By now, those of you who are interested have noted that the price of crude dipped balow $50/barrel today.
You may also have noticed that I have thought for some time that much of the price range that was achieved this last summer was the product of human herd behavior in treating this commodity as a "poker chip" in large scale and ever more complex Ponzi schemes.
We have probably not reached the bottom in the process of what is now quaintly called "de-leveraging" of those prices.
Down underneath the hot air and fluff there are prices for crude oil that are supportable on the basis of cost of production and transport plus a profit margin sufficient to cause producers to accept the risk involved in the "ahl bidness" as they say in the Permian Basin.
What is that price? pl
PS – Yes, you can throw in "Peak Oil" in your comment if that is soothing.
At least in part the oil price reduction is premised on the collapse of the international economic system. Maybe it wasn’t housing after all that brought on that US first economic collapse but the stupidity of the oil producers, refiners, and retailers. Time will tell!
Still sticking with $200 a barrel by 2010!
This is impressive. I thought they gonna stick at $60. I was cynical, because a lot of major OPEC countries need it at around $40 or so.
ok. well, what we need is 99c/gal gas back to spin up the economy at positive speed again.
Of course with the total implosion of bond market and global trade. It’ll take a 10months+ to get back up.
Great call Pat!
We now have the financial crisis metastasizing into a global economic crisis which will then lead to a funding crisis.
The problem as I see it is that those responsible for the problem are being tasked with the solution. Once again these people believe that easy money and sham accounting with casino economics based on leverage will be the salvation.
IMO, what we are seeing is the breakdown of the “Greenspan Put” and the market clearing what should have been cleared in the first place. Never a pretty sight.
Is anyone even talking about the $75 billion capital that Citi raised from the Arabs, Singaporeans and other sovereign and private interests that has been wiped out of their market capitalization in the last months. And the $25 billion of taxpayer funds that Paulson handed them? Yet Vikram Pandit has already taken home over $165 million and is being paid a few million in salary to preside over this evaporation of shareholder and taxpayer capital. Anyone want to bet his options are being repriced to current values? And yes Clinton Treasury Secretary and Goldman Sachs alum Bob Rubin has walked away with over $150 million from Citi shareholders.
We are beginning to see glimpses of a setup towards a funding crisis. Some Japanese economists are calling for Obama Bonds. Note the parallel to the Carter bonds issued in Deutsche Marks and Swiss Francs.
Frankly, Paulson and Bernanke have pissed away $2 trillion with all their handouts and asset swaps. This is money Obama is going to need for infrastructure spending.
Right now there is a massive flight to US Treasury bills and bonds. 3 month bills are yielding 0.02 per cent. Monetary policy has moved to quantitative easing as the Fed Funds rate is now meaningless. As monetization accelerates I believe there will be a debacle in the Treasury market. There is no doubt in my mind that we will have to restructure all this debt. Either we can do it proactively in a sensible and controlled manner or the market will do it for us. The auto companies for example have to restructure to a 12 million automobiles a year business and then build up back to a 17 million a year business on the back of growing wages and incomes of Americans. Debt is not a substitute for incomes and savings when the marginal utility of debt is declining. Capital formation will have to formed from savings. We are going to have to return to bedrock common sense principles. We are unwinding in an uncontrolled manner the cycle of easy money and leverage. Unfortunately our politicians playing to the vested interests are not getting ahead of the curve of this inevitable debt restructuring. Will our fellow citizens wake up before even more destruction of our economic well being takes place.
I’m still not sure what you are arguing with regard to herd behavior, ponzi schemes, or well dressed investment scum bags driving up the price of oil. Perhaps speculation is something of a factor. However, in September alone, the DOT reported miles driven dropped 4.4 percent in this country – following months of decline preceding. That’s in America of all places!! Likewise, some subsidy for consumption in developing countries – notably China – had significant impact on demand. The economic vortex around which the world is currently circling has a direct impact on the price of the vital and fungible commodity of oil whose supply is decidedly inelastic. I have yet to hear a convincing mechanism for the majority of the run up in price being speculative.
