Gas and Stock Prices: Tied Together By Speculators?

If you are old enough to remember the 1970s, the idea that gasoline and stock prices would be correlated seems bizarre. The oil shock years brought stagflation, gas rationing, and a major bear market. And some economists, James Hamilton in particular, believe that the oil price runup of 2008, which helped push retail gas prices in the US over the then-critical $4 a gallon threshold, is what pushed over-levered consumers over the edge and produced the terminal phase of the financial crisis. If you hew to Hamilton’s view, that provides further support to the idea that gas prices should be negatively, or at least not strongly positively, related to stock prices.

John Harvey at Forbes (hat tip Philip Pilkington) uses the following chart to show that the reverse is true, that for over a decade, stocks and gas prices have moved in synch:

How has this come to pass? Harvey explained in an April 2011 post that the doubling of gas prices in 26 months could not be explained by fundamentals:

Today’s spike is being driven by speculation, just as it was up to the financial crisis…. While there as clearly been a huge jump in growth from 2009 to 2010 and this does coincide with a rise on the gas-price chart, compare this with what happened from 1991 to 1999 (even 2002, save for a brief spike). Supply, according to world reserves, changed only slightly, but there was strong and consistent world growth year in and year out. If ever there was a time we should have seen a huge rise in prices, it was then. Instead, prices bounced around between $1.40 and $1.00. Today, not only have known reserves risen substantially, but we are only just emerging from the worst recession since the Great Depression–hardly a boom period. For comparison, world growth averaged 2.6% from 1991 through 2002. Since then, it’s also been 2.6%, and over 2008-2010, it was 1.1%. This is not sounding like “It was supply and demand.” Is it surprising that gas prices are rising? No, not at all. The economy is recovering (albeit not nearly enough given our 13.5 million unemployed, but that’s another story) and there is considerable tension in the Middle East. But, do underlying forces justify an increase in pump prices from $1.81 in February 2009 to $3.81 as of yesterday? Absolutely, positively not. Nor was there a reason for the run from $1.07 in December 2001 to $4.00 in July 2008.

What’s left out of the equation is the financialization of the US.

His new post focuses on one important contributor:

…the key was President Clinton having signed into law in December of 2000 the Commodity Futures Modernization Act, allowing (among other things) speculation in a market that had previously been dominated by actual end users of oil…

The data series starts in 2001, right after the law came into effect. For the first couple of years, there is no strong correlation. Once the stock market boom took hold in 2003, however, the trend is very clear. On a deeper level, there is a self-fulfilling prophecy at work. The new law meant an influx of fresh money buying oil futures as a financial investment rather than as a means of locking in future prices (which is what actual users of oil had been doing). This meant an appreciation of oil futures prices. Then, those pumping oil out of the ground saw the higher futures prices and figured, why pump it out today when it will be worth more tomorrow? That caused current oil prices to rise, leading those who had bought the futures to say, “Oh my God, I was right–the prices ARE going up! Buy more!” And so on.

Now this may all seem a bit crude analytically (no pun intended) but more rigorous work has come to similar conclusions (for instance, see this study on agricultural commodities and commentary on it).

Of course, it is not surprising that the view that commodities prices might be distorted by financial speculators is often derided, most loudly by finance professors at business schools who receive large donations from Wall Street firms and their employees.

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  1. ex-PFC Chuck

    Should the last four words of the first paragraph read, “related to stock prices,” and not “related to oil prices?”

  2. kris

    Thank you.
    I’ve been saying this over and over on Zerohedge and FTAV but little attention was paid.

    Simple logic. Stock market can be this high only if energy is cheap. If both go high, that means that a 3rd party (the government/primary dealers/financial criminals) are buying both.

  3. different clue

    So, the Commodity Futures Modernization Act was another one of Clinton’s monuments, eh? Another one of those “gifts which keeps on giving”.

    Among the many other things we need, we need a political combat movement based on tearing down and reversing the Reagan Revolution. He wasn’t the only Great DeRegulator, but he was the one who put DeRegulationism into happy cheery compelling words.
    Imagine getting a President whose first Inaugural Address begins with this: ” The Reagan Revolution is over. The Counter-Reagan DeRevolution has begun. The Brezhnev Doctrine for Conservatism ends here.”
    Conservatives would understand exACTly what THAT means.

  4. F. Beard

    How much is the speculation fueled with credit, the population’s stolen purchasing power? Almost all of it? Since speculators love leverage?

  5. R Foreman

    Seems to imply the ‘speculators’ are the largest dogs in the market, and they’re driven in the same direction at the same time (on both gas and food). The Fed/Treasury is flooding the world with dollars.. all the money has to go somewhere, and the few major recipients (large banks?) will eventually overwhelm all other market participants.

    A lot of commodity prices are effectively controlled by exchanges (at the behest of gov’t no doubt) by the use of margins.

    I seem to recall that dollar fx and interest rates were correlated as well; seems reasonable since tightening (rising rates) correlates to a rising dollar fx (dollar denominated assets get more expensive).

  6. wunsacon

    >> Today’s spike is being driven by speculation,

    No mention in this article about Fannie, Freddie, and the Fed handing out $3T+?!

    The feds gave out the money. And it went everywhere. Instead of dropping another 20%, house prices bounced 10%. Basically, what would’ve been my sizable downpayment has become a miniscule. Why wouldn’t gasoline go up, too? Food, rent… Good thing there’s global warming and fracking to destroy the aquifers — otherwise more people would freeze over high NG, too!

    Lambert, this is the inflation you say doesn’t exist. Do you already own a house/mortgage and lots of investments? If so, it might explain why we see things differently.

      1. wunsacon

        Yes, I read it, Yves.

        Does your question-response mean you think Fannie/Freddie/Fed money printing are *not* primary factors in the bounce since 2008, in everything from houses to food to gas prices?

        1. Yves Smith Post author

          You are still not addressing the issue in the article, which is that this pattern has been in place since 2001. I’m not going to deal with a straw man.

          1. Nathanael

            Two solid explanations for the correlation have been proposed:

            1 – this is effectively just a currency devaluation, and the price of oil and the price of stocks are flat.

            2 – oil production is flat, while demand is correlated tightly with economic activity. Then any increased economic activity increases the price of oil (and reduced economic activity decreases it). Stock prices reflect increased economic activity.

