Friday, June 06, 2008

Congress Blames the Hedge Funds, Part IV: This Isn’t Complicated

We’re still scratching our head at the conspiracy theories now being tossed around for the egregious price of energy.

Seems like everybody—even readers of this blog—would like to blame hedge funds, traders and speculators for what is, in fact, a natural result of two factors: supply, which, as we have seen with Indonesia, is not exactly shooting the lights out; and demand, which until very recently was.

So let’s go back not quite 24 months ago—when oil was $70 a barrel—and review one of the issues that really got us here.

Hint: it has nothing to do with traders.

Monday, July 31, 2006

Until This Changes, Don’t Expect $2.00 Gas…

Not quite a year ago, in the halcyon days when oil was trading at a mere $65 a barrel, we reported (in “Why We Have an Oil Crisis, Or; Wait 'Til Chuck Schumer Gets a Load of This,” September 25, 2005) that British So-Called Petroleum was spending more on dividends and share repurchases than on finding oil.

Seven billion dollars more last year, in fact.

We are not making that up.

The Investors Relations person of British So-Called Petroleum told a group of investors back then that it made no sense to plan its exploration spending based on $65 a barrel crude oil when everybody knows crude oil prices fluctuate—so BP was using a more conservative oil forecast when calculating where and how to invest its unstoppable cash flow.

How conservative?

If you guessed $50 a barrel, you would be wrong. If you guessed $40 a barrel, you would also be wrong. Not even $35 a barrel would have been close.

No, the crude oil forecast British So-Called Petroleum was using in its forecasts was $20 to $25 a barrel.

We are not making that up, either.

We suggested that BP should change its name to “British Dividends & Share Repurchases,” our point at the time being that the energy crisis wasn’t like to end so long as the major oil companies felt compelled to return more money to shareholders than they spent exploring for new sources of crude.

Now, you might think that given, 1) the rising political heat, and 2) the fact that crude oil is now over $70 a barrel, the majors would have re-thought their low-prices-forever forecasts and started pushing the pencil on more expensive projects that would help bring more supply on the market.

But just last week, Exxon Mobil announced earnings, and while the headlines in the mainstream media all focused on the so-called obscene profits now falling into the lap of the world’s largest oil company, not much has changed: the world's largest bank—er, oil company—spent $5 billion on capital projects, including oil and gas exploration.

But it spent $8 billion making its shareholders richer.

Our official view here at NotMakingThisUp is that the U.S. government's Detroit-Friendly energy policy of the last 30 years has been dead wrong, and we're getting exactly what we deserve; also, the windfall profits tax stuff floating around Washington these days is the usual shoot-the-messenger grandstanding our own “Senator Forehead,” Chris Dodd, practices every time a crisis comes along that he has been doing nothing about when it was not a crisis.

But with Big Oil getting $70 a barrel and giving more of it to shareholders than to drilling companies...they're asking for it.

Jeff Matthews
I Am Not Making This Up

© 2006, 2008 Not Making This Up LLC

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author.


Bamass said...

Those estimates may look silly now, but the oil companies got burned big time in the 1980's when they tried to take advantage of $35-40 oil only to see it crater to under $15. Once bitten twice shy and all that.

But that almost seems like a moot point in today's political environment, wherein the feeling is that if you start a new oil drilling project you might as well be nuking the polar ice cap.

mxq said...


Miserable energy policy? yes

Increased demand from EM's? yes

Underinvestment in energy infrastructure? yes

Unfortunately, all of this has to funnel down into a decision, made by human beings, on a trading floor.

Those human beings, currently, have carte blanche with respect to their ability to exploit the above concerns.

If oil is $135 after we makes sure PIMCO-super-double-leveraged-absolute-return-natural-resource-so-you-can-hedge-against-inflation-while-driving-up-inflation Fund doesn't own 25% of the world's oil...then great! We have a proper price discovery mechanism at work.

