An Ominous Cloud

The June report on Japan's trade surplus shows why oil should keep falling in price. The highlights of the report:

1) Exports to the U.S. were down 15.4 percent, the tenth straight monthly drop and the largest since November 2003.

2) Exports to Europe fell 11.2 percent, the second straight decline.

3) Total exports decreased 1.7 percent in June from a year earlier.

An Oil Bull then pops his head up and screams, "Oh don't worry, China and the rest of the emerging markets will make up the slack, you'll see."

Well, not quite:

4)Exports to Asia grew 1.5 percent, the slowest in two years.

5)Exports to China grew 5.1 percent, less than the 12.2 percent growth in May 2008, and down from 23% growth in May 2007.

It won't be long until official figures from China show a slowdown and/or decline in China exports.

A global slowdown in economic activity starts in the U.S., spreads to Europe and Japan, and then hits China and the rest of the emerging economies of the World. This makes perfect sense since we are the largest consumers in the world, and it takes some time for a slowdown in that consumer spending to work its way through the supply chain.

Confirmatory Bias and Oil Investing - Part Three

I recently came across a post on the Victor Niederhoffer Blog about the concept of Confirmatory Bias. I shall reprint the standard quote from Sir Francis Bacon that is used in much of the literature on this subject:

"The human understanding when it has once adopted an opinion (either as being the received opinion or as being agreeable to itself) draws all things else to support and agree with it. And though there be a greater number and weight of instances to be found on the other side, yet these it either neglects and despises, or else by some distinction sets aside and rejects; in order that by this great and pernicious predetermination the authority of its former conclusions may remain inviolate..."

After searching further, I came across a paper published in the Review of General Psychology in 1998 authored by Raymond S. Nickerson of Tufts University. I believe that the concepts he discusses have applicability to current beliefs by bullish energy investors in the oil market.

He presents a modern definition of the concept of Confirmatory Bias;

"...the seeking or interpreting of evidence in ways that are partial to existing beliefs, expectations, or a hypothesis in hand."

In his paper he reduces the concept to its component parts.

I have already discussed the first two parts last week, and parts three and four here.

Today I present my own concepts. They don't really come under the strict definition of Confirmatory Bias, but they are certainly biases that support the bubble, and after all, its my blog and if I want to write about them I will.

Glorification of results or the market must be right.

Oil and Energy has been in a multi year bull market and if there is one thing I have noticed in investing, it is the presumption that because the "market" says something, then the "market" must be right. This is a situation where the "psychological high" that accompanies good investment results is substituted by investors for thorough analytical thought.

Commodities are up 50% this year, well there must be something to it. "These guys must know what they are doing, I guess I'm just not smart enough to figure it out," an investor mumbles under his breath as he heads to his broker, bitter about missing out on the good times.

I can find quotes to apply to other bubbles as well. How about this one for the Housing Bubble. "My neighbor owns five houses and flipped three last year, why can't I do the same? Home prices never go down so what do I have to worry about."

The Cheerleader Effect or talking heads on TV as the second coming of Jesus

Investors are constantly bombarded with information in support of the bull from talking heads on Television, either from professional investors, or from sell side analysts, the great facilitators of the bull market whose job it is to hold our hands while we continue our journey through commodity investing. All of these people have vested financial interests in the bull, and although this is disclosed, usually at the conclusion of the appearance, I don't think that it is generally understood.

This positive reinforcement has a huge unconscious effect on investors. I think that being on television somehow leads to this aura of omniscience that filters down to investors who watch them. Is it that hard to get on television? I don't know - they do need a constant flow of material to entertain us with.

What I do know is that sometimes it is hard to take what they say seriously when two weeks earlier, I saw the same guy during a conference, trying to fondle an 18 year old stripper who was bouncing around on his lap during the evening entertainment hour. Incidents like that tend to dissipate any aura around them in my eyes. These people are not Gods, they are not divine and they did not spring from the head of Zeus.

Investors will usually deny this effect, which can be subtitled "cult investing," but if you read between the lines you will see it is true. These analysts and pundits let you down before when it came to Internet stocks, and they let you down when it came to Real Estate. Are you going to believe them this time? Remember, Growth always disappoints in the end.

