Gregor.us

Greetings,
Oil is cheap. Oil allows one the ability to save two hours a day going to a job that you can purchase the oil(gas or diesel) to by working 15 minutes. Oil is purchased with a fiat currency that has eroded in real value 87% in 38 years. You arrive at work cool and fairly well rested from your ride. You have all the benefits the rest of the world provides our 4.7 % of the population based on this fluid that lubricates our economic system. You benefit by the borrowing power of our financial geniuses to swap electronic digits on a silicon chip that will never be satisified by any significant physical commodity as we supply a service to provide protection by our military to make up the amount our 537 elected scorekeepers determines we the people should remit to our system to get a continuing supply of this magic fluid and the other 9900 different physical items we deserve for administering a small sphere. Very simple if you can follow a run-on sentence. Any reply appreciated.

Gregor, have you posted your thoughts anywhere specifically on the Semgroup suit? I know you have disdain for conspiracy theories in general as explanations for the oil price rise last year, but the allegations regarding the Semgroup are hard to dismiss, at least for me. Is it your view that an already tight market simply allowed a squeeze?

http://www.1440wallstreet.com/index.php/site/co...

Yep. It's been my view for about 3 years that on a shorter term basis--usually 15 days but sometimes as long as 60+ days--that the price of oil can be taken up or down to extremes. Overlay a few factors at once, and this gets easier.

I am actually surprised the SemGroup story was re-floated this year as though something new was discovered. Also, I would point out you won't find anyone that actually experienced oil at 147. That was a brief one-two days. Also, even the amount of time oil spent above 125.00 was rather short.

Any over- focus on SemGroup would only serve as a way to disregard the more important situation last year, which was that oil made sense around 100. The average price for oil in 2008 I believe comes in at around 99.50. 147 oil was not dissimilar to the print of 49.99 in January of 2006--in which traders drove the whole complex down to get rid of a surplus of heating oil.

My view is always: no need to choose. In 2008 you had tight supply, no spare capacity, China was hoarding diesel, and then you had this squeeze with SemGroup. I remain confused as to why we can't have speculation as an influence on the price of oil--apart from the idea that speculation caused the price of oil to rise for 5 years. I don't get it. Just seems like a basic failure of analysis to me. It would be like saying that Apple had double digit sales growth for five years but everyone stands around saying "this is just a bubble" as Apple's stock rises, and then in the final 3 months of the price move there is a short squeeze and it conforms the speculation thesis --backward looking--over 5 years.

I only say this because the legion of people who said "this is all specualtion" starting in Spring of 2004 especially is huge.

I fully expect there to be many more speculative blow-ups in oil in the years ahead. My basic point is that you can't establish or change the price trend with speculation.

G

I think you correctly understand the geology of oil. Yes, Mexico is in trouble. Yes, N. American production has peaked. Yes, political authorities in the USA act as if they don't have a clue. But at the same time I don’t think that you correctly understand the nature of the relationship between oil and economics. This relationship is highly counterintuitive.

The consequence of peak oil is NOT a price of oil that is too high, but the opposite, a price of oil that is too low (measured from price peak to price peak, or price trough to price trough, i.e., across the oil price cycle).

What does too low mean?

Take the last few years. Oil supply flattened while demand and prices rose. The economic system came under increasing stress until it cracked at a vulnerable place. The resulting recession dropped the price of oil into a 40-50 dollar range. This is far too low. It is a price that tells people that oil is more available than is the case, which means: consumers consume too much; suppliers supply too little; and (as you point out) long term problems, requiring long term strategies, are not attended to.

You could well be right that the price of oil will spike again. I would be surprised if you were wrong, especially given the trillions of dollars of claims being thrown by government into the economic system. These claims (i.e., dollars) might well have an effect that is benign at first. If so, then surely you are right. The price of oil will spike again. But this spike will have the same effect as last time. It will send waves of stress once again through the system, causing the next layers of vulnerability to shatter. Economic activity will fall, and the price of oil will once again fall as well.

