Everyone is looking for someone to blame for high prices of oil and other mineral and agricultural commodities. Speculators (among others) are high on the list, followed by the Federal Reserve. While I don’t think blame is necessarily the right concept here, I have been arguing that low real interest rates have worked to raise real commodity prices through a number of channels. Each of these channels could be called “speculation,” if speculation is defined as behavior based on expectations of future prices.
A number of commentators, including Don Kohn and Paul Krugman, have argued that low interest rates and speculation cannot be the sources of the problem, because oil inventories are low. It is true that low interest rates, other things equal, should in theory increase firms’ desire to hold inventories.
US crude oil inventories do not appear to be especially low in the graph above, showing June 1998-June 2008 (from Bloomberg). But it is true that they are not especially high either.
We are talking about relatively integrated world markets, however, so it is world inventories that should matter most. According to the International Energy Agency’s Oil Market Report, oil inventories held in developed countries have been above average during most of the last year, as the next graph shows.
These numbers are far from conclusive, but still…
The theory is meant to explain the mystery why prices of virtually all mineral and agricultural prices are high, not just oil, and in some ways fits others better. Inventories of some commodities are indeed high now. The price of gold, the last graph shown, is a good example. Here the evidence supports the theory (1) that easy monetary policy has driven up the price, and (2) that one channel is low interest rates making it more attractive to stockpile the yellow metal. But, as with oil, the biggest inventory is the one underground.
[Thanks to Pravin Chandrasekaran.]
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[...] Original post by Jeff Frankels Weblog | Views on the Economy and the World [...]
[...] Kung Fu Trader » WELCOME wrote an interesting post today onHere’s a quick excerpt Everyone is looking for someone to blame for high prices of oil and other mineral and agricultural commodities. Speculators (among others) are high on the list, followed by the Federal Reserve. While I don’t think blame is necessarily the right concept here, I have been arguing that low real interest rates have worked to raise real commodity prices through a number of channels. Each of these channels could be called “speculation,” if speculation is defined as behavior based on expectatio [...]
Jeff, the most important issue in this inventory debate is completely ignored. There simply isn’t much oil storage capacity. The drunks (at least the ones who overlook the “inventory in the ground” notion) are all looking under the streetlight for their keys.
Per Daniel Dicker, a floor trader at the Merc who writes a commodities column:
….in the world of energy trade, there is lack of fungibility that has always broken down thus: Electricity, non-storable — Natural gas, more storable — Crude oil, mostly storable.
Although easiest of the three, oil storage has been historically inelastic, no matter the price…. over the last 4 years (and for most of my trading life) forward stocks have always hovered between 50 and 55 days — storage is expensive and limited, and just not efficacious.
This is why, at least in my view, that supply arguments are often overblown in oil pricing theory — supplies remain closely aligned to demand and rarely overrun — as OPEC members have time and again explained but are ignored. this is why President Bush can walk in to a meeting with Saudi ministers and be patted on the head like a silly schoolboy — “you don’t understand, Mr. President — we’ve got nowhere to SELL any more right now” and Bush will run home and talk about increasing domestic supply as if he hasn’t heard a thing …….
I’d rather cite a more illustrious source, but the more illustrious sources seem to have missed this one completely.
Reply to Yves Smith,
You have a good point, that capacity to carry oil inventories is limited. A comprehensive definition of inventories would include not just oil tanks but also what’s in pipelines, tankers and — in the case of refined petroleum products — how full are the tanks in drivers’ cars. Some of this may be missed by the official measures, especially internationally. But, as I have mentioned, the oil that is in the ground dwarfs any measure of inventories.
Even if oil storage capacity is limited, inelastic, and expensive, the folks on the other side of this debate still have a point. Inventories (”stocks”, if you are British) are still a useful indicator of what is going on. The less elastic is the supply of storage capacity, the higher will the price of oil have to go, corresponding to a given quantitative increase in inventories, even if that quantity is small. We know there is at least some room for variation in inventories; one can see that in the graphs I posted. So if interest rates are low we should observe inventory holdings moving toward the top of its historic range, however narrow that range, at the same time that oil prices go up. The same is true if the increase in demand comes from “speculation.” (The same is also true it comes from higher expected economic growth or increased political uncertainty, via the convenience yield.)
Now if you think the oil inventory data are unreliable, that is another story. — JF
What I would like to see is data for production of each oil conglomerate and sovereign oil producing country. If I were the leader of Venezuela, I would pump less oil out of the ground because I only need to pump as the revenue allows for me to cover my country’s expenses. The less I pump out today, the more there is for the future wellfare of my country. It’s not like growing corn where I will try to grow as much as I can every year. If demand has gone up causing the price run-up (as we are told), what is happening to supply? If it is increasing, then production should be increasing. If supply has decreased in response, then total production can stay the same with rising prices.
My best guess is that this is a commodities bubble *mostly speculative inflows* (accompanying low interest rates) that’s causing oil producers to store it in the ground.
[...] Jeff Frankels Weblog, HarvardU [...]
For people who want to see a good explanation of the basic economics of speculation, there is an excellent slide presentation by the International Energy Agency. It is sad that we live in such an intellectually challenged era that they had to begin by reminding even sophisticated audiences about elementary economics. However, the first few slide do it very well.
http://www.iea.org/textbase/speech/2008/eagles_mtomr2008.pdf