Given the opacity of the state of any given oil field, Peak Oil is hard to determine. Still, at least with Peak Oil there is a mechanism influencing price called Supply and Demand.
So what’s the price point? For me, that begs the question as to how bad the global economic crises gets. In the non-catastrophic scenario with the significant and protracted downturn that seems all but baked in, I’d guess we have further to fall. If it gets bad enough, maybe we’ll even fall close to the Saudi targets. Of course, if it gets Mad Max bad, then we’re talking motorcycles, mohawks and a pint of the holy go-juice worth your life……
Pitch
How low can it go? How much slack in the supply until the production cuts made by OPEC affect that supply? How much further will demand drop? Out of work Americans won be doing much motoring. A cold winter for the East Coast might keep that price around $50.
“PS – Yes, you can throw in “Peak Oil” in your comment if that is soothing.”
Don’t speek too soon Col Lang…This does not refute hubbert’s bell curve theory; a “peak” is still looming in the horizon.
End of 2009 I see oil heading up to around the $90 a mark, which is getting to be around it’s true price.
Many of the oil deposits that are easier to get to are running out, & it’s getting more expensive to extract.
Still plenty around, but cost to extract will steadily rise.
Add rising industry in China, India & Brazil, Russia gradually getting back up to being an industrial powerhouse, as well as many other countries from Asia, South America & even Africa increasing local industries & wealth, don’t see oil staying at this level for very long.
This is a hiccup due to over speculation & the financial collapse.
Most observers see things rising back to approaching normal by the end of 2009, when the major industrial centres get through the shock & the financial industry is reorganised..
Using the Ito calculus for stochastic or random processes, Black, Schole, & Merton in 1973 developed the Black-Schole partial differentikal equation (PDE) for evaluating any kind of financial future.
Hedging, once popular in the Chicago Board of Trade, for orange juice, soybeans, wheat, and other commodity futures, now moved to Wall Street and Financial Engineering was born.
To repeat a post
pbs nova online
the formula that shook the world (remarkably similar to a heat transfer equation)
“www.pbs.org/wgbh/nova/
stockmarket/formula.html ”
“Let’s not kid ourselves: The Black-Scholes option-pricing formula is a difficult concept to grasp. To begin to understand the explanation of the formula below, you might want to first review the section on call options. Then click on the formula itself for definitions of its various elements. Finally, have a look below at the theory behind the formula. For a more comprehensive explanation of the formula, we recommend Chapter 20 of Investments, by Zvi Bodie, Alex Kane, and Alan Marcus (Irwin Press, 1996), and Finance, by Zvi Bodie and Robert Merton (Prentice Hall, 2000), the primary sources for this article. ”
more from the nova online article and a question
“Theory behind the formula
Derived by economists Myron Scholes, Robert Merton, and the late Fischer Black, the Black-Scholes Formula is a way to determine how much a call option is worth at any given time. The economist Zvi Bodie likens the impact of its discovery, which earned Scholes and Merton the 1997 Nobel Prize in Economics, to that of the discovery of the structure of DNA. Both gave birth to new fields of immense practical importance: genetic engineering on the one hand and, on the other, financial engineering. The latter relies on risk-management strategies, such as the use of the Black-Scholes formula, to reduce our vulnerability to the financial insecurity generated by a rapidly changing global economy. ”
Discovered in 1973, Nobel Prize in 1997, gave birth to financial engineering, HEDGE FUNDS.
So what happened to the “reduce our vulnerability to the financial insecurity generated by a rapidly changing global economy?”
Paulson says it’s one in a century or once in a 50 year event!
De Borchgrave likens the coming contraction to that of 1929. It will be world wide in scope. If so, oil could go down to $20/barrel.
It could last five years if the governments are timid and try to balance budgets. Now is the time to turn loose the spigots, put people to work, and start building infrastructure!