            Here’s the problem with this article’s conclusion: if it was “speculation”, then there’s no reason for oil and stock prices to be tied. Speculators have fads and would be speculating preferentially in one commodity or another. You would expect choppy prices which DON’T correlate.

          2. Nathanael

            (FWIW, *any* short-term spike in price is driven by speculation, always. It’s the claims that the long-term pattern is driven by speculation — those are what is suspect.)

  7. steve from virginia

    @Unknown Dummy sez:

    “Today’s spike is being driven by speculation, just as it was up to the financial crisis…. While there as clearly been a huge jump in growth from 2009 to 2010 and this does coincide with a rise on the gas-price chart, compare this with what happened from 1991 to 1999 (even 2002, save for a brief spike). Supply, according to world reserves … blah, blah, blah …”

    Right! The world is just the same as it was from 1991 to 1999, when a barrel of crude oil cost a bit under $20. Last Friday the Brent price (close to most spot blends including GOM) was $110/barrel. In 1998 a barrel of oil cost anywhere (spot) from $6.50 (Mexican Azteca blend) to annual average price of $11, per barrel. (EIA). Certain sour Saudi blends cost about $7/barrel in 1998.

    Please note several refineries closed last year on the US Eastern Seaboard because the high current price of crude and stifled demand made refining unprofitable.

    The squeeze is on between refiners and customers and drillers and customers. Believe it or not crude oil is hard to find and bring to market. Drilling in 2 miles of bluewater ocean or in tight rock formations is very costly and the amounts of fuel obtained are modest. Other supplies are non-crudes or very sour such as many Saudi and Venezuelan blends. Only a few refineries can handle such crudes (Valero) and others cannot be ‘switched over’. Alberta ‘tar sands’ product isn’t crude, it’s bitumen, not much different from asphalt.

    The implication is that gasoline prices should be cheap and that getting rid of the speculators would bring prices to pre-2000 levels.

    Be careful of what you wish for you might get it. With crude extraction costs being +$100/barrel for most countries (Russia and Saudi Arabia for instance) a decline in ability of customers to stump up the high prices will do two things: a) shut in crude supply and cause shortages, which will then b) cause the credit system difficulties. Both credit and supply are joined at the hip: less credit means lower prices => less crude deliveries => shortages => less credit in a vicious cycle.

    Another thing to keep in mind is the transition from current regime of rationing by access to credit to the regime of physical shortages is likely to be gradual, with a continuing ‘rolling’ shortage that began last year that will occur over the course of this year. There will be higher than usual gasoline prices in some areas not others, then high-price shifts to other areas or even temporary physical shortages (California and NY area last fall). All else being equal there will be permanent physical gasoline shortages appearing by the end of 2014 in the US as customers will not be able to borrow enough to support high-cost drillers. High fuel prices have an effect, they make fuel customers poorer. The US is bankrupt.

    Within this short time frame, the false facade of ‘recovery’ will be stripped away and the real source of our economic distress will be revealed: that we Americans have burned through our entire world’s resource patrimony for zero gain while whining about how much it cost to do so. For this crime against the future the US deserves to be destroyed, frankly.

    Permanent shortages means what it sounds like … as in 100 million years short, permanent. Get ready.

    1. R Foreman

      Ok I thought I was pessimistic, but you got me beat with that post. I’m just wondering when some of this is going to hit my world, as in social unrest, violence, business closure, etc. So far at the office it’s mostly business as usual. If any of the key people are worried they’re keeping it well under wraps.

      1. Nathanael

        Move to a location with good water supplies and convert your house to 100% renewable energy. (It’s not that hard, it just costs money.)

    2. jake chase

      Yes, the only thing which has kept the wheels turning since 1971 is speculation in fiat currencies, notably electronic dollars. It is all high speed rearrangement of the Titanic deck chairs. A handfull of lucky fools gets to live like aristocrats, and this raises hackles among those obsessed with ‘equity’, but the positive side is that most people (at least in this country) get to live like human beings and at least entertain burgeois aspirations, if not for themselves, at least for their children. And as my friend the Judge said when somebody railed against ‘the corporations’, ‘without corporations we’d still be living in tents.’

      When the speculation stops the entire world economy will go down the cr**per.

      1. American Slave

        “without corporations we’d still be living in tents.”

        Ha. Now there’s the joke of the year.

        Did people in the Soviet Union live in a tent? But at least for all the crap the Soviet ruling class gave there was a 6hr work day or less if its construction or heavy industry work to show for it, and even they knew to give people free food, housing, utilities, extra allowance money for getting good grades in collage and absolute unlimited unquestioned welfare for those who wanted it (and trust me a million times no one slept under a bridge of lived under a pile of news papers on a park bench) and yet still they produced more than any other country at the time as well as its scientists and engineers building the first space station Salyut and inventing ion thrusters, PWM and many others.

        The politics sucked except for maybe the community councils but the economics had huge potential, what is badly missed is the 6hr work day under which a lot of production was done or the fact that you could take a vacation and not get fired and this comes from a union guy.

        All in all now its about working 14hrs a day or unemployment with them trying to bankrupt me by trying to force me to get a job at mc crap wage paying place and im tired from it.

    3. James Cole

      steve from virginia:
      In my view it’s not so much “credit” per se as it is the particular type of credit that manifests in the form of the ability of the US to continue to finance its operations through the Fed/QE – Treasury – Bond triangle that evidently manages to keep the dollar price of oil tolerable for the US political system, and which itself is underwritten by our 9 aircraft carriers and other big sticks, for now.

    4. Yves Smith Post author

      Wow, is anyone who is commenting on this thread reading the premise of the article, or are you just in Pavlovian “say oil and I’ll give you my peak oil speech” mode?

      Tell me why high gas and oil prices should be correlated with high stock prices, please. And tell me why oil and gas prices should double (and then fall back dramatically) and double again based on fundamentals.

      1. James Cole

        I, for one, was taking the premise of the article–that correlation is due to financialization–as a given. My point is that it’s just part of a broader picture of petro-dollar diplomacy.

      2. Adam Noel

        Could it be the case that oil prices are higher then the 90s due to a price floor and this is a break from past oil trends? Oil production growth has been sluggish over the last decade while oil demand growth has been growing due to emerging markets. In the 90s demand did not outstrip supply while in this decade demand outstripped supply. The change in demand is in developing nations especially the middle-east.

