Economics Questions

Re: Oil Futures Market

Kakugo — Wed, 23 Apr 2008 13:28:57 GMT

The problem is not a conspiracy or the OPEC being in cahoots with the big banks. We all know about the inflation and taxes part, so let's skip that chapter.

The first part of the problem boils down to the financial market. Investment funds are buying raw material futures like there is no tomorrow, everybody knows that. They are betting (at the moment rightly) that somebody will pay any price for these goods. Problem is demand is already contracting itself: for example China has been steadily cutting her imports of non-ferrous metals since last November and European oil refinineries have cut their crude imports by about 4% since the beginning of the year because of reduced demand for fuel. The average consumer is already cutting back on pretty much everything and it will only get worse.

"Speculators" have turned to raw materials because they are the only source of "quick cash" currently available. Gone are the days of the so called junk bonds or tango bonds, gone are the days of the booming mortgage industry and even the great housing industry is slowly coming to a halt. So let's buy corn, steel, crude oil... somebody will have a need for that pretty soon. And with cheap credit available courtesy of the central banks there's no limit to what we can purchase.

I am not an economist and I do not pretend to be an expert, but I carry a bit of real-life experience under my belt. Higher prices simply mean that we cannot afford as much as we could before. Let's say the price of fuel goes up. I'll start driving around less. The price keeps going up, adding to my fuel bill and to pretty much everything I buy. I cut my consumption yet another time, and I am forced to cut on everything. When prices reach a certain level I cannot afford the good anymore so I either buy just as much as I need to keep going or I stop buying it altogether. The US consumer may still "like to drive around in his gas-guzzler" but to afford to keep his wheels rolling he's cutting back on other goods. Think about the Vietnamese fishermen or the Manila taxi-drivers now, who haven't got as much disposable income as the Westerners.

Sooner or later (probably the former) the oil price is bound to go down quite a long way, and greed will be yet again the undoing of a whole category. Until then let's sit tight and hope we can muddle through as best as we can.

Re: Oil Futures Market

i2idotorg — Tue, 22 Apr 2008 20:12:25 GMT

Juan:
The oil market is not a free market and neither is the financial sector. GIven that fact, to dismiss off hand some sort of fraudulent dealing between actors sounds to me like vulgar libertarianism.

True, but bear in mind, essentially everything boils down to a supply and demand issue. Neither institution may be free, but both are constrained by economic laws.

Re: Oil Futures Market

i2idotorg — Tue, 22 Apr 2008 20:10:42 GMT

Jon Irenicus:

Good response, I think it captures all the essentials. Is your friend a libertarian?

Yeah, and merely libertarian is probably an understatement.

Re: Oil Futures Market

Juan — Tue, 22 Apr 2008 19:59:45 GMT

The oil market is not a free market and neither is the financial sector. GIven that fact, to dismiss off hand some sort of fraudulent dealing between actors sounds to me like vulgar libertarianism.

Re: Oil Futures Market

Jon Irenicus — Tue, 22 Apr 2008 15:34:10 GMT

Good response, I think it captures all the essentials. Is your friend a libertarian?

Re: Oil Futures Market

i2idotorg — Tue, 22 Apr 2008 15:29:40 GMT

Here is a response from one of my economics buddies, and I tend to agree with him:

"The inherent flaw in his argument is the supposed ability of big banks to continually influence the markets with upward price pressure. I'm sure one or two larger financial institutions could do it for a short period of time but the level of collusion required to sustain this farce is extraordinary. One bank could simply short the futures or even have option calls for oil futures to dip, break up the cartel and reap enormous profits while the other banks face regulatory pain. The fear of this situation alone would prevent large scale collusion.

However, if he needs to figure out the problem on his own, allow him the "theory" that the banks and OPEC are colluding in price. That doesn't explain why private companies that purchase, drill, develop their own fields will stick to market pricing at the expense of market share. These independent companies could undercut the futures market in order to capture their own market share, and then create a supposed "monopoly" in the collusion arena instead of having Saudi Arabia negotiate with many different parties. The more parties involved, the higher the bargaining costs and lower margins on the benefits of collusion.

In the end though, I think you will be banging your head on the wall. His only response, and a good one at that, is to say the hallmark of a good conspiracy is the absence of evidence to the contrary. If he's watched Conspiracy Theory enough, there's no way to change his mind other than to get him a job at a futures/derivatives firm in Chicago and have him experience the life first hand."

