Oil bubble - Speculators hijack oil market (?)

[mtzianos]

This is a dated article (late 2004), but still relevant, as effects of speculation on oil and (even more) nat.gas has increased even more during 2005.

I accept speculation as legit activity.

But it's important to understand that it's not real supply/demand imbalances due to phantom China/India demand or OPEC supply policies, or the world is running out of oil etc that is driving the oil bubble.

http://business.timesonline.co.uk/article/0,,9072-1257188,00.html

Speculators hijack oil market
Prices have been forced up unnecessarily as investment banks and hedge funds join the ‘black gold rush’. Robert Winnett reports


A LARGE WAREHOUSE in Amsterdam may seem an unusual place to attract the City’s top traders and hedge funds. But, in the past few months, Morgan Stanley has been accumulating warehouse space in the Netherlands to store its hottest new property — oil.
This and the tankers that have been hired by the investment bank illustrate just how important oil is now becoming in the City of London and Wall Street.


Morgan Stanley may be among the most advanced of the new breed of oil speculators, but, over the past year, many banks and hedge funds have joined the “black gold rush”. With the stock market proving lacklustre, the oil market has been a godsend for the banks, which describe it as the “new Nasdaq”.

Speculators have helped to drive oil prices to near record levels — peaking at almost $50 a barrel last month. Oil is the talk of the City with many millions of pounds being made every day, and oil traders are among the most sought-after employees.

“If you can spell derivative, you can earn six figures, and anyone who can navigate his way round the oil market is offered $1m just to sign a contract,” said one trading executive.

There have traditionally been two distinct oil markets. The first is the futures markets in London and New York that trade the right to buy oil at a predetermined point in the future. About one-sixth of all oil is sold this way, although most contracts are traded and then lapse without oil changing hands.

This “paper” market, the main stamping ground for speculators, acts as a benchmark for the price of oil in the second market — crude bought direct from oil companies.

If prices on the futures market rise too far above the so-called physical market, oil users such as airlines and

petrol dealers pull out, so prices fall. If prices on the futures market are lower than in the physical market, the users pile in, pushing up prices.

However, this traditional equilibrium has been rocked by short-term speculators dipping in and out of the futures market. This has led to sharp rises in the price and far more volatility.

Meanwhile, banks such as Morgan Stanley are also beginning to move into the physical market to buy oil — or even entire oilfields.

Morgan Stanley recently won the contract to supply fuel to United Airlines, and Goldman Sachs recently bought 10m barrels of oil.

A senior oil company executive said: “Even within this firm, the mechanics of the market are not widely understood. When oil prices go up, everyone talks about fundamentals and geopolitics, but the role of speculators and banks is now very significant.”

 

[mtzianos]

In the City, Barclays, Morgan Stanley and Goldman Sachs are leading the charge into oil but, in addition, several secretive hedge funds are now wagering hundreds of millions of dollars every day in the oil market and reaping the dividends. Over the past few months, ABN Amro has also built up an oil-trading team.

“We have a database of about 300 people in London who are capable of trading oil so, as you can imagine, they are very highly desired,” said one bank executive

However, consumers and businesses are paying the price of the speculators’ profits with higher petrol, energy and air-travel bills. Last month, British Gas increased its prices sharply as a result of higher oil prices. Npower followed suit last week.
Nationwide building society calculates that the impact of higher oil prices on households is the same as a quarter-point rise in mortgage costs.

The International Energy Authority, an intergovernmental organisation, recently criticised the role of speculators. They have also been attacked by French and American government ministers. Alan Greenspan, chairman of America’s Federal Reserve Board, said that speculators had caused oil prices to “surge”.

A secret analysis of the market carried out by a big European oil company recently found that speculators were adding between $7 and $8 — or between 15% and 20% — to the price of a barrel of oil.

This month, rocketing petrol prices forced Gordon Brown, the chancellor, to delay a proposed increase in fuel duty.

