Soros: Skyrocketing Oil Prices a Bubble

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Veteran investor George Soros, in an interview with the Telegraph, describes speculation as a significant factor in the recent spike in oil prices. However, he doesn’t expect prices to break until there are signs of economic weakening. Later in the post, I’ll provide some information that suggests how traditional supply/demand forces could have been swamped by the volume of futures trading.

First, from the Telegraph:

Speculators are largely responsible for driving crude prices to their peaks in recent weeks and the record oil price now looks like a bubble, George Soros has warned….

In an interview with The Daily Telegraph, Mr Soros said that although the weak dollar, ebbing Middle Eastern supply and record Chinese demand could explain some of the increase in energy prices, the crude oil market had been significantly affected by speculation.

“Speculation… is increasingly affecting the price,” he said. “The price has this parabolic shape which is characteristic of bubbles,” he said.

The comments are significant, not only because Mr Soros is the world’s most prominent hedge fund investor but also because many experts have claimed speculation is only a minor factor affecting crude prices….

However, Mr Soros warned that the oil bubble would not burst until both the US and Britain were in recession, after which prices could fall dramatically.

“You can also anticipate that [the bubble] will eventually correct but that is unlikely to happen before the recession actually reduces the demand.

“The rise in the price of oil and food is going to weigh and aggravate the recession.”….

He said: “The dislocations will be greater [than in the 1970s] because you also have the implications of the house price decline, which you didn’t have in the 1970s.”

The warning undermines predictions that Britain will suffer only a brief and relatively painless recession, unlike the precipitous dives of previous years.

Mr Soros also warned that the Bank’s inflation report represents a “Faustian pact”, obliging it to keep interest rates high to control inflation, even as the economy is starting to slump.

“You had the nice decade,” he said. “Now that is over and you are in a straitjacket.”

Now let’s consider how Soros’ argument might be correct. In general, the notion that spot prices accurately reflect supply an demand is a bit overdone. As Matthew Simmons noted in 1998:

In our opinion…prices over the short-term tell us nothing about the supply and demand fundamentals for oil. Rather than being a perfect indicator for the fundamentals, price is a perfect indicator for the psychology of a small number of funds.

There are two arguments made against the speculation thesis. One is arbitrage: if oil was too high, someone would go short the future and buy oil in the cash market cheaper, and earn the arbitrage profit.

The problem with that logic is that price discovery happens in the futures markets; there isn’t another venue for setting the price and thus arbitraging it against futures. Worse, a substantial amount of that trading is either over the counter (hence not reported to US futures regulators) or on the ICE exchange in London (ditto).

The two most important visible markets are NYMEX and ICE, and far and away the two most important types of crude (in terms of price discovery and setting global prices) are West Texas Intermediate and North Sea Brent. A June 2006 US Senate Permanent Subcommittee on Investigations report on “The Role of Market Speculation in rising oil and gas prices,” found:

…there is substantial evidence supporting the conclusion that the large amount of speculation in the current market has significantly increased prices….

Until recently, US energy futures were traded exclusively on regulated exchanges within the United States, like the NYMEX, which are subject to extensive oversight by the CFTC, including ongoing monitoring to detect and prevent price manipulation or fraud. In recent years, however, there has been a tremendous growth in the trading of contracts that look and are structured just like futures contracts, but which are traded on unregulated OTC electronic markets. Because of their similarity to futures contracts they are often called “futures look-alikes.”

The only practical difference between futures look-alike contracts and futures contracts is that the look-alikes are traded in unregulated markets whereas futures are traded on regulated exchanges. The trading of energy commodities by large firms on OTC electronic exchanges was exempted from CFTC oversight by a provision inserted at the behest of Enron ….

The impact on market oversight has been substantial. NYMEX traders, for example, are required to keep records of all trades and report large trades to the CFTC. These Large Trader Reports, together with daily trading data providing price and volume information, are the CFTC’s primary tools to gauge the extent of speculation….

In contrast to trades conducted on the NYMEX, traders on unregulated OTC electronic exchanges are not required to keep records or file Large Trader Reports with the CFTC, and these trades are exempt from routine CFTC oversight. In contrast to trades conducted on regulated futures exchanges, there is no limit on the number of contracts a speculator may hold on an unregulated OTC electronic exchange, no monitoring of trading by the exchange itself, and no reporting of the amount of outstanding contracts (“open interest”) at the end of each day.

ICE started trading WTI futures (and provided screen in the US) which meant that WTI trading was increasingly unsupervised by the CFTC. As the Senate report noted,

ICE’s filings with the Securities and Exchange Commission and other evidence indicate that its over-the-counter electronic exchange performs a price discovery function — and thereby affects US energy prices — in the cash market for the energy commodities traded on that exchange.

Moreover, the 2006 report found that $25 of the then $60 a barrel price was due to speculation, based oil inventory levels.

In recent testimony before Congress, Mike Masters discussed at some length how, via the so-called Swaps Loophole, futures transactions on exchanges by financial players, which ought to be listed as speculators (anyone other than a commercial buyer or seller is “non-commercial”) are instead classified as commercials. Thus even the trading under the CFTC’s surveillance is categorized incorrectly.

Now let’s look at the price discovery question. Derivatives markets can supersede cash markets because it’s more convenient to trade there. And we have examples in other markets of derivative prices distorting price formation in the cash markets.

Exhibit A is the credit default swaps markets. Estimates vary, but at $62 trillion, the amount of CDS is believed to be roughly ten times in aggregate the amount of cash bonds (some names have much bigger multiples of CDS written on them than others). This year, corporate bond issuers, even AAA rated ones like General Electric and Berkshire Hathaway, have raised fund at costs over the risk free rate that seem wildly high. Why? Disruption in the credit default swaps markets due to a shortage of protection writers and blow-ups in correlation models. It’s generally agreed that the resulting price in the cash markets are “wrong” but guess what? Via arbitrage, the CDS price drives the cash market price.

