the price of Brent crude, which analysts view as a better indicator of global prices than Nymex. While Nymex futures are down 30% since April 29, Brent is down 18%.” And the story is accompanied by a graphic, above, which graphically illustrates the point that Brent seems to be the relevant reference point.

So why the struggle to cast this story about gasoline prices that are not falling fast enough?

Oil speculator witch hunt, 2011 edition

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Lynne Kiesling

Following up on Mike’s post yesterday about pandering politicians and their 2011 edition of the recurring petroleum price witch hunt … Others have weighed in on the idiocy of this “Oil and Gas Price Fraud Working Group”. Let’s start with KP’s go-to energy finance economist, Craig Pirrong:

… it’s an opportunistic effort to scapegoat others on the basis of zero evidence in order to distract attention from the real issues–but that’s cool!

Here’s a non-enabling professor’s take:

“Craig Pirrong, a finance professor at the University of Houston who specializes in commodity prices, says the task force is hardly needed, since the agencies already have the tools to monitor for fraud and take action. [Yeah.  It's like their day job.]

“This is a transparently political fishing expedition that insinuates that fraud or manipulation is distorting oil prices without providing even the flimsiest factual basis for such a suspicion,” Pirrong said. “This is part of a broad effort by the administration to deflect criticism with regard to gasoline prices.””

Actually, the “fishing expedition” characterization is probably optimistic.  Especially given Obama’s assertion of ownership of the issue, and his personal identification with the claim that speculators are distorting prices, there is a high likelihood that fishing expedition will give way to witch hunt.  Remember when Obama told bankers “[m]y administration is the only thing standing between you and the pitchforks”?   It is becoming increasingly clear that Obama won’t be standing between oil “speculators” and the pitchforks this time.  Indeed, he’s taking leadership of the mob.

And this from KP’s go-to journalist (and, I’m convinced, sometimes more-eloquent inhabitor of my brain), Reason’s Matt Welch:

Here’s your federal energy policy: Do nothing significant to increase domestic supply, create mandates to have XX% of future supply come from magical green leprechauns, then when prices (surprise!) go up, you know what to do: Blame the “speculators”.

Finally, Cato’s Jerry Taylor and Peter VanDoren in Forbes give a thorough, straightforward lesson on how futures market works to indicate how ludicrous the “speculators are raising petroleum prices” argument truly is:

If this is going on we would expect to see some sort of inventory buildup. While crude inventories in the U.S. are increasing, they always increase at this time of year, and this year’s increase is well within the normal range. More important, gasoline inventories are decreasing and decreasing much more rapidly than normal. Hence, there’s no evidence that speculators are reducing the supply of crude or gasoline through increased storage.

Producers, however, could react in the same way to higher futures prices by decreasing current production to allow more future production at higher prices. Alas, we see no evidence of suspicious reductions in producer output that might give this story credence.

They then go on to give a good, concise summary of recent research showing that both prices and quantities in petroleum futures markets are reacting to global factors, such as political unrest in Libya (shifting the oil supply curve to the left) and increases in economic activity (shifting oil and gasoline demand curves to the right). Even a basic understanding of introductory economics would enable the interested observer to conclude that, while the ultimate quantity of oil and gasoline transacted is ambiguous, the combination of a decreased supply and an increased demand will unambiguously increase prices.

Perhaps someone should inform the DOJ and the Obama Administration, assuming that they actually care about the underlying economic fundamentals …

Crude oil prices in 2008: Was the spike a bubble?

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Michael Giberson

In the physical world, spikes and bubbles are quite different things that don’t generally get mistaken for one another.  Curiously, in economic metaphor, the same phenomena can be called a spike and a bubble.  Argument among economists continues on the issue of whether the oil price spike in 2008 was or wasn’t a bubble.

A few weeks ago Paul Krugman dismissed the idea that the 2008 run up in oil prices was a bubble, and suggested that high oil prices “are largely caused by fundamentals.” In a May 2008 op-ed Krugman also argued against the bubble claim, claiming that if speculators were to  blame there would be tell-tale signs like the accumulation of excess inventories.

