Hedonic Man:

Finance is a tool for greasing the wheels of an economy, and when it
serves its proper role, finance can be a very good thing. But it can
(and should) never be the economy itself; it is fundamentally
derivative on the labor of real people doing real work. By extension,
an economy that gives pride of place to what should be a tertiary
concern is an economy that is winding down and running out of ideas.
Just as the ascendancy of the lawyers is the death knell of an industry
(cf. the dying spams of the major record labels and the RIAA), so the
dominance of financial services signals an economy that has become
tired and spent.

EconTalk, Economics Podcasts Hosted by Russ Roberts: Library of Economics and Liberty:

$145 for oil in December 2016, as the futures market is prices, does
not mean that the price of crude oil will be $145 in Dec ‘16.

Currently,
oil is at $131.25 for delivery in the month of July. If I contract to
buy oil from a supplier, in the year 2016, I effectively have paying a
higher price than today for “storage” costs. The price structure where
nearby prices are cheaper than deferred prices is what we call
contango. This is normal and not indicitive of a bubble. It means
supplies are adequate.

When that price structure changes,
whereas nearby prices are more expensive than deferred prices
(backwardation), that is a bullish market. Effectively, the market
punishes those who sit on supplies. It brings available supply to the
market by making it a losing proposition to store supplies.

Looking
at the current price structure, the market is backwardated from ‘08 to
‘12 and then in contango. The market is very concerned over available
supplies in the market for now, largely due to increased demand and
stable production. There certainly is more oil in the world to be
tapped, but it will take time to bring it to the market.

As for
US prices, we are perhaps the only country in the world with known
existing supplies that the government forbids oil companies to explore.
Our own government forbids exploration and drilling on the outer shelfs
over the Pacific and the Eastern gulf of Mexico where large quanties of
oil and natural gas exist. Oil companies are also barred from exploring
oil shale in Colorado, Whyoming, South Dakota, and North Dakota.

This country has a 250 year supply of coal, but we hamstring the new construction of even clean coal power plants.

We have the energy reserves but the US government needs to get out of the way.

Supply in the US might be near average levels, but oil is a global
commodity. A supply disruption in Nigeria impacts global prices. A
refinery outage in France cause prices to go up in the US because it
reduces the availability to import refined products (which is a
bottleneck in the US). By the way, oil traders don’t care about Kenya,
its Nigeria or other oil producing countries in Africa. That said, if
tension in Kenya might spread into Nigeria….

As far as ‘speculators’ are concerned, we can make money selling markets, too, not just bidding up prices endlessly.

Essential
raw commodities must be priced by the marketplace. Will prices go too
high or too low on the fringe, sure, but that is how prices are
discovered. How many consumers were complaining when a gallon of gas
was $1.00? Price too low? Well, there wasn’t enough incentive for oil
companies to invest in more production. So when an supply shock
happens, prices have to rise to provide an incentive to produce more.

During
all the 90s, food prices were so low and crops yields came in so high,
that countries began imported food on an “as needed” basis. Stockpiles
of grains for a rainy day dwindled.
Well, over the past two years,
because of poor yields in wheat around the globe and increased demand,
supplies of food have decreased materially, and created a panic in
wheat prices. But what did producers do in response? They planted a
record amount of wheat this past year. That is what markets do.

The
high price of oil is bringing changes. People are changing habits,
trying to reduce demand. New technology is heavily researched and
hybrid cars are rolling out. But it will take years for new oil wells
to be drilled, and it will be costly.

From Exxon: Exxon Mobil is
the largest U.S. oil and gas company, but we account for only 2 percent
of global energy production, only 3 percent of global oil production,
only 6 percent of global refining capacity, and only 1 percent of
global petroleum reserves. With respect to petroleum reserves, we rank
14th. Government-owned national oil companies dominate the top spots.
For an American company to succeed in this competitive landscape and go
head to head with huge government-backed national oil companies, it
needs financial strength and scale to execute massive complex energy
projects requiring enormous long-term investments.

To simply maintain our current operations and make needed capital investments, Exxon Mobil spends nearly $1 billion each day.

Iranian oil is a heavy sour crude oil. It is more expensive to refine
into products than light crude oil, like that of Saudi Arabia and WTI.
That’s the reason that WTI oil is usually priced lower than Brent Oil.
Crude oil is not the same where ever its drilled from. It comes in many
different grades and some are much cheaper to refine than others. So
Iran has a surplus of heavy sour that isn’t as valuable right now.