The misinterpretation of information usually by twisting it intentionally.

There is an entire cottage industry of analysts and talking heads whose job it is to manage and shape investors thoughts. If, God forbid, any bearish or contrary ideas begin to bubble up to the surface, it is their job to squash it in its womb, so nothing will impede the march of the Bull. As contradictory and bearish evidence begins to mount during the late part of a cycle, this becomes more and more difficult to do. This is the Wall Street equivalent of "spin control" in politics. Here is an example:

China and other Asian countries have partially removed subsidies on products refined from Oil, and sold to its citizens, many of whom have been shielded from the soaring cost of oil, and the resulting soaring cost of gasoline. So common sense would tell you that as the price of gasoline and other products go up, people should use less of it thus reducing demand. While this demand response tends to be closer to inelastic than elastic in the short term, there is an effect. Anyone who doubts this should look at highway miles driven in the United States the last three months.

Somehow this negative data point has been ridiculously twisted to instead mean that Asian countries will actually import more oil to refine into product because they can now lose less money than before, since they can charge more. So here's how it really works - if you sell 5 million gallons of gas and lose 50 cents a gallon you have lost $2.5 million. If you sell 10 million gallons and lose only 25 cents a gallon, well guess what, you've lost the same thing.

This reminds me of an old story that my father used to tell me. He worked in the garment or "schmata" business. After reviewing a new line of clothes, it was determined that to sell them at a competitive price, they would lose money on every piece they sold. The executive just leaned back in his chair, smiled and said, "don't worry, we'll make it up on volume."

Is There Really a Conundrum?

I don't blog much about economics and there is a reason for that - I find the term "dismal science" a little bit too charitable for the subject. So go easy on me after reading this.

There is this consensus building in the market (God, how I hate that word) that the Federal Reserve is caught between a "rock and a hard place." The Fed wants to raise interest rates to fight inflation expectations that are clearly building in our society. This can be seen in the two charts below. The first is Household inflation expectations, and the second is the adjusted 10-year TIPS-derived expected inflation:





It is unable to fight these inflation expectations by raising rates since the economy is so fragile, and it is thought that any increase in short term rates will crush any incipient recovery in its womb.

But would higher rates actually have that effect? It seems the problem is more availability of credit, not the cost of credit. This can be seen in the results of the latest Senior Loan Officer Opinion Survey on bank lending practices conducted quarterly by the Federal Reserve. The survey reports the percent of lenders who,in this case, have tightened lending standards over the previous three months.

"55 percent of domestic banks—up from about 30 percent in the January survey—reported tightening lending standards on C&I loans to large and middle-market firms over the past three months."

"80 percent of domestic banks and 55 percent of foreign banks—fractions similar to those in the January survey—reported tightening their lending standards on commercial real estate loans over the past three months."

"60 percent of domestic respondents—a somewhat larger fraction than in the January survey—indicated that they had tightened their lending standards on prime mortgages."

An article in the Financial Times yesterday had the quote from a banker "...and the banks are canceling revolvers wherever they can.”

It might be better to raise rates to defend our currency. This would have the dual effect of breaking the upward momentum of Oil as traders will have to find another excuse to push it up. Once Oil starts trading back toward the level it should based on fundamentals, inflation expectations should come down. If gasoline prices follow oil down, then that will free up money for discretionary consumer spending.

Raising rates will have the deleterious effect of hurting those homeowners with adjustable rate mortgage resets, but the opening up of credit markets for them may be a side effect of a stronger dollar.

Japan Export Slowdown

Japan just released its May trade surplus report, and although it beat expectations, it was down for the third straight month, hurt by rising prices for the Oil that Japan imports.

While exports to China and the rest of Asia were strong, analysts said the gain was a little deceptive, as shipments to China were artificially boosted after the recent earthquake on May 12.

Even more important was that:

1) Exports to the U.S. fell 9.5% as demand for Japanese cars and other products slowed.

2) Exports to Europe were down for the first time in 31 months.