Now remember, the CDS is ten times as big as the cash bond market. The Nattering Naybob was so kind as to do the math on the size of a futures contract relative to the underlying physical trading. Remember, you can arbitrage futures to physical only if you are permitted to do so (only certain traders, known to have access to the storage and transport, are allowed to take or make physical delivery) and can actually obtain the relevant commodity:

Global Oil Production 2007 is 85.6 million barrels PER DAY.. times 365 = 31.244 Billion per year…The amount of Brent on ICE is only a small portion of the whole.

Considering EIA estimates, total European oil production for 2007 of which the bulk of Brent originates from is 5.426 million barrels per day times 365 days = 1.980 billion barrels per year.

Now divide 57 billion ICE Brent contracts by 1.980 billion barrels and the price leverage is 28.78 to 1.

NOTE: The price of Brent as traded on the International Commodities Exchange is predicated on barrels of Brent for delivery at Sullom Voe.

Brent crude is a blend of oil from several fields in the northern part of the North Sea, including Ninian and the Brent field itself.

Sullom Voe is an inlet between North Mainland and Northmavine on Shetland in Scotland. It is a location of the Sullom Voe oil terminal.

Oil is pumped to Sullom Voe via the Brent and Ninian pipelines. Crude from the Schiehallion and Clair fields are also exported from Sullom Voe.

According to a Bloomberg article,

“Brent exports from Sullom Voe peaked in 1985 at about 1.2 million barrels a day.”

2007, estimated total oil exports from the UK, which includes Sullom Voe:

616 million barrels divided into 57 billion virtual barrels = 92.4 to 1 pricing leverage.

Consider: this is only the volume trading on exchanges. It does not include the amount traded OTC, which is considered to be significant.

The argument against the notion that oil prices are distorted (which clearly is possible given the weight of money in the futures market versus the actual value of the physical commodity traded) is that if prices were too high, you’d see physical hoarding of the commodity.

Consider where the mystery inventory might be:

1. Given the speed of the run-up, there may be a delay in hoarding taking place (real world buyers and sellers may have thought prices would fall back, as they did for a bit earlier this year).

2. Tankers full of Iranian crude are floating around the Gulf. Admittedly, this is nasty, less preferred crude, but it is still in surplus

3. The Chinese are very secretive, and known to be stockpiling diesel, and possibly crude as well to prevent any embarrassing outages before and during the Olympics. According to Xinhua, China’s oil and oil derivative products growth 1Q 2008 versus 2007 is well ahead of GDP growth of 10.6%.:

China’s net imports of crude oil was 44.95 million tonnes in the first quarter, up 14.9 percent, and net imports of oil products rose by 31.8 percent from a year ago to 5.47 million tonnes, according to General Administration of Customs. China’s imports of diesel in the first quarter surged over 600 percent to 1.66 million tonnes and the imports of gasoline, rose by nearly twice to 76,654 tonnes.

The article also noted:

Deng Yusong, a researcher with the Development Research Center of the State Council, said that abnormal needs boosted by below-cost prices of refined oil products controlled by the central government over concerns of the country’s rising CPI is another major reason contributing to the country’s surging oil consumption.

In other words, domestic players suspect that the government will have to raise oil prices and are moving their purchases forward.

4. The IEA only counts primary inventory as inventory. Anything else is demand:

Demand is total inland deliveries plus refinery fuels and bunkers minus backflows from the petro-chemicals sector. It is thus equivalent to oil consumption plus any secondary and tertiary stock increases.

Further note how narrow the definition of primary stock is:

Unless stated otherwise, all stocks included in the report are primary. They include stocks held in refineries, natural gas processing plants, oil terminals and entrepôts (where these are known), pipelines and stocks held on board incoming ocean vessels in port or at mooring.

Thus any end user inventory, which is one place you might see hoarding, would not be included as inventories.

5. Finally, some suppliers may simply be choosing not to pump. Some readers and commentors have provided anecdotal evidence, and James Hamilton in his new paper also provided some quotes from the Saudis and Kuwatis along those lines. A reader gave the logic:

It is being left in the ground.

For over a hundred years the oil industry has been building out a huge infrastructure for mining, transporting, refining and distributing oil and its associated products.

It doesn’t make much sense to add to this infrastructure, if we’ve reached the peak of physical throughput. Going forward, refining capacity will probably move closer to the source of crude, and more of the transport will be devoted to moving of product. But, that prospective shift is a detail.

There’s no accumulation of speculative inventories in the refining and distribution chain, because there’s no slack in that chain, and won’t be any, because, looking forward, creating such slack makes no sense.

The only way to “hoard” oil effectively in these circumstances, is to delay oil production from fields with low marginal unit cost, while shifting production to fields or sources with high marginal unit costs. This conserves the expected rents, in a balanced way. That is, those with low marginal cost oil to produce see their wealth rising, while those with quasi-rents on infrastructure are protected.

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  1. mxq

    Yves…apropos to Soros, Buffet remarked in 2006 (via Evergreen LCG Commentary):

    “We share Warren Buffett’s view that there may be a bubble in commodities. In the Berkshire annual meeting in May of 2006, Warren Buffett said, “I don’t think there’s a bubble in agricultural commodities like wheat, corn and soybeans. But in metals and oil there’s been a terrific [price] move. It’s like most trends: At the beginning, it’s driven by fundamentals, then speculation takes over. As the old saying goes, what the wise man does in the beginning, fools do in the end. With any asset class that has a big move, first the fundamentals attract speculation, then the speculation becomes dominant.” He went on to say, “It’s like being Cinderella at the ball. You know that at midnight everything’s going to turn back to pumpkins & mice. But you look around and say, ‘one more dance,’ and so does everyone else. The party does get to be more fun — and besides, there are no clocks on the wall. And then suddenly the clock strikes 12, and everything turns back to pumpkins and mice.” (Source:, May 6, 2006)”

  2. Anonymous

    Soros gives an assertion. He makes no case, and provides no data whatsoever to back up his assertion.