Second,
OPEC only accounts for 40% of the worlds oil supply. You know who the
largest supplier of oil to the US is? The United States of America! If
congress ever let oil companies drill off the Pacific coast and the
eastern shore of the Gulf Coast, we would be swimming in oil and
natural gas. Our second larget supplier of crude? CANADA. Third?
MEXICO. OPEC is only part of the equation.

Thirdly, we don’t
have to run out of oil before prices go up. OPEC typically producers a
surplus of oil of about 2.5 million barrels per day. That surplus
production however, dropped by 80%, from 2000 to 2005. The price of oil
in 1999? $10 a barrel.

Why should OPEC pump oil for $10 a barrel? oil prices bottomed in 1999 and rallied to $35 a full year before 9/11?
Can you explain how prices more than trippled from ‘99 to ‘00?
Easy, there was huge excess supply in the market. Oil producers cut back on production.

Uh
oh, then 9/11, concern about flow from the Middle East. Uh oh,
economies in India and China begin cranking up. Uh oh, huge hurricane
in the US wipes out oil production in the Gulf of Mexico. Uh oh,
violence in Nigeria wipes out 500,000+ barrels per day for over a year.
Uh oh, Iran working on nuclear weapon. Uh oh, China begins creating
stockpiles of raw goods. Uh oh, 30 year old refineries in the US can’t
keep up with demand for products. Prodcution in Alaska is declining.
Production in Mexico is declining. Venezuela nationalizes most of the
oil industry. Production in Venezuela drops.

We will come out of
this bubble in prices, but as the saying goes, “The cure for high
prices is higher prices.” High prices encourage more supply to come
online, encourages alternatives, or reduces demand. The market, however
painful, is doing its job. If prices have overshot ‘fair value” then
prices will correct.

New technology will compliment crude oil, not completely replace it.

Think
of all the plastics that are produced today. The only known substitute
currently is bio-oil and then we’re entering the food/fuel debate. But
certainly if we get the food situation cleaned up and streamlines (no
thanks to Argentina) then we can continue to produce some excess
bio-oil for manufacturing processes.

Crude oil and its
products are portable energy. Why in the world do we use oil to produce
electricity in stationary power plants? Nuclear power is one solution.
As is clean coal technology. So are other renewable sources. Many of
these ideas of been on the board for quite some time (geo-thermal,
solar, hydro, wind, etc) but have been too costly in comparisson to
fossil fuel. That’s all changing. Its not to say that eco-friendly
solutions are necessarily pocket-book friendly solutions, but it does
add some spare capacity to the system (think ethanol).

Alan Greenspan stoked the dotcom bubble with low interest rates, all the while blowing smoke about productivity and the new Economy.

Barely had that bubble burst than he was stoking the real estate bubble with low interest rates, blowing smoke about financial innovation and new collateralised instruments.

Barely has that bubble burst than Greenspan’s equally inept successor Ben Bernanke has further slashed interest rates, financing rampant, margin-fuelled speculation in commodity futures, creating a crude oil price bubble.

There’s no way the oil price is due to supply and demand fundamentals. Demand did not spike suddenly, nor did supply plunge. It’s a bubble. It will burst. The price of oil will plunge when it does. Commodity traders will queue up behind mortgage lenders.You read it here first.

The age of bubbles. Exciting time to be alive.

Bank of America – $13B / ~10% of equity
Countrywide – $2.0B / ~14% of equity
Citigroup – $39.4B / ~31% of equity
JPMorgan Chase – $6B / ~5% of equity
National City – $8.7B / ~72% of equity
SunTrust – $.7B / ~4% of equity
US Bank – $.5B / ~2% of equity
Wachovia – $14.6B / ~21% of equity
Wells Fargo – $1.6B / ~3% of equity
Fannie Mae – $8.9B / ~22% of equity
Freddie Mac – $6.5B / ~25% of equity
E-Trade – $1.75B / ~40% of equity
Ambac – $1.5B / ~25% of equity
CIT Group – $1.5B / ~21% of equity
MBIA - $1.1B / ~16% of equity
WaMu – $12B

Via Econbrowser: Fast and Easy Fannie

From page 102 of Fannie’s 2007 Annual Report, as of the end of 2007, the enterprise had leveraged $44 B in stockholders’ equity with $796 B in short- and long-term debt to acquire $761 B in mortgages either held outright or intended for resale or trading. I read that as an equity cushion against a 5.8% loss on the mortgages held directly (44/761 = 0.058). But in addition (page 1), Fannie has guaranteed $2.1 trillion in separate mortgage-backed securities it has sold to outside investors, for a ratio of core capital to total book of business of 1.6%.