Is this more evidence that the decoupling theory is not valid? Last week it was reported that exports from Singapore to the developed world were down as well.

Here is a list of important questions to answer:

Is it possible that the economic recession in the U.S will lead to a decline in Consumer spending on discretionary items?

Is it possible that this decline in consumer spending will be exacerbated by the increasing price of gasoline and food?

Is it possible that some Asian economies, who are heavily dependent on exports, will not be able to export as much as in the past because there aren't as many buyers?

Is it possible that these Asian economies will not grow as fast as in previous years or as much as the market or pundits expect?

Is it possible that when these Asian economies don't grow as fast, they will use less energy (oil) than the market expects?

Is it possible that the supply and demand fundamentals for oil will not meet the market expectations and we will have a surplus of oil over the next 12 months leading to a rapid rise in inventories?

Is it possible that I am out of my mind?

More Demand Destruction

Another example of Demand Destruction due to high oil prices. A little dated perhaps, but I was at the beach all last week.

The latest “Traffic Volume Trends” report for April 2008 from the Federal Highway Administration (FHWA) shows that Americans drove 1.4 billion fewer highway miles in April 2008 compared to April 2007. The report said that vehicle miles traveled (VMT) on all public roads for April 2008 fell 1.8 percent as compared with April 2007 travel.

All regions fell, except for the Northeast. The Northeast has the lowest amount of driving, maybe due to the proliferation of mass transit in many of the urban areas, and the smaller amount of square miles in the region.

West - down 2.8%
North Central - down 2.1%
Northeast - Up 1.4%
South Gulf - down 1.5%
South Atlantic - down 2.6%

By State the biggest declines were:

Florida - down 3.5%.
Vermont - down 4.1%.
Minnesota - down 4.1%.
North Dakota - down 4.5%.
South Dakota - down 4.8%.
Idaho - down 5.3%.

So basically, Americans are driving the same amount of miles they drove in June 2005. It would seem that demand is elastic in the long term after all.

Quote of the Day - June 23, 2008

"My basic message to those who say that prices have to go up forever is that the oil markets have been cyclical for 140 years. Why should that have stopped?" says Edward Morse, chief energy economist at Lehman Brothers.

Oil and the Great Deception - Part Three

"Oil Production in the United States is in a permanent decline."

This is one of the loudest of all claims by oil bulls, and the one stated with the most smug self satisfaction, a seemingly impregnable statement that no one with even half a brain could possibly refute. This claim is usually made in conjunction with some comment about M. King Hubbert, and his prescient statement about the aforementioned peak, complete with the required head bowing and reverence for the so called "messiah" of the peak oil movement.

How can anyone deny this after all?

According to the Department of Energy web site, domestic oil production peaked in 1970, at 9.6 million barrels per day. On a Monthly basis, it peaked in November 1970, at 10.4 million barrels per day. However, this doesn’t tell the entire story.

1) Production in the U.S has stopped declining and was flat in 2007 vs. 2006. While there is some noise in the numbers due to recent hurricanes, it is estimated that in 2008, production will again be flat before a large 4.1% increase in 2009. The chart below shows the reversal in this decline.



2) During a four-year period, from 1982 to 1985, domestic production grew every year, a legacy of increased oil exploration while prices were high in the late 1970’s and early 1980’s. The total percent increase in domestic production was 4.65%.

Here is a chart from Google Docs. Although hard to see in the chart due to the scale and my technical incompetence in trying to remove the lower numbers, production did increase before tailing off once prices collapsed.



3) Domestic oil production also increased in 1977 and 1978, including a whopping 5% in 1978.

4) Domestic oil production increased 10.3% from 1976 to 1985, from 8.1 million to 8.9 million barrels per day.



5) Recently, sequential production has increased for four straight months (December 2007 to March 2008), although still down on a year over year basis. And yes, I understand that four months does not a trend make, just thought I would mention it.

Why am I wasting time writing this?

To demolish cherished beliefs held by millions of investors who rely on others to do their homework for them. Stop regurgitating what you hear on TV, and do your own god damn research.

What you should really be thinking about is that if production can actually increase in a mature basin like the United States, then imagine what could happen in areas of the world that are at the cutting edge of exploration.