    You say that the IEA reports too narrowly on inventory?!?!? They count as inventory all oil in refinery storage, producer storage, in pipelines, en route in tankers, and being stored in ships. Where else exactly do you suppose oil is being stored, Yves? Are you thinking gas stations are suddenly building tank farms out back?

    It doesn’t matter where oil is traded (on ICE or anywhere else), or how much of it is traded OTC. Just look at any 24-hour chart of oil prices broken down minute by minute, and you will see clearly that NYMEX is what controls the price. Non-NYMEX trading either mirrors what happened on NYMEX that day, or it gets quickly cancelled out by the trading on NYMEX the next day.

    No matter how you trade the oil, and matter what the financial instruments used, if the price were getting too high we’d see a build in inventories, and we’re not seeing that. Instead we’re seeing inventory declines and fuel shortages all over the world:

    Production drops 5.1% in Australia:

    Sinopec warns of fuel shortage in China for Olympics: and

    Petrol shortage in India:

    Diesel shortage in Yemen:

    Production in Mexico drops 13%:

    Fuel crisis in Nepal:

    UAE burning oil in power plants to make up for natural gas demand/supply gap:

    Moe Gamble

  3. retread


    You are predictable. It wouldn’t have mattered what Soros said, you’ d dismiss it.

    You don’t read very well. Someone here said that INDUSTRIAL end user stockpiling wouldn’t be counted by the IEA. Hasn’t it occurred to you that industrial users have storage facilities? Per what I read (and I can read) the IEA does not count secondary and tertiary inventory. Distributor inventories appear not to be included in primary inventory either. My family was friendly with a distributor in the first oil crisis who hoarded enough gas (multi-millionaire at the time) that he went bust when prices fell. Distributors also have enough storage capacity to stockpile.

    You also didn’t read as far as trading was concerned. The point was that that the volume of trading contracts on the exchanges alone is so large that it dwarfs the value of the underlying. That means the tail can wag the dog, and that’s not counting OTC. Either you didn’t get it or chose to muddy things.

    And you ignored China’s hoarding. But you consider diesel shortages in Yemen noteworthy. Yemen? You have to be kidding.

    Soros may not have presented facts, but he has a track record. You are interested only in facts that support your opinion. The more I read you, the more you come off like a zealot not an analyst.

  4. Anonymous

    This is Moe Gamble again, continuing my first post.

    The example you give for Brent, where contracts traded greatly exceeds actual barrels, in no way represents leverage. Every paper contract is a bet on price that must be bet by a paper contract representing an opposite bet on the price. The number of paper contracts in relation to the actual barrels simply doesn’t matter. A producer can provide barrels for his end of the contract, or he can simply short with paper contracts if the price gets too high. A producer is in no way limited in his shorting with any obligation to provide actual barrels.

    If you look at the CFTC report, you will see that commercial traders overwhelmingly dominate trading in Brent, just as they do WTI, Dubai, and every other category of oil, oil product, and oil-related swap.

    You have clearly not read the 2006 Senate report. I have, and Engdahl either didn’t read it himself, or is being deliberately misleading about its contents. The Senate committee staff were split in their views and recommendations, and that’s noted in the report. Their view that speculators can control prices was based solely on natural gas trading by one hedge fund. The price of gas went up, and this hedge fund was very long. Half of the Senate committee staff people who prepared the report believed the hedge fund had caused the price to go up–the other half didn’t feel that the hedge fund was the cause.

    The 2006 Senate report stated that oil got $25 too high in 2006. That was based solely on production costs at the time (when $90 deepwater production wasn’t needed for supply). But it’s also true that in 2006 the price of oil was bid up too high by speculators. However, there was a ton of evidence in 2006 that the price had been pushed up too high by speculators. Spec net longs were extremely high. Inventories were soaring–in fact, tankers full of oil were sitting in harbors all over the world, unable to unload because onland storage facilities were all full. The price soon crashed to $50.

    By contrast, spec net longs are very low in oil right now, and inventories are at average to below-average levels. (For the U.S. see:

    OECD inventories are also slightly below the average:

    In addition, the backwardation premium is extremely low right now. When the price is at $130ish, the backwardation premium right now is only a few cents. Backwardation is essentially a market mechanism for commercial traders to pay speculators a premium to take price risk the commercials don’t want. When the backwardation premium is very low, it means the commercials, who know a lot more a lot earlier about what the inventory report will show, don’t see much risk of the price falling.

    It is very misleading to say that tankers full of Iranian crude are floating around the Gulf. In the first place, this crude is accounted for in the IEA inventory reports, so you can’t call it hidden hoarding. In the second place, this inventory is already on the way down, as the refineries that process that type of oil are now back online after routine spring maintenance. And again, this oil is less in demand because it’s sub-optimal for making diesel, and the worldwide shortage is in diesel.

    There is no evidence that the Chinese are stockpiling diesel–in fact, there is evidence (see the links in my post above) that they are experiencing shortages. It is true that China, like the United States, is trying to build a strategic petroleum reserve, but the current energy crisis related to the earthquake shows exactly why such strategic reserves are important.

    The run-up hasn’t been all that speedy. Prices nearly doubled from January 2007 to December 2007–that was plenty enough of a build-up to trigger hoarding, over a time plenty long enough to give us some evidence of hoarding.

    Regarding hoarding in the ground, it would be smart if nations started limiting production, because the fact is we’re running out of oil and we have no replacement in place for it. Unfortunately, there is little to no evidence that any significant discoveries are being left undeveloped for the future.

  5. Anonymous

    retread: Hear, hear. The price of everything, the value of nothing. Sound and fury too.

  6. Anonymous

    Regarding retread’s post, if Soros had provided any useable data, I would consider it because it’s extremely important to me not to bet wrong.