Two things are certain:
1) Demand has not reached bottom yet.
2) When it does, the price will over-react on the downside, just as it did on the upside.
Long term, prices will rise dramatically.
1) Production is dropping 9% per year in mature fields.
2) There are not that many major, new fields. Many of the newest fields are high cost.
3) The financial crisis and low prices are damaging investment in new production and alternatives.
Even if demand remains depressed for a while, how long can it be before declining supply force an inexorable upwards climb again? 2-3 years?
Present day costs of production average around $25 per barrel and transport/refining can run up to $6 barrel. Now the present ongoing “de-leveraging” in our economy is effecting that price so lets say a 35% drop and your at $20.00 per barrel total cost to the pump plus tax.
The most recent oil price collapse a decade ago brought the price to $10.00 per barrel. Thus my prognostication is somewhere between $10-$20 per barrel within three months and $200 per barrel within 5 years.
While I probably can’t make too informed of a guess on final oil price before the upward climb begins again, one thing I can say.
Its time to go after some of the staggering incomes beign racked up by the Top 1% of wealth in this country. When the senior leadership of imploding financial companies continue to rake in HUNDREDS of MILLIONS in earnings, while robbing the taxpayers, its time to raise some marginal rates. And I’m not just talking back to 39%.
This nation has entered what is likely the most serious economic crisis since the Great Depression and as others alluded, we need to save more and consume less. I’m pretty sure those autoworkers in Ohio are doing their part to spend less (of course, they’re so far into debt, they may never be able to actually save money again!). Hell, they won’t even be able to enjoy the deflationary spiral we’re on now. But what about the Paulsons, the Pandits and the Rubins? Not only will they enjoy the deflation but they are poised to profit more from it. So, I’m with Biden on this issue – it IS patriotic to ask those with the most to help the most.
And no doubt, the Federal (and state and local) Government is going to need cash to help push through this mess with stimulatory infrastructure and social spending. And it can’t raise that cash from the unemployed (whose rolls topped 4 MILLION this month).
Its already past time to get moving to repair the economic damage. As the London Banker recently pointed out, “If people go hungry their children go hungry. When children go hungry, people riot and governments fall. Everyone along the supply chain should worry about their children going hungry…[and] everyone in governments should worry about the riots.”
SP
Colonel,
gop money types are betting that oil will fall to $30-$35/barrel by buying the february puts on nymex crude oil contracts down to the $30 price.
how a localized regional U.S. housing risk spread nationwide, and then worldwide through securitized mortgages and derivatives causing a worldwide contraction- simply explained by Ajit Balakrishnan
Greenspan & Atlas Shrugged
“www.business-standard.com/india/storypage.php?autono=340133 ”
ok, i got over my laziness and opened up the source code.
my previous post b/ in html
Ajit Balakrishnan: The novelist who is to blame-THE WORLDWIDE FINANCIAL CRISIS
Kevin:
Don’t speek too soon Col Lang…This does not refute hubbert’s bell curve theory; a “peak” is still looming in the horizon.
Colonel Lang has made it abundantly clear that he is not talking about secular (long-term) price behavior. Thus the peak of peak oil looming in the future is not in play in these near-term price fluctuations.
Well, there’s one important exception to that assertion, and therein lies the problem of trying to fit diffusion models like Black-Scholes to economic systems. The problem is that particles that diffuse in an isotropic medium are actually much smarter than humans, because particles don’t listen to CNBC or read the Wall Street Journal, hence their movements are independent of such collective bias.
Humans affect these pristine mathematical models by virtue of such behaviors as pack responses. Economists know about these biases, but they don’t know how to incorporate them accurately into models (in fact, it may not even be feasible to do so). So they ignore them and pretend that these factors don’t matter. But they do.