Now before you your make your comments about how stupid I am or how I just don't understand, please read the following about things I am specifically not saying, so please don't accuse me of this:

1) I did not say that U.S production will ever reach its previous peak of 10.4 million barrels reached in 1970, just that production could head up again due to increased exploration.

2) I did not say that it is easier to find oil in the United States.

3) I did not say that the possibility of a small increase in production in the United States will solve all of our supply problems.

Oil and the Great Deception - Part Two

"It is getting much more expensive to find Oil these days."

While it is true that it is getting more expensive to find oil, one has to examine whether that increase is of a permanent nature as many argue. The reason that it is getting more expensive to find oil is mainly because service, drilling and other costs are sharply increasing. While this may seem like a circular argument at first, my intention is to demonstrate that the cost of finding oil is rising to a cyclical peak, and that it is not secular in nature.

All the data shows that the cost of finding Oil is rising sharply. Why? Very simply because of a self reinforcing boom in exploration and production, which led to a capacity shortage in oil services and drilling as demand for rigs and services increased faster than supply. Other costs, such as for steel, or the acquisition of existing producing properties has also increased for the same reason, a shortfall in capacity in various sectors, or an imbalance between supply and demand.

It is therefore, a cyclical increase in the cost of finding oil, not a secular or systemic one. If the exploration and production sector cuts drilling significantly, say 30-40%, then extra capacity will flood the oil services and drilling market leading to a plunge in prices and then the cost of finding and developing oil will decrease.

This argument is supported by data from many sources.

The Energy Information Administration (EIA) study entitled Oil and Gas Lease Equipment and Operating Costs, which has data from 1976 to 2006. The chart below demonstrates the cyclical nature of oil services.



Look at the green line back in the early 1980's when the cost index fell from 123.3 to 82.6 in just five years. This study does not include drilling and completion costs. If you included these, the cyclicality would be even more pronounced. Also, this data is only through 2006. The green line currently is significantly higher.

The same trend can be seen in the HS/Cambridge Energy Research Associates (CERA) Upstream Capital Costs Index. The latest monthly release from May 2008, shows that "the latest increase raised the index to 210 points from its previous high of 198. The values for the UCCI are indexed to the year 2000, meaning that a piece of equipment that cost $100 in 2000 would cost $210 today."



This index tracks "the construction of a geographically diversified portfolio of twenty eight onshore, offshore, pipeline and LNG projects."

As an example, five years ago, it may have cost $ 250,000 per day to lease a rig to explore deep offshore. Today, if you can find one it may cost you $800,000 per day. According to Cambridge Energy Research Associates (CERA), dayrates can be 30-40% of the cost of an offshore well.

So in a sense, it is getting more expensive to find oil, but people who say this are either ignorant of the reason why or being disingenuous to further their investment case. Bullish investors use this as an excuse to justify that oil prices have to stay higher because the cost to find oil is higher.

Please understand that I am not predicting that this these various cost indices will turn down soon, only stating for the record that they can turn down, and have turned down precipitously in the past once capacity catches up to demand.

If you argue that the cost of finding Oil is permanently higher, then you are accepting the argument that industries that have been intensely or even pathologically cyclical for 100 years are no longer subject to those conditions. This is a bold statement to make and you better be damn sure you are right.

Please read my earlier post of the fallacy of demand growth in emerging markets.

Oil and the Great Deception

"What matters is growth from the emerging markets, not the United States or other mature markets."

Oil Bulls love to trot out China, and to a lesser extent, India, when discussing the unbelievable growth from emerging markets. I heard a money manager call such growth "massive." Well let's see just how massive this growth is. In 2006, China consumed 7.2 million barrels a day, and in 2007 it consumed 7.58 million barrels a day. This is "astounding" growth of 380 thousand barrels a day. In 2008, the barrel per day growth is estimated to be 420 thousand barrels. While the growth rate is fairly impressive on a percent basis, the absolute increase is hardly more than a rounding error in an 87 million barrel a day market.

