An oil standard

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Ok. Oil. Exxon Mobil reported a second-quarter profit of nearly $12 billion — a number that works out (as many did) to about $39 for every man, woman and child in America; $90,000 a minute etc.

Mark Thoma has a think about the future price of gasoline for us. The punch line:

If past global expansions are a guide, global demand will recede only gradually. This is a direct implication of the model underlying this analysis. This suggests that US gasoline prices will remain high for the time being. Barring a major economic collapse in emerging Asia, prices will stabilise only as the world economy learns to economise on the use of oil and gasoline and as the supply of crude oil expands. Both corrective forces will take time to gain momentum.

As an investor however I believe that there is a definite skew in the probability distribution. Who ever heard of an extra 5 million barrels per day unexpectedly hitting the market? Yet, there is a distinct possibility of that much being unexpectedly withdrawn. Better to own the upper tail than the lower.

Brad Setser revisits the Gulf-inflation story — single digit interest rates, double digit inflation.

I’d like to see more game theory applied to the oil price analysis. If they did peg their currencies to price, the Gulf could be the world’s ultimate monetary authority. They can open the spigots whenever world growth flags below a targeted rate, and pull back when things are running a little hot… I’d rather own a currency based on oil than one based on gold.

Alternatively, they could pull back whenever there is talk of carbon caps, open up when it looks like alternative energy is getting too much interest and investment…

If I were advising them, here’s my spin: Gulf states announce that they are voluntarily limiting the production and export of petroleum in order to contain global warming; and coincidentally conserving global oil resources for future generations… Home run.

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  1. Anonymous

    While I do like the sound of oil backed currency…I doubt it would happen. At the first whiff of such independent thought there would be a couple of additional aircraft carriers off the east coast of Somalia.

  2. Lune

    Agreed with Anon 1:38. More than once, the American military has war-gamed scenarios in which they take control of Saudi and other middle eastern oilfields (of which one scenario is currently being played out right now, albeit perhaps not as well as originally hoped…). If the Middle East were to assert control of money supply as well as oil supply, they’d need an army far larger than the one they currently have to defend their peg.

  3. Anonymous

    Oil is the commodity that all other commodity prices are based upon. Farming, ranching, transportation, mining, fishing, etc, are all oil dependent. Industrial production and electricity generation are also dependent on oil to some degree.

    Oil might not be viewed as the defacto world currency but without oil the world economy would come to an immediate stop.

    If dollars and other fiat currencies were to disappear today they would be replaced by other fiat currencies…Not so oil, it has no substitute that we have discovered.

    Oil producers do not have to ‘assert control’ over the money supply for they already have that control.

    For those that believe that a military solution is possible in the quest for oil they merely need look at the current ME, Nigeria, Venesuela, etc, situations for refutation. Has the price of crude decreased since the US occupied Iraq? Would anyone hazard a guess regarding the price of oil if Iran or SA is attacked?

    Aircraft carriers? They are already or will soon be in the same catagory as the battle ships of Pearl Harbor. No country currently has the means to stop anti-ship missles flying 50 ft above the waves at 3,000 + MPH. Any country that places it’s aircraft carriers or other military ships into the Persian Gulf is asking for a humiliating defeat.


  4. DownSouth


    Agreed. Iraq was the last, best hope for a military solution to the U.S. energy problem, and our failure there marks the passing of our century-old pretensions to Mid-Eastern, and to a larger degree world, hegemony.

    Russia doesn’t get much mention in these discussions, but that country has emerged as a major world player in the oil game. All recent indications coming out of Russia are that it is evolving into as big of a price hawk as Venezuela and Iran.

    It is extremely difficult for the United States–its leaders and its citizens–to realize and accept that they have little control over world oil supply. With the U.S. military failure in Iraq, combined with a massive foreign debt and a huge current account deficit, the oil baton has been passed to the OPEC-Russia axis.

    Expect those countries to control oil supplies to their benefit, not ours. They will eventually develop a system that resembles the Great Depression-era Interestate Oil Compact (IOC). As the State of Texas archives explain:

    “State governors and oil company executives formed the Interstate Oil Compact (IOC). The IOC aimed to stabilize the industry in the name of a steady supply of oil, predictable prices, and minimal federal interference. Each state would control its own production. Members of the IOC would have monthly meetings to review predictions of demand and establish production totals. Congress approved the existence of the IOC in August 1935.”

    Many predict that a world-wide recession would bring back $60 barrel oil. That is mere wishful thinking, cognitive dissonance at its best. After the establishment of the IOC, and in spite of being in the midst of the Great Depression, oil prices rose to $1.12 per barrel, well above pre-Depression and pre-East Texas Field levels.

