Oil Hoarding

April 26, 2006

Oil Hoarding

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

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.

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.