    Distributor inventories are, first of all, not of oil but of product, so they would have zero impact on oil inventory, which is what we’re talking about. But distributor inventories are indeed counted in the inventory. That’s what the IEA is talking about when they talking about the pipeline inventory. Also, industrial end users are refineries, plastics manufacturers, and the like, and their supplies are indeed counted in the IEA inventory figures.

    Just because an individual trader went broke on his inventory during a price crash, doesn’t mean his inventory wasn’t counted by the IEA and EIA.

    retread says I didn’t address some of the issues in Yves post, but that is because when I tried to post a full reply, it was rejected, possibly as too long. So I rewrote the post in two parts. The second of my posts addresses the rest of Yves’ and retreads’ points.

    retread comes off to me as someone who, again, doesn’t reply with facts. People who want to believe that prices are in a bubble, rather than responding to fundamental supply and demand imbalances, are free to do so and are going to do so. But belief doesn’t refute data, and I’ve provided a lot of data in a very long series of posts going back some weeks now. If you have some data to counter my arguments and data, I’d be very interested in seeing it.

    Moe Gamble

  7. Anonymous

    Re: “”You can also anticipate that [the bubble] will eventually correct but that is unlikely to happen before the recession actually reduces the demand.”

    What he is speaking of is people parking SUVs and trying to sell them from pennies on the dollar. He is also speaking of very few people traveling or being able to spend money anywhere, or to borrow to buy things like homes, cars, luxury goods; things will slow down to a crawl and then oil prices will rocket down to $60 and then in 5 years, the next tech bubble will attract attention by those that have jobs.

  8. Anonymous

    One last point, from Moe Gamble again:

    I posted on nakedcapitalism a couple of weeks ago that prices were due to supply and demand, but that I expected the price to stabilize in June. I have also posted that I wouldn’t be suprised to see a 10% dip in the price from the top, but that I’m not confident we’ll see it because speculators simply aren’t very long. There are not many people to scare out of the market.

    Still, I wouldn’t be surprised by a better buying opportunity (lower risk, higher reward potential) in the fall, when seasonal demand declines, before buying starts for the winter. And even that will depend on the timing of new production coming online toward the end of the year.

  9. Anonymous

    regarding anonymous 1.46pm’s post, of course we are starting to see people parking SUVs. And purchases of high fuel efficiency vehicles are up by a large percent this year. But that’s a large percentage of a very small percentage. The overwhelming majority of new vehicles being sold are not the most fuel efficient vehicles.

    As the poorest consumers get cut out of the market, demand elasticity goes down. The people who remain in the market are relatively rich, and are bidding for supply against other relatively rich people.

    Long-term, studies show that elasticity is likely to get higher, partly, as you state, because of the effect of high energy prices on the overall economy. But people who are predicting big falls in the price due to demand destruction are just wrong, simply because of how much supply would go out of production if prices fell that much, and how much demand would return if prices fell that much.

    Again, here are some excellent studies of short-term and long-term demand elasticity:

    “Evidence of a Shift in the Short-Run Price Elasticity of Gasoline Demand” (from the Univ. of CA, 2007):

    A 2008 study from the Congressional Budget Office:

    A 2005 Department of Energy study:

    And one more point: Counting on destruction of the economy to lower oil prices is a very bad idea, though tempting to those who believe they’ll survive the crisis.

    The only way to restore a reasonable cost of energy to the economy, without destroying the economy, is by investment in energy efficiency. If you use energy efficiently enough, it doesn’t matter how expensive the price of oil gets. You’ll be using less and less of it to get the same effect.

    Moe Gamble

  10. mxq

    RE: ” if the price were getting too high we’d see a build in inventories, and we’re not seeing that. Instead we’re seeing inventory declines and fuel shortages all over the world “

    Moe, why don’t you delineate between a shortage due to unavailability of inventory and sovereign gov’ts halting subsidies…clearly, there is a big difference.

    And by the way, If anybody here is “misleading”, clearly it is you, as you offer zero countervailing facts to your arguments and criticize those that do. In fact, you are a case study in the “overconfidence effect”…dick thaler has made a mint off people like you.

    That said, here is more detail on why there are huge cracks in your “shortage” hypothesis.

    The crux of the supply shortage in the story RE: India was this: “The supplies were disrupted because the Manmad Municipal Council sealed the HPCL depot for non-payment of dues”…you wanna know why?

    B/C Retailers are going bk, choking down subsidies:

    “At this rate, Hindustan Petroleum (HPCL) and Bharat Petroleum (BPCL) can only pay for imports till end- July. Indian Oil (IOC) can only sustain till mid-September,” the official, who did not wish to be identified, told reporters.”

    In addition, According to the Economic Times: “With international crude prices hovering around $132 a barrel, oil PSUs—IndianOil , Bharat Petroleum and Hindustan Petroleum— are jointly looking at losses of $46 billion this year.”

    These are sub-prime mortgage-esqe losses we’re talking about, Moe. That’s per annum…for India alone.

    And speaking of financing, according to (indian newspaper): “global suppliers of crude and petro-products are not going to honour contracts unless money is paid upfront, which means the country could be looking at a frightening scenario of a fuel shortage.”

    Repeat: “global suppliers of crude and petro-products are not going to honour contracts unless money is paid upfront, which means the country could be looking at a frightening scenario of a fuel shortage”…not because OPEC can’t pump enough…nope.

    Prices ARE too high, Moe. Just you wait.

    And to all readers, feel free to subtract Moe’s “noisy” contribution from Yves argument regarding speculation, as it is more or less off-kilter.

  11. Anonymous

    re: mxq’s post, I have posted at least a half dozen times that part of the reason for high demand at these oil prices is government subsidies of product prices in the Gulf states, China, India and the U.S.

    So, we have no disagreement there. However, China has already stated that they are not going to increase product prices at this time, because they are trying to use price controls to control inflation.