For example, if the citizens of a city (e.g., Atlanta) read in their newspapers that there are gas shortages occurring in nearby cities (e.g., Knoxville, TN), then many of them will rush to their local gas stations to top up their tanks before the shortage hits. And in doing so, they can readily cause a gas shortage to occur, thus fulfilling their predictions.
That happened this year, where some otherwise-manageable shortages in gas supply turned into unmanageable shortages because local gas buyers all believed the same thing at the same time, and thus wished their thoughts into existence (or more accurately, created a bigger problem than otherwise needed to occur).
So “Peak Oil” may indeed have played a role in this summer’s oil price spikes. The widespread recent press coverage of this long-term supply problem could have been a factor in the gullibility of those who were paying such high prices for oil futures. After all, somebody has to cover the other end of every bad trade, and in some cases, peak oil might have been their justification for doing so.
High oil prices resulted in recycled petro dollars invested in Treasuries. Which, like state lotteries, was a form of indirect taxation. That party is over, at least for present. If prices fall below the cost of production – if anyone knows what that is – then OPEC budgets get balanced by cashing in those bonds. That doesn’t sound good.
I recall Hugo Chavez boasting that at $60 a barrel, Venezuela had the largest proven reserves in the world. It’s just that much of it wasn’t light sweet crude, but heavier, more expensive to refine stuff. Looks like that party’s over, too. Maybe he had the time to pump up his economy such that it would not be as dependent on oil revenues.
Everywhere you look, bad news. At some point we’ll stop with the academic chit-chat, and get down to, “can I borrow a cup of sugar?”
This housewife saw the shortage behavior last winter in supplies of wheat flour and white rice. Suddenly you could not find rice in any store. Flour prices went sky-high and there were disconcertingly similar articles in newspapers nationwide discussing the effect on local pizzerias of the price shortage. My suspicious mind considered for a moment whether the frenzy was orchestrated; certainly the news articles in Oakland and New York were alike in structure, only varying in location and name of pizza parlor.
Anyway – I don’t know if peak oil is going to bring zombies to my neighborhood next month to barbecue my children, but I am stocking up the pantry as Sharon Astyk suggests on her blog. Whatever happens, we have enough to feed ourselves and some friends and relations for a few weeks.
Dave, I just bought fifteen pounds of sugar on sale. You’re always welcome to a cup.
Housewifely question:
How much of global oil consumption goes into plastic junk we don’t need for our quality of life: packaging, disposables, toys and trinkets? I mean the amount of plastic tubs going into Lebanese landfills boggles the mind – just for yogurt alone it’s phenomenal. We don’t really need plastic to eat yogurt; humanity ate yogurt for millenia without plastic. Crockery, glass, metal; and cut drastically the use of shrink wrap, individual containers, plastic utensils, and shopping bags.
Does anybody have good numbers on this? Seems to me it’s a win-win – reduce inessential use of petroleum, cut down on pollution.
supply is finite in the short term. long term, that is not the case, nor has it been with oil.
That is why the peak oil bell curve looks so ominous when you take a look at it, as it reflects short term supply.
Long term, the supply can be expanded. Not every discovery is known or announced. Prices at some point will indeed increase back up to $100+, but at that point, exploration will also expand to include areas previously not explored, and new technology will be brought online enabling higher yield from current fields.
Oil is an investment vehicle. So long as leading companies, and other assets are selling at severely depressed price levels, the opportunity cost of going into oil will be too high. Thus I hate to burst some bubbles here, but oil will not be at $200 anytime within the next 5 years. In fact, I would go so far as saying we won’t see $100 oil for the next 24, or perhaps 36 months.
What is that price? pl
Oil companies are ‘natural monopolies’ and should be regulated as such.
If oil companies are storing crude on the high seas waiting for a better price point it may provide a ceiling for crude until this excess inventory is consumed.
