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If Crude Oil Is A Bubble Where Is The Smoking Gun?

Commodities / Crude Oil Jul 08, 2011 - 04:50 AM GMT

By: Andrew_Butter

Commodities

Best Financial Markets Analysis ArticleOn 22nd June, Brent closed at $113. Then IEA made their move; the price dropped, and by 26th June it closed at $104 which was 8% down on the 22nd. Today it’s up to $114, back to square one; that’s hardly “Mission Accomplished”.

Not quite sure what they were thinking, forget about the “allies”, America’s Strategic Petroleum Reserve is 270 million barrels, that’s 20-days pumping at full capacity for Saudi Arabia.


Of course it makes sense for America to pop a bubble in oil, if there is a bubble. The higher the price of oil the more she has to borrow from aliens to pay for it, and the less the few remaining companies in USA that haven’t been out-sourced can sell what they make to aliens and so the country can get hold of foreign exchange to buy oil from aliens, without borrowing (from aliens); because if oil prices go up the aliens spend more money on oil, and less on Caterpillar engines etc.

And America has every right to do a bit of “reverse manipulation” of markets, if she suspects that the markets are being manipulated against her interests, or for some reason that no one quite understands, they are in disequilibrium.

But 60 million barrels does nothing. America may have the biggest and most expensive military in the world, but when it comes to oil, she has about as much power as a cow on a feed-lot waiting passively for lunch, before milking time.

If speculation or some other thing disrupting the market is the reason for the oil spike, 60 million barrels is not enough to wage a conventional war. But it’s enough to wage a guerilla war; which is something America must by now have learned a thing or two about from the insurgents (still) planting road-side bombs in Iraq, and the 25,000 Taliban facing 250,000 conventional troops. 10:1 is pretty much standard in such situations, imagine if America could leverage 270 million barrels to pack the punch of 2.7 billion?

But there are a few ground rules, (a) you don’t tell anyone when you are going to buy or sell, before you do, just as you don’t advertize where or when you are going to plant a road-side bomb, (b) you don’t announce when you are going to run away with your tail between your legs shouting out “Mission Accomplished”, over your shoulder.

So was 2011 a bubble, and if so did it pop, or partially pop, and either way, what happens next?

Interesting that the run up from oil at $90 to oil at $127 pretty much mirrors the run up in 2008, interesting also that then, like now, the big run up was from New-Year to Mid-Year.

But on 1st May 2011 the lines diverged; Brent dropped 12% in a week. Perhaps that had something to do with the article I published the day before saying (a) oil was a bubble (b) it was about to pop?

http://www.marketoracle.co.uk/Article27857.html

Could it be possible that one obscure article read by 2,772 people had more impact on oil prices than collective pronouncements by OPEC, Saudi Arabia, the IEA, and Goldman Sachs, put together? Perhaps I’m psychic…or perhaps the model that predicted that, works better than the model Goldman Sachs is using?

Either way, that’s the past, what interesting is where is oil going, and if it is a bubble, what’s driving the bubble? If it’s a bubble, is it the same thing that drove it in 2008, or is it something different?

There are three variables; first…what is the price of oil, at which the world economy, particularly America’s economy, will start to suffer if it is exceeded? That’s called the conundrum of Parasite Economics.

Successful parasites make sure that the value they bring is more than the harm they cause to their hosts. That applies whether the parasites are little birds picking the teeth of crocodiles, bacteria in the human intestine, farmers milking a cow, or oil producers; no one wins if the cow gets sick, or heaven forbid, drops down dead.

Talk to anyone who knows about nature, whether they are a bird-watcher, a trout fisherman, or a virologist, they will tell you that the natural world is all about equilibrium.

Sometimes the equilibrium is disrupted, by a volcano, or by man; sometimes the equilibrium is permanently disrupted, as in the population of cod off Newfoundland, and sometimes equilibrium returns, like the ozone layer, and life as we know it trundles on, and so in the words of John Maudlin, “we will muddle through”.