Now let's look at the "mature" markets that don't matter. Demand from the 30 countries countries belonging to the Organization for Economic Cooperation and Development (OECD), was 48.96 million barrels per day in 2007. This demand has been flat for several years and is roughly the same as it was in 2003. This demand will begin to fall, as it has done in the past when oil prices reach very high levels. We have already seen evidence of this in reports on miles driven on U.S. highways which fell 4.3% in March 2008.

Let's look at what that impact will be:

OECD Demand declines one percent - 490,000 barrel per day decline.
OECD Demand declines two percent - 880,000 barrel per day decline.

As you can see, a one percent decline in demand from "mature" economies would wipe out all China's absolute growth last year. A two percent decline would be equal to twice China's barrel per day growth. So emerging markets don't really matter except in the context of the entire market. Are the OECD demand declines I listed above realistic? Yes, demand has fallen in previous years when prices were high.

Dear Mr. T. Boone Pickens

World oil supplies won't exceed 85 million barrels a day because of high depletion rates of existing wells, Pickens, the founder and chairman of Dallas-based BP Capital LLC, said yesterday in a speech at Georgetown University. "There is only 85 million barrels of oil globally in the market coming a day and I don't think you can increase that 85 million," Pickens said. (April 2008)


World oil supply rose to 86.6 million b/d in May, up nearly 500,000 b/d from April's 86.11 million b/d as production rose from OPEC, China and the former Soviet Union, the International Energy Agency said Tuesday. OPEC raised its crude supply to 32.31 million b/d last month, up from 31.91 million b/d in April, the IEA said in its latest monthly oil market report. (June 2008)

What if Hubbert Was Wrong but Nobody Cared?

It is a mantra of the Peak Oil movement that oil production in the United States peaked in the 1970’s, and that this production peak has, or soon will occur in worldwide production of oil. M King Hubbert, of course, is the prophet of this movement, his legendary status enshrined by his uncanny and correct prediction that production in the U.S would reach a peak. Hubbert, so to speak, is the “Jesus Christ” of the Peak Oil movement.

But anyway, what if Hubbert was wrong? How would that impact the Peak Oil movement, and indeed Hubberts own messianic status in that movement?

According to the Department of Energy web site, domestic oil production peaked in 1970, at 9.6 million barrels per day. On a Monthly basis, it peaked in November 1970, at 10.4 million barrels per day. However, this doesn’t tell the entire story. While it is true that domestic production has been in an inexorable decline since then, with 2007 production at 5.1 million barrels per day, the following is also true:

1) Production in 2007 was flat with 2006, the first time this happened since 1991.

2) During a four-year period, from 1982 to 1985, domestic production grew every year, a legacy of increased oil exploration while prices were high in the late 1970’s and early 1980’s. The total percent increase in domestic production was 4.65%.

3) Domestic oil production also increased in 1977 and 1978, including a whopping 5% in 1978.

4) Domestic oil production increased 8.8% from 1977 to 1985.

5) Recently, sequential production has increased for four straight months (December 2007 to March 2008), although still down on a year over year basis. And yes, I understand that four months does not a trend make, just thought I would mention it.

So why am I writing this? Two reasons:

The pundits used to say the same thing about Natural Gas production domestically – that it was impossible to increase production, that the entire country was drilled over, and that high decline rates on new discoveries would work to keep production flat or in decline forever. Well guess what? Domestic gas production as measured on a gross, marketed or net basis is rising and has been for a while.

So if we can increase natural gas production domestically, due to increased exploration and development, when new wells decline 50% after the first year, why can’t we increase domestic oil production due to increased exploration and development when decline rates are much lower?

The second reason is that I want everyone to understand that just because you hear something repeated over and over on television and on the Internet doesn’t make it true. Most of the people saying it have a financial interest in seeing it come true. Do your own research for yourself and then decide.

Now please don’t jump all over me for this article, I am not making a broad statement on the validity of Peak Oil, just the narrow point that domestic oil production can, and has increased during a long term decline, and that this can impact supply and therefore the price of Oil. OK, that’s it. Let the name-calling and data mining begin.