OPEC Set to Cut Crude Supply 3.8 Percent This Month,
PetroLogistics Says OPEC will cut oil supplies by 3.8 percent this month as the group implements its Oct. 24 resolution to reduce production, according to provisional data from Geneva-based consultant PetroLogistics Ltd.
http://www.bloomberg.com/apps/news?pid=20601104&sid=acfeczHuCimg&refer=mideast
Cieran,
An interesting short paper by Andrew Oswald, an economics professor at the University of Warwick, echoes your argument about pack or herd behaviour, suggesting that neglect of such behaviour is in fact an Achilles heel of contemporary economic theorising. He also argues that the fundamentally flawed policy conclusions to which such neglect leads are a significant part of the background to the current economic crisis.
An extract:
“Why do herds form? They happen when relative position matters. People paid extraordinarily high prices for houses, even though not justified by fundamentals, because they felt they were trailing behind the Joneses. Brokers sold unsound mortgages because they had to keep up with rival brokers. Money managers — remunerated on their relative performance against other managers — traded shares with the same motive.
“Yet conventional economics contains no recognition of such action. The word ‘herd’ does not appear in leading textbooks. In consequence, those texts do not offer an intellectual framework that could have predicted, or can help policy-makers in, our current dilemma. The research journals are little different. Since 1970, on an electronic count, only 3 out of the last 8000 articles in the Economic Journal discuss herd behaviour; 2 out of 2000 articles in the Quarterly Journal of Economics; and 4 out of 1500 articles in the Journal of Financial Economics. It would be difficult to prove that this is why the world is in a mess. But common sense suggests that the lacuna is a powerful contributing factor. Just as before the Great Depression, economists and central bankers have been using the wrong model of human behaviour.
“It will be necessary to rewrite standard economics. We must bring the idea of relative comparisons and herd behaviour into the centre of our thinking. A good place to start is William Hamilton’s article on defensive herding in the 1971 Journal of Theoretical Biology, and work by Andrew Clark and others in, for example, the 1998 Journal of Public Economics.
“In a world with herd behaviour, there exists a natural intellectual case for government intervention to internalize the externalities created. The coolheaded individuals of our unrealistic traditional textbooks do not need to be regulated. Herds do.”
(See http://www2.warwick.ac.uk/fac/soc/economics/staff/faculty/oswald/herdcrisis2008.pdf.)
Among larger questions involved is at what point the use of mathematical methods in economics moves from being a source of extraordinary illumination to being a source of obfuscation; and also how far people are prone to come to define reality in terms dictated by the intellectual tools they are good at handling.
David Habakkuk:
Thank you for the reference on herd behavior in economics. This material lies at the heart of the debate regarding regulation of financial markets, and the fact that this obvious influence is ignored in theory makes it even more important to remember its effects in practice.
I continue to be astonished by the reverence the financial community holds for such mechanistic models as Black-Scholes. While many assert that these models involve difficult mathematics, in fact they don’t (the math involved is primitive relative to what is needed to include effects such as herd behaviors). The underlying mathematical models barely describe simple physics (e.g., linear one-dimensional diffusion), and have no prayer of capturing the real-world behaviors of markets with any degree of robustness.
The fact that institutions such as the U.S. automotive industry are now at risk because the globalized financial world developed a dubious infatuation with oversimplified economic models is something we should never lose sight of. Real-world citizens are losing their jobs because of collective idiocy on Wall Street, and as that fact emerges in the political discourse, the only appropriate speculation would seem to be in pitchfork and torch futures.
2 Trillion next year, for cleaning up Bush mess.
http://www.nytimes.com/aponline/washington/AP-Meltdown-Deficits.html
Federal Deficit Could Hit $1 Trillion This Year
The federal government’s ledger has gone from a surplus just seven years ago to facing a prospect of a $1 trillion deficit next year.
Given those dire financial straits, President-elect Barack Obama said at a news conference Tuesday, ”Budget reform is not an option. It’s a necessity.”
But unlike his predecessor President George W. Bush, who in better economic times talked about returning to surpluses by 2012, ”balanced budgets” were not in Obama’s vocabulary.