It used to be that Mom, Pop, and the industrial complex had an effect on oil prices, but now it seems that even that is slipping away as big time speculators are increasingly in control.
According to the Wall Street Journal, one of the major reasons for the recent spike in oil prices has been the effect of complex, often short term, trading strategies by large financial interests, as the real world and the trading world are starting to merge.
The Journal reported that the massive drain of supplies in Cushing, Oklahoma, the delivery hub for U.S. oil futures, was significantly influenced by "financial players who have piled en masse into commodities trading in recent years" who "have made oil markets more unpredictable."
In fact, according to the Journal "Until mid-July, unprecedented conditions in the oil market had given oil companies and speculators alike a financial incentive to sock away oil in storage tanks for sale later. Then, almost overnight, it became more lucrative to sell oil immediately, and in short order, the cushion of stored oil shrank."
So what changed? For some it was the lure of taking profits, but for others, including "investment banks and other financial firms" it was about "shifting their oil-trading strategies this summer. Even the credit crunch sparked by the subprime mortgage fiasco had an effect."
According to the Journal, three years ago, financial firms started moving into the oil storage business.
The situation was quite profitable and "Storing oil became big business." The big money bank became "Tank owners and companies that leased storage." Some included "Wall Street giants such as Morgan Stanley," who "turned sizeable profits simply by sitting on tanks of oil. They would buy oil for immediate delivery and stick it in their storage tanks, then sell contracts for future delivery at a higher price. When delivery dates neared, they closed out existing contracts and sold new ones for future delivery of the same oil. The oil never budged. The maneuver was known as the oil-storage trade."
This worked well as long as oil prices in the future remained higher, a situation known as contango. The opposite situation where future prices are below current prices is called backwardation. Of late oil prices in the future are below the current or near month futures prices, giving those involved in the "storage trade" the potential for losses.
In Cushing, the "storage trade" led to a huge expansion of storage tanks, which now cover an area estimated to be over 9 square miles. Cushing is a town that houses some 8500 people, including 1000 prison inmates, according to the Journal.
Finally, as in all markets that reach over capacity, four major developments hit, nearly simultaneously, according to the Journal.
1. "This summer, however, several factors conspired to squeeze the profit out of oil-storage trades. Global oil demand kept growing, and when supplies lagged, prices for immediate delivery rose. A big Midwestern refinery suddenly began consuming a lot more of Cushing's benchmark crude, which helped lift spot prices."
2. "Buyers began paying more to get oil right away than to take delivery in the future -- a market condition known as backwardation. The contango market had ended. It no longer paid to hold oil off the market, so investors sitting on stored oil began selling. Inventory levels in Cushing and elsewhere began to drop."
3. "Moves by financial firms accelerated the changes. Some hedge funds had entered into agreements to sell oil at a set price in the future, but they didn't have oil sitting in storage to fulfill the contracts. With spot prices outstripping futures prices, they had to move rapidly to close out their contracts at big losses."
4. "Separately, the subprime mortgage mess sparked a credit crunch, which made it more expensive to buy oil with borrowed money. Mr. Armstrong, chief executive of Plains, says some of his smaller customers with low credit ratings saw their borrowing costs go up 8% or more in August and September. Some traders unloaded their stored oil to cover losses on other investments."
Conclusion
Is there an oil shortage or not? That is the big question.
And the answer is at this point unknown, except in Cushing, Oklahoma, a small town with more empty tanks than it's had in a few years.
The problem with oil, is that no one ever knows how much there really is, given the fact that some of it is sitting in tanks, while some of it is in a pipeline somewhere.
Meanswhile, OPEC, not known for its virtuous bookkeeping, is in control of 40% of the world's supply.
Throw in Wall Street investment banks, big hedge funds, and now pension funds and even some mutual funds, and you've got a real mess as far as getting a handle on supply.
One thing is nearly certain, though. Winter is coming, and the perception seems to be that supplies, at least supplies that can be moved to refineries in the U.S., are tight.
The devil is in the details of course. Are they tight because they are in storage and getting the stuff moving is hard? Or is the real reason that we've used up a whole lot more than we thought we had?
The truth is that no one really knows. And that's the big problem, which of course means that when the first big winter blast hits Minneapolis, Boston, and Buffalo, we'll find out soon enough whether there is enough of the stuff to go around.
Also remember this. Uncertainty leads to volatility. And volatility leads to opportunity. |