A senior executive at one oil firm said: “This is the hottest oil market I have ever seen. There has been a massive increase in hedge-fund activity. And what we call non-commercial interests (those who do not use oil for their business) has doubled recently.

“A lot of new banks are coming in and all the speculation is very disruptive.”

Much of the trading by hedge funds has been driven by sophisticated computer-trading models. The models, known as “black boxes”, use complicated formulas to determine trades for a hedge fund.

Over the past few years, a number of hedge funds have added the oil markets to their trading systems as the price of oil tends to rise sharply after periods of strong economic growth. Hedge-fund insiders therefore say that oil is an excellent short-term bet.

The sharp rises and falls in the market over the past month are symptomatic of such computer-generated trading. Prices rose sharply to almost $50 a barrel, at which point the computers kicked in to automatically sell huge positions.

Last week, the computer trading models kicked in again to cause the biggest daily fall in oil prices for three months — a drop of 4% to $42.81 a barrel.

Jeffrey Currie, head of commodities research at Goldman Sachs said: “The number of speculators is typically correlated with high economic growth. They work off macro-economic trading models.

“Equities are anticipatory assets — you buy them when you expect the economy to do well — but commodities such as oil are spot assets that you buy when the economy has done well.”

Man Group’s AHL hedge fund and Aspect Capital Management are two of the London-based funds that have moved heavily into oil.

Stephen Butler, an oil expert at Aspect, said: “We are one of the biggest in Europe and have built up our exposure over the past 18 months. We probably have up to $250m (£140m) exposure a day on the London and New York markets.

“Our trading is determined by computer so we don’t have the emotional factor. It has worked well on the energy markets and has been one of our best-performing sectors.”
But apart from the short-term speculators, the investment banks have also identified a looming “oil crunch”, which has encouraged them to move aggressively into the market.

Goldman Sachs calculates that for the first time this year demand for oil will outstrip the world’s capacity to refine and distribute it.

Benoit de Vitry, head of commodities at Barclays Capital, said: “The oil system has cracked. There is a lack of refinery and distribution capacity. The spare capacity is now down to 1m barrels a day. People are not worried about having their meal on the table today, but fears are growing about the future.”

According to Goldman Sachs, the capacity of oil tankers and oil refineries has been dropping since the early 1980s because of a lack of investment, and the crunch will come this year. Since 1983, real spending on exploration and production of energy has fallen by 49.5%. To build the extra infrastructure that is required will take years, possibly more than a decade, to complete.

The International Energy Agency forecasts that over the next 30 years the energy industry globally will require $16,000 billion in new investment to catch up — and it is not clear where this money will come from.

Apart from the oft-quoted, short-term oil price, there is also a lesser-known market in long-term oil futures — the right to buy oil in five years’ time. This has traditionally been a rather staid market, and the price of a barrel of oil in the long-term market has been around $20 for most of the past 20 years. However, over the past 18 months, the price has rocketed to $35 a barrel as the speculators have moved in.

The bleak, long-term outlook for oil prices is also why banks have begun to buy up oil supplies directly. Morgan Stanley and Deutsche bank recently bought the rights to 36m barrels of oil between 2007 and 2010 direct from a North Sea oilfield.

The pattern of supply and demand for oil this decade is also undergoing a fundamental change. The countries that make up the Opec oil cartel — in particular Saudi Arabia, the world’s biggest supplier — have young populations and the cost of their public services is burgeoning. On average, the nine Opec nations are expected to need to charge at least $31 per barrel to avoid government budget deficits over the next decade.

Meanwhile, demand for oil is booming. Since 1980, the consumption of oil has risen by an average of 1% a year. However, this year, consumption worldwide has risen 3.2% as a result of soaring demand in China. During 2003, China’s use of fuel oil rose by 22%, while its use of crude oil and petrol rose 10%.

Figures released last week show that, in July, Britain recorded its first deficit in the trade of oil for 13 years, signalling that the country will soon lose its energy independence.

