Oil illusions and/or delusions

(Part 1 of 2)
I posted a piece on the current oil price decline. I could be wrong on my interpretation. Now that I think more about it, I just don’t know.

There are many different angles and factors in the issue. I decided to list some of the variables in an attempt to put the pieces on the table to get a full view, not to prove one view or another. I just thought it would be interesting to see the components.

Basically there is a view catching wide reporting that the decline in prices have hurt the domestic oil industry, and in particular Texas. Some reports describe it as a Saudi war on Texas. The narrative is that Saudis are flooding the market with oil with the intent to hurt our production, namely shale and fracking businesses, which are more cost intensive than cheaper Saudi oil.

A lot of people believe that and follow that line of reasoning. I’m not so sure. I wrote the previous piece off the cuff in reaction to a couple reports I saw getting widely spread. A few days later and I see more reports from economists with the same perspective. It has me wondering am I the lone person who questions that? Did I miss something or am I making a mistake, as sometimes happens? Am I too quick to jump to conclusions or is my bias getting in the way? There can be different opinions.

By nature some reports are kind of hard to understand and complicated anyway. But then I am no economist, and many of these people are degreed academics. I generally have some healthy skepticism and especially when I see piling on a theme. In the end, maybe there is no correct view, and maybe it cannot be seen in just one way.

Supply and demand. This is the talking point that we have heard most in the last 6 or so years. They claim it is market forces driving the high consumer prices we have seen, and actually come to accept as the new normal. This explanation is so institutionalized that we had countless investigations on higher oil prices only to be told it is just supply and demand. Those investigations don’t reveal any gimmickry, so we’re told, and no market manipulation. In fact, reports are no one can manipulate the industry. The very idea would be absurd.

There are investors and traders and hedge funds, oh my. We hear they are the ones to blame for prices. They call them speculators. They bid the prices up to higher levels. There is an awful lot of trading going on.

Cheap oil flooding the market. In the latest analysis the Saudis are leveraging their low cost oil by flooding the market in an attempt to lower costs, making higher cost production less profitable, if at all. This will stop the investment in these processes and stop the industry in its tracks. This is the point of the current reports.

Consumer demand. We will buy something at a marketable price. But in theory the higher the price is the less you will buy, or the less you want to buy it. As prices moderate or come down, you sell more of it. So even in a down economy people will buy just what is necessary, sometimes taking from other expenses. Especially at rising, or higher prices, other goods are affected because they have less money to spend. So people cut back in discretionary spending or luxury areas to offset the higher prices at the pump. Plus they cut use of the product in any ways they can. But other areas of the economy have to be affected because a bigger chunk of the money is going to a particular necessity. For instance less for clothes, food, and less disposable income.

Subsidized economies. Some countries subsidize certain areas of the economy. Many oil rich countries have lower consumer prices due to government subsidies. Some governments own or control the resources and depend on those resources for revenue to fund their government.They make budgets and decisions based on price projections.

Taxes. the money paid to gov’t on refined goods. Higher prices bring higher taxes.

OPEC, a group of oil rich nations allying to make adjustments en masse on production etc.They meet frequently to discuss their issues and concerns. (That I compare them to the Genovese crime family is neither here nor there — they are what they are) They can move or function as a bloc. They have a union concept working for them.

Oil companies, international or domestic, that produce and explore for resources. (Or if you are a card carrying leftist, the bad guys) Private companies in this country making decisions based on a bottom line profit margin, which employ many people. They are involved in production, transportation, refining, storage etc.

Government, involved in regulating, making regulation, protecting resources and assets. Also dispenses permits and approvals, and has oversight capability. It also collects revenues on the business models, as well as on consumer goods, such as refined products.

Retail businesses: Stores that sell finished goods directly to the public consumers.

Fracking and shale oil newer and higher cost drilling operations.

Cost – benefit analysis study of the benefits derived from the cost of materials and production, and projections or decisions based on those factors.

Industry and bulk users corporations and industry that use a particular commodity as basic in their business models. Airlines, freight, energy companies.

Speculators or investors and put hedge funds in this bracket. People or companies investing in oil based on its price fluctuation or performance over a period of time. People buying futures as in any other market, who hope to make a profit. (Such as Hilary’s pork belly futures)

Now, the idea is not to make some grand conclusion by these factors. Just say these are some relevant tangents in the overall picture.

RightRing | Bullright

Oil boom, doom and gloom

I have to take some disagreement with the general views in this piece.
So I’ll take some issue with it.