Re: Oil Futures Market

Bogart — Tue, 22 Apr 2008 13:39:59 GMT

The only conspiracy is that the US Government and its regulator the Federal Reserve keep reducing the value of money that is used to buy oil. Oil speculators read these signals that this inflation is never going to end and bid up the price of oil. Suppliers join in to by slowing down their delivery of oil. Eventually, like in the past, 1980, 1996, etc several oil suppliers, traditionally Russia, Mexico and Venezuela, pump more oil and take the profits. This puts downward pressure on price taking the bottom out of the oil market.

What is different now from then:

1. More oil suppliers so the higher the price the more temptation to supply more oil.

2. Big Ben at the Fed refuses to let securities and real estate prices drop more than 10%, (He even said this!!!!). Reguardless of his actions which are slightly deflationary in total but the speculators get to further bid up the price.

Re: Oil Futures Market

Kakugo — Tue, 22 Apr 2008 08:02:22 GMT

Juan:
Perhaps your co-worker is indeed correct ? Given that we're not in a free market and that (most) oil companies and the financial industry both are rather suspect, from a libertarian POV, what he says makes sense to me.

I completely agree with you. I read a couple of interviews with analysts from both ARAMCO and ENI and they both agree that "according to the system of demand-supply" NYMEX oil should be around US $60, not more. Less valuable oils would of course be much cheaper. Curiously both analysts were very cautious in their approach to the oil (and commodities) futures market. They probably did not want to upset anybody.

I know I will not sound very libertarian (mostly because I have never considered myself to be one) but monetary politics and the financial markets seem to be conspiring to drive commodities prices to new heights. And as Tom Petty sung "what goes up, must come down".

Re: Oil Futures Market

Anonymous Coward — Tue, 22 Apr 2008 03:55:12 GMT

You could always point out that fuel hedging can lead to a loss in profits to the oil companies if it is done properly. Southwest Airlines is pretty good at it and pays a lot less for a gallon of fuel than their competitors because of this.

I guess that this could also mean that Big Oil is also in cahoots with a couple minor airlines too though...

Re: Oil Futures Market

BlackSheep — Mon, 21 Apr 2008 23:35:09 GMT

i2idotorg:

I guess he believes that it's a win-win for both the buyers that get the profits and the cartel who gets to keep raising the price of oil and thereby increasing their profits.

Okay, so those financial organizations would increase the demand, thus giving them a justification to raise the prices... Since they have signed plenty of agreements, they might need stuff like this to pass through the holes...

I doubt this, but, for sure, there is a lot of dirty business going on... Actual humanitarian autrocities, like in Nigeria go on all the time. With regard to prices, I think it's related to inflation. I mean, you got to point out to your friend the double-digit inflation in Saudi Arabia. That's a serious issue.

And, there is of course a lot of oil to extract, but it gets more and more expensive to get to it, so you would see prices rising regardless. A free market would provide us with alternatives like based on electricity, that could be generated low-cost in large scale via nuclear plants. Or we'll have to adapt our lifestyles, like telecommuting more, carpooling, etc.

Re: Oil Futures Market

Juan — Mon, 21 Apr 2008 23:08:36 GMT

Perhaps your co-worker is indeed correct ? Given that we're not in a free market and that (most) oil companies and the financial industry both are rather suspect, from a libertarian POV, what he says makes sense to me.

Re: Oil Futures Market

i2idotorg — Mon, 21 Apr 2008 18:34:38 GMT

I guess he believes that it's a win-win for both the buyers that get the profits and the cartel who gets to keep raising the price of oil and thereby increasing their profits.

Re: Oil Futures Market

BlackSheep — Mon, 21 Apr 2008 18:21:24 GMT

What does he say is the motivation of the Saudis to share their profits with financial institutions?

Oil Futures Market

i2idotorg — Mon, 21 Apr 2008 17:23:18 GMT

I've got this co-worker who is completely misguided about the oil futures market and I'm looking for some evidence to show him that his conspiracy theories are unfounded. He believes that the oil futures market is the reason oil prices are "skyrocketing." So, this is where the conspiracy comes in. He belives that financial institutions buy huge amounts of oil futures at inflated prices and then the oil cartel sells the oil at an even higher price, thus allowing them the profits. For example, Company X buys 10 million dollars worth of oil futures at a price of $105 per barrel, then the Saudi's sell the oil on the market for $107 per barrel. So the financial institutions and big buyers are in cahoots with the Saudi's. How am I to show this person that this is not how things work, and that in the futures market, if you bid too high and predict wrong, you lose. He will not listen to logic obviously, because he thinks they are working together. I am at a loss now, any suggestions will be appreciated.