        This change is what is causing high gas prices relative to the 90s. The development of new oil sources causes a price floor (The shale oil “boom” is probably a result of oil prices being high enough to make the marginal barrel of oil attractive) where falling demand causes falling supply causing prices to go back up none the less. I am unsure where the price floor is located to and it could be something like $60-70 a barrel (I’m thinking brent crude when I say this).

        The price above this is speculation in the oil market. Anybody who thinks the oil market perfectly represents the oil picture is mad. Just follow oil prices for a week and follow the explanations for why oil prices are rising and falling and you’ll recognize it as speculation. The story of oil speculation and supply constraints can both be true.

        Of course the reality of the actual economy is distorted by the financial system and until then it is impossible to separate reality from speculation.

      3. x_scylla_x

        I stated my case below. Oil (gasoline) prices are not DIRECTLY linked to stock prices. Oil prices are INDIRECTLY linked to stock prices via economic activity. Increasing economic activity raises stock prices while raising oil prices at the same time. The same effect happens when economic activity is lowered (prices drop) The low gasoline prices stated ($1.07 in 2001 and $1.81 in 2009) both occured during a period of economic contraction. Prices did not RISE FROM these levels- prices FELL TO these levels. The reason people are dragging out peak oil is because this is a direct result. In the past rising prices would bring more oil to market and then lower prices. This is no longer possible. Oil extraction is now limited by volume and rate due to geology. The only way to lower oil prices (temorarily) is to lower economic activity. This was all predicted. Nobody likes paying $4.00 a gallon, but I am afraid we have to understand that we have gone from abundance to scarcity.

      4. from Mexico

        • Yves Smith says:

        Tell me why high gas and oil prices should be correlated with high stock prices, please.

        Could it be because the people who maniuplate the prices of stocks are also the ones who manipulate the price of oil, and they’ve decided that both should be high at this particular moment?

        • Yves Smith says:

        And tell me why oil and gas prices should double (and then fall back dramatically) and double again based on fundamentals.

        Do we have to choose between speculation and fundamentals? Could oil price not be determined by both of these, plus other factors?

        Here are some suggestions as to some of the factors which I believe impact upon oil prices:

        1) World oil demand,

        2) The actions of OPEC,

        3) The cost of the marginal non-OPEC barrel of oil, which at this moment is US shale oil (mainly the Bakken in the Dakotas and the Eagle Ford in Texas), the oil being mined in Alberta, and deep water offshore, such as BP’s infamous Macondo #1. All of these have production costs north of $60 per barrel. When Harvey says that “known reserves have risen substantially,” what he doesn’t say is that most of the rise comes from these, as well as the Orinoco in Venezuela, which is also what is classified as “extreme” oil — difficult and very expensive to produce. If it were all so easy as Harvey would have us believe, what does he believe explains Venezuela’s precipitous plunge in oil production, even though it sits on top of the world’s largest proven oil reserves?

        4) The actions of speculators and market players.

      5. Max424

        We had a speculation bubble and pop in 2007-2008, no doubt about that. And we can look forward to more oil price bubbles (much bigger ones, in fact), no doubt about that either.

        But, the relatively quick re-inflation to current (and for 3 years now, very stable) price levels is based mostly on fundamentals, in my opinion.

        The big picture is, world demand for oil is up a whopping 12 million bpd since 2000, moving in 12 short years from 79 to 91 million bpd, while crude oil production flatlined in 2005, at around 75 million bpd.

        Note: Subtract 75 from 91 and what do you get, besides corn ethanol, fracking, and an exponential worldwide increase in coal usage? Exactly what you’d expect on the backside of Hubbert’s Curve, a yawning –crude oil– supply and demand gap, leading to what I call, the Age of Desperate Explanations.

      6. jake chase

        Stock prices and commodity prices have very little to do with fundamentals. They are driven by fiat money speculation-all those electronic dollars chasing returns at the speed of light. The upward trend is periodically interrupted by crashes caused by withdrawals of credit- lenders get frightened by “events”.

        Supply and demand are horse and buggy concepts.

      7. kayjay

        “Steve from Virginia” response is both deceitful and untruthful. Just look at Statoil’s extraction costs in their annual reports. You will see that their extraction costs are in the neighborhood of $7-$11, never mind the value of the Norwegian Kroner. They dig deep oil in some of the worst conditions with the most environmentally secure technology, which is much better than that of Shell Oil and BP if not Exxon and Chevron (remember, Brazil).

        The planet has gobs of oil underground of different grades; West African (Ghana, Nigeria, Cameroons, Gabon and of course Angola) and now even East Africa (Mozambique) have enormous amounts of sweet crude. It is the consumption that has declined in response to the recession/depression. Concomitantly, so has production to maintain prices at very high levels: the Saudis decided to raise their production just today (seasonal demand) acording to Bloomberg. Valero and Tesoro, never mind Chevron and Exxon’s refinery profits are at very high levels: What does this suggest? Both oligopolistic behavior and the financialization of futures markets. Thank you Bill Clinton! You also gave Mobil away to Exxon and let us not forget the sale of Atlantic richfiels to Shell.

        I am beginning to wonder about blogs and the distortions and lies that continuously worm their way into otherwise sensible and decent intent.

        1. bstoll

          Not all that long ago Libyian extraction costs were about $2/bbl. Our recent footprint there has probably changed that though.

      8. steve from virginia

        @Susan Webber sez:

        “Wow, is anyone who is commenting on this thread reading the premise of the article, or are you just in Pavlovian “say oil and I’ll give you my peak oil speech” mode?

        Tell me why high gas and oil prices should be correlated with high stock prices, please.”

        “Okay, I’ll take ‘Evil Speculators’ for six hundred dollars … ” (YAAY!)

        What of it? Would it/does it make any difference? What is the point? That gasoline prices need to be lower? Why?

        The entire article is a non-sequitur. There is no comparison between the stock market and gasoline retail or even the gasoline (or crude) futures’ market, there is nothing to connect them other than they are traded in US dollars.

        So are flea-markets, their fortunes have likely followed the S&P just like gasoline.

        Stocks are collectibles like Picassos, they are the province of the wealthy. Gasoline is an instrument of the poor. Even speculators must sell their gasoline to food-stamp-riddled retail customers at some point, if they cannot sell they lose money or must sell at a loss … repeat the losses enough times and the speculators are out of business.

        Just like refiners have been going out of business. The only ‘growth’ industries in the US are poverty and entropy. USA = Detroit.