    It’s unclear whether India is going to decrease subsidies, because half the government is strongly supportive of subsidies. We’ll have to see what happens there.

    There is no sign whatsoever that the U.S. has any immediate plans to end its gasoline subsidies via ethanol.

    And there is no sign whatsoever that the Gulf states plan to end their subsidies of gasoline.

    As I have posted repeatedly over the past couple of weeks (with links to data) China and India are both running short on supply because with the price of crude what it is, their producer cannot provide product at the gov’t-controlled price without going broke. Over the past year, China has responded to this problem by repeatedly finding ways to subsidize their producers’ purchase of oil, rather than by raising product prices.

    Until there is some fundamental change in the subsidy/demand picture, or the supply picture, prices reflect a balance of current supply and demand.

    And here’s an assertion to balance Soros’ assertion: “U.S. Treasury Secretary Henry Paulson told CNBC Thursday that rising oil prices are not driven by market speculation but instead reflect tight supplies and growing global demand.

    “‘There aren’t easy short-term solutions,’ he said. ‘But it’s about increasing the supply over the longer term and developing new sources of energy.'”

    Since it’s easy to find opposing assertions, the best way to find out what’s right is to look at real data.

    And by all means, everyone feel free not to read my posts, if that makes you feel better.

    Moe Gamble

  12. mxq

    Ooook…back to the issue at hand (speculation):

    The shork report said this today: “spot crude oil prices on the NYMEX continue to surge last week and the term structure continued to collapse. Whereas the average front-month contract for Jul’08 delivery has jumped by more than #17 a barrel or 15% over the last month, the contract for delivery in December 2016 inextricably surge by nearly $32 a barrel or 30.5%. Thus, we don’t care how many times Boone…and other, less telegenic hedge fund managers…pontificates, there is no fundamental that justifies that kind of price path in that short of time.”

  13. mxq

    Moe said: “You say that the IEA reports too narrowly on inventory?!?!? They count as inventory all oil in refinery storage, producer storage, in pipelines, en route in tankers, and being stored in ships.”

    I want to see the link that explicitly verifies this Moe…until you provide it, I’m chalking it up as BS.

    Moe said: “It doesn’t matter where oil is traded (on ICE or anywhere else), or how much of it is traded OTC. Just look at any 24-hour chart of oil prices broken down minute by minute, and you will see clearly that NYMEX is what controls the price. Non-NYMEX trading either mirrors what happened on NYMEX that day, or it gets quickly cancelled out by the trading on NYMEX the next day.”

    Where do you get this stuff, Moe? It reads like a shot from the hip. According to the NYMEX re: WTI calendar swaps: “Settlement – Financial, based on the arithmetic average of the NYMEX Light Sweet Crude Oil first nearby contract settlement price minus the ICE Brent Crude Oil Futures first nearby contract settlement price for each business day that both are determined during the contract month.”

    You’re wrong again Moe. The exchange where Oil is traded IS very relevant.

    Back to Yves re: Soros…John Mauldin sent this out in his newsletter last weekend (entitled “Whither Oil”:

    “I called George about six this evening and asked him about the Iranian situation, as that is a lot of oil that could come on the market at some point, as well as a possible reason that oil supplies are down. George has analysts on top of this situation.

    He told me, “John, it’s more interesting than that. It is not just Iran. Today we started checking on how many tankers Iran had, and soon discovered that there is a serious tanker shortage. Lease prices have soared in the past few weeks. It is clear there are a lot of speculators betting that oil is going to rise to $150 or so and are willing to pay very high prices for keeping the oil on the seas waiting for higher prices. It is a speculative boom.”

    He then told me about flying into New York in the early ’80s. Outside the harbor were 30 or so tankers just sitting, waiting for prices to continue to increase as they had been doing for some time. When they did not, they all tried to get into the harbor at the same time, and of course they couldn’t. It was the top of the market. Prices dropped, and the owners of the oil had to go to the futures market to hedge what they could. I had heard that story, but George saw it with his own eyes.

    Almost everyone (except the stock market) is convinced oil is going higher in the near term. As I noted above, this week’s rally was partially due to short covering by large institutions and companies which had sold production far into the future at much lower prices. They finally threw in the towel and took off their hedges.”

  14. Anonymous

    In response to mxq, I say that almost everyone thinks oil prices are in a bubble, which is why speculative net longs are so low. The studies discussed in this report by the CFTC show that the recent rise to prices above $100/barrel has not been accompanied by increased speculation.

    Iran’s hiring of oil tankers to store their heavy crude is well-known, and I’ve posted about it myself here a number of times, with links explaining the situation. The situation is that Iran’s heavy crude has not been in high demand during a period in which refineries that process the heavy crude have been down for spring maintenance. Heavy crude is not in demand because it’s not optimal for making diesel. Oil prices are high because of a worldwide shortage of diesel. (Shortage of diesel means demand is for light sweet:; iran’s stored oil is heavy crude and refineries that process it are down for maintenance:

    This is a completely different situation from the one Soros observed in the early 80s, or even from the one we saw in 2006. Soros clearly doesn’t understand the diesel/heavy crude situation.

    EIA’s definition of primary dealers ( “Primary stocks of crude oil and petroleum products held in storage as of 12 midnight on the last day of the month. Primary stocks include crude oil or petroleum products held in storage at (or in) leases, refineries, natural gas processing plants, pipelines, tank farms, and bulk terminals that can store at least 50,000 barrels of petroleum products or that can receive petroleum products by tanker, barge, or pipeline. Crude oil that is in-transit by water from Alaska, or that is stored on Federal leases or in the Strategic Petroleum Reserve is included. Primary Stocks exclude stocks of foreign origin that are held in bonded warehouse storage.”