You won’t find the words “Parasite Economics” in an Econ-101 textbook, which is the universal primer for a popular but much discredited pseudo-science of how to shoot yourself in the foot 101 times, and still expect a different outcome, next-time. Parasite Economics says the equilibrium now for the price of oil of $90, which is also in the range of what the Saudi’s say it is now ($80 to $100 depending on their mood).

http://www.marketoracle.co.uk/Article24849.html

So if that price is maintained, plus or minus 15%, world economic growth will not be constrained by oil prices. That would be “nice”, but that doesn’t mean it’s going to happen. The US housing bubble proved one thing, which is that “nice” and “muddle through” are not given, bad things can happen.

The second variable is how much would it cost to bring in new oil? Like for example if Israel bombed Iran, and then Iran rocketed Saudi Arabia and then America nuked Iran, but then the survivors closed down the Straights of Hormuz for a couple of years by deploying upgraded Sunburn anti-ship missiles to cut oil-tankers in half, built with plans stolen from China

Which are as hard to detect and just as lethal as the new-version roadside bombs being slipped across the border that can rip a HUMVEE in half (literally). As three poor souls from the security company, OLIVE, found out just the other day; and no you won’t read about that in the newspapers, only “good news” is allowed out of Iraq these days.

How much would it cost to replace that oil?

Sure the “Bomb-bomb-bomb-bomb Iran” option sung along with “Barbara Anne” is “worst-case”, some might call it a “Black Swan Event”, but who would have thought, ten-years ago, that America would spend $4.7 trillion of borrowed money, chasing phantoms round dusty mountainsides?

The CEO of Exxon recently testified to Congress, that the price at which deepwater oil is profitable is about $75. That price is more than something of academic interest, because there is no denying that the rate of consumption of oil now-days, far exceeds the rate at which it is being discovered and brought to market, and who knows how much deepwater oil there is…and then…deep-space oil?

The third variable is manipulation of the market-place.

Most people would agree that the ascent of oil prices to $140 in 2008 (Brent – average over a week) was a bubble. Certainly what happened next had all the characteristics of a bubble bursting; the price went down to $45 (average over a week) and the square-root of $140 x $45 is $80 which according to the science of BubbleomiX defines the fundamental or intrinsic price, or what International Valuation Standards calls the other than market price, in bursting bubbles.

If it walks like a bubble, and it quacks like a bubble, well it probably is a bubble, and significantly, all through the spike the Saudis were saying; “this is a bubble, the correct price (then) was $75 to $85”, and then, as predicted, that was the price it came back to, except by then the “fundamental” had moved up a bit.

Perhaps it’s time to take the Saudi’s seriously and given the power that they have to influence the direction of the world economy, in a positive way, as opposed to the somewhat negative technique Rambo uses, as in blowing things up with precision guided cluster bombs, perhaps they would be a more sensible choice for a Permanent Seat on the UN Security Council than UK or France?

Either way, buy that logic and oil is a bubble and it’s going to pop, although calling the top of a bubble is a mug’s game, particularly if you are not sure about what’s causing the bubble.

What’s irritating; is that no one can figure out why there was a bubble in 2008, and if 2011 is a bubble, why there was a bubble in 2011.

It’s easy to blame “God’s Workers” the “speculators” and more recently the “hyperinflationary-money-printing” of Ben Bernanke. But blame is one thing, a smoking gun is something else; so far no one found one, and it’s not for lack of trying

A recent analysis by the Bank of Canada looked at commodity speculators, and came to the conclusion that the 2008 spike was nothing to do with them; meanwhile the SEC has a case against a so-called perpetrator of the spike, they will probably loose.

http://www.cbc.ca/fp/story/2011/07/05/5053308.html

The commodity futures market is a very old market that started off helping farmers to pass on some of the year-to-year risks of farming, these day’s airlines use it to hedge the risk of price spikes, it’s relatively transparent and it serves a useful economic purpose.

Did that market “cause” the spike?  I doubt it, not that I am an expert on that market, but I figure that if it caused the spike, someone would have found a smoking gun by now.

And insofar as all those “hyperinflationary” dollars Helicopter-Ben printed, that the Econ-101 students have been hyperventilating about for the past two years. Well first of all Ben can’t just “print” dollar, to do that he has to put up some collateral with the Federal Reserve Agent (a government employee), that could be US-Treasuries or the cleverly designed lookalikes that Ben calls “Troubled” and everyone else calls “Toxic”.