The Second Leg of Demand is Threatened

An article in the Financial Times last week caught my attention:

Asia to cut subsidies as oil hits $135

By Kathrin Hille in Taipei, John Burton in Singapore and Raphael Minder in Hong Kong

Published: May 22 2008

"Asian governments on Thursday moved to cut energy subsidies to protect their finances and those of state-owned energy companies in the face of soaring oil prices. As crude oil pushed through $135 a barrel for the first time, Taiwan, Malaysia and Indonesia announced plans for urgent action to free prices or cut subsidy costs. China denied rumours of an imminent increase in retail prices, but may relax price controls."

I wrote about the beginning of the end of subsidies in my blog post from May 13. As consumers in Asia begin to pay higher or even market prices for gasoline and other refined products, the effect on demand will be staggering. This process will not occur overnight but will eventually filter its way into the overly optimistic demand projections in emerging economies.

Article Highlights

Taiwan

"In Taiwan, the first act of the newly elected administration of President Ma Ying-jeou was to abolish price controls on petrol and diesel from June 1. The new government also said it would raise electricity prices in July."

Malaysia

"Malaysia said it would soon announce a new petroleum subsidy scheme to keep its fuel subsidy bill at around last year’s level of M$40bn ($12.5bn) in spite of rising oil prices....also suggested that the government would take the unpopular step of raising electricity tariffs. “If there is a rise in the price of [natural] gas, we will have to pass that along, since we are not going to see Tenaga [the state power monopoly] lose money,” he said."

Indonesia

"The Indonesian government said it would “soon” go ahead with a plan to raise fuel prices by an average of 28.7 per cent."

China

"The Chinese government said that stock market rumours of an imminent increase in domestic fuel prices were “groundless”. However, analysts forecast that Beijing would eventually endorse subsidy cuts."

Full Article

Other countries not discussed in this article are also ending subsidies:

"Egypt - the most populous Arab state - has raised petrol prices by 40pc, despite protests in Cairo.

"Sri Lanka lifted diesel and petrol prices by 25pc over the weekend."

"India may have to follow soon to prevent its trade and budget deficits climbing to dangerous levels. "The situation is alarming. We need to stem the rot," said India's energy secretary, MS Srinivasan."

Peak Demand?

Everyone talks mercilessly about Peak Oil, but is it time to introduce the concept of Peak Demand? At least in the United States? The Federal Highway Administration (FHWA), a part of United States Department of Transportation (DOT) released its monthly "Traffic Volume Trends" report last Friday.

The report showed that estimated vehicle miles traveled (VMT) on all U.S. public roads for March 2008 fell 4.3 percent as compared with March 2007 travel. The report also said it was the first time March travel on public roads fell since 1979.

The 11 billion mile drop in March 2008 compared to March 2007 was the sharpest yearly drop for any month in FHWA history. This report was first issued in 1942, so there is 66 years of data.

The negative demand trends should continue in April and May since gasoline prices have moved up sharply from March.

Predictably the market ignored the report, and no doubt oil bulls spent all weekend mining the data for something to support the bull case.

The perfect storm seems to be brewing for Oil demand domestically right now. The main use of Oil in the United States is for transport, and we are starting to see the effects of high gasoline prices on demand as people drive less. If that wasn't bad enough, ethanol production is starting to take market share from gasoline, leading to even less demand for oil.

We put forth our opinion on the fundamentals for oil in our previous post on May 12.

We still maintain that fundamentals don't support current prices for oil. Emerging economies don't matter. What matters is world wide supply and demand for the commodity, and as we stated earlier, a 5% drop in demand in the United States would translate to a decline in demand twice China's oil consumption growth last year.

Read the Press Release.

And the Band Played On

This article came out yesterday:

Iraq could have largest oil reserves in the world.

"Iraq dramatically increased the official size of its oil reserves yesterday after new data suggested that they could exceed Saudi Arabia’s and be the largest in the world. The Iraqi Deputy Prime Minister told The Times that new exploration showed that his country has the world’s largest proven oil reserves, with as much as 350 billion barrels. The figure is triple the country’s present proven reserves and exceeds that of Saudi Arabia’s estimated 264 billion barrels of oil. Barham Salih said that the new estimate had been based on recent geological surveys and seismic data compiled by “reputable, international oil companies . . . This is a serious figure from credible sources.”