    So, anyplace that can store 50,000 barrels is included as a primary dealer, as well as anyplace that can receive product by tanker, barge, or pipeline. That would leave out only places that are receiving oil by tanker truck, and a tanker truck can carry only roughly 9000 gallons, or 214 barrels. Tanker trucks are used to supply gas stations, not tank farms. Gas stations store only a 2-3 supply. Tertiary supplies are literally in the hands of consumers–it’s literally the product in home heating oil or propane tanks. The reason the EIA doesn’t bother with secondary and tertiary inventory is because they’ve got a handle on it and it’s so small relative to the 320.4 million barrel inventory they’re tracking.

    The WTI/Brent swap has nothing whatsoever to do with what Yves is expressing concern about–that is, his fear that prices are being set by speculators buying like crazy on ICE, or over the counter, or in other markets that no one is looking at. ICE is where the most Brent contracts are traded, and NYMEX is where the most WTI contracts are traded. Sometimes Brent trades at a different price than WTI, so what? The question is, is WTI’s price being controlled by forces or trading outside of NYMEX, and it clearly is not. You can tell this by watching the markets overnight–the trading is extremely thin. The bid and ask price are often far apart. If the price gets run up a few dollars, you virtually always see NYMEX take the price back down.

    If manipulative mass trading on ICE was controlling the price of oil, oil price charts would look a lot more like the charts for currency futures–you’d see huge gaps in the price overnight that did not get corrected in U.S. markets.

    Now, let me know what other links you need to get adequately informed about what’s going on in these markets.

    Moe Gamble

  15. Anonymous

    In reply to mxq about the leap in 2016 WTI futures prices, that was a short squeeze (on a day when all shorts were squeezed) and the price has already come sharply down to normalish levels. To see that this is true, simply look at a chart for CLZ16.

    The price of that contract had jumped to $145.60. Now, two days later, it’s back down to $130.50. It had been at $130.40 before the big jump.

    Moe Gamble

  16. another anonymous

    In reading through this, I see a pretty clear pattern. People raise objections. Moe responds with lots of data that often doesn’t refute the point. I’m getting tired of it.

    mxq talked about Indian companies not being able to pay for diesel any more, that was the cause of shortages, and made a more general point about needing to clarify the role of subsidies (or withdrawal of them) in diesel shortages. You ignored his point that de facto, the subsidies in India HAVE broken down. The gov’t oil companies are broke. So some politicians want to continue the subsidies. Yeah, and some here want to rescue the housing market too. Overly expensive measures have a funny way of not happening.

    Similarly, Moe never addressed the point re China and hoarding. I’ve seen quite a few places the Chinese are hoarding, they don’t cooperate with international data sources. Yes, unofficial, but the official data on China is no good. And that’s not just true in oil, it’s true in a lot of other areas.

    And you have repeatedly talked about speculation yet never addressed what Yves said about speculation, the trading volume versus underlying, the fact that investors are classified as commercials. You’ve instead dropped lots of red herrings.

    I’m coming to agree with mqx, you may have lots of facts (or as he has shown, shooting from the hip masquerading as facts), but the more I read, the more this comes off as intellectually dishonest or deluded.

  17. Anonymous

    another anonymous says I ignored mxq’s point that Indian oil companies were not able to pay for diesel anymore.

    That is absurd–I have stated repeatedly that Indian oil companies cannot pay the market price for diesel or oil because the Indian gov’t will not allow them to sell diesel at the market price. The “subsidies” the Indian gov’t provides to Indian consumers is to hold the price by decree below market price.

    another anonymous has provided absolutely no data to show that China has been hoarding. I have provided numerous links with reports showing that gas stations in five Chinese provinces are running out of diesel everyday at this time by mid-day. I also provided a link that showed that Sinopec had announced that diesel shortages would exist in China at the time of the Olympics unless the either gov’t controlled consumer prices were increased, or gov’t subsidies to Sinopec were increased, because Sinopec can’t afford to buy diesel on the market and sell it at the price set by the Chinese gov’t. Again, this is the form the Chinese subsidy takes. I hope it’s clear to you now.

    I also have clearly addressed Yves’ point about the volume of trading in paper contracts vs the volume of product supplied. What I said was that it didn’t matter that there were more paper barrels traded than physical barrels, because every paper or physical barrel long has to be met by either a paper or physical barrel short. Oil producers can thus sell as many paper barrels as they want–it’s not like there are a limited number of shares that speculators are competing for.

    If you had read the link to the CFTC report I provided ( you would see that the CFTC receives weekly reports from ICE about the members/customers trading WTC on ICE, and that data is part of their research. The CFTC also receives info on the volume of trading originating from the U.S. The report says, “Thus, CFTC surveillance staf knows the positions and identities of members/customers who meet or exceed position-reporting requirement levels… and can consider that data along with the large trader reporting information that it receives from NYMEX…”

    The report also says that the CFTC has “the tools to adequately police the markets falling under CFTC jurisdiction” when it comes to over the counter trading. As they explain “The first thing to recognize about OTC contracts is that they are typically benchmarked to NYMEX futures prices.” They specify that they know the number of OTC contracts cleared through NYMEX and ICE.

    Also, you are wrong that there are non-commercial traders trading as commercials. Again, the report to which I link spells out exactly how traders are classified as commercial or non-commercial. A bank may have commercial status when trading interest rate futures, but would still be listed as a non-commercial trader for any trades in oil. See p. 7 & 8 of the report.

    another anonymous has clearly not read any of the reports to which I linked, or any of the arguments provided in my posts.

    Moe Gamble

  18. Yves Smith


    I don’t like doing this, but I am putting you on warning. And though I am sure you will attribute it to the byplay today, it’s in fact based on my inbox.

    One of my goals for this blog is to encourage active discussion. It helps me and it helps readers. I think one of the big reasons Calculated Risk is as successful as it is is that they have a very active, high quality community.

    It is becoming apparent that your comments are driving out rather than encouraging others to speak.

