60 Minutes story on oil speculation

Sunday, January 18th, 2009 | Economics |

60 Minutes did an interesting story on the unprecedented spike in oil prices in 2008, followed by an equally rapid price collapse. The gist of the report is that investor speculation - not supply and demand - was behind the rapid price changes. Parts 1 and 2:

An excerpt:

If anyone had any doubts, they were dispelled a few days after that hearing when the price of oil jumped $25 in a single day. That day was Sept. 22.

Michael Greenberger, a former director of trading for the U.S. Commodity Futures Trading Commission, the federal agency that oversees oil futures, says there were no supply disruptions that could have justified such a big increase.

“Did China and India suddenly have gigantic needs for new oil products in a single day? No. Everybody agrees supply-demand could not drive the price up $25, which was a record increase in the price of oil. The price of oil went from somewhere in the 60s to $147 in less than a year. And we were being told, on that run-up, ‘It’s supply-demand, supply-demand, supply-demand,’” Greenberger said.

A recent report out of MIT, analyzing world oil production and consumption, also concluded that the basic fundamentals of supply and demand could not have been responsible for last year’s run-up in oil prices. And Michael Masters says the U.S. Department of Energy’s own statistics show that if the markets had been working properly, the price of oil should have been going down, not up.

“From quarter four of ‘07 until the second quarter of ‘08 the EIA, the Energy Information Administration, said that supply went up, worldwide supply went up. And worldwide demand went down. So you have supply going up and demand going down, which generally means the price is going down,” Masters told Kroft.

Seeking Alpha agrees with the 60 Minutes analysis:

The 60 Minutes story asserted that there were 27 barrels worth of futures contracts traded for every barrel of physical demand and a fraction of those ever took delivery. This too is a FACT - 60-70% of the futures contracts which were (as the story indicated) initially created to help users hedge were held by either small or large specs - I.e. CTAs, hedge funds commodity day traders. You can look at commercials as a percentage of open interest and see how bullishly involved speculators were. Not unlike the real estate market, easy money (institutions that could borrow easily and lever themselves up 20 to 1) and a market that never seemed to go down sucked the suckers in and they got what they deserved.

My message is that if it looks like a duck, quacks like a duck and acts like a duck, don’t let some clown who can’t or won’t deal with the facts tell you different. If you didn’t watch the story, go see it for yourself. If we were running out of oil or couldn’t produce enough to meet demand, you would see the kind of lines and rationing we saw in the 70s. Anyone who was around back then recalls what shortages look like - people waiting for an hour or more in line at gas stations and couldn’t even fill up. To even suggest it was all supply and demand is laughable. The crash is proof in and of itself - markets driven by fundamentals do better to sustain price advances.

Previously