The Trouble With the Falling Oil Price

Generali

Well oil prices continue to fall: Brent crude is down to below $61/bbl and WTI or West Texas Intermediate, another 'benchmark' oil, is rapidly approaching $55/bbl. Lots of analysts have been talking about prices going to $40/bbl although these are the same analysts that a few short months ago were talking about $200/bbl oil.

My feeling is that this is a massive boon for the consumer and for industry. This is the same as a huge cut in taxes in terms of the impact on consumers and is disinflationally as more cash chases more goods (the best thing of all in terms of living standards).

Production shows no sign of falling as yet. There's been lots of chat about it but very little substantial action. That's as I expected quite frankly. Nobody can afford to cut production at these prices as they need all the revenue they can get. As no one firm can impact on the oil price it's in nobody's interest to cut production as they lose and everyone else wins (basic game theory - I think this is a prisoners dilemma).

So all virtuous stuff so far. What has caused it? Probably the beginning of the end of QE in the US. I've heard lots of chat over the past couple of years about how people have been using commodities as collateral in a strange carry trade. Usually a carry trade is where you take advantage of interest rate differentials to borrow where interest rates are low (eg US) and lend where they are higher (eg Aus). The argument goes, I think and I am still a bit hazy on this, you can borrow at ~0% to buy a commodity using the commodity as collateral such as oil, gold or copper which then becomes a store of wealth for you. If you are really clever you can use the commodity to collateralise partially two loans, one to buy the commodity and one to lend to a Chinese developer through the shadow banking system (which sounds more sinister than it is! ).

michaels

At the end of the day though once you reach spot surely the market has to clear, storage is not a costless option for a tanker full of oil in Rotterdam or wherever so I don't see how speculative cash can drive up prices?

Thrugelmir

Generali wrote: »

Well oil prices continue to fall: Brent crude is down to below $61/bbl and WTI or West Texas Intermediate, another 'benchmark' oil, is rapidly approaching $55/bbl. Lots of analysts have been talking about prices going to $40/bbl although these are the same analysts that a few short months ago were talking about $200/bbl oil.

My feeling is that this is a massive boon for the consumer and for industry. This is the same as a huge cut in taxes in terms of the impact on consumers and is disinflationally as more cash chases more goods (the best thing of all in terms of living standards).

Production shows no sign of falling as yet. There's been lots of chat about it but very little substantial action. That's as I expected quite frankly. Nobody can afford to cut production at these prices as they need all the revenue they can get. As no one firm can impact on the oil price it's in nobody's interest to cut production as they lose and everyone else wins (basic game theory - I think this is a prisoners dilemma).

So all virtuous stuff so far. What has caused it? Probably the beginning of the end of QE in the US. I've heard lots of chat over the past couple of years about how people have been using commodities as collateral in a strange carry trade. Usually a carry trade is where you take advantage of interest rate differentials to borrow where interest rates are low (eg US) and lend where they are higher (eg Aus). The argument goes, I think and I am still a bit hazy on this, you can borrow at ~0% to buy a commodity using the commodity as collateral such as oil, gold or copper which then becomes a store of wealth for you. If you are really clever you can use the commodity to collateralise partially two loans, one to buy the commodity and one to lend to a Chinese developer through the shadow banking system (which sounds more sinister than it is! ).

Oil has only returned to the price it was in 2009. So you wonder how much of the price has been speculative.

Generali

michaels wrote: »

At the end of the day though once you reach spot surely the market has to clear, storage is not a costless option for a tanker full of oil in Rotterdam or wherever so I don't see how speculative cash can drive up prices?

For metals you simply take delivery and bung it in a warehouse. Oil I'm a bit hazier on.

Crashy_Time

Thrugelmir wrote: »

Oil has only returned to the price it was in 2009. So you wonder how much of the price has been speculative.

Hopefully house prices will go back a lot further than that.

Generali

Thrugelmir wrote: »

Oil has only returned to the price it was in 2009. So you wonder how much of the price has been speculative.

Also back to where it was in 2005.

A long term average was ~$30/bbl for quite some time. If we take a base year of 1995 that gives us a price after adjusting for US inflation of $45/bbl. $41 if we use 2000 as a base year. 1990 gives us a little shy of today's price. Take your pick really.

In looking at this I found an interesting tidbit. The reason Norway has the oil and Denmark doesn't? Per Haekkerup, the Danish foreign minister, was drunk (apparently) when the treaty was signed to put the sea border on the map.

antrobus

Generali wrote: »

For metals you simply take delivery and bung it in a warehouse. Oil I'm a bit hazier on.

I think for oil, you bung it in a tanker, and park the tanker off the coast somewhere.

antrobus

In other news;

Russian rouble dives despite shock rate rise to 17%
http://www.bbc.co.uk/news/business-30492518

Brent oil price falls below $60 a barrel
http://www.bbc.co.uk/news/business-30491801

UK inflation rate at 12-year low of 1% as fuel costs fall
http://www.bbc.co.uk/news/business-30493967

michaels

It is this that worries me more:
http://www.bbc.co.uk/news/world-europe-30429349

Russia is a crony state, Putin's handles on power are his security apparatus and his ability to dish out largesse. Take away the later and it is questionable whether the former will provide sufficient.

So stage one of the US / Saudi strategy is working.

But what would you do if you were in Putin's shoes and potentially mortally wounded? Not much upside in meekly submitting to the IMF, more in lashing out and hoping that in the confusion oil prices rebound and you have a good excuse to impose much stricter domestic control. If it were me I would probably go into Eastern Ukraine and the Baltics with perhaps a plan to give up the Baltics later.....

Generali

antrobus wrote: »

I think for oil, you bung it in a tanker, and park the tanker off the coast somewhere.

Probably although that brings in a confounding factor being the cost of oil tankers. Storing copper is cheap. I don't imagine oil tankers are although I'm willing to be disabused of that.