Saturday Oil Report — March 12, 2011

The Nymex price stands at $101.16 for a barrel of oil, and has fallen for four consecutive days from an intraday high above $106. I thought the price would settle below $100 in my previous report, but I underestimated how fast fear and speculation can push up the price. As I explained yesterday, the oil markets are broken. Trouble in Libya has not spread into the Persian Gulf, though there have been small, ineffectual protests there. The oil markets appear to have sobered up because of the tragic, enormous earthquake off Japan's coast. Therefore, I am lowering the alert level.

Oil Alarm Level — Orange

I wanted to call this post Games People Play. From Colin Barr's Speculators double down on oil—

Big traders are betting the ranch that oil prices will keep rising, testing the pain threshold of an economy that is not exactly setting records as is.

Large noncommercial speculators – firms that play the futures markets without taking delivery – added to their long position in West Texas Intermediate crude by 50,200 contracts last week, according to Commodity Futures Trading Commission data.

The surge of speculative money into the oil futures pits shows that big financial players are expecting the price of WTI crude to surge well above the recent $105 or so seen last week. If they are right, it will bring $4 gasoline a step closer.

That will not be good news for most consumers, though it could help some big energy traders score  big paydays, thank goodness. You would hate to see the talent fail to get its due.

"It does not get any clearer which way Wall Street is trying to take oil," says Stephen Schork, who writes the Schork Report energy markets newsletter in Villanova, Pa.

Schork notes that speculators now own nearly six times as many barrels of oil – 268,622 futures contracts representing nearly 269 million barrels – as can be stored at the WTI trading hub in Cushing, Okla. And since the CFTC numbers released Friday only go through last Tuesday, they likely underestimate the degree of speculative fervor building in the energy markets...

The speculative fervor is so remarkable that the big trading firms now have nearly twice as many long contracts open as they did in 2008, when oil spiked to $147 in the summer, a development that either foreshadowed or caused the global economic meltdown, depending on how you look at it.

And who are these "big financial players"? Well, I could name several, but Goldman Sachs comes to mind. This is where things get interesting for aficionados of oil markets. Goldman makes a boatload of money trading commodities and also luring investors into long-only positions in their commodities index fund. Goldman's interest is to drive up the oil price. And how does one accomplish that? One excellent way is to cast doubt on Saudi Arabia's spare capacity or production. Lately, this argument has taken three forms—

1. Saudi Arabia has no spare capacity, so they can't raise production.
2. Saudi Arabia didn't really raise production by 700,000 barrels per day because they want to drive up the price.
3. Saudi Arabia was already producing that much as early as last November, so they won't (or can't) raise production now.

Goldman Sachs created story #3. From Goldman Says Saudi Arabia Is Misleading the World About Oil Production, published in the Wall Street Journal on March 8—

Goldman Sachs has accused Saudi Arabia, the world’s most important oil supplier, of misleading the world about its oil production since late last year.

If true, this allegation would mean that the Organization of Petroleum Exporting Countries has far less spare production capacity to make up for the disruption of Libyan supplies than it claims, leaving oil markets in a much more perilous situation than anybody realizes...

After the outbreak of serious civil violence in Libya late last month shut down around at least half the country’s 1.5 million barrels a day of oil exports, Saudi Arabia stepped in to fill the gap. It promised to pump an extra 700,000 barrels of oil a day, taking its oil production to 9 million barrels a day, to ensure that nobody ran out.

This was a typical move from the Saudis, who like to play the role of Federal Reserve for the oil world, using their unparalleled influence to prevent the oil price surging too high or dropping too low. However, much like naysayers who claim the Fed is playing fast and loose with the U.S. dollar, Goldman believes Saudi Arabia isn’t being straight with the oil market.

Analysts at Goldman Sachs said in a research note Tuesday:

“We believe that Saudi Arabia has been producing 0.5 million to 1 million barrels a day above the official numbers since November…implying that OPEC spare capacity is significantly lower than reported.”

Spare capacity is important, because the size of this supply buffer has a close relationship to oil prices. According to analysis by Bernstein Research last week, when spare production capacity diminishes, prices tend to rise because markets are more fearful of unexpected supply disruptions.

@#%&*! To quote Matt Taibbi, Goldman Sachs is "a Giant Vampire Squid wrapped around the face of humanity." In this case, the squid wants to suck the blood out of Americans buying gasoline.

There is no convincing evidence of a shortage of oil in the the world's markets. None. Zero. Zip. I hope this latest speculative episode has now ended, and we can return to business-as-usual. Of course, BAU says we will have a real oil price shock, a big one, sometime in 2012 or 2013 if China's oil demand growth remains robust.

Oil in the international markets continues to be very expensive. For example, Bonny Light (Nigeria) is going for $117.91. If this trend continues, I will talk about it in my next report. Is $117 the "real" price of oil? If it is, why aren't global inventories (and here) sinking like a stone?

What will the Nymex price be on March 26? I think American oil will be trading in the $97-$101 range.

Comments

[BS]

So in my infinite optimism, I watched Obama's press conference yesterday. It had been billed as discussing the increasing oil price.

After a few minutes of boilerplate on the Japan situation, I was ready for the meat! The administration is "willing" to release oil from the SPR. That was it. No mention of what price would be required to trigger this feat. Especially when the SPR is supposed to be there to mitigate supply disruptions. I guess Libya is not a supply disruption.

What I was hoping to hear was an actual SPR release plan and a limit of speculative positions by the CFTC. I guess we will have to wait until GM is bankrupt again!

Leadership we can believe in.