This question will lead to knee-jerk reactions about “greedy hedge funds!” or “bad policies by political party X” by people who don’t know what they’re talking about. So I’d like to enforce a rule: if you don’t know the difference between the “futures market” and the “spot market”, then you don’t understand my question. Please keep that in mind
So explain how the spot price of oil (measured in what I pay for gas at the pump) doubled in a year and then fell to a 5 1/2 year low. Yes, I get that the futures market oil price can fluctate wildly based on expectations of recession. I get that the futures price of oil can be manipulated by hedge funds and politicans. But hedge funds never take physical delivery of oil – they have to sell the futures contracts on the spot market, so the spot market has to be based on ordinary supply & demand. I contend (prove me wrong) that gas prices at the pump reflect the true supply-n-demand cost of oil and can’t be manipulated by hedge funds, politicans, or other factors. But if that’s true, then why did oil spike so sharply and fall so rapidly?
Yes, demand for oil is starting to fall on fears of recession, which explains some of the recent decline, but oil demand is NOT 1/3 of what it was in March. I know part of it is currency trading too; but that doesn’t explain it all either.
So why did gas prices rise & fall so rapidly? (Please don’t just say “greedy hedge funds” unless you can refute the above points about spot market vs futures market).
Well, first, was their rise & fall especially rapid? As compared to other commodities traded daily in the market?
I really don’t know, but I remember growing up, and having neighbors who would listen to the opening hog market prices every day, because they changed so rapidly. Sometimes when the price was especially good, they would load their hogs into a truck and drive them into the South St. Paul market, because they could get there to sell them before the market closed for the day. They claimed to make as much as double the average price by doing this. So at least the hog market price could rise & fall very rapidly over a single day.
And I know from movies (Trading Places) that the market for orange juice could fluctuate wildly within just an hour or two. If that’s accurate, it certainly beats the oil price changes.
According to Saudi Arabia’s oil minister on 60 Minutes last week, much of the rise was due to panic buying. Investors saw prices rise, so they scrambled to buy before prices rose higher, which made prices rise, which caused investors to scramble to buy before prices rose higher…
My armchair theory is that Opec is feeling a little scared right now at the worlds intrest in finding alt. fuels.
So they figure they will distract us for a whiile with cheap gas prices until our addiction becomes full blown again. Then they’ll go back up on prices.
There are two things at work. When production is tapped out and demand rises above that level (and even if the Saudis really did have more spare capacity, they weren’t turning it on so that’s moot - if people aren’t opening more taps at $140/bbl it’s almost certainly because there aren’t any more taps to open), prices will rise until until enough demand is priced out of the market to balance it with supply. Turns out, people like energy and it takes a pretty steep price to price them out of the market.
On the other hand, when you have excess production (which is now the case with even the relatively small decrease in demand), prices will fall until they’re approximately in line with the marginal production cost of a barrel of oil. Even just a few years ago, this would have been rather lower than the current cost of oil, but these days the hypothetical marginal barrel of oil is from oilsands or some deep offshore rig, and costs more than $15.
Then, of course, there’s speculators and such, but speculators don’t actually buy or sell oil, just futures, and so it’s pretty hard to warp the price very far from what supply and demand fundamentals dictate for very long. Since the speculators must sell their futures before the delivery date, they’re playing a zero sum game. Panic buying by large consumers (airlines, etc) locking in prices to avoid having to pay even higher prices later will have no doubt played some role. But that’s still just supply and demand.
Sorry, but that isn’t even remotely true. In this case it wasn’t because there were no more taps to open, it’s because no finance organisation was stupid enouigh to lend money based on a projetcion of $140/bl. The lenders knew perfectly well that oil wasn’t going to sustain that price for the 15+ years that a new drilling operation requires to make its money back. So they refused to lend based on that price, and as a result there was no money to turn the new taps on.
IIRC the financiers were only lending if you could prove that your proposed operation was profitable at at $35/bl average over the next 15 years.
Jeez, at $140bl there are an almost unlimted numberof taps to turn on. Shale oil and tar sands become profitable at ~$90/bl and there is about 10, 00 time smor e oil in those forms than there is liquid crude, and thety remain essentially untapped.
So to say that people weren’t opening more taps because there were no more taps isn’t even remotely true. People weren’t opening any more taps because the tap price was grossly overinflated and unsustainable and thus didn’t justify buying knew taps.
If you think about where someone would be today if they had taken out a loan for a new drilling operation 12 months ago based on a price of $120/bl you will soon see why the nobody was rusing to investin new taps at that price.
Now when the price reaches a sustainable $140/bl and nobody is opening new taps then your statment has some basis. But saying that there mustn’t be any new taps because nobody will take out a 15yr loan base don a 3 year trend is in no way true.
Why on earth would a price drop of 2/3s imply a demand drop of2/3s? When did you last see a straight-line relationship of supply and demand in the real world?
Oil is a very important and useful product, but the price behavour is not massively different from baked beans or anything else - nearly everybody is willing to buy beans at 29p a tin, a few less are willing to buy them at 58p a tin, even fewer are willing to buy them at 87p a tin. Ramp the price up to 87p, sales drop noticeably, price drops to 58p and sales go up, then the extra orders placed by supermarket to take advantage of the 87p bonanza arrive, forcing clearance sales which push price down to 29p, clearing the market. The total difference in sales between the 87p level and the 29p level might only be 10%, or it might be 90% - it depends on how much people want their beans and how cheaply supermarkets are willing to clear their stock.
