Japan: Fundamentals Warrant Oil Only at $60 a Barrel

Forgive me if you’ve heard this one before, but a classic Wall Street joke illustrates an important concept.

On a slow day in the markets, trader A decided to open bidding on a can of sardines. He offered it at $1. It was snapped up by B at $2, who sold it to C at $3. D jumped in at $4 and E finally prevailed at $5.

Proud owner E opened the can and found the sardines had gone bad. He went back to A and complained, ” You sold rotten sardines! I want my money back.”

Grinning, A said, “Son, those weren’t eating sardines. Those were trading sardines.”

Anything can be made into a store of value if everyone agrees. Western societies have had a fondness for gold and precious metals, but any material will do. The Mayans used feathers.

Oil and commodities are increasingly being used as a store of value as inflation concerns make the wisdom of relying on financial instruments seem dubious. But per the little story above, once participants quit seeing commodities as an inflation hedge, they will revert to their fundamental price level. And the indications increasingly are that those values are well below the price the market currently assigns them.

Reader Michael e-mailed us this story from Platts. Note that by Japanese standards, this is an unusually pointed discussion:

Japan’s vice minister for economy, trade and industry, Takao Kitabata,said Monday that current oil market fundamentals only supported a crude price of $60/barrel, less than half current levels.

Speaking to reporters, Kitabata said current oil prices could not be explained by fundamentals and blamed speculative funds for pushing up prices, according to a transcript of his press conference in Tokyo…

“About three weeks ago Goldman Sachs said crude oil prices would exceed $140/b, and prices shot up by $10/b from levels of around $120/b. Then Morgan Stanley said oil prices would reach $150/b during the driving season by US independence day [July 4],” Kitabata told reporters.

“Oil prices rose to above $130/b after the Goldman Sachs announcement, but retreated to $120/b levels after the US Commodity Futures Trading Commission’s announced investigation.”

“However, prices have risen by $10/b after Morgan Stanley’s announcement,” Kitabata added. “I said [three weeks ago] that it was hard for us to define the cause [of high oil prices], however I must express anger [over the movements].”

The vice minister said the rise of oil prices above levels than can be explained by fundamentals would lead to oil-producing countries receiving more money than they need for their exports, while at the same time hurting consuming countries, especially developing countries without their own oil production.

“We believe producing countries’ economies will function if oil prices hover more or less at $60/b,” Kitabata said. “Despite the weakening of the US dollar, we believe Saudi Arabia’s [economy will function] if oil prices are at $45/b and Kuwait’s [economy will function] if oil prices are at $55/b,” Kitabata added.

When asked why energy ministers from the G8 — the US, Japan, Canada, the UK, France, Germany, Italy and Russia — failed to have sufficient discussion at their July 7-8 meeting on the link between high oil prices and flows of money from investment funds into the oil market, Kitabata argued that the ministers had had “spirited discussion on the matter.”

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  1. Anonymous

    Maybe oil prices will drop 50%… but I still feel that $4.00 to transport a 5,000 pound Sport Utility Vehicle 20 miles is a bargain.

  2. mxq

    Anon @ 5:35


    RE: “oil prices could not be explained by fundamentals and blamed speculative funds for pushing up prices”

    ML’s Dave Rosenberg flagged this article on monday…its a piece that ran in FT, written by London School of Economics Prof. Emeritus Meghnad Desai.

    Of particular note:

    “…this (oil) paper market is not driven by the pressures on demand and supply but entirely by price expectations. An underlying situation – which may well indicate a medium-run rise in oil price – is being exacerbated by the bolstering of expectations that prices will rise even faster. It is this extra layer of price rise that is driving money into even the farther future contracts. There are futures contracts being bought and sold for 2016 at $138 – only astrologers pretend that they can forecast that far ahead”

    However, he goes on to say raising margin requirements to ~50% for “purely financial traders” is a way to solve the problem. As Yves pointed out, there could be some unintended consequences with this sort of action.

  3. Melancholy Korean

    NASDAQ 6000, baby! New Ecomony, heehaw! Get long the “infrastructure” plays. Buy the whole Telecosm. B2B, B2C, B2BS…

    oh, wait. Wrong market.

  4. Anonymous

    Is there a way to speculate about the speculation about whether oil is in a speculative bubble?

  5. CTMM

    EM… with respect, bullshit. English (as a language) sucks because we don’t have words to differentiate commodities that have potential energy (wheat, oil, bacon fat, etc.) from those that don’t. (gold, non-radioactive metals, Guns ‘n Roses CDs, artwork, fiat currency, etc.)

    The first class has fundamental value, the second has only speculative value.

    We’re fucked, currently, because emphasis has been put on things with speculative value because the potential profit is greater and because corporate entities are interested in profit, not life.

    Actual real live people are probably concerned with realizing profit in their lifetime.

    A corporate entity really can’t lose by locking in supplies of fossil fuels. They just don’t make it any more.