From the beginning, my conception of a really big financial meltdown would be one that pulls one of the GSEs into insolvency. Please tell me why it can’t happen.

Click to Enlarge:

A Primer On Gasoline Prices

The State of California operates its own
reformulated gasoline program with more stringent requirements than
Federally-mandated clean gasolines. In addition to the higher cost of
cleaner fuel, there is a combined State and local sales and use tax of
7.25 percent on top of an 18.4 cent-per-gallon Federal excise tax and
an 18.0 cent-per-gallon State excise tax. Refinery margins have also
been higher due in large part to price volatility in the region.

California
prices are more variable than others because there are relatively few
supply sources of its unique blend of gasoline outside the State.
California refineries need to be running near their fullest
capabilities in order to meet the State’s fuel demands. If more than
one of its refineries experiences operating difficulties at the same
time, California’s gasoline supply may become very tight and the prices
soar. Supplies could be obtained from some Gulf Coast and foreign
refineries; however, California’s substantial distance from those
refineries is such that any unusual increase in demand or reduction in
supply results in a large price response in the market before relief
supplies can be delivered. The farther away the necessary relief
supplies are, the higher and longer the price spike will be.


California was one of the first States to ban the gasoline additive
methyl tertiary butyl ether (MTBE) after it was detected in ground
water. Ethanol, a non-petroleum product usually made from corn, is
being used in place of MTBE. Gasoline without MTBE is more expensive to
produce and requires refineries to change the way they produce and
distribute gasoline. Some supply dislocations and price surges occurred
in the summer of 2003 as the State moved away from MTBE. Similar
problems have also occurred in past fuel transitions.

$945 billion estimate of losses to the financial sector. From the IMF’s Global Financial Stability Report

Click to Enlarge

It’s Hard to Thaw a Frozen Market – New York Times

PIMCO Bonds – Global Central Bank Focus- March 2008 “Not Good Times”

Interfluidity :: Credit Crisis for Kindergarteners

EconWeekly: How the Fed took the money out of monetary policy

Old Pros Size Up the Game – WSJ.com

The Market for Lemons

Interest Rate Parity, Money Market Basis Swaps, and Cross-Currency Basis Swaps

Via Foreign Affairs – Arctic Meltdown – Scott G. Borgerson. The opening up of Arctic means big for international shipping industry with huge political ramifications.

Black gold | Free exchange | Economist.com

the relationship between market uncertainty, currency fluctuations, and inflation. Economic weakness is pushing the Federal Reserve to lower interest rates. This helps push the dollar downward, which contributes to increasing prices for dollar-denominated commodities. Flight to security also pushes up commodities, and it’s therefore no surprise that gold, silver, copper, oil, and all sorts of other things are shooting upward. (See this, too, for discussion of the connection between Fed policy, negative real interest rates, and commodities prices).

You want the truth?
You can’t handle the truth!

In a sense, a central bank’s relationship with asset markets is like that of a man who claims he is going to the ballet to make himself happy, not to make his wife happy. But then he sheepishly adds that if his wife is not happy, he cannot be happy.

• K. Rogoff

Chinese Yuan will appreciate very strongly in the coming months and years. Why? Because thats the main tool by which the Chinese central bank will fight inflation in China. The National Bureau of Statistics in China says that the consumer price index has increased by around 7 percent in January from a year earlier. The yuan will rally to 6.70 per dollar by the end of 2008, according to the median estimate of 26 analysts surveyed by Bloomberg News. Forward contracts show traders are betting on a 12 percent advance in the yuan to 6.3150 in the next 12 months.

Van Eck Global has launched currency exchange-traded notes offering exposure to the Chinese renminbi and also the Indian rupee. The Market Vectors – Chinese Renminbi/USD ETN (NYSE Arca: CNY) is the first exchange-traded products to offer exposure to the Yuan.

The notes are designed to go up in value when the Yuan/Rupee appreciates against the U.S. dollar, and down when the dollar strengthens. The ETNs are underwritten by Morgan Stanley, and Van Eck is the agent. The notes charge 0.55% in annual fees.

Buy them in tax-sheltered accounts. Marc Faber and Jim Rogers have been bullish on the Yuan for sometime. There is consensus that the Yuan is undervalued and will need to rise in the months and years ahead. With no real attractive bull markets in US equities, this trade can garner good returns.

Lowering the discount rate on Sunday night. Way to go, Obi Wan Ben (Bernanke).

Instead of waiting 48 hours to announce this at the end of the FOMC
meeting, you do so early so the whole world will panic. And panic they
are.