Oil and Speculation from the CFTC

The Interagency Task Force on Commodity Markets has released its Interim Report on Crude Oil. This publication addresses the role of "speculators" in the oil futures market. I am still wading through the report but I found an apparent contradiction between two points that the task force made.

On page 18, the report said:

"The current short-run demand for oil is relatively price inelastic, meaning the quantity demanded does not change much relative to price changes (it takes a very large price increase to reduce the quantity demanded significantly). In the short run, the supply of oil is inelastic as well: the quantity supplied is not responsive to changes in market price, due to low spare capacity, the inability to bring new supplies online quickly, and relatively low inventories to draw down."

On page 28, the report said:

"Crude oil inventories can also shed light on whether the price run-up depicted in Figure 13 reflects mostly fundamental supply and demand factors. Artificially high prices will create an imbalance between supply and demand that should lead to inventory accumulation. However, as shown in Figure 14, inventories of crude oil and petroleum products in the United States and in OECD countries have generally declined over the past year. Based on these inventory figures, current prices, although high, are not prompting the inventory accumulation that would be associated with artificially high prices."

Well you can't have it both ways. On page 18, they correctly stated that both oil supply and demand is inelastic in the short term. On page 28, they said that if prices were "artificially high" meaning propped up by speculators, then demand would fall or supply would increase, leading to an inventory accumulation.

Are they making a distinction between the impact of "artificially high" prices and just "high" prices? Or is the distinction between long and short term impacts? If it is the latter, then I don't think that they have given enough time for this inventory accumulation to appear.

A Psychoanalytic Interpretation of Dot.com Stock Valuations and its Application to the Oil Market

I recently came across a paper by David Tuckett and Richard Taffler entitled "A Psychoanalytic Interpretation of Dot.com Stock Valuations." I believe it can shed some light on the current situation in commodities.

The two authors examined the academic literature on the dot.com boom of the late 1990's from a psychoanalytical perspective and came up with five stages: Emerging to View, Rush to Possess, Psychic Defense, Panic Phase, and then finally Revulsion. These stages can be applied to Commodity Investing in general, and oil in particular.

Emerging to View

It is during this stage that an investment first comes to the attention of investors, usually due to the efforts of financial analysts and the Media. As interest builds in these investments, they become "alluring phantastic objects." For the Internet Bubble, the authors identify the Netscape IPO in 1995 as the starting event that kicked it off. Other seminal events that come to find were the $1000 Amazon (AMZN) price target prediction, the Globe.com IPO, and many others that have been lost to history.

For oil, it is hard to come up with a starting event. Doug Terreson's piece on the "Golden Age of Refining" comes to mind, or perhaps the publication of Matt Simmons tome on peak oil, or T. Boone Picken's almost psychic predictions on the price of oil, but it doesn't seem like there was one dominating event to kick it off. It was more of a gradual process.

Rush to Possess

The second stage is called the "rush to possess." During this stage a stampede of sorts begins as investors engage in compulsive behavior. The key to this stage, according to the authors, is the introduction of the idea that some sort of "new world" is starting. For the Internet boom, it was the emergence of a "new economy" where old ways of doing business were no longer valid. Remember when no one was going to shop in malls, or read newspapers or bank in person. Get ready we are told, don't be left behind.

We are toward the end of this stage for oil as we have been told to prepare for the world of $7.00 gasoline by CIBC just last month. We must live in a resource constrained world, according to the pundits. Americans in particular, come under some harsh lecturing. We are accused of profligate consumption, without regard to anyone else. We are no longer the center of the world, it's time for China and India to have its share. If we had followed the European model, we would have been better prepared. Investors rush to possess the investments that will benefit from this new world.

Psychic Defense

The third phase is marked by an increase in skepticism by some investors who question the fundamentals behind the rise in the investment. There were many voices who raised objections during the Internet boom, but they were shouted down or ridiculed as "not understanding the new world."

Clearly, for oil, we are in this phase. Any attempt to question the assumptions behind the growth estimates for the emerging economies or supply growth is met with shrill objections by those who have the most at stake financially, and their followers, or what I call derisively call "barnacle investors" who cling to the bottom of the more well known investors in the space.

Psychic defenders of oil investing, on a psychoanalytical basis, engage in denial, projection or splitting. Evidence is seen only through the prism that supports their beliefs. Data is mined or ignored. Skeptics are shouted down or called names.

Panic Phase

There is usually an event that pricks the bubble. For the Internet bubble, the authors cite the article in Barron's on March 20, 2000, that stated the 25% of all dot.com companies would run out of cash within a year. Once "material reality" imposes its will on the "phantastic objects" that investors held so dear, panic sets in.

We don't know what this event will be for oil. Perhaps it will be sub par growth from China, or a stunning drop in demand in the OECD.

Revulsion

The blame game begins as participants begin to question all the assumptions that everyone took for granted during phases 1-3.

Read my other posts on oil investing.

Two More Banks Go Down

Last Friday, the Federal Deposit Insurance Corporation (FDIC), issued its usual late afternoon press release announcing the seizure of two more banks. This Friday afternoon watch is starting to become a popular blogging sport for many of us. There is not much to add to this story since it has been well covered, but I will publish the final stats for the banks from 3/31/2008.

First National Bank of Nevada - Reno, NV

Noncurrent assets plus other real estate owned to assets - 4.28%
Percent of loans noncurrent - 8.35%
Total risk-based capital ratio - 9.67%
Tier 1 risk-based capital ratio - 8.40%
Core capital (leverage) ratio - 6.24%
Equity capital to assets - 7.37%

First Heritage Bank - Newport Beach, CA

Noncurrent assets plus other real estate owned to assets - 1.26%
Noncurrent loans to loans - 1.89%
Equity capital to assets - 11.89%
Core capital (leverage) ratio - 12.16%
Tier 1 risk-based capital ratio - 14.40%
Total risk-based capital ratio - 15.66%

This bank has very high capital ratios, and fairly low rates of non current loans, which begs the question of what did them in. The OCC said it closed the bank because it was undercapitalized, which is not reflected in the numbers above so a lot must have happened since the end of March 2008.

Read my post on the failure of Hume Bank and First Integrity Bank