Amy Myers Jaffe responded at the Baker Energy Institute Forum blog:

The problem with Krugman’s logic is that he was in factual error. Oil inventories were indeed increasing as prices were going up, and by a large amount, especially if you add in what we in the industry call “oil at sea” which refers to a build up of the number of large tankers of oil floating offshore or slow steaming to markets that lack sufficient demand for that supply.

Right around the time that Krugman declared that there was no oil bubble, Energy Intelligence Group was reporting that oil inventories in the industrialized countries had risen by 1.2 million barrels per day in April 2008, which put them well above the five-year average. In a telling sign of how limited on-land oil-storage space was at the time, Iran had to commission ten very large crude oil carriers (VLCCs) to hold its unsold oil afloat off its coast, a practice not seen since 1989, when oil prices were collapsing.

The problem with Jaffe’s response is that it ignores long established oil industry patterns. High prices or low prices, the industry tends to build inventory in the first four months of the year and draw down those inventories during the next five or six months. (For example: U.S. Energy Information Administration on oil stocks: “World oil stocks follow a seasonal pattern in which they are typically drawn down rapidly in the middle of the winter and re-built rapidly in the spring…”)

Jaffe needs inventories to accumulate in excess of normal industry practices to sustain her argument.  Her claim that inventories in April 2008 were “well above the five-year average” is ambiguous; was April 2008 inventory above the five-year average for that time of year or just above the average level for every month of the previous five years?  It makes a difference because it is ordinary for April to have higher inventories than any other month, and only relevant to the case if April 2008 was extraordinarily high.

I don’t have the Energy Intelligence Group data at hand, and I don’t find other world inventory data readily available.  U.S. inventory data from the EIA shows the typical pattern of inventory accumulation in the spring and draw down over the summer.  Early 2008 does show slightly higher inventories (less than 2% higher) relative to the average inventory for the same week of the year over the prior five years.  On the other hand, early 2008 also showed slightly lower inventories (less than 2% lower) relative to the average inventory for the same week of the year over the prior 20 years.  The inventory build up in early 2008 doesn’t seem so far off typical industry practices to justify bubble claims.

Admittedly, crude oil inventory is the U.S. is only a part of a bigger picture. If you have better data to share, I’d be interested.

The Iran anecdote that Jaffe tossed into here story seems to be the result of temporary and idiosyncratic conditions, so probably not revealing on the larger issue.  On May 2, 2008, Bloomberg reported:

Iran, OPEC’s second-largest oil producer, more than doubled the amount stored in tankers idling in the Persian Gulf, sending ship prices higher as demand for some of its crude fell, people familiar with the situation said….

While oil rose to a record $119.93 a barrel on April 28, Iran has a glut of its sulfur-rich crude as refineries that can process the fuel shut down for maintenance. The discount on Iranian Heavy crude compared with Oman and Dubai petroleum has more than doubled since the start of the year, according to data compiled by Bloomberg.

“There’s not much demand for heavier crudes such as those from Iran,” said Anthony Nunan, assistant general manager for risk management at Mitsubishi Corp. in Tokyo. “It’s the peak of the refinery maintenance season in Asia, and Iran also sells oil to Europe and the Mediterranean, where some refineries are having turnarounds,” or seasonal shutdowns for repairs, he said.

I’m not claiming Krugman is right; I generally don’t read Krugman and particularly don’t rely on his opinions on energy market issues. I’m also not claiming that Jaffe is wrong.  What I am claiming is that Jaffe simply doesn’t offer sufficient backing for her argument.

Price signals and free markets lead to oil exploration: who’d a thunk it?

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Lynne Kiesling

From a good article in today’s New York Times: 2009 is turning out to be a bumper year for new oil discoveries; new oil discoveries always occur, but this year has been unusually fruitful. This quote from the article illustrates the important dynamic intertemporal incentives that price signals provide:

These discoveries, spanning five continents, are the result of hefty investments that began earlier in the decade when oil prices rose, and of new technologies that allow explorers to drill at greater depths and break tougher rocks.

