Thursday, October 22, 2009 Oil Price Disconnect Hurts us All

Just a wonderful piece in by Daniel Dicker on a topic we've touched on in the past. [Jul 7, 2009: NYT - Swings in Oil Prices Hobble Forecasting]

Recently, commodities bulls have been aided by the Federal Reserve keeping rates low and banks' short-term funding flowing. As cash flows into oil futures, their prices rise relative to spot prices. That makes it profitable to buy physical oil, store it and sell it forward.

Yet the indicators that would traditionally signal lower prices — like high oil inventories or OPEC’s large spare production capacity — do not seem to hold much weight today, analysts said. “Crude oil prices appear to have been divorced from the underlying fundamentals of weak demand, ample supply and high inventories,” Deutsche Bank analysts said in a recent report.

But its moves are reminiscent of last summer, when the sheer amount of money chasing crude overwhelmed the supply-and-demand equation. Says Michael Korn, president of brokerage Skokie Energy Corp.: "It's the same play going on." For many, that play was a tragedy.

As with all things in America the shenanigans going on will only be addressed when it becomes a full blown national emergency. Dan says we're catastrophe driven... hmm, sounds vaguely familiar - emergency, catastrophe; potato, tomato. [Jun 18, 2008: America - The Land of Never Addressing Anything Until it's a Full Blown Emergency]

I have not been following the refining space closely the past 18 months but if Dicker is correct, as the world is awash in barrels of oil we could be facing gasoline shortages since refiners are being crunched by the ever rising price of their input. But as readers know, the effect on peasants is not the important thing; what is key is hedge funds are making money as are the investment banks... you know, like JPMorgan storing oil in tankers offshore (backstopped by the taxpayer) since the Fed made money so cheap and it's all about speculation of assets. [Jan 11, 2009: 60 Minutes - Speculators and Oil] That's the sign of strength in a new age, finance based economy.

And yes the weak dollar is a part of this but as with all good basis for trades (i.e. Chindia is growing through the roof, therefore it makes sense for oil to go from $70 to $140 in under 2 years - ever hear that one?) it's just part of the explanation. Oh well, I am just waiting patiently for the Congressional hearings where we parade the oil executives - rinse, wash, repeat ...

Dan Dicker has been a floor trader at the New York Mercantile Exchange with more than 20 years' experience. He is a licensed commodities trade adviser. Dan's recognized energy market expertise includes active trading in crude oil, natural gas, unleaded gasoline and heating oil futures contracts.


Why isn't anyone getting mad about the lunacy of the oil market? Why isn't anyone asking, "What is going on here?" anymore. It must be the highflying stock market and decent earnings reports, convincing us that at least the financial end isn't nigh. Everybody must be too busy trying to make back the money they lost last year to care about the catastrophe in oil that is replaying itself.

Last year, as oil ratcheted up to $150 a barrel, I felt alone in screaming about the obvious decoupling of the fundamentals from the price, fighting the opposite viewpoints of the likes of heavyweights such as then-Secretary of the Treasury Hank Paulson and Nobel Prize-winning economist Paul Krugman.

This year, every oil analyst who comes on CNBC now seems to sound like me: "A liquidity trade," they crow. "A play on the weak dollar," they advise. These are euphemisms for a market with no tethers to supply and demand fundamentals, and it's arguably worse now than it was last year, as we have the added fuel of rapidly expanding ETFs in energy to add kerosene to this already raging liquidity fire. But now that we're all "on the same page" on what's causing this, I am astounded by the blithe spirit of all of these analysts. I wonder where the outrage is. Where is the concern?

People continue to forget that commodities aren't stocks.

If the stock market runs ahead of itself and decouples from its fundamentals, as most experts believe it probably has now, no one needs to get outraged about it. If stock prices have now gotten ahead of reasonable forecasts for earnings and growth, everyone still understands the game: You make your bets and take your chances.

But oil decoupling hurts everyone.

It hurts American consumers and reduces purchasing power. It sends more than $200 billion a year overseas into sovereign wealth funds of Middle Eastern countries that don't like us very much.

For American business, it's even worse: Fully 25% of the companies represented by the New York Stock Exchange are energy-dependent. Nothing can have a bigger and more direct impact on the productivity and potential for our economy more directly than the price of the crude barrel.

And now, there's one recent trend to assure prices go even further up, making these ridiculous prices look cheap: Domestic refineries are being forced to shut down. Sunoco(SUN) has closed a big refinery in New Jersey, and Valero(VLO) has shut one of its largest in Aruba.

They've done this to combat puny margins caused by rising liquidity and investment-driven crude prices. And I think more shutdowns are on their way.

They've got no choice, the refiners. They're fighting back the only way they can. But these shutdowns will cause a synthetic shortage of refined products -- the stuff people actually use. It's already beginning. The Department of Energy reports from last week showed a 5 million-barrel drawdown in gasoline. I'm expecting this week to be much the same, showing an outsized draw of refined products. And you can't stop and restart refineries like you can a kid on a skateboard.

By the spring, we're looking at a full-fledged shortage at the pumps. Now that's a fundamental you can bank on to send the prices of refined products and crude higher -- much higher. Put a little shortfall of gasoline into this mix of low-dollar, ETF-crazed crude trading and can $120 oil be far away again?

And it will happen while demand is at 14-year lows, while we are still a long way from a full recovery from the worst recession since the 1930s.

I have to ask again: Where's the concern? Maybe when oil unnecessarily goes over $100 again or touches $150, we'll see some. But I don't see it yet. Maybe we've all become inured by triple-digit prices. But we're staring into a fresh disaster on oil that could single-handedly derail whatever recovery we're expecting.

We're catastrophe-driven, I guess, and when the catastrophe looks to be averted, everyone forgets.

Last year, I screamed to make a point about the lunacy of oil pricing. This year, in a way that has astounded me, the disaster is repeating itself in perhaps even worse form. This year, it seems, that's what I'll have to be screaming about.

[Oct 16, 2009: Crude Oil Follows Goldl in Technical Breakout]
[Sep 4, 2009: Meet Optiver, High Frequency Trading Friend in Oil]
[Jun 17, 2009: CNNMoney: Obama v the Oil Bubble]

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