  6. trotsky

    unfortunately for the gentleman from Japan, global monetary inflation IS a ‘fundamental’ fact that flows into the calculation of prices. let us not forget that money and credit have been inflated at historically unprecedented rates for nearly 4 decades. as long as the effects of this inflation showed only up in financial asset prices, nobody complained. now they are in the process of migrating elsewhere. did the purveyors of money and credit really think they could inflate so much for so long and the effects would never percolate through the economy? they have created one of the worst cases of malinvestment ever witnessed (the global real estate bubble), and now we see the secondary lagged effects of their policies pop up in all sorts of unwanted places, such as the price of oil. when the minister talks about the fundamentals of the oil price, he appears to be forgetting the most important fundamental factor of them all (a quick look at Japanese money supply expansion over recent decades confirms that his country has been a generous contributor as well). besides, how does anyone know what the ‘correct’ price is? the market price IS the correct price. there is no substitute for it – it reflects all fundamental factors plus expectations about future developments of these factors. oil is not ONLY rising due to the lagged effect of inflation of course. there is the not inconsiderable fact that non-OPEC production has entered what appears to be a steepening rate of decline, which collides with pretty steady long term demand growth of 2% per annum. over 80% of oil production is in the hands of various government bureaucrats instead of the private sector, which largely explains the colossal failure to react in timely fashion to the price signals.

  7. juan


    Claims to commodities are financial assets. What began as diversifying reallocations has, over the last years, taken on a life of its own and a ‘life’ which may not conform to efficient market theories but have more to do with the term ‘bubble’.

  8. Francois

    All the CFTC has to do is raise the freakin’ margins!

    Unintended consequences…pray tell what could be worse than having oil going up up up?

    After all, it’s been done before no? Did everyone stopped trading for 2 decades after that?

    I say, raise’em to 35 – 50% just to test the mettle of those who have skin in the game. Margins can always be readjusted downward after a while anyway.

  9. P. Coyle


    Hey man, can you remind the North Sea that it’s in the hands of the private sector? We’d like production there to stop declining.

    If the Saudis really, really wanted to stop the speculation, they could (a) dump a million barrels a day of light crude on the market and (b) release firm reserves data to reassure customers that they really can maintain adequate flows in the future.

    Oops and oops.

  10. juan

    Within the modern oil price regime, price of oils is real market related, not real market determined. Contrary to previous regimes (e.g. ‘seven sisters’ and then OPEC), financial markets are in the driver’s seat and these drivers are not exactly sober.
    Where are the cops?
    Legislated away.

  11. Jonathan Bernstein

    I’d enjoy lower oil prices as much as Japan’s MITI Vice Minister Kitabata. Nonetheless his logic leaves a little to be desired. Says he, “Kuwait’s economy could function at $45/ barrel.” So, Kitabata seems to be saying that the price of oil should be set at a level commensurate with the economy of its producer being “able to function?” in his judgment? Bet that one had them rolling in the aisles in Kuwait City. And he is outraged that sentiment and news headlines can drive the oil market’s daily fluctuations? Bet he loved it when sentiment drove the Nikkei UP during the Eighties.

    To Yves’s point: As long as M3growth continues at 18% p.a. (per John Williams’s shadowstats.com) people will seek inflation hedges and that will be part of the oil price equation.

    I don’t doubt that commodity funds and ETFs bias the market price of oil upwards to a degree. It’s no different than what happened to stocks after Congress passed the Employee Retirement Income Security Act of 1974 (ERISA). Thereafter we made equities an institutional asset class and inaugurated a semi permanent structure of funds and institutions to invest in them. That is why Warren Buffett has said that stocks may never become as statistically cheap as they were at the 1974 bear market bottom: these institutions are to a degree long only in stocks and so stocks will always have a bit more of a bid than before the pension investment merry-go-round started. And so it is for commodities now. Why not invest in something whose supply may be close to peaking and is fantastically useful to our civilization? Sounds like a better reason for longterm investment than many things I have heard in my career in this business. Even if oil might well be overbought short term.

  12. Yves Smith


    Having worked with the Japanese, and having some dealings with their regulators, my belief is that the way this article came off is more a function of their limited experience in handling Western media (the Japanese don’t spin the way we do, and Japanese is a much less “specific” language. so they tend not to go into detail like we do). There are almost no truly bi-lingual, bi-cultural Japanese, and they certainly wouldn’t be at the top of an important ministry (except one which had significant interactions with the outside world). Being too comfortable with foreigners makes one suspect.

    The Japanese are also fiends for getting data and gossip, so I wouldn’t bet against them having a basis for their view. Now that doesn’t mean they might not have been misled, but this $60 view almost certainly has some analysis behind it.

    The way I read this complaint (the use of the word “angry” is very rare) is that this was directed at OPEC. The minister is basically alleging that OPEC can or should do something, which means he thinks they could supply more (even if really not warranted, just to kill the oil bulls) but are choosing not to.

    The problem, of course, is that no one but the Japanese gets the symbolism of these complaints. For them, it’s significant to go public like that, while other countries scream and posture all the time.

  13. Jonathan Bernstein

    Thanks for your interpretation, it sounds exactly right given my (more limited) acquaintance with the Japanese. As you say, no one knows how much more OPEC could supply if they cared to. I’m just not sure it is in OPEC’s interest to care.

    Until this upward price trend began, it just might have been in OPEC’s interest to do what Japan wants them to do. To the extent that we credit OPEC itself and not world market forces, OPEC did well in keeping the price high enough to make money and low enough to keep customers addicted to oil. Now with peak oil approaching if not already here, that game may well be ending.

    The first big shift in oil pricing happened because the US production peaked in 1971. With the US finished as world oil swing producer, only then could Libya successfully squeeze Occidental Petroleum in the prelude to the 1973 embargo. Now that the Saudis are no longer swing producer (and that there seemingly is NO swing producer) we can expect more price explosions in the long term, even if we might be overbought or in a recession that could slow demand growth. OPEC has no reason not to take as much as they can get, for if we are at the world peak, by definition there is no one left to take market share from them if they fail to raise their production.

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