    In the normal course of events (excluding one guy I correspond with regularly) I get maybe one or two e-mails a week with information. Almost always these are research reports, and I am very happy to get them.

    However, in the last three weeks, I have gotten 14 messages from a range of writers, all with information (articles, research, etc) questioning some aspects of the bull oil hypothesis. A high proportion of these have even come on days when I have had a post up.

    That says they do not want to participate in comments.. And I can see why. You may not realize it, but your posture is that you are right and you not only want to win, you are going to win.

    Brokerage firms screen for that quality (high desire to dominate) in retail salesmen. It isn’t necessarily a plus in other contexts, and this is one of them.

    I also notice that you called your comments “post”. Big Freudian slip. This is my blog, If you want to post, get your own blog.

    You do not contribute to any other discussions on this site, your sole objective seems to be to come and prove your point of view. Why this so important to you is beyond me, but getting interesting information in my mailbox that instead should be posted in comments is a burden to me and a disservice to other readers. I’d rather have the community kick it around when it relates to an active topic.

    Further, you haven’t taken the hint from the software. The fact that your comments are overlong and are being truncated is a message that you are taking too much airtime.

    I don’t know about CR, but Barry Ritholtz tells me he polices his comments aggressively and deletes those where the writer has abused his privileges.

    The biggest drawback of your contributions is the one I suspect you will find hardest to recognize and moderate, namely, the aggressiveness, the insistence. Reading the threads, you seem determined to drown out all views that differ from yours. If you can’t contain that, I will have to intervene.

  19. chegewara

    to all the commodity bulls out there, just one remark: if futures market always reflect fundamentals, how come they are so consistently cornered? commodity market index funds are the all time biggest corner in the markets. and the way institutional investing is built right now (give more money to winners, i.e. momentum) it will yet again take a disasterous mispricing and consequent drop off the cliff in demand to bare the truth.

  20. S

    Tangential to the oil bull bear case, is the question of where the nxt trade lies. It seems the world (hedge) is warming to technology as it provides a sliver of the opacity (in deference to earlier comment on a post on the dark pools in today’s FT – by who other than LEH). The alternatives, already narrow, are becoming tightrope like. Looks like there is a few last breaths in stocks at least, but it seems we draw nearer and nearer to a stone dropping. Perhpas it is the broker earnings..As an aside also interesting that Al Quaeda is out with a threat to use WMD as Iran is being sanctioned by IAEA for non discloure etc..(again). Perhaps the filling of the Strat Oil Reserve was for a purpose. MAn walks in off street and hands Idsraeli govn’t evidence against the dove. Too many things are happening in the geo space that are highly coincidental – the road is being paved to Tehran. Oil at 250, dollar tanking, US bank system insolvent: what is left to lose at this point, really? The military is the only remianing solvent institution in this country, agree or disagree with the war notwithstanding. Stratfor also out with a weekly on oil winners (Russia) losers (China) also interesting.

  21. Anonymous

    I’m either thick or not reading deeply enough… and I read a lot… but no-one seems to be providing the knock out punch here in terms of making sense of the causality between futures contracts and spot prices. So maybe if I try to elaborate on my confusion I can elicit the aha moment:

    Would anyone ask whether trading weather derivatives might cause weather changes? Would anyone think that betting on a horse might actually cause that horse to win? No? So how do we define the difference between “markets” like these mentioned with the futures market such that the causality of high investment in commodities futures on high commodities prices is explained?

  22. Anonymous

    Weather derivatives, you’ve got your analogies all wrong.

    There was a time a long time ago when the pricing of oil was done apart from the exchanges. But now the futures exchanges have become the place where price discovery takes place. There is not other place to go for oil prices. They are set in reference to the prices on exchanges.

    And separately, even if there was more separation between futures and cash prices, Yves gave an example in the post with credit default swaps and bond prices.

    We are talking about a price setting mechanism in one market affecting prices in a closely linked market.

  23. Anonymous

    Weather derivatives, didn’t mean to seem harsh, it’s just weather isn’t bought and sold. And there isn’t an active trading market in racehorse prices. Even a horse in a claiming race is at a set price.

  24. Anonymous

    I’m a lurker here, but just wanted to say I don’t see anything said by Moe that is inaccurate whereas the statements by Soros which he corrected were.

    I’m just going to add a couple more points to Moe’s list: 1) Canterell is collapsing. 2) Bergen is collapsing. 3) The North Sea is in serious decline. 4) The Saudi’s have not only NOT increased production (many argue because they couldn’t if they wanted to), they’ve also now made comments to the affect they are going to treat their oil like a strategic asset for the long-term wealth of their citizens, and that means they’re not going to rush to pump it, 5) If you look at Russia’s projected production, they look like they peaked last year and will only be able to sustain current production until 2012 before starting to decline, 6) That superfield in Brazil, the one heralded as the third largest ever found is so deep, and is at such pressure and high temperature it is technically impossible to produce with today’s best technology, 7) China is not hoarding. It’s announced it is creating its own Strategic Petroleum Reserve that will exceed 300 million barrels, 8) India, Japan and many other nations all have plans to build SPR’s exceeding 25 million barrels, 9) China and Japan have both already signed deals for Liquified Natural Gas at $16/mmcf which although a different commodity clearly identifies the future projected price of energy (North American rates are currently $11.00 and were actually significantly lower when the Japanese & Chinese deals were announced) 10) If you look at the remaining global reserves of oil, a huge majority are in what would be deemed unstable nations (Saudi Arabia, Venezuela, Iran, Iraq, Nigeria, etc.) – increasing the likelihood of future supply disruptions – increasing the likelihood of higher prices due to those disruptions – increasing the tendency of individuals/corporations wanting to lock-in future prices now if they can.

    Bottom Line: Until prices reach a level that destroy demand, prices are going up because of fundamentals….not speculation.

    Cheers all, Matthew.