OPEC Messes With Texas

by Kristin Tate 28 Nov 2014 | Brietbart

It’s official: OPED has declared war on Texas gas and oil. During a meeting in Vienna yesterday, OPEC countries kept crude oil output targets unchanged. The policy is likely to cause trouble for U.S. oil production, much of which is conducted in Texas.

As to not lose market share to the American fracking boom, Saudi Arabia has inundated the U.S. with cheap oil. The intention is to push U.S. producers out of the market space.

Crude oil is currently selling for around $70 per barrel. At this rate, much U.S. drilling could become unprofitable. Leonid Fedun, oil tycoon and vice president of OAO Lukoil, said that some U.S.-based producers are at risk of becoming “victims of their own success,” according to Bloomberg News.

Fedun reportedly said, “In 2016, when OPEC completes this objective of cleaning up the American marginal market, the oil price will start growing again. The shale boom is on a par with the dot-com boom. The strong players will remain, the weak ones will vanish….The major strike is against the American market.”

Fracking helped transform Texas into an energy powerhouse. The process — which involves blasting water, sand, and other chemicals deep into the ground the bring up oil and gas — has allowed for cost-efficient oil extraction. Earlier this year, the Lone Star State was projected to produce 3.4 million barrels of oil by the end of 2014. If this threshold is met, Texas alone would likely outproduce every OPEC nation except for Saudi Arabia, the world’s cheapest oil producer.

To combat the competition posed by U.S. fracking, Saudi Arabia has flooded the market with cheap oil. So far they have been successful, wiping out “hundreds of billions of dollars in equity value from the market capitalization of U.S.-traded securities,” according to the Dallas Morning News. […\]

More: http://www.breitbart.com/Breitbart-Texas/2014/11/28/OPEC-Messes-With-Texas

Well, I don’t buy all that. As if lower prices hurt us not help us. The eye always has to be on the longer term. Not to be beholden to OPEC’s and Saudis’ agenda would be a good thing. We’ve been strictly reactionary too long.

Also break that down, the other people hurt by collapsing prices — which were over inflated to begin with — are Iran and Russia. Should we accommodate their wishes for higher prices? The market will drive costs down, with the right policy adjustments.

The expense of building our infrastructure was a big part of getting started. Now that is well under way. The cost curve in most things inevitably bends downward. But meanwhile, price reduction does break the bubble of conventional wisdom on oil — over the last six or so years. So those players are not happy.

I think it is a positive that OPEC has not cut production. Saudis know those high prices were helping Iran. I would hate to fall in line with the agenda of Russia and Iran.

If it is a “war”, let’s examine the other side’s motives for a minute. A war means that they, predominately socialist economies, are inflicting lower prices on us as a weapon. Do you remember price wars? Who benefits by those? So now we are worried about the lower prices of oil, because the prices of heating fuel oils are still high. Have you checked, too, the difference in prices between regular and upper grades of gas? I’ve seen 60 an 70 cents per/gal differences.High test is only where regular was months back. Since when are lowering prices a problem?

I’ve read elsewhere that at 65$ per/barrel fracking etc is still profitable. And Iran needs about 117 per/barrel to fund themselves.(part of which is their terrorism outreach) And the profit margin still appears to be there in the refined products.(crack spread [1]) Maybe its me, but I’d think our government poses a bigger threat to the industry(bottom line) than Saudis flooding us with cheap oil.

But the way it hurts those mostly socialistic economies is worse, in effect, than what we see here. The article mentions the mitigating factor, Texas is invested in much more than oil. Even in the Midwest there is a lot more to the economic story than oil prices. Contrast that with Mid East countries. They depend on oil revenue for everything. It pays their bills.

So who is hurting whom? Are we to believe they are intentionally hurting their own economies to spite themselves, just to make it harder on Texas, and the US, to carry out our policies? If they are, that is a competition(challenge) worth engaging in. We need to win in the end by not being hostage to their demands and desires. In the above thinking, I guess we owe a big thanks to Saudis and OPEC for propping up oil prices to help Texas, and develop our resources. In effect, that would mean we are cutting our throats by developing these resources. Thus, they want OPEC cuts and higher prices?