I seem to recall that at the price peak sales of gasoline in the UK were down 20% - that’s a pretty big fluctuation in demand for any commodity, which I’d expect to result in some pretty drastic price reductions.
Blake - By “taps”, I think Gorsnak meant it literally, i.e. production capacity that could be brought on line in days or weeks by activating existing underutilized facilities.
I don’t think anyone disagrees with the notion that over a span of years a lot of additional capacity in mostly non-traditional areas can be brought on line. But that’s not at all relevant to the OPs question about short term (<1 year) volatility in pump prices.
I think he was talking about existing oil fields where all you have to do is turn on the pumps to sell more, not new fields.
People talk all the time about OPEC fine-tuning the price of gas by dumping more or less crude into the market. But they don’t have that much control. Saudi Arabia doesn’t have oil wells operating at 50% capacity that they can quickly change to 100% capacity when they want to lower the price of oil. It costs a lot of money to keep your oil infrastructure operational, you can’t have the workers sitting around reading magazines for months waiting for the call from the Illuminati that oil prices are too high and they should get back to work.
Turns out that crude oil is fairly difficult to pump and it takes a massive expensive infrastructure. That means that supply is relatively inelastic in the short term since you can’t easily start pumping more oil without a large new investment, and you can’t easily pump less oil without losing money on your large current investment. And demand for oil is relatively inelastic in the short term, since people still have to get to work and heat their homes and it takes them a while to figure out how to substitute (work from home, move closer to work, sell the SUV, take the bus, carpool, insulate the attic, etc etc etc). As you say it takes years to develop new oil fields, and it takes months for people to change their gasoline/diesel/fuel oil consumption. Inelastic supply coupled to inelastic demand means high volitility in price.
Quite correct. Some people seem to think that OPEC can produce any amount of oil at will, and that they are intentionally holding back to push prices higher. While the Saudis maintain they have lots of excess capacity, it’s not clear that they do. The only evidence is that they say they do. Most other OPEC nations have declining capacity these days, and are (or were, a few months back) at or near the limits they can produce.
As for oil shales and the like, let’s please be reasonable. If it were possible to significantly jack up productions of the must less capital-cost-intensive Alberta oilsands, a great many companies would have done so. In fact, a great many companies are doing so, at the cost of many, many billions of dollars in capital expenditure. And still, oilsands capacity in terms of Mbbl/day is only growing slowly, and isn’t projected to ever hit anything like what could be had out of a conventional oil field of that size. The shales would only be worse. Ramping up production of such oils is pretty much nothing like opening taps. For such unconventional production of oil to grow at a rate to bridge the gap between growing demand and leveling or declining conventional drilling will require trillions in capital expenditure and untold environmental costs.
Just because hydrocarbons are sitting there with a theoretical profitability level doesn’t mean they are available on demand at that price. There are no taps built to turn on in their cases.
But… but… The Saudi oil minister on 60 Minutessaid they had plenty of oil!
They did show a complex at a new site. It’s located about 400km (or was it 400 miles?) out in some massive sand dunes. They literally had to move a sand dune in order to build a runway, and they had to build a road through the dunes. The oil minister said that previously it was too difficult to drill there. Leslie Stahl said that the Saudi government is paying cash, so loans aren’t an issue. The minister said that Saudi Arabia needs oil to sell for $55/barrel in order to run the government; so, he said, the current low price is costing them. Oil should start flowing in a few months.
I’m going on memory here, so I hope I’d remembering correctly. I assume the segment is available online.
I have always wondered-doesn’t the Texas State railway Commission regulate the well pumping schedule in Texas? granted, Texas on-shore production is fairly small-but it could make a big difference whn supplies of crude are tight. Second: the US Navy still has vast petroleum resrves 9Teapot Dome, WY, Kettleman Hills, CA)-could this crude be brought to market quickly?
Finally, the Norwegian and British governments have production caps on the North sea oil-presumably they could hike output quite a bit, if they wanted to
The price elasticity for oil is very low in the short term. This means that small changes in supply and demand can have a large effect on the price. The availability of oil had been in decline because in most places government controls oil extraction. The rising prosperity of China and India caused demand to go up. This, along with speculation spiked oil prices. Higher prices led to more oil being found and pumped and poor economic news led to lower global demand. This has swung the price of oil in the other direction.
I don’t know if this explains it all, but it probably explains some of it. The Saudi oil minister once said, “The Stone Age didn’t end because they ran out of stones.” and he has been trying to avoid too high a price for that reason. One possible explanation is that when the price started to fall they were too slow to lower production. Don’t worry, they will.
If I had a spare 100,000 gallon tank, I would fill it with heating oil at today’s prices. One July day when I was living in an apartment building in Zuerich, I saw an oil tank truck drive up and pour its oil into a pipe in the sidewalk. When it finished, a second one drove up and did likewise and maybe a third one as well. They explained to me that the price was chapest in July and the owner was buying his annual supply.