It appears to be the case that a fundamental insight of economic theory does not apply to oil and economics. An increase in the scarcity of oil is not leading to a rise in the price of oil in such a way as to send price signals that are correct and useful. Why is this?

The answer is simple: the primacy of energy.

Peak oil people have understood and have been harping on the primacy of energy for years, but even they have not understood the economic implications of their insight, i.e., that a spike in the price of oil slows the system down, and this slowdown causes the price of oil to fall. Peak oil people have done real damage by arguing (and thinking) that peak oil means high priced oil.

I think that it is very likely that we are in an intellectual trap, caused by the ideas that we use to frame our understanding of the world -- from which there is no exit. To deal with scarce oil requires political pressure. But political pressure cannot be generated when the price of oil most of the time languishes in a 30, 40 or 50 dollar range.

Because of the misunderstood relationship between oil and economics, we are going to deal with each wave down in the same way that we are dealing with the current wave down. We are going to waste resources trying to solve the wrong problem. (This, let me say as I aside, assumes the existence of a genuine desire “inside the beltway” to deal with problems and not simply rip-off the system as much as possible. In other words, this assumes that we have not already, in essential ways, collapsed. I don’t make this assumption.)

Very nicely written and I agree with you completely. While your characterization of misunderstanding of price, especially among the oil depletion people, is true--it's also true there is a good range of views among these observers about the issue of price, in the context of the economy. On this blog, I have written some about this issue. And in my current newsletter, the framework I use is one of wide bar Amplitude. For myself, starting in late 2005, I began to expect that the price of oil would behave just as you say. Oil, in my view, is now tracing out a price pattern typical of a depleting resource. (see price charts of Whale Oil for example).

The problem is that 200 dollar oil is still cheap. It may not be cheap in the context of lifestyles in distance-based topographies, like Phoenix, AZ in 1965. And it's not cheap now, in counties like Orange County CA and greater SoCal, where the infrastructural hangover from the post-war buildout is now a burden. But in terms of portability and concentration of energy, it's cheap.

What's interesting is that emerging Asia's progressive, new demand for oil has been characterized more by small vehicle, short-trip useage. In this context, whether it's with trucks or cars or motorized bikes, new Asian demand is characterized by short-haul not long haul trips which of course makes sense: For a person in Asia to experience their first motorized transport, just the ability to travel 4 miles a day is transformative. Let me tell you what concerns me: that Asian demand is not constrained by price, and will explode higher not because of any notable shift in the global economic cycle--but just because of the critical mass of population growth.

This process is already underway and I would observe that Americans have to drop a car, or drop miles, or take up some public transport trips--so that supply can swing to Asia.

My model is somewhat the same as yours. It's just that I do expect at least 2 if not 3 more horrendous spikes, with price collapses in between. In addition, my report does not suggest that prices above 200 are easily sustained. However, I do expect that next price crash to result in sustained prices above 100.

Yes. We are in many intellectual traps. I encourage you however to to add to your energy primacy emphasis the behavioral factor. Part of my view is that oil will, before 2015, experience a hoarding price regime. The Hotelling Rule will come into play.

We could see a 6 month period in which oil is above 225, but oil demand is falling hard. Oil seems a prime candidate to me to take on different values. Once scarcity is understood, we can then break free of the industrial value phase. Obviously, given the money flood globally, Yen, USD, and now SDRs from the IMF--as you acknowledge--the opportunity for an inflationary/monetary influence on oil is high. And scary.

Are you writing on these issues, anywhere? Can I read more of your views?

Best,

G

Thanks for a thoughtful reply to my post. Sorry about my saying that you didn’t understand the relationship between oil and economics. I was wrong. You clearly do, and yes, I agree, even $200 per barrel oil is cheap. I wonder, though, can we take another “horrendous spike” in the price of oil given the impaired state of affairs of the current scene? If it happens, it is going to be something to see.