  25. mxq

    Moe…take it easy on the filibuster-length arguments. There are more constructive/concise ways to get your point(s) across.

    That said, last time I checked, this isn’t a forum for teaching blog etiquette. Your posts are obviously passive-aggressive attempts to torpedo posts and other comments. That’s right in line with an asshat.

    IMO, If you are incapable of “living” in the blogsphere, perhaps you should live somewhere else.

  26. Anonymous


    With all due respect, there are a lot of ideas that get muddlied in the public discussion.

    A market price would be one that matched price and demand, and the way most people like Paul Krugman construe it, that means REAL, CURRENT demand for use. Anything else, whether you call it hoarding or a strategic reserve, is inventory building. That will lead to a higher price than the true market price, that is, one that matches demand (for use) and supply.

    So a Chinese petroleum reserve is, from a pricing/inventory standpoint, no different than hoarding. Yves provided a quote and some data above that suggested there was hoarding. Given all the corruption and decentralization in China, I’d bet there is an element of the authorities not knowing in full what is going on as well as trying to disguise their moves.

    Now you can argue that it would be better if prices were higher due to coming supply pressures. That is a good point, but is separate from the “does the current price really reflect demand (in use) and supply?”

    And I am really surprised Yves didn’t may hay out of Hamilton’s paper. Hamilton tried to find evidence of the Hotelling principle, that oil prices reflected scarcity rent, but had trouble. The most convincing support he could find was maybe big producers like the Saudis and Kuwatis are not pumping as aggressively as they might.

    So all this adds up to a dearth of explanations of why oil prices increased by 50% in what, six months? If speculation isn’t part of the reason, I’d like to know what could possibly justify a rise of this magnitude.

  27. Anonymous

    Anon 10:41 Not harsh at all. Obviously Yves addressed phenom. of tail wagging dog as being the issue. Re-reading. Thanks.

  28. jeff65

    Is hiding money from inflation now equivalent to speculation? Cry about speculators all you like, but it is the central banks that have created this monster. Money doesn’t tend to hang around in places where it slowly dwindles away.

  29. Anonymous

    Moe is correct. The CFTC has investigated the issue of whether speculators “disguised” as commercial traders are responsible for the rising price of oil.

    If you look at the chart on p. 15 of the CFTC report linked to in his post, you will see that while commercial long futures positions have increased during the price run-up, commercial short futures contracts have increased at the same pace. Speculator longs have also increased at the same pace as speculator shorts.

    Personally, I’ve appreciated Moe’s posts.

  30. Juan

    The Chinese Ministry of Commerce only issued its “Regulation on the Administration of the Oil Product Market” on 4 December 2006 and, since that Regulation
    – Requires oil product licensing
    – Stronger examination and approval
    – Implementation of supervision and inspection by government

    it seems implied (even though related to WTO requirements) that the earlier (2004) Interim Regulation may not have successfully captured supply, storage and consumption realities.

    Much better though, the IEA’s notion that it can properly adjust apparent demand in China “..for…direct crude burning, smuggling and stock changes…” (Provided by the same, or another Ministry which keeps tabs on smuggling? No. More likely a pure IEA creation).

    “Calculation varies by country. For example, in China, apparent demand is defined as refinery output plus net product imports (adjusted for fuel oil and direct crude burning, smuggling and stock changes). In the FSU, by contrast, apparent demand is equal to crude and condensate production minus net exports of crude and products.”
    (OECD/IEA 2007)

    There’s a certain level of absurdity…

  31. Juan

    anon 1:18 AM,

    as i’ve not bothered to read it yet, did the CFTC break index traders out of the commercial category or, in contrast to its Supplemental (that covers only a few ags), maintain the pretense of these being what they are not?

  32. Anonymous

    per Juan,

    if OTC or other swaps by non-commercials can be (meaning are) classified as commercial (my understanding of the Masters testimony) then the CFTC doesn’t have good information. Any “commercial” vs. “non-commercial” classification from them is rubbish.

    And do you think the CFTC would put out any data that would support the argument that speculation or any activity that might be viewed as speculative is rising? No, or if there was such data, they’d muddy it as best they could.

    Remember, the SEC also said Bear Stearns had sufficient capital.

  33. Juan

    anon 3:00 AM,

    guess you missed that part of my comment which said: “…or, in contrast to its Supplemental (that covers only a few ags), maintain the pretense of these being what they are not?”

    spelling it out – since the cftc does publish a suplemental report (CIT)* that, for a number of ag commodities, does break out index traders and since that cit does provide a picture of these traders’ large and very imbalanced positions, it is not unreasonable to expect that agency could do same for other commodities which it, at least nominally, regulates.

    there have been a few good articles about this, including pressures to avoid more extensive disclosure.

    the point in my prior comment does not contradict masters but questions whether the cftc, in an effort to prove its ‘argument’, maintained the pretense that it could not do what it has done elsewhere.

    This has less to do with data quality than quality of the cftc itself.

    ‘being what they are not’ means being classified as bona fide commercials when they clearly are not.
    which, yes, is a muddying but an obvious one.

    *CIT, 20 May, 2008, take a look:

  34. Anonymous

    Since late May when Moe made his comments and he and others bashed Soros, oil has fallen from $135 to $37.

    Soros shorted oil at $137. If he held on thus far, he is up $100 per contract. If Moe stayed long thus far, he is down $100 per contract, a loss of 73% in 7 months.

    The market has given its judgement as to who was right and who was wrong. Unsurprisingly, Soros was the one who the market proved to be right, and the no name bashers here were wrong.

    That’s the great thing about the markets. Morons get their comeuppance sooner or later.

  35. Mazhar Hussain Shah

    Much better though, the IEA’s notion that it can properly adjust apparent demand in China “..for…direct crude burning, smuggling and stock changes…” (Provided by the same, or another Ministry which keeps tabs on smuggling? No. More likely a pure IEA creation).

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