    It is a huge blow to the ego of most Americans, this end of the era of American exceptionalism. Denial is the first line of defense to go up, even on blogs like this one with intelligent, introspective commenters. It is Timothy Garton Ash who best captured the moment:

    “If you want to know what London was like in 1905, come to Washington in 2005. Imperial gravitas and massive self-importance. That sense of being the centre of the world, and of needing to know what happens in every corner of the world because you might be called on – or at least feel called upon – to intervene there. Hyperpower. Top dog. And yet, gnawing away beneath the surface, the nagging fear that your global supremacy is not half so secure as you would wish. As Joseph Chamberlain, the British colonial secretary, put it in 1902: ‘The weary Titan staggers under the too vast orb of his fate.’
    The United States is now that weary Titan.”

  5. Anonymous

    We already have an oil backed economy….oil is purchased around the world only in US Dollars.

  6. Anonymous

    Why does the notion that Iraq was to “control” oil fields persist? The US gets 30% of its imports from the Middle East. That’s about 25% of American consumption. Japan, on the other hand, gets 90% of their imports (which equals 90% of their consumption) from the Middle East … most of the Asia Pacific is in the same boat.

    Had the US been interested in ensuring more oil supplies, a much surer way of doing so would have simply been to get rid of sanctions on Saddam’s regime. In fact, it is only as of late last year that Iraqi exports reached pre-invasion levels. The notion that Bush-Cheney did not understand this is pretty unsustainable and based on the arrogance of ignorance.

    If the argument were that the US wanted to put a bottom on the price of oil in order to give alternative fuels momentum, OK, that would make sense, but that in itself obviously seems unlikely.

    Security is required for the complicated business of integrated oil. The US did not appear to be especially concerned about security following the invasion. What, exactly, the aims of the Administration were, I dunno. But if cheap oil were the aim, it is plain as day that the persistent crescendo of sable-rattling over Iran was counter-productive. (I won several bets over the last 3 years that the US was not about to attack Iran … even top level oil insiders appeared to be convinced.) Everyone in the oil markets understands what a war with Iran would do to the oil balance.

    This whole speculators thing is total nonsense as well … SemGroup was short CL–that is why they blew up.

  7. Juan

    Price management via production control has a long history, from major domestic producers’ pressure for prorationing and greater power in hands of Railroad Commission of Texas right on over to the international level with formalizations in the 1928 Achnacarry and Redline Agreements, the so-called ‘International Oil Cartel’ and ultimately OPEC.

    The latter’s reign was, though, relatively short lived, failing due to the confluence of: Global economic slump, increased non-OPEC production, revolution in Iran, Saudi attempt to discipline other OPEC members,,,overproduction and price collapse.

    IOW, the type of structure mentioned in the post is not so different that that which ended in 1986 and, during 1987-88 was replaced with a formula pricing structure based on both the physical trade and price discovery via futures markets. or, “market related” pricing.

    The modern price regime had been born but has itself undergone change as the spot to futures channel became very much less important than the futures to spot channel.

    The current phase is perhaps best exemplified by saudi arabia, iran and kuwait’s (then others) 2001 shift to futures prices alone as benchmarks (i.e., the pricing of shipments to europe in relation to ipe (become ice) brent weighted average futures, to u.s. on basis of nymex wti lt swt futures, to asia in relation to dubai/oman).

    As I wrote on the 5th:

    If financial markets were not open to trend-following, return seeking, self-justifying momentum but in fact captured real and most likely conditions in an efficient manner, the above would be no problem.

    Under such conditions, it seems unlikely that we would have seen total otc commodity derivatives notional value rise from $1 trillion dec 2004 to $9 trillion dec 2007 (BIS) or such a ballooning of exchange traded commdity derivatives, of which energies constitute a major portion.

    Yes, there have been substantial changes in the world real economy but not, imo, sufficient to justify the divergences and bubble-type prices which developed.

    S. Aramco et al price in reference to prices made in financial markets, a situation which came about due to squeezes and other manipulations in benchmark crude oils’ markets as their production fell and physical trade thinned.

    Most mistakes in the popular press and elsewhere seem related to a failure to recognize changes that have taken place but to demand that causation runs one way, physical trade to financial even though what developed has been a system in which price and real economy fundamentals can substantially diverge, and not only over short terms.

    The Oil Wars:
    Draft Achnacarry Agreement, 18 August 1928:
    OPEC Pricing Power, March 2007:
    Multiple others and modicum of experience.

    Anon 12:45,

    Wasn’t SemGrp short even as prices ran against them.

  8. Anonymous

    Anonymous at 12:45 ‘Why does the notion that Iraq was to control oil fields persist?’

    Perhaps it is because the US’s first and only interest when arriving in Baghdad was to sieze and guard the oil ministry?


    Perhaps the idea was not to ship all Iraqi oil to the US but to control the destination of the oil leaving Iraq?

    The ME oil fields are the prize as Cheney said long ago. Did you miss that speech?

    He who controls the oil spigot of the ME controls the world.


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