But right now, whether that's true or not is anyone's guess...including Morgan Stanley's $150 "guess."

reeb said...

I think some people are looking at the "traders controlling price" in an analogous way that people look at music/movies/videos games causing violence. Sure there are instances of people listening to a rap song and then committing a violent act just as there is some element of the price manipulation by traders. But by and large the artists who make the movies are reflecting the culture around them and what the population wants just as the traders reflect the supply and demand around them and the prices people are willing to pay. There were wars and fights long before video games just as we'd still be having this problem even if there were no hedge funds.

Paul Krugman wrote in the NY Times? (inside joke, no?) on May 12th:
"The only way speculation can have a persistent effect on oil prices, then, is if it leads to physical hoarding — an increase in private inventories of black gunk. This actually happened in the late 1970s, when the effects of disrupted Iranian supply were amplified by widespread panic stockpiling.

"But it hasn’t happened this time: all through the period of the alleged bubble, inventories have remained at more or less normal levels. This tells us that the rise in oil prices isn’t the result of runaway speculation; it’s the result of fundamental factors...

"Saying that high-priced oil isn’t a bubble doesn’t mean that oil prices will never decline... But it does mean that speculators aren’t at the heart of the story."


admin said...

MS used shipping patterns and price evo from last year to come up with that number, is not pulled out of their collective a**.

oil co's work for their owners, or are supposed to. look at exxon decision last week. if the owners decide to pay themselves, or take the working capital and go home it's their money. I'd like to see you founding a company and then have the govt tell you where to invest your money for the greater good.

oil will be 150 and I hope it goes to 1,500 because of the energy policy. speculators only speed up the inevitable.

Aaron said...

Jeff: If one compares the rate of return on BP to XOM from the period of 9/23/2005 to last Friday's close, one can obviously see that management at XOM is a better steward of shareholder capital than the management at BP (I am not making this up - readers can go to Google and perform a chart lookup for the two companies over that period of time).

One other comment Jeff: With inflationary pressures (i.e., cost of capital, equipment costs/day rates, labor shortages in drilling) on the rise, one has to wonder whether one of the issues that brought us to the high price of oil is the cost to get it out of the ground and deliver it? I know this is more a supply concern than demand, but I think both factors, to a degree, play a part. I could be wrong though.

Guambat Stew said...

Jeff, Your resurrection of that old post is spot on. I did it myself in a post on my own blog, Guambat Stew, a couple of weeks ago, on May 28. When I first read you post back in 2006 I was gobsmacked, and it was burned into my brain back then. It has been a great forecast of things that have come.

Brad Meikle said...

I think the most germane point which is being overlooked by most Americans, and in this discussion, is that there is only enough oil to sustain the world until maybe 2040. OPEC doesn't want you to believe we've seen PEAK oil but prices would support that notion- Demand continues to grow and supply does not. OPEC votes are determined by the size of one's reserves, which are a deep secret and not independently verified. Traders cant cause a sustained move from $40 to $140. If the demand wasn't actually there prices would fall and traders would panic. The only thing that changes this trend is new sources of energy for both fixed and transportable consumption. This is of course a reality that the energy industry and its deep reaching influence goes to great measure to conceal. Perhaps traders have driven up pricing recently but its merely symptomatic, and temporary in nature. The US consumes 25% of the worlds oil with 5% of the population.

Bamass said...

I thought this post might be worth revisiting in hindsight of the -- well let's just call it what it is -- the collapse of the oil market. What was blasted as over-conservatism by the oil companies last summer is certainly looking a lot wiser now.

What's funny is, it's come so fast that it really hasn't sunk in with people yet. I talked to a co-worker the other day who was getting ready to buy a scooter for commuting purposes. "Why now," I asked, "when gas is back under $2.00 a gallon?" "Because it's just going to go right back up," he responded with no uncertainty whatsoever.

A one-person survey, to be sure, but still very interesting I think.