        The implication is the poor deserve low-priced gasoline, which is completely false. Nobody is entitled to anything that is destructive of capital. Only fools burn their houses down to keep warm for entertainment.

      9. TC

        “Tell me why high gas and oil prices should be correlated with high stock prices, please.”

        Because in the post-2008 period there are a dearth of AAA-rated trinkets which to pass around and pretend the underlying capital streams will remain intact? As leverage has been forced elsewhere, no doubt some goes into more tangible things (such as farm land and commodities more generally). Bottom line, systemic leverage positively must increase, or the banking system collapses. In a yield-hungry, confidence scarce, liquidity abundant climate exchange-traded derivatives (energy-related and otherwise) might be more highly prized, particularly given a backdrop no less opaque than in 2008.

        Now, one thing we can say with fair certainty about stocks since ’09 is that, the force sustaining their levitation is NOT one characterized by increasing accumulation of shares. Rather some [hopelessly bankrupt] interests are holding tightly their supply and consistently manipulating price discovery mechanisms to force quotes higher. Leverage these employ higher up in the capital structure (no doubt precipitating an ever-intensifying blizzard of OTC credit derivatives activity–can you say “fee junkie?”), as well as in commodities, thus appears all the more sustainable in the interplay.

        “And tell me why oil and gas prices should double (and then fall back dramatically) and double again based on fundamentals.”

        There’s just one “fundamental” at work here: a hopelessly insolvent banking system whose addiction to fraud is blithely overlooked by captured regulatory agencies in order to sustain a wildcat, unhinged industry sitting at the pinnacle of a grand illusion of “normalcy,” the likes of which now features such fundamentally inexplicable energy price swings as you have noted (among far worse things). It’s imperialism at work. The financial dynamic underlying 2008’s energy price spike is not the same as this second go. Likewise, the physical dynamic has changed, as well (the observation per shuttered refining capacity is relevant). The common thread, however, is imperialism and the oligarchic wont to cultivate such vulnerability (scarcity) as benefits its capacity to crush the republican spirit otherwise deemed a threat. The case to be made claiming both financial and economic war is being waged on the United States (as has been the case, indeed, over the past 40 years) is fairly compelling in fact. The hour is late, really, for resting on assurances leading one to suppose that, noble are intentions behind circumstance whose undesirable consequence only grows increasingly burdensome, while never substantively abating in the least–the 10-year-running heist at the gas pump being “on point” per the matter you raise.

        1. Nathanael

          “Rather some [hopelessly bankrupt] interests are holding tightly their supply and consistently manipulating price discovery mechanisms to force quotes higher. ”

          The low volumes in the stock market are the clue that there’s something funny going on. You don’t usually see a big rise on low volumes.

    5. American Slave

      @ steve from virginia

      All I have to say is that comment was spot on, probably the only thing I could add on is the soaring very expensive cost of building and upgrading oil refinery’s its really crazy how far its gone up.

    6. from Mexico

      steve from virginia says:

      With crude extraction costs being +$100/barrel for most countries (Russia and Saudi Arabia for instance)…

      That is simply not ture. The cost to extract legacy reserves in Russia and Saudi Arabia doesn’t come anywhere near $100/barrel. Even the total cost to produce “extreme” oil (assuming externalized costs are excluded, which is current industry practice to do so) is less than that.

      You’re just talking nonsense.

      1. steve from virginia

        Markets set countries’ prices then countries justify it.

        Total extraction costs are total, they include but are not limited to the well-head costs.

        If Mr. Naimi sez he needs $100 he needs $100, you can argue with him, I won’t. He probably needs $110. As for a discount … I wouldn’t ask for it if I were you.

        1. from Mexico

          Here’s a link to Rosneft’s annual report for 2011:

          Rosneft is the largest oil company in Russia. In 2011 it produced 869 million barrels of oil and 12 billion cubic meters of natural gas.

          Total Production and operating expenses for the exploration and production segment were $2,586 million and depreciation, depletion and amortization were $4,945 million, for a total of $7,531 million.

          If we divide the $7,531 by the 869 million barrels of oil produced, and assume zero costs to produce the 12 billion cubic meters of natural gas, that’s only $8.67/barrel.

          Heck, even if you throw in taxes the total production cost was only $14,564 million, or $16.76 per barrel.

          There’s not a scintilla of truth in what you are saying.

          1. Malmo

            In general, the production cost of a barrel of oil:

            “…Oil companies are often reluctant to give precise cost information, but analysts peg average costs in the neighborhood of $80 per barrel for the U.S. benchmark West Texas Intermediate (WTI) crude and about $94 for the European benchmark Brent. That’s still more than $20 below each of these benchmarks’ current spot prices…..”


  8. Elliot

    Well, no, those of us old enough to remember the 1970’s recognize speculation driven price changes quite well. We’re also old enough to remember the Hunt brothers and what they did to silver. It will happen to food commodities too if we don’t look out.

    1. AbyNormal

      we ain’t seen nothin yet

      Financial giant makes $400 million as high-risk commodity trading pushes already fragile food system to breaking point

      Goldman’s food speculation contributed to a roughly 68 per cent jump in profits for 2012, The Independent reports, while it increased the average pay and bonus package of its bankers to nearly $396,500.

      Swiss trading giant Glencore hit the headlines in August when its head of agriculture proclaimed that the US drought will be “good for Glencore”.

      The extent of Goldman’s food speculation can be revealed after the UN warned that the world could face a major hunger crisis in 2013, after failed harvests in the US and Ukraine. Food prices surged last summer, with cereal prices hitting a record high in September.

      Food Prices on the Rise

      1. Emperor Wang of Market Mongo

        But..but…higher prices are supposed to encourage higher production, no?

        Just kidding


          1. Emperor Wang of Market Mongo

            Yes! And you Earthlings have thereby figured out how to convert water into energy!

      2. Larry

        I have to admit to being confused as to what’s going on with regards to speculation vs. market fundamentals. I certainly understand how commodity speculation can drive prices in ways that are not beneficial to end consumers, but Naked Capitalism itself linked to a FT story last month about how commodity funds were losing money and customers in droves as they had underperformed for two years running:

        One fund went from $5 billion under management to around $2 billion. Look at this small selection from the piece:

        High quality global journalism requires investment. Please share this article with others using the link below, do not cut & paste the article. See our Ts&Cs and Copyright Policy for more detail. Email to buy additional rights.

