Arnold Kling  

Oil Hoarding

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James Hamilton summarizes and comments on a blog discussion of the fact that oil futures prices are high relative to spot prices. He writes,


There is currently very little spare capacity in global oil production, meaning that a supply disruption of just a few million barrels a day could easily result in a pretty impressive spike up in the spot price of oil in September. Where might such a supply disruption come from? Oh, maybe Nigeria, or Iran, or Iraq, or Saudi Arabia, or Venezuela, or Russia, to name a few. Even if the probability of such an event is low, the large payoff if it occurs could give an attractive expected rate of return

Two years ago, oil futures prices were below spot prices, a phenomenon known as backwardation. At the time, I wrote,

Backwardation induces people with oil to sell it today. In principle, if you have oil in inventory, you should sell every drop while the price is at its peak. If you want to benefit from or hedge against further price increases, you can buy oil futures contracts instead.

Note that if you had done this, you would have made a big profit. Even though you would have been selling your oil at $41.50 that is now worth $73, you would have bought futures contracts at $36, and those futures contracts (assuming you rolled them into 2008) would be worth more than $75 now.

My main point is that today the futures market is telling people to hoard oil. That includes not just refiners with inventories. It also includes anyone with oil in the ground. The futures markets are saying, "If you leave the oil there, it will be worth more later, so don't bother pumping any oil now."

My guess is that every time Iran's President makes another reckless statement, this raises the value of hoarded oil, which drives up futures prices, which in turn drives of spot prices. Maybe he is crazy like a fox.

Also, read Nick Schulz on how our economy has become less energy-intensive over time.


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COMMENTS (3 to date)
Scott Peterson writes:

Another excellent post, Dr. Kling. I have been trying to clarify in my mind what the effects of the "contango" situation are with respect to producers' incentives and this nails it.

Brad Hutchings writes:
My guess is that every time Iran's President makes another reckless statement, this raises the value of hoarded oil, which drives up futures prices, which in turn drives of spot prices. Maybe he is crazy like a fox.

Yeah, why isn't anyone picking up on this? Iran jumped the shark yesterday with its pledge to ship nuclear technology to Sudan. As if they hadn't already with dancers holding vials of enriched uranium. What if Iran has basically bluffed the price of oil up? Even Chavez in Venezuala doesn't think it's sustainable -- witness his recent proposal for a $55/barrel fixed price. So what if Iran is just bluffing the price up, then gets UN sanctions slapped against it, then gets attacked by Israel and the US? What happens then to the price of oil? In a time of war, they can't possibly want to shut off their cash cow. In summary, Iran's President ain't half as smart as he thinks he is.

aaron writes:

I like this theory. It's very plausible. It's in Iran's interest to be a percieved threat, but never an actual one.

But how long can they play that game, eventually we have to call their bluff whether they are developing weapons technology or not. Just like Iraq.

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