Amazing how Oil Bulls ignore any evidence that contradicts the fundamental basis of their argument for higher prices. So basically they will disparage the source of this information. This is what they will say:

1) This guy doesn't know what he is talking about, he probably hasn't left the Green Zone in years.

or

2) Even if he did know what he was talking about, it would take years for the production to come on line.

Yet I keep hearing that the price keeps going up because the market has doubts about the long term supply of oil. Certainly this discovery will go a long way toward solving those long term concerns on supply.

So Which Is It?

Saudis to boost oil output after US pressure
By Javier Blas in London and Andrew Ward in Washington
The Financial Times

May 16 2008 14:06 | Last updated: May 17 2008 00:27

"Saudi Arabia said on Friday that it was increasing its oil production to its highest level in two years, bowing to intense US pressure after the price surged to a fresh record of almost $128 a ­barrel."

or

Saudis Rebuff Bush on Oil
By JOHN D. MCKINNON, STEPHEN POWER and NEIL KING JR.
May 17, 2008
The Wall Street Journal

"The Saudi king rebuffed President Bush's request for higher oil production, in the latest sign of how U.S. leaders are struggling to combat soaring energy costs that have become a major election-year issue."

or

Does it not matter because Oil Bulls don't believe that the Saudis can raise production anyway?

or

Does it not matter because Oil Bulls believe there is infinite demand for Energy - if you pump it, they will buy it?

Is Oil the New Globe.com?

Here is why Oil shouldn't go to $200 a barrel. Notice I didn't say won't go to $200, as betting against a commodity in this market is tantamount to financial suicide.

1) The fundamentals don't support an accelerating price for Oil. While the U.S is not officially in a recession, growth has slowed down here as well as in the rest of the world. Less economic growth means less demand for Energy. Has supply changed in the last month? Only in the minds of those bulls who believe any time a gun is fired in an oil exporting nation, supply is threatened.

2) The elasticity of demand for Oil may not be linear - that is to say that each 1% increase in the price reduces demand to a different extent. Is it possible that the higher the price, the more demand impact occurs? It is not inconceivable that demand for oil worldwide could flatten out for several years - it has happened before.

3) Many countries subsidize the price of refined products to its citizens to promote social stability. As the price of Oil moves up, the cost of these subsidies increases to the point where it is no longer economically feasible to do so. Once these subsidies are reduced or eliminated, the impact on demand may be tangible. Turkmenistan recently ended subsidized gasoline for its citizens, and others will follow suit as the price of Oil goes higher. While demand from Turkmenistan is negligible in the world market, many countries use subsidies, including China. China, is in effect, hurting itself by shielding its people from increasing prices. Since demand doesn't fall internally as prices rise, this leads to even higher prices.

4) Although demand for Oil is inelastic in the short term due to a lack of substitution, there is a "crowding out effect" as consumers pay up more for gasoline, they will cut back on purchases of consumer items and other discretionary purchases. This will cause a further decrease in demand for Oil since many products use Oil in the manufacturing process. Many of these products and items are made in China, which still relies heavily on exports. So won't this "crowding out effect" eventually reach the end of the supply chain, and cut demand for Oil?

5) The price of Oil is firmly in the hands of speculators and financial players as everyone knows. This is difficult to prove, but it is clear that technical reasons and momentum are keeping the price elevated. As a trader on the floor said this morning on Bloomberg, the market wants to go up. And we all know that what the market wants, the market gets, at least in the short term. When this momentum ends, the impact will be staggering.

6) Much is made of the growth in demand for Energy from emerging economies, but the United States still uses 30% of the world's oil, and lack of growth here will eventually have an important effect on the market. In other words, a 5% growth in demand in the U.S. is worth 1.1 million barrels a day, while China's much hyped up growth of 7% was only worth 600,000 barrels a day. What if demand in the U.S declined 5%? Could China make that up?

