Also, some commentators claim that Iraq before the war was planning to sell its oil directly for Euros, breaking with the general practice of selling for dollars. How would such a transaction relate to the oil futures market in London and New York?
At 03:47 AM 2/17/2005, you wrote:
i do not think you phone shell and buy oil. you will phone mexico saudi arabia kuwait and they will ask you to go buy dollars before you buy oil no!
then since mid eighties opec lost control of oil pricing and the price was decided in the futures market. so the price of oil cross cuts with other financial and equity instruments making it more difficult to pin oil price fluctuations on develepments in the oil market not to mention the increasing role of expectations leading to volatility. it is not a myth... it is real very real..
Middle East Economic Survey
VOL. XLVII
No 22
Mabro On The Futures Markets And The Price Of Oil
The following commentary was written for MEES by Professor Robert Mabro, Oxford Energy Seminar, Oxford.
Whenever oil prices rise towards the $40/B level a familiar litany of complaints begin to be heard loud and clear. We are told that high oil prices will damage the world economy by stopping a fragile recovery in its tracks. This sombre message is associated with demands that OPEC should increase its production to supply a thirsty market. This exhortation is then followed by sceptical comments: OPEC cannot deliver because nobody has got enough spare capacity, not even Saudi Arabia. And even if capacity is available, OPEC will be acting too late. Had production increases materialized a few months ago prices would not have risen to these high levels. And so the litany goes on.
As usual the loudest complaints come from the richer countries of the world. The G7 finance ministers joined the chorus last week. The complaints of poor oil importing countries of the third world who are less able to cope with balance of payments problems and with a deterioration of their terms of trade are rarely heard. On the international scene wealth and power raise the sound of some voices and obliterate others.
I do not know whether the $40/B will or will not affect the world economy. A reduction in the rate of economic growth is possible. This issue, important as it is, is not the subject of this paper however. The purpose here is to address the price determination issue and analyse the nature of the relationships between OPEC and the oil market. This may enable us to assess the simplistic recommendation of the formidable G7 ministers – only if OPEC produced more the price issue will be resolved – and reveal the inadequacy of the exclusive focus put by many commentators on OPEC or Saudi Arabia in facile explanations of current price behaviour.
The price of oil in international trade is no longer fixed by the oil companies as it used to be in the years up to 1974. Everybody knows this fact and nobody assumes otherwise today. The price of oil in international trade has ceased to be fixed by OPEC since 1986. Everybody ought to know that. Yet, the fascination induced by OPEC, and OPEC’s news, lead some commentators either to ignore this fact or to advance arguments which are inconsistent with it.
The reference prices for oil in international trade are determined in New York and London in the futures exchanges for WTI and Brent respectively. Any attempt to understand why oil prices have moved in one direction or another, or why they are high or low must take its starting point in the futures market.
Those who trade on futures markets are moved by a host of factors that include expectations about future developments in supply and demand. Some traders have longer time horizons than others. Those who look, say, six months or longer ahead worry today about the following factors.
First, the Iraqi situation. There are fears that insurgents may succeed in blowing up an important oil installation, and that the flow of exports from Iraq will be seriously impaired for a while.
Second, the political stability of Saudi Arabia. The discourse on Saudi Arabia in the US media, in publications emanating from a number of think tanks, and in a number of fora has been particularly negative after the tragic events of 9/11. The idea that political stability is under threat, which is repeated ad nauseam, is unnerving the market. An unstable Saudi Arabia could lead to some disruption in oil supplies. A market where traders focus on what they are led to believe are possible future developments will naturally worry about the security of supplies. To argue that these fears are not justified, or not shared by those who have a better knowledge of the Middle East than the merchants of doom does not cut much ice. The issue is the prevalence of a view, not its validity.
Third, China. Demand for oil has been growing at a fast rate recently. The latest IEA Oil Market Report states in its first page that this demand increased by 1mn b/d in 1Q04. This may be true or wildly exaggerated. I know not. But the relevant point, here again, is the number as published by the IEA, not whether it correctly measures the actual increase in China’s oil demand. And some in the market naturally wonder whether it will be possible to meet such huge demand increases should they continue unabated month after month
Fourth, the gasoline problem in the US. There is no visible shortage of gasoline in the US today but a perception that a problem could arise in the summer. Commercial inventories of gasoline are smaller than in the corresponding period last year. Demand has grown. The US refinery system is stretched to the maximum (current rates of refinery utilisation is of the order of 95-96% which simply means that they cannot be pushed higher). The market, anticipating problems, has caused gasoline prices to move to high levels, and this in turn has boosted crude oil prices albeit by a smaller percentage.