 Second, that money didn’t get out into the economy; it just sat in bank vaults as part of the charade of the “regulation” of fractional reserve banking based on calculation of capital adequacy using Voodoo Valuation standards to “value” the assets.

So, if 2008 was a bubble in oil, and 2011 is a bubble too, what was the cause?

Well just because you don’t have an explanation for why something happened, doesn’t mean you can’t make predictions. My six-year old niece can predict with astounding accuracy where the sun will come up tomorrow morning; and she has an explanation for why that happens. Personally I don’t buy the explanation, but there is no disputing the accuracy of her predictions.

Remember the housing bubble in USA. That started when the politicians decided it would be good if more Americans owned their own homes and the Students of Econ-101 came up with a brilliant model that showed that could be achieved if the price of house went up through the roof.

Don’t ask me how they figured that out, like I said, there are 101 ways to shoot yourself in the foot, personally I’m not interested in any of them.

So they put in all sorts of subsidies for home ownership, tax breaks on mortgage payments, tax breaks on capital gains, and they gave a wink and a nod to Fannie & Freddie to make money available for that noble cause, at less than the real cost of money. And all the while, all the Students could say about the insanity of those policies was…err…”our genius model may be detecting a bit of froth”.

I have two points; the first is that countries subsidize oil consumption. In USA they give tax-breaks to oil companies, and the tax returns on oil consumption do not cover the real cost of having to borrow money from aliens, to pay for it. But USA is not the only one, India, Philippines, China, UAE, all have implicit and explicit subsidies to hide the real cost of oil from the consumer, and to pay for that from money gathered elsewhere.

It’s impossible to understand cause an effect when the Students of Econ-101 get into gear, tweaking this or that with this or that that incentives; but a market can only be efficient, if the real intrinsic or fundamental cost is reflected in the price; in the market for oil and it’s products. Instead the “market” is controlled by the same idiotic philosophies that gave us “inflation targeting” and “affordability”.

My second point is that although the commodities futures market might be relatively transparent, the spot market is not where the real, i.e. “intrinsic” price of oil is worked out.

Remember how God’s Workers used to value Toxic Assets, they had “markets” for them which were almost completely moribund and had hardly any transactions; most of the buying and selling was done direct, outside the markets. But the “index” of the carefully constructed and often manipulated “markets”; were used as a way of valuing the garbage, and in the end, the insanity of that unraveled.

The market for oil is not in the place where the price of Brent or WTI is traded, it’s in contracts typically between state-owned corporations in Philippines, India, China etc, and state-owned producers, or traders with links into the producers. That’s not a transparent market.

Bubbles happen when there is asymmetry of information between buyers and sellers, that’s how Toxic Assets got over-valued, allowing the housing bubble to go stratospheric.

And that’s the most likely cause of the 2008 bubble in oil, and what looks like the bubble of 2011. The “loss” of 1.5 million barrels of oil from Libya ought to have had no more than a 3% effect on oil prices, and in any case the Saudi’s said they would make up the difference; but mysteriously no one wanted to buy.

The problem was that the people who used to rely on Libya which had a particularly “sweet” type of oil, had to go to the spot market to buy, so the spot market went up. But then that price hike got passed along to all the contracts that are based on the spot market, and that got reflected in new contracts.  The “index” said the “fundamental” had gone up, and everyone believed that, but the index was wrong.

If this thesis is correct, 2011 was another bubble, and the proof of that will be if oil prices measured on the Brent index, go down to $70 or so, before the end of the year.

And then, well third-time lucky?

By Andrew Butter

Twenty years doing market analysis and valuations for investors in the Middle East, USA, and Europe; currently writing a book about BubbleOmics. Andrew Butter is managing partner of ABMC, an investment advisory firm, based in Dubai ( hbutter@eim.ae ), that he setup in 1999, and is has been involved advising on large scale real estate investments, mainly in Dubai.

© 2011 Copyright Andrew Butter- All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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