        The obvious reason for the sector’s malaise is performance. According to Newedge’s closely-watched index of commodity hedge fund returns, the sector as a whole suffered its worst year on record last year, losing 3.7 per cent.

        The article mentions gas speculators among all other classes. So I admit that the picture to me is not clear on what is driving the price. Perhaps it is speculation, but the speculators don’t seem to be profiting. Perhaps it’s just the heard shifting it’s capital around chasing anything that might net a return, but in the end even all that hot money can’t drive true demand so a very profitable price spike will not emerge. I would be interested to hear Yves take on this since some stories in the links downplay the role of speculators in commodity prices and other links or posts posit a strong role for speculators in markets. It seems very opaque, and damn it I’m am amateur economist, professional microbiologist.

  9. Pat

    One reason for the stocks-oil correlation is that the Gulf Oil states, the main beneficiaries of the recent oil price rise, are required to recycle their money back into US markets. In the 70’s the US apparently made an agreement (unofficially, of course) with the Arab OPEC states to protect them in return for which the Arabs would invest their money back into the US. So the Arabs take all their big profits and buy either American real estate, bonds and/or stocks. RE is overvalued and bonds provide no return, so apparently they have been buying stocks. That’s my guess.

    The US government doesn’t care that much if oil goes up, provided it does not kill economic activity, because a lot of the oil money soaks up all those newly-printed helicopter dollars, because oil is priced in dollars, which then come back to the US and goose the markets.
    (Don’t forget that one reason the US is so peeved at Iran is that they wanted to use other currencies than the dollar to trade oil, which would have been big trouble for the dollar. And look what happened to Saddam, who sold his oil for Euros.)

    If you look at it logically, I imagine you would conclude that this back-door method of goosing American assets and soaking up dollars is stupid and inefficient, since a lot of the oil prices go to countries like Russia, Malaysia, Venezuela that do not send the money back to the US. It would have been better for the US just to print the money and give it to itself. Maybe the US Treasury Dept thought they couldn’t get away with it.
    The correlation is not exact, of course, since stocks could go up with home-grown funny-money speculation, as happened in the 90’s and 2000 internet bubble.

    1. jake chase

      Actually, the main beneficiaries of the process you describe are the banks. It was the banks who benefitted most from OPEC’s quadrupling of the world oil price (1968-73), and the subsequent doubling (1978-79). The petrodollars were recycled to energy poor countries at astounding profits, and the Treasury bailed out the banks’ blunder into Mexico in 1982, just when it seemed the entire system would crash. It is always banks, banks, banks, banks at the bottom of all this financial and energy chicanery. An excellent book on the Fed’s role in all this is William Greider’s Secrets of the Temple, written nearly 30 years ago.

      It is the interest of the banks that keeps energy prices high when supply and demand factors suggest they ought to decline. You can always bet against an energy bust, because so much bank collateral is based upon high oil prices.

  10. Gerard Pierce

    Everything I am reading here seems perfectly plausible – except when it isn’t. Once again I have the feeliing that I simply do not understand. Not unusual.

    Supposedly Iraq has more oil than SA (Saudi Arabia). Iran has more oil than SA. Venezuela has twice as much in the way of reserves as SA and everyone else.

    And the US had finally decided that it’s time to develop the domestic resources that were deliberately held off the market by windfall profits taxes and other governmental actions.

    When you combine all of this with Keystone, it would seem that the entire world should be up to its butt in oil leaving us with a carbon problem not an oil problem.

    O course, Keystone is now a lot less necessary since Venezuela may once again be up for grabs. Venezuela may no longer be able to control our oil just because it located in their country).

    And at one time, Chavez made us an offer of a continuous supply at $50 per barrel. The offer was declined, but it’s interesting that Chavez thought this was a workable price.

    So what am I missing and what is the cause of the coming shortage?

    1. Adam Noel

      The biggest problem, as far as I’m concerned, is the increasing cost in producing newer oil reserves. This does not mean shortages in oil but rather will cause demand destruction in the near term. The best oil reserves have already been tapped and tapping future sources will be more expensive. Increasing efficiency and reducing demand for oil via good supply chain design could, at least for the interim, allow some growth to continue.

      The other problem is growing oil demand worldwide at the point where conventional oil sources are depleting and new sources are becoming more expensive. This is causing demand to outstrip supply and the depletion of conventional oil sources makes it harder to grow supply. The result is a plateau of oil production with periods of growth and contraction at a time when oil demand is continuing to grow.

  11. TheMomCat

    Clinton left us some financial legacy: Free Trade, the end of Glass/Steagal and gas prices through the roof. But, he is charming.

  12. Lambert Strether

    Maine has the highest home heating oil use in the country. There’s nobody anywhere on the political spectrum who doesn’t think the price is manipulated. Just can’t do anything about it.

    1. Nathanael

      Only one thing to do about it: get off of oil. Personally.

      Hard for those with no money. But there are a lot of options, if you can figure out how to solve the money problem. Best option for heating is a PassivHaus, followed by geothermal; after that come electrical heatpumps and then wood-pellet stoves.

  13. x_scylla_x

    I love this website. I read it daily. But I have to disagree with you on this one. There is no doubt that oil prices are correlated with the stock market, but not in the way you state.

    It works like this: Stock prices rise and economic activity increases, as economic activity increases, more energy is needed for production and transport, when more energy is demanded the sources of that energy see price increases.

    Many on this site are well aware of the peak oil phenomenon. We are at/near/have passed peak production. Demand is increasing, but production has stagnated. I fear that this is one place where substitution is just not possible. Economic activity is being crushed by high prices brought upon by worldwide oil reservoir depletion and increased consumption internally in petroleum producing states. I have no doubt that speculation can move oil prices, but only in the short term.

    I am currently fighting my mid-life crisis by returning to college in middle age as a petroleum engineering/finance major. It is breath taking, in my opinion, how little understanding there is in the mainstream world regarding how closely our economy is linked to the geology of petroleum reservoirs. Higher prices are bringing some extraction methods into play that were not previously, but this is not changing the math. Everyone is looking for someone to blame, be it speculators, politicians, or environmentalists. But the fact is the rocks beneath our feet are part of the problem and we need to understand that our desire to consume is another.

    1. TomDor

      “It works like this: Stock prices rise and economic activity increases, as economic activity increases, more energy is needed for production and transport, when more energy is demanded the sources of that energy see price increases.”

