Post by agito on Jul 4, 2008 0:30:12 GMT -6
I was reading paul krugmans column and then began perusing the user comments, some are laughable and sometimes you happen upon a golden nugget:
PK sayeth “Speculation can affect spot prices because it takes physical stuff off the market.”
I think the flaw here is that PK assumes that there is an efficient spot market on the whole of world-wide oil production. But there isn’t such a thing as a world-wide oil market. There is no such thing as a “generic” barrel of oil that can be traded between all producers and all consumers.
The only thing which is traded openly is the West Texas Intermediate crude and the Brent crude, both light sweet crude with very high API, respectively 39.6° and 38.06° and with very low sulfur, 0.24% and 0.37% respectively. There is also the Dubai spot but it’s already a much sourer crude, 31° API and 2% sulfur (And the supposedly wider “OPEC basket” is a backward-looking joke, that was the market that was).
But pretty much everything else in the world is bought and sold on the basis of those two benchmarks with an essentially constant discount (rarely premium) set by the producer based on quality and logistical constraints. The result is that there is no market, no price discovery on the largest part of the world’s oil production. A change on the small WTI or Brent markets is transmitted as is, very stiffly, to all oil transactions. In addition, most orders to sovereign producers are generally placed more than two months forward to allow for transportation and, even more important, for actual production. The result is that if non-traded oil doesn’t find takers at its (benchmark minus preset discount) price, it is simply not produced.
To make things worse, the benchmarks suck. They benchmark precious nothing. They are both tied to very narrow and shrinking productions with an extremely inelastic market, essentially US and European refiners, who have strict sulfur limits on their end-products and fairly old refineries, incapable of dealing with sour crude. They can’t switch sources just like that. It’s light sweet or bust for them. It’s also fairly inelastic on the sell side as proven by the huge dive, 30% or so, the WTI benchmark took between mid 2006 and early 2007 on fairly minor excess inventories at Cushing. It doesn’t take much to move those benchmarks. It’s easy to corner and game them - all the more that a large part of the transactions are OTC, not spot - and, right now, it’s buy, buy, buy.
There is virtually no feedback from the larger world-wide production to the benchmark. (As an aside, the unidirectionality of pricing signals also explains why refiners bounds to those light sweet crudes have little incentive to invest in sour crude processing as most independent refiners who process sour crude also bear the price vagaries of light crude through the indexed prices.) I say “virtually” as it seems that the Saudi are starting to jack up their discount, may be a corroboration of their claim that they don’t produce more because they just don’t have buyers. But that feedback is very slow and has a very long and indirect path towards impacting markets. It has to go all the way through the production, delivery, storage, refining, then storage and distribution again as end-products then push back on end-product markets (which are extremely fragmented, peripheral and opaque with a lot of players to capture the spread on the way) then back to the benchmarks through the whole reverse chain of end-products storage and distribution then the WTI/Brent-bound refiners, their own storage then finally the benchmarks’ spot markets. So, yes, the Saudis and other sovereign producers have the power to move the market but it’s extremely slow and long acting. I don’t know what’s the time constant on this one but it’s in months and may be in years.
So, rather than ponder large aggregates, economists must take a much closer look at the actual oil pricing mechanisms - no relation whatsoever to an efficient market - and consider the role of those narrow benchmarks and the widely diverging time constants of the various players from future traders working on a minute or second basis to OPEC which operates in years. It’s a hugely complex and opaque beast.
— Posted by Fifi
PK sayeth “Speculation can affect spot prices because it takes physical stuff off the market.”
I think the flaw here is that PK assumes that there is an efficient spot market on the whole of world-wide oil production. But there isn’t such a thing as a world-wide oil market. There is no such thing as a “generic” barrel of oil that can be traded between all producers and all consumers.
The only thing which is traded openly is the West Texas Intermediate crude and the Brent crude, both light sweet crude with very high API, respectively 39.6° and 38.06° and with very low sulfur, 0.24% and 0.37% respectively. There is also the Dubai spot but it’s already a much sourer crude, 31° API and 2% sulfur (And the supposedly wider “OPEC basket” is a backward-looking joke, that was the market that was).
But pretty much everything else in the world is bought and sold on the basis of those two benchmarks with an essentially constant discount (rarely premium) set by the producer based on quality and logistical constraints. The result is that there is no market, no price discovery on the largest part of the world’s oil production. A change on the small WTI or Brent markets is transmitted as is, very stiffly, to all oil transactions. In addition, most orders to sovereign producers are generally placed more than two months forward to allow for transportation and, even more important, for actual production. The result is that if non-traded oil doesn’t find takers at its (benchmark minus preset discount) price, it is simply not produced.
To make things worse, the benchmarks suck. They benchmark precious nothing. They are both tied to very narrow and shrinking productions with an extremely inelastic market, essentially US and European refiners, who have strict sulfur limits on their end-products and fairly old refineries, incapable of dealing with sour crude. They can’t switch sources just like that. It’s light sweet or bust for them. It’s also fairly inelastic on the sell side as proven by the huge dive, 30% or so, the WTI benchmark took between mid 2006 and early 2007 on fairly minor excess inventories at Cushing. It doesn’t take much to move those benchmarks. It’s easy to corner and game them - all the more that a large part of the transactions are OTC, not spot - and, right now, it’s buy, buy, buy.
There is virtually no feedback from the larger world-wide production to the benchmark. (As an aside, the unidirectionality of pricing signals also explains why refiners bounds to those light sweet crudes have little incentive to invest in sour crude processing as most independent refiners who process sour crude also bear the price vagaries of light crude through the indexed prices.) I say “virtually” as it seems that the Saudi are starting to jack up their discount, may be a corroboration of their claim that they don’t produce more because they just don’t have buyers. But that feedback is very slow and has a very long and indirect path towards impacting markets. It has to go all the way through the production, delivery, storage, refining, then storage and distribution again as end-products then push back on end-product markets (which are extremely fragmented, peripheral and opaque with a lot of players to capture the spread on the way) then back to the benchmarks through the whole reverse chain of end-products storage and distribution then the WTI/Brent-bound refiners, their own storage then finally the benchmarks’ spot markets. So, yes, the Saudis and other sovereign producers have the power to move the market but it’s extremely slow and long acting. I don’t know what’s the time constant on this one but it’s in months and may be in years.
So, rather than ponder large aggregates, economists must take a much closer look at the actual oil pricing mechanisms - no relation whatsoever to an efficient market - and consider the role of those narrow benchmarks and the widely diverging time constants of the various players from future traders working on a minute or second basis to OPEC which operates in years. It’s a hugely complex and opaque beast.
— Posted by Fifi