Fifth, misunderstandings about OPEC’s policy responses. Since OPEC does not fix the oil price but is always very concerned about its level and movements, it can only attempt to steer their course by sending signals to the futures markets where reference prices are determined. The signalling device is announcements about production policy. A decision about a quota reduction essentially means that OPEC is worried about bearish sentiments in the market which may eventually cause prices to fall. And when OPEC talks about a production increase it simply means that it is uneasy about the high price level attained. The production language is to be translated into one about prices. Actual production following a policy decision on quotas usually turns out to be closer to demand than to the volumes defined by these quotas. This phenomenon can be easily explained. It is not expedient to produce more oil than demanded as this will either oblige the producer to stock the excess at high costs or to offer reluctant buyers heavy discounts. And to offer less oil than demanded is a drastic measure which can only be justified in a situation of fast falling prices. In less dramatic instances no producer is inclined to upset a good customer by refusing to supply the required volume; and this for perfectly understandable reasons. The only constraint on the ability to supply is extant capacity.
In September 2003 and in early 2004 OPEC decided to lower the levels of quotas. This decision was made in a context of market pessimism about expected price movements ahead. In September the non-commercial entities on the NYMEX were holding short positions which means that they were betting on a fall in prices. OPEC aimed at counteracting these bearish expectations by announcing quota cuts. In 2004, many authoritative commentators were talking about a big fall in demand during the spring.
Non-commercial entities held long positions. The danger then was that a reversal of these traders’ expectations would induce them to sell in a massive way bringing prices down. If you are made to believe that demand will fall in a significant way, seasonally or otherwise, your only option is to announce a reduction in supply. As too often, alas, a world that depends on stable oil supplies and prices has been let down by those whose comments, analysis and data turn out again and again to be wrong.
Considering these five factors and their influence on the ‘animal spirits’ of traders in the futures markets who take a relatively long view I am not surprised that oil prices have risen to current levels. I am rather surprised that those who ought to know better appear to be surprised.
But What About OPEC Today?
The issue is not one of increasing production just for the sake of it. The issue is to meet demand whenever demand materialises, and Mr Ali Naimi’s emphatic statements that Saudi Arabia is prepared to go to full capacity within a few days if required should reassure the market. The statement is credible because Saudi Arabia did exactly that in March 2003 quietly and effectively.
The gasoline problem in the US is not due to a shortage of crude oil – whether heavy or light. As the US refineries are working at 95-96 % of capacity today one may ask how can they realise this high rate if they are short of crude? And if the US industry is short of crude how do we explain that commercial crude oil inventories are higher than last year? One would have expected them to be depleted.
Part of the oil price problem arises in the US. Insufficient refining capacity, multiplication of gasoline specifications, a Middle East policy that aggravates the instability of the region and a hysterical and uncritical discourse about Saudi Arabia that affect the credibility of its intentions on oil policy.
There is little that OPEC can do on these fronts. OPEC today needs to remember however that it is powerless in a tight market. The potential power of OPEC only exists when the market is slack, that is when everybody believes that OPEC is weak.
If OPEC believes that a tight market will continue in the near future it should cease talking temporarily about quotas and simply say that demand will be met up to the limit of capacity and that after that point is reached the entire game is in the hands of the market.
Daniel Davies <[EMAIL PROTECTED]> wrote:
- noop, you can buy and sell oil in whatever currency you wish. This urban
- myth of the left economics world (that there is some very great importance
- about the fact that oil is typically quoted in dollars) has its genesis in
- the fact that if you want to buy and sell petroleum or petroleum futures on
- an exchange, then you will usually find that the price is quoted to you in
- dollars per barrel. (actually, the Brent crude contract on London's IPE is
- still quoted in sterling, but there you go). But a) there's no law saying
- that you have to buy your petroleum on an exchange; if you phone up Shell
- and say you want to buy a load of oil for euros they will most likely sell
- you it (they will have a look at the curren $ price and the exchange rate
- first though). And b) so what anyway; if you have some euros and want to
- buy something quoted in $, it is not exactly difficult to find someone who
- will sell you $. Somehow, this issue about oil has got entangled with the
- more general issue of seignorage and US dollar hegemony (which I think there
- is a decent explanation of on Doug Henwood's site) and has been the source
- of a lot of avoidable error.
- in other words your instincts are right; this supposed arrangement sounds
- weird because it doesn't actually happen that way.
- best
- dd
- -----Original Message-----
- From: PEN-L list [mailto:PEN-L@SUS.CSUCHICO.EDU]On Behalf Of jeff
- sommers
- Sent: 16 February 2005 18:51
- To: PEN-L@SUS.CSUCHICO.EDU
- Subject: Oil & dollars
- Hello!
- Question regarding oil and dollars. I understand the logic behind
- petrodollar recycling, where rich oil producers parked their wealth in the
- US, thereby mitigating US deficits and helping the latter prosper.
- But, I am somewhat unclear on oil pricing in dollars. Do the major
- producers ONLY accept US dollars in payment? I know the Saudis cut a deal
- with Kissinger regarding this, but how does it work in practice. Must oil
- be paid for in dollars and what prevents oil producers from taking other
- currencies?
- Thanks,
- Jeff
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