      I have to disagree with the above – Stock prices are not an indication of economic activity – they are a result of financial activity. Initial offerings of stock may indicate increase of activity..maybe but, once you get into trading of existent stock you are only using a crystal ball, of sorts, on which way the stock will go – it does not represent actual investment in industrial capital that actually translates to more sales of coffee or paint or nik-naks or widgets that translates to increased consumption

      1. x_scylla_x

        Tom, having reread what I previously wrote, I agree with you. I should have phrased that differently. (I will blame it on not being properly caffeinated yet). But my point is that we cannot blame the sustained high oil prices on speculation. Prior to 2000 (approximately) higher oil prices brought on by economic activity would spur additional production that would outstrip demand and push prices back down. Up until 2005-2006 (approximately) higher prices brought more production online that would (temporarily) arrest rising prices. After 2006 higher prices have not been able to bring enough additional production online to outstrip, or even match demand. In the world we are in now, the only way to lower oil prices is to lower economic activity, as we saw in 2008-2009. High prices are not brought on by speculation, but by consumption and the geological limitations.

        We are in the process of moving from recovering hydrocarbons from porous/permeable reservoir rock, to recovering them from non-porous/impermeable source rock.The so-called “shale revolution” is a misnomer. It is not a revolution, it is a last ditch effort to keep production up and it is hugely expensive. High prices are the only thing that enables the processes necessary for producing from these formations.

        1. from Mexico

          @ x_scylla_x

          Even though there is a good bit of truth to what you say, I think it’s more complicated than that.

          Oil men profess to be some of the most fervent true believers in free market ideology, but the irony is they produce a product whose price, since the 1930s, hasn’t been determined by the operation of free markets, but has been set by the intervention of governemnts. And oil men lobbied long and hard to make it this way.

          You can read the long version of how it happened in Nicholas George Malavis’s Bless the Pure & Humble: Texas Lawyers and Oil Regulation, 1919-1936. I think there may be some short versions on the internet.

          Up until the 1970s, at which time US oil production peaked, the US was the world’s swing producer. Then the baton was passed to the US’s client state, Saudia Arabia. Up until the 1970s the legal mechanism used to curtail oil production was called “proration.” Now it’s called OPEC.

          In Malavis’s book you can read all the reasons that the oil men and their lawyers invoked as to why the oil price should be set by the government and not the markets. And their arguments prevailed. Obviously, something as important to the life of the nation as energy cannot be left up to the irrationality, fickleness and uncontrollable gyrations of the market.

          1. x_scylla_x

            I won’t deny that in the past collusion took place to force up prices, but for that to happen you need spare capacity. Today, we are at a place where the existence of spare capacity is questioned. I personally think the valves are wide open.

          2. from Mexico

            x_scylla_x says:

            Today, we are at a place where the existence of spare capacity is questioned.

            True enough. There’s been a lot of speculation to that effect.

            x_scylla_x says:

            I personally think the valves are wide open.

            But that is unknowable, at least for mere mortals. Saudia Arabia is a dictatorship that operates with complete opacity.

            But hey, Saudi’s should look on the bright side. The Saudi Royal family doesn’t have anything on Obama when it cpmes to the opacity department.

  14. Malmo

    “But, do underlying forces justify an increase in pump prices from $1.81 in February 2009 to $3.81 as of yesterday? Absolutely, positively not.”

    Okay. Well one could just as well argue that pump prices falling to $1.81 in Feb of 2009 was an overreaction from speculators, and thus bore no relation to underlying forces.

    What I’d like to know, however, is just what should the price be for a barrel of oil MINUS the so called speculative premium?

    1. x_scylla_x

      You see, this is the point I am trying to make. Gas prices did not RISE from $1.81. They FELL to $1.81. Demand was destroyed by the massive drop in economic activity due to the recession. “Nor was there a reason for the run from $1.07 in December 2001 to $4.00 in July 2008.” We are picking data points here. The low price in December of 2001 is another (the same as the above stated $1.81 in February of 2009). The price did not RISE from $1.07, it FELL to $1.07 as a result of a drop in economic activity.

      Reserves are limited, and extraction rates are also a limiting factor. We are peaking/post peak (I know you don’t want to hear this Yves) but I really think we need to understand that the only way to lower oil prices is to cut back on demand (in other words-lower economic activity) as we can no longer increase supply.

      1. Malmo

        There was significantly more spare capacity in the mid to late 90’s (16 mbd) than there is today (1.5-2.5 mbd), thus price shocks aren’t that difficult to fathom. Also, in spite of the global economic woes of late, the world is consuming 18-20 mbd more than in the mid 90’s. Speculating might explain price/price volatility, but supply and demand has no small part to play either.

  15. Emperor Wang of Market Mongo

    Well, your Emperor is not really the superstitious type. But he does believe in conspiracy theories.

    So the correlation starts around year 2000.

    In the later 90s Glass Steagall repealed, Commodity Modernization Act passed. Later in 2000 Greenspan invented the then shocking 1% interest rate. TBTFs born and now have internal stock and commodity trading desks, and they always did loan to fund external hedge fund and broker margin accounts. Now they also loan to internal TBTF “clients”.

    If you Emperor hung around the water cooler in the hedge fund margin lending department and got a feel for when his lending comrades were considering raising or lowering external broker and hedge fund margin requirements and/or interest rates (before it was officially announced to the external trading world), he would be a very brave commodity margin trader. Nelson Bunker Hunt would be impressed with how easy things are in the New Millenium.

    1. Emperor Wang of Market Mongo

      Of course it would also be instructive to plot the progress of the Chinese industrial revolution that went into overdrive after admittance to the World Trade org vs. the price of oil.

      Also in the mid 90s Congress passed US light truck and SUV 35% trade tariffs in the US to help Detroit and oil company profits by launching the popularity of the SUV and not so light trucks.

      Helps us along the path towards peak oil.

      I’m tempted to call all this the Clinton Triple Play, but then I recounted and got 4 boo-boos, so it would be more correctly the Clinton Home Run.

      Clinton was the smart guy, right?

  16. TomDor

    Let us not forget the lessons of ENRON.
    They were speculating by manipulating electrical production through the provider – “hey buddy, could ya drop your electric plant out of service…I need to raise prices on the consumer to make a buck….I’ll pass some money your way…just say ya had to stop production to maintain some equipment”

    So yes – undeniable oil speculation via manipulation – I would eyeball-it at about a third of the cost…at least.