I have some stuff about oil and economics that I have written for my own benefit, mainly to think things through. Nothing original, I assure you, and nothing that others and you in particular have not already said better than I ever could.

My concern in any case is not oil or economics directly. I am not even really concerned about survival. What I am concerned about is liberty, that is to say, latitude of action with respect to those who control the instruments of violence. As others have also said better than I ever could, it is not possible to be an empire abroad and a republic at home. One of the two has got to go – and it looks as if the one that is turning out to be expendable is the republic.

Perhaps I am succumbing to paranoia, but I detect a shift in vibes emanating from government at all levels. The shift is from service to authority (as somebody put it recently, can’t remember where). It seems to me that government in the USA is on its way to becoming what government has been most of the time in most places throughout history: the best organized criminal gang around. This is sad, sad, sad to see, but there it is. It is happening. Deal with it.

But how?

I feel compelled to deal with it first at the personal level. Due to accidents of history, I have some alternatives. My family has connections to Argentina, and in fact, my brother has lived in northern Argentina for 25 years. I think he is even a citizen down there now, but in any case, he is well rooted and universally known and liked. This would be a huge advantage for us should a retreat to those parts become necessary. The government of Argentina is of course a criminal gang to the core – ah, but a criminal gang estilo criollo, that is to say, one with all the efficiencies of dear old Argentina herself. The people down there have a lifetime of experience dealing with it. They have made their world one in which nothing is linear, which is infuriating until the goons of the state show up, then it is good. So Argentina is possibility. I used to speak passable Spanish, and probably could revive it without too much trouble.

But, the fact is, while I despise Washington inside-the-beltway government (which with N. American efficient is managing to give us the worst of two worlds, crony-capitalism AND crony-socialism) I love the history and what is left of the landscape of the South, where I grew up. I don’t want to abandon ship. I am thinking about building a small house on land that my cousin will sell me, a little piece of a plantation that has been in the family since colonial times. This house, this retreat, is the place for the making of a stand. The plantation has deep roots for me, and one that I hope will make possible retention of some latitude of action.

Whew. Sorry. This is a lot about me. Forgive me for thinking out loud. (Also for historical reasons, I have spent my life as an observer of the passing scene. Now, on the outskirts of old age, I have to change and do something different. Not easy.)

I think, Gregor, that you write with vigor, and I sense that you have what very few have these days -- a mind pliable enough and flexible enough to grasp issues in a way that is useful. But I decided not to subscribe to your newsletter, which I am sure is excellent. I am just not interested in the oil story any more. Oil is not the story. How we respond to oil (and a lot of other things that are linked) is the story.

Anyway, ya basta. Enough. This response is a bit of an indulgence. Please forgive.

I gave the Green Sheet permission to excerpt some key passages from my March newsletter this weekend.

G

Demand is also failing, never mind falling. Tax on oil should be 2$ a gallon. Pay for a lot of fences...

Thanks for sharing some of your premium content with us. Personally, I don't see the world economy coping with oil at 200 unless we all get a lot more energy efficient (like Japan is). So if it gets to 200 and we're not ready, it'll probably trigger yet another massive recession.

Yes, that is exactly what will happen. However, by late 2011 and into 2012, I don't expect car ownership or driving miles to have experienced any growth. OECD oil demand never really recovered much from the last recession. The entire 2003-2008 story was emerging market demand. This will get worse. As Jeff Rubin said once, people in the OECD need to drive less and own fewer cars, so that people in emerging markets can get their first small car, and drive it a little. The populations in the latter are of course huge.

Best.
G

Gregor

Do you also have a forecast for natural gas prices?

My view is that NG provide our only real source of incremental BTUs, so I expect the US to become a nation of NG. This may be more bullish for the NG companies than trying to ride NG--which is always hard. i.e. in a world of 15 dollar NG 2+ years from now the share prices of the NG names could be very high on a reserves-security basis.

G