Research reports highlighting these patterns are among the most avidly read publications in the City and on Wall Street, so the speculators look like they are here to stay. But now their role has been exposed, the City speculators may find themselves the target of fuel protesters complaining about the spiralling costs of petrol.

 

[mtzianos]

The only bottleneck in PHYSICAL oil market right now is in REFINERIES in oil consuming nations. Oil stocks are at 5yr highs.

Why do you think there's a bottleneck in refineries?

I have many friends in shipping biz (owning oil tankers and delivering all over the world), and know the status of the physical market.

In my opinion, this whole circus of the last 2yr over oil, is thanks to Dubya (acting on behalf of Big Oil, giving them overnight profits they'd have to earn over 10yr).

Coupled with WallStreet speculation.

Just as long as everyone knows they're walking a very fine line here, because if major economies go into recession (basically the US consumer of last resort rolls over) because of oil prices, then oil-producing countries will be the first to suffer.

OPEC statement:

OPEC says growth in its output capacity to outpace call on its oil in 2006

Monday, 18 July 2005

Vienna, 18 July 2005--OPEC has assured that the growth in its oil output would outpace the demand for its oil through the year. In its Monthly Oil Market Report for July released here, OPEC said the demand for its oil should rise 0.1 mb/d to 29.0 mb/d in 2006, or well below the 0.7 mb/d increase in OPEC capacity expected in the same year.

"The increase in OPEC capacity over the last two years also stands in sharp contrast to developments in world refinery capacity where increases have lagged well behind demand growth and the increase in OPEC and non-OPEC supply, the report explained.

It welcomed the recent agreement by the Group of Eight industrialized nations to consider measures to encourage the expansion of refinery capacity. However, it pointed out that “this positive statement needs to be translated into immediate concrete actions if the growth in product supply is to keep pace with the expected rise in demand.” OPEC Member Countries the report added, have already begun to increase their investments in the downstream. It noted, “without meaningful and timely measures in the main consuming countries, the high and volatile oil prices noted in the G8 Communiqué are likely to remain a feature of the market,” it stated.

"The preliminary forecast for 2006 showed world oil demand projected to average 85.2 mb/d, implying a rise of 1.5 mb/d or 1.9% over total 2005 consumption. On a regional basis, the largest contributor to demand growth is expected to be the Developing Countries followed by the OECD and China with an estimated growth of 0.6 mb/d, 0.5 mb/d and 0.4 mb/d, respectively," the report said.

It indicated that, "in 2006, non-OPEC oil supply (including processing gains, OPEC GLs and non-conventional oils) is expected to average 56.2 mb/d, an increase of 1.4 mb/d versus 2005. On a regional basis, the report said , the largest contributor is expected to be the African region, followed by the FSU, Latin America and North America (mainly Canada), whilst OECD Europe and Pacific, and the Middle East are expected to show a net decline. The net contribution from Russia is expected to be just 70,000 to 100,000 b/d, and is considered the main risk factor for non-OPEC growth next year," it explained. "In terms of overall crude quality, the net increase is expected to be overwhelmingly medium sweet, in contrast to recent years when increases have been mainly medium sour," the report added.

Of significant, the report indicated a downward revision to the current year world oil demand growth by 0.15 mb/d from the prevoius report citing the slowdown in world economic activity and preliminary demand figures from some major consuming countries, including China, "pointed to significantly lower consumption in the first half of the year." It said global demand growth was now projected to rise by 1.6 mb/d or 2 per cent year on year to total 83.7 mb/d. It said the full year demand for OPEC oil in 2005 was estimated at 28.9 mb/d, representing a reduction of 260,000 b/d, while those of non- OPEC supply growth has been revised slightly down from its last month's estimates. "Non-OPEC supply was expected to increase 0.8 mb/d over the previous year, a revision of 40,000 b/d from last month’s report. Revisions in the outlook for Russia account for the bulk of the negative revisions in the third and fourth quarters of 2005," the report said.


Report by Umar AMINU, OPEC News Editor 43 1 21112/380

OPEC, Vienna, Austria.