  17. briansays

    a factor in cali for some time has been a supposed cutback in production to convert the refineries over to a summer/seasonal less polluting blend

  18. joecostello

    Well the easiest and most correct thing would be to say, correlation is not causation, or the wrong causation. I’ve noticed for a decade this correlation, and it never made sense. It doesn’t make sense in equity prices bringing up oil, but even more nonsensical is the price of oil doesn’t sink equities.

    Oil has always been under or even not valued in economics, only few on the fringe, if you consider there’s a fringe to myth telling, even acknowledge oil at all, this despite the 70s and all since. The biggest reason economics doesn’t look at oil is because the oil industry has set the price for a century and still does. That the Saud oil minister last January said $100 a barrel is good price and that’s where Brent has been, no one pays attention to. That Europe is paying $110 a barrel for oil, never gets into the equation of what’s “wrong” in Europe.

    Be that as it is, we are also now in the beginning of the fourth decade of a changing debt-money banking system. For the first three decades, its been mostly a private debt-money bubble led by the banks, in last half-dozen years the central banks have pumped directly to keep things aloft. So, the question of the price of anything is a good one, but one thing for sure the supply/demand market price setting myth of Econ 101 is a farce to Wall Street/bank/debt-money.

    What price oil? Always a good question, particularly in Wall Street debt price setting “market”, for example what is the price of the “New American Energy Revolution” for example oil shale, or just as good natural gas — let’s ask Chesapeake

    The best with this is Reverend DeLong’s “insight” in the links section. One of our economic priesthood, I’m not sure what order he is, Keynesian, Neo-something? but in the piece he admits technology plays a fundamental role in economics? Phew!

    Not as expected a very good understanding though, and it certainly doesn’t get that energy, since the industrial age, has been one of the pillars of money, whether economics, the banks or Wall Street want to admit it. Most comical is de long’s conclusion, where he states,

    “This post-1750 history takes place in two stages. The first stage is the nineteenth century: the century of the British Industrial Revolution. Call it 1750-1870. It opens up the possibilities. The second stage is the twentieth century. Call it 1870-2010. It sets the patterns into which the human world is likely to grow in the future.”

    He falls into bad habit or better goes back to the faith from which supposedly at the beginning he has offered insight, by dividing eras politically. Its better understood the first is beginning of coal, the second is the oil era. And well if you believe Al Gore’s Global Warming, the coal era needs to come to an end. And as far as the second era of cheap oil, that’s done, and to show delong is no infidel, he returns to his faith claiming the oil era, “sets the pattern into which human world is likely to grow in the future.” This despite all real world evidence this era is failing all around, be comic if it weren’t so tragic.

    1. from Mexico

      joecostello said:

      The biggest reason economics doesn’t look at oil is because the oil industry has set the price for a century and still does.

      Ah, but you see, to acknowledge that would completely destroy the Alice-in-Wonderland world that classical and neoclassical economists live in, and which they insist we live in too.

      To acknowledge that it is government power, and not free markets, that sets the price of the most important commodity for 20th century economies would upend their whole little make-believe world.

      1. Malmo

        “To acknowledge that it is government power, and not free markets, that sets the price of the most important commodity for 20th century economies would upend their whole little make-believe world.”

        Come on. You really don’t think oil traders, and economists in general, don’t understand the dynamics of the oil business and the implications from govenrment involvement therein?

        1. from Mexico

          So what are you saying, that they know what the score is, but concoct these cock and bull stories to dupe the mullets?

          1. from Mexico

            @ Malmo

            Oh, I see now. You’re one of the ones concoting the cock and bull stories in order to dupe the mullets.

            That’s what I thought from your previous comments, but now you’ve confirmed it beyond any doubt.

          2. from Mexico

            Malmo says:

            What I’m saying is that you’re caricature of the oil business is specious.

            Well, I suppose the best defense is a good offense. But you’re not going to blow smoke up my ass. And while you might have some success in that regard with the general population, I doubt you’ll have much success with NC readers.

            Until Saudi Arabia reaches “peak oil,” it will fulfill the role of global swing producer. What that means is that it has excess producing capacity which it withholds from the market. Conversely, if it wants oil prices to go down, it can open the spigot.

            This is not to say that Saudia Arabia’s oil production will not someday peak, that is to say that production of it’s legacy reserves of conventional oil will peak. And of course after that day gets here, it’s a totally new game.

          3. Malmo

            I, like the late Matt Simmons, am sceptical of the Saudi’s claim regarding spare capacity. But even if thier claim is on the up and up, why, pray tell, should they be obligated to produce at peak capacity? How much risk premium would be shave off the price of crude if they did, and for how long? Nevertheless, and bottom line, geopolitics and the induced supply constraints caused thereby ultimately influence price. Where do you and I differ on that score?

          4. from Mexico

            Malmo said:

            Nevertheless, and bottom line, geopolitics and the induced supply constraints caused thereby ultimately influence price. Where do you and I differ on that score?

            If you’re saying that free markets have had only a cursory and ephemeral effect on the price of oil since the United States Congress passed the Connally Hot Oil Act on February 22, 1935 and Governor Sterling sent in the Texas National Guard and the Texas Rangers to shut down production from the East Texas Field, then strictly controlled production with the use of proration allowances after that, and that Saudia Arabia now does something similar to limit supply and thus manipulate oil price, then we differ nowhere.

            If you’re saying that most economists and traders knowlingly evangelize the fiction that oil markets are free, either that or they themselves drank the Kool Aid and buy into the fictions of liberal economic theory, then we differ nowhere.

  19. Max424

    “…consumption that has declined in response to the recession/depression.”

    Worldwide consumption of oil has not declined. Repeat: NOT DECLINED.

    The facts: despite the economic implosion of 2008, consumption of crude oil –and expensive crude oil substitutes– has increased at an almost exponential rate since the year 2000.

    “…the planet has gobs of oil underground…”

    If the planet has gobs of oil underground, they are all, FAST depleting gobs. Worldwide, the discovery of new oil fields peaked close to 50 years ago, in 1965. The last IMPORTANT oil discovery on this planet occurred in 1976.*

    *That would be Mexico’s Cantarell oil field, found off the coast of the Yucatan. The former giant, once the world’s most productive field next to Ghawar, is now reduced to a trickle.