Note: “A crack spread measures the difference between the purchase price of crude oil and the selling price of finished products, such as gasoline and distillate fuel, that a refinery produces from the crude oil. Crack spreads are an indicator of the short-term profit margin of oil refineries because they compare the cost of the crude oil inputs to the wholesale, or spot, prices of the outputs (although they do not include other variable costs or any fixed costs). The 3:2:1 crack spread approximates the product yield at a typical U.S. refinery: for every three barrels of crude oil the refinery processes, it makes two barrels of gasoline and one barrel of distillate fuel.” –  eia.gov

RightRing | Bullright

What’s behind gas relief?

A broad question but Bloomberg diagnoses some reasons, starting with the Fed.

Crude Falls on Federal Reserve Stimulus Halt, U.S. Supply

By Mark Shenk Oct 30, 2014 | Bloomberg

West Texas Intermediate oil fell after the Federal Reserve ended its asset-purchase program and U.S. crude production surged to the highest level since the 1980s. Brent declined in London.

Futures slipped as much as 1.7 percent in New York. The dollar strengthened a second day against the euro after the Fed’s announcement, curbing the appeal of commodities priced in the U.S. currency as a store of value. U.S. crude supplies rose for a fourth week as output increased to 8.97 million barrels a day,

“Yesterday’s Fed announcement is pushing the dollar higher, which is putting selling pressure on commodities,” Gene McGillian, an analyst and broker at Tradition Energy in Stamford, Connecticut, said by phone. “The supply build yesterday may have been smaller than expected but it was still quite large. Ample supply and economic worry are going to continue to weigh on the market.”

WTI for December delivery dropped $1.05, or 1.3 percent, to $81.14 a barrel at 11:59 a.m. on the New York Mercantile Exchange.

Crude has collapsed into a bear market amid increasing global supplies as leading members of the Organization of Petroleum Exporting Countries resisted calls to cut production. Futures are down about 11 percent in October, set for the largest monthly loss since May 2012.

More Bloomberg

It’s only about time. We cannot have economic growth when oil is sucking up all the oxygen. Prices have been doubled since Obama took office. So the Fed is a reason. I guess we should have been blaming the Fed for the high prices, then.

The interesting thing is that Opec is holding production. Prices are bound to affect oil rich countries, especially Iran. Reuters 2012: “Tehran requires $117 [per barrel] to balance the books, according to the IMF”.

Here’s to hoping Obummer doesn’t do anything to stop the long-awaited correction. Was this supposed to be a pre-midterm surprise? I don’t know. The Opec statement hints at it.

UAE Oil Minister Says Oil Prices Are Not a Threat to Global Economy

Published May 27, 2013 – Fox Business

Crude oil prices are at a fair level and aren’t posing a risk to the global economy, United Arab Emirates’ new energy minister said in remarks published Monday, signaling a consensus among OPEC members over prices.

“From the producers” point of view, the current price level continues to be an incentive for the ongoing investments that are necessary to increase oil production capacity,” Suhail Al Mazrouei told the state-run news agency Wam. “As for consumers, this level does not adversely affect economic recovery and the prospects of growth in the future.”

However, OPEC kingpin Saudi Arabia may have to persuade other members of the group to cut output to keep oil prices above $100 a barrel for the rest of the year, the kingdom largest unlisted lender National Commercial Bank said in a note.

Read more: http://www.foxbusiness.com/news/2013/05/27/uae-oil-minister-says-oil-prices-are-not-threat-to-global-economy/#ixzz2UbL2x4wa

So if the UAE oil minister claims prices have no ill-effect on economies, and gas and oil prices are in line, then why do so many Arab countries subsidize their domestic energy? Why don’t they follow their talk and allow market prices on their domestic energy? Let’s see if that has any negative effects on their economy?

Research paper:
“Arab Human Development Report”- by Bassam Fattouh and Laura El-Katiri

The policy of maintaining tight control of domestic energy prices has characterized the political and economic environment in most Arab countries, together with many other parts of the world, for decades. The objectives behind such a policy range from overall welfare objectives such as expanding energy access and protecting poor households’ incomes; to economic development objectives such as fostering industrial growth and smoothing domestic consumption; and to political considerations, including the distribution of oil and natural gas rents in resource-rich countries.

Energy subsidies distort price signals, with serious implications on efficiency and the optimal allocation of resources. Energy subsidies also tend to be regressive, with high-income households and industries benefiting proportionately most from low energy prices. However, despite such adverse effects, energy subsidies constitute an important social safety net for the poor in many parts of the Arab world, and any attempts to reduce or eliminate them in the absence of compensatory programmes would lead to a decline in households’ welfare and erode the competitiveness of certain industries.

Anyone want to take bets on what effects it would have on their economies and growth?