“That’s the wonderful thing about price signals in a free market — it puts people in a better position to take more exploration risk,” said James T. Hackett, chairman and chief executive of Anadarko Petroleum.

More than 200 discoveries have been reported so far this year in dozens of countries, including northern Iraq’s Kurdish region, Australia, Israel, Iran, Brazil, Norway, Ghana and Russia. They have been made by international giants, like Exxon Mobil, but also by industry minnows, like Tullow Oil.

Note here the hetergeneity of both the location of the discoveries and the types of firms that are exploring and discovering.

See also the comments and the tie to peak oil from Tim Haab at Environmental Economics.

There’s also an interesting similarity, and contrast, with how high natural gas prices have induced further exploration and discovery in the U.S. in the form of shale gas. Extracting shale gas is more costly because it’s embedded in shale rock, but the high natural gas prices since 2003 have induced innovation and exploration. That, combined with other discoveries, has led to historically high natural gas inventories (shifting out the supply curve); this year’s recession has reduced the demand for natural gas (shifting in the demand curve). Not surprisingly, therefore, the price of natural gas is about one-fourth of what is was back in, say, 2005. This week NPR has been running a series on natural gas innovation and exploration; the first in the series is here, and there are more resources associated with the series on their web site as well.

Crude oil price volatility

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Michael Giberson

The New York Times observes that crude oil price volatility has been exceptionally high for the last eighteen months.

Daily changes in the spot price of crude oil, 1983-2009

New York Times graphic: Daily changes in the spot price of crude oil, 1983-2009

(Hmmm. Eighteen months ago … January 2008 … the Iowa caucuses … the U.S. presidential primary season gets underway in earnest … nahhh, couldn’t be all due to presidential politics.)  Actually, eyeballing the chart that accompanies the article, it looks like volatility didn’t really take off until the macroeconomic slide later in 2008. From the story:

“To call this extreme volatility might be an understatement,” said Laura Wright, the chief financial officer at Southwest Airlines, a company that has sought to insure itself against volatile prices by buying long-term oil contracts. “Over the past 15 to 18 months, this has been unprecedented. I don’t think it can be easily rationalized.”

Volatility in the oil markets in the last year has reached levels not recorded since the energy shocks of the late 1970s and early 1980s, according to Costanza Jacazio, an energy analyst at Barclays Capital in New York.

Energy price volatility may have implications for various energy policy proposals seeking to dramatically reshape the industry.  Research published in the Energy Journal (“Does oil price uncertainty affect energy use?” Gerard Kuper and Daan van Soest, 2006. Link to abstract.) reported that oil price volatility discourages investment in new energy-using technology:

Volatility clustering implies that high levels of volatility today give rise to the expectation that volatility will remain high in the foreseeable future, and hence the probability of price change reversals is expected to remain high as well. Volatility itself induces firms to respond sluggishly to energy price changes, and this effect is exacerbated if volatility is clustered over time as higher volatility today implies that tomorrow volatility is likely to be high too….

Our results thus give support to the theoretical prediction that energy price volatility renders energy-saving technologies less attractive. The policy implications are that in uncertain times, energy taxes are not expected to be very effective in reducing energy use, and that reducing and managing uncertainty should be high up on the policy agenda.

AN ASIDE: Between when I first read the NYT story yesterday and posting about it this morning, the title of the article morphed from “Volatile swings in price of oil stir fears on recovery” to “Swings in price of oil hobble forecasting.” I wonder if that change is a editorial judgment to minimize negative tone toward the economy, or just an effort to make headlines into statements of the obvious?

ANOTHER COMMENT: The Energy Journal doesn’t make it easy for web-based researchers to locate and link to articles in the journal (as compared to, say, the Electricity Journal or Energy Policy). As research has become increasingly web-based, that is probably not the best long-term approach.