7) Another important reason is less analytical - take a look at the people that are telling you that everything will be OK with Oil in particular, but also with Commodities in general. That prices will stay high. Do they look familiar? They should, as they are the same ones who told you that everything would be OK in the housing market and the Homebuilders. Remember that crap? They didn't buy land any more, they "optioned" the land. They had access to capital, etc. None of these reasons stopped Homebuilders from going down 75% from the peak. Consider your source.

8) Another non analytical reason is this - eventually someone in OPEC will stand up at a closed door meeting and say this: is it really wise for us to have oil so high for so long? Won't this eventually lead to permanent long term changes to demand as countries adjust their economies? Won't it stimulate the growth of alternative fuel sources? Or might it cause so much inflation that it will crash the world economy?

What could end the momentum play? Here are a few scenarios:

1) A Democrat in the White House releases oil from the Strategic Petroleum Reserve to bring prices down. The government has twice as much Oil in its inventory as the entire commercial market does. Sure, OPEC might cut production to balance the market, but then there goes the spare capacity argument.

2) A Democrat in the White House pushes a Windfall profit tax through during the first 100 days. This tax is not on Oil companies but on commodity traders and speculators. Or they could push up margin requirements for futures trading on certain commodities.

For those of you who don't remember, the Globe.com, was the poster child for the start of the Internet boom in the late 1990's. It soared way above its true value as money piled into a speculative play. The company is now long gone, and I am not saying that Oil will one day be "long gone," but might there be some lessons we can learn from our past mistakes.

Have No Fear My Fellow Americans

I have to admit it is tough to be an American lately. Everyday I read about the weak dollar, soaring commodity prices, huge deficits, foreigners buying our country, collapsing Real Estate values and a slowing economy. Are we in the last Chapter of the sequel to Edward Gibbon's, "The History of The Decline and Fall of the Roman Empire ," entitled appropriately enough "The History of The Decline and Fall of the American Empire?" Will your children have to learn Chinese or Russian?

Fear not, my fellow Americans, people have written us off before and here for you amusement is a sample of some of that commentary, from the fear mongering media outlets that dominate our culture:

THE BUYING OF AMERICA

Time Magazine
For Sale: America
September 14, 1987
Link to Story

"Suddenly, the U.S. seems to have become a country for sale, a huge shopping mart in which foreigners are energetically filling up their carts. Result: foreign ownership in the U.S., including everything from real estate to securities, rose to a remarkable $1.33 trillion in 1986, up 25% from the previous year....By the end of this century, the U.S. may have the most modern manufacturing sector in the world, but it won't own it." Says Democratic Representative John Bryant of Texas: "America has been selling off its family jewels to pay for a night on the town, and we don't know enough about the proud new owners."

My Commentary: The Japanese were the main buyers of America back then, and they bought most of it at peak prices and sold it at a loss.

HIGH OIL PRICES

Time Magazine
The Seven Lean Years
Dec. 22, 1980
Story Link

"In all the sweep of postwar history, no event, no issue, no political or social process has more profoundly shaken the established world order, or brought about more rapid and tumultuous economic change, than the end of the era of cheap oil. This change has been called the energy crisis, but the term is too limiting. Rather than being merely an ongoing trauma over oil, the energy debacle has become a crisis of economics, of politics, of the very balance of power in world affairs. In short, it is an all-embracing, mesmerizing Everything Crisis....Since then, oil-consuming countries have paid the oil producers a staggering $370 billion for the precious black product that is essential to industrial survival. Saudi Arabian Oil Minister Sheik Ahmed Zaki Yamani warns that oil could easily rise to as much as $60 per bbl. in the foreseeable future."

My Commentary: Well not quite. In fact, the price of Oil collapsed by the mid 1980's.

THE FALLING DOLLAR

Time Magazine
What to Do About the Dollar
Oct. 09, 1978
Story Link

"The fate of the dollar calls into question the way the whole world does business. The international monetary system is a precarious structure held together largely by paste, baling wire and confidence in the dollar, since it is the currency in which most international deals are made and which central banks keep in their vaults as reserves. During recent runs on the dollar, the first signs of financial panic could be seen."


My Commentary: Well, it looks like we survived this crisis too.

Oh wait...maybe its different this time.