    Think about that: mankind’s the last major find, and there’s almost nothing left of it.

  20. Hugh

    It never ceases to amaze me that every time we have a discussion on energy, so many forget we live in a kleptocracy and despite financialized speculation everywhere else, they will maintain that oil is somehow exempt and that its price is driven by fundamentals such marginal costs of extraction, peak oil, or supply and demand.

    The following is a graph I prepared showing the benchmark price for US crude from the 1940s onward.

    The first step up occurred from the 1974 Arab oil embargo, the larger increase at the end of the 70s and into the mid-80s resulted fro the Iranian Revolution and the Iraq-Iran war. Notably, prices dropped back to previous levels in the mid-80s with no recession in sight and remained fairly stable for the next 15 years. It was only at the end of the 90s or early 2000s, depending upon where you want to start the trendline, that oil prices began their surge upward. However, note too that after prices spiked massively in 2008 where they collapsed to, around $40/bbl. Now it is unlikely that producers were selling their product at a loss, at least in the aggregate. There may have been some losses in the supply line, but the area of $40 is an indication of where the baseline price for oil was located even as recently as 2008.

    There are other observations that could be made. Pay no attention to reserve estimates, these are all lies. The reserve numbers are suspect for all kinds of reasons. The larger the reserve number, the larger heft a country has politically internationally and in organizations like OPEC. Reserve numbers don’t have much to do with the number of barrels that can actually be produced. Reserve numbers often don’t change for years despite massive production.

    Higher oil prices will make it economical to go after oil produced at a higher marginal cost, but you have to wonder with all the fudging of the numbers what the marginal cost actually is and how much profit may be built into it.

    Peak oil is not a peak. It is more of a plateau we have been in for a few years now. We are still a few years off the inevitable downward phase of it.

    One of the reasons we are is present levels of consumption can be maintained or even increased now, but at the cost of leaving less for later. It is rather like having a box of candy with 100 pieces in it. Every so often 4-5 pieces are added to it. Even so we have eaten half the pieces already and we are eating the pieces far faster than they are being replaced. But for now we can still eat at our current rate because there are pieces still available. It just means that we will hit the wall of no more candy faster than if we were adjusted our habits and ate it more slowly.

  21. steve from virginia

    @Kayjay sez:

    “The planet has gobs of oil underground of different grades; West African (Ghana, Nigeria, Cameroons, Gabon and of course Angola) and now even East Africa (Mozambique) have enormous amounts of sweet crude. It is the consumption that has declined in response to the recession/depression. Concomitantly, so has production to maintain prices at very high levels: the Saudis decided to raise their production just today (seasonal demand) acording to Bloomberg. Valero and Tesoro, never mind Chevron and Exxon’s refinery profits are at very high levels: What does this suggest?”

    Feel free to comfort yourself with fantasies of low prices that will appear behind the forcing of speculators from the fuel markets, keeping in mind that crude sales are international and the critical players are now China and India … don’t forget the subsidized consumption of the oil producers themselves. Keep in mind also that subsidies are added to market costs as they must be borne by someone, somewhere.

    BTW, how many barrels are in a ‘gob’?

  22. steelhead23

    Q: Why should oil prices reflect stock prices?
    A: Because Bernanke loves to blow bubbles.

    Globally. oil is sold almost exclusively in U.S. dollars. The U.S. is devaluing its currency meaning that the purchasing power per dollar is declining. Thus, in order to maintain the purchasing power of their oil, they charge more.

    Yes, I believe speculation plays a role. No, I do not think production costs play a role. Stop doing QE, giving large banks money to play with and the speculation would cool. Stop doing QE and bucky would recover and OPEC et al. would have less angst that they are getting a reasonable return on their resource.

  23. alano

    The price of oil is completely manipulated. Peak oil is another lie to control pricing. Auto’s in U.S. get pitiful miles per gallon numbers, while technology exists to at least double the mileage. BP customers are paying for the gulf spill. What happened to Obama’s plan to make America the leader in alternative energy like solar power? Entrenched capitalistic predators have stopped all progress beneficial to mankind.

  24. Nathanael

    Correlation doesn’t prove causation.

    Throwing out an alternative hypothesis for you:

    The majority of the valuation of the major stocks on the stock market basically represent oil investment.

    Oil companies certainly do, and usually go up with rising oil prices, so this isn’t a crazy idea.

    Steelhead23 proposed another alternative hypothesis: that we’re watching the devaluation of the dollar and stocks are retaining constant prices in terms of oil for that reason.

    1. Nathanael

      X_scylla_X had yet another explanation, based on oil as a production-limited factor in all economic activity.

      Most of these are good explanations.

      I’ll be blunt: this article’s conclusion is wrong.

      Although there is speculation in oil, *speculation in oil would not track so neatly with the stock speculation*. Speculators get fads and would not be speculating on both stocks and oil simultaneously, but rather in one at a time.

      This means that the data points to a more fundamental correlation.

  25. A Real Black Person

    This article is a fine example of first world, developed country privilege. There’s no rational explanation for why so many people think they are entitled to cheap petroleum, given global trends. Not only is there no strong case for causation, Yves Smith has yet to encounter an actual “oil speculator”. I don’t think there is such a thing. There are oil investors investing in unconventional oil sources that are only profitable at higher prices. They don’t make money when the market goes into recession. Demand drops so far during a recession that prices follow. Here are the reasons behind oil prices. They’ve been clearly stated: There is a global economy that requires more oil. There is growing consumption of oil within oil-producing states. There is depletion. Depletion of existing oil fields and rising prices , due to demand, are encouraging the development of unconventional oil supplies, which are not cheap to develop. All of these things contribute to these higher prices.

    Investors are guilty of many things, but accusing them of oil price manipulation shows a fundamental misunderstanding of how markets work. The problem isn’t OPEC or investors, it is our addiction to a finite supply of petroleum.

    1. James Cole

      What about the original article makes you think Yves or anyone else for that matter feels entitled to cheap petroleum?

      1. A Real Black Person

        The fact that they are attributing higher oil prices ONLY to oil companies and the investors of oil companies overcharging for someone thing that SHOULD be cheaper than it is. That is an entitlement point of view. The Right has blamed OPEC for high prices since the embargo the in 1970s, while the Left has begun to blame investors and oil suppliers for being “greedy”.

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