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The Hyperinflation Hoax is worse than we thought: We can’t change the price of Oil

April 26, 2011 5 comments

Another Hoax?

Remember that post about the futility of using monetary policy to impact the price of oil?  It turns out that the elasticity of oil is even lower than I thought!  The IMF – ok, no jokes – came out with a report showing the short term price elasticity is nearly irrelevant, while the long term price elasticity is freakishly tiny.  The Blog world is a-titter about this.

The IMF says that a 10% increase in the price of oil results in 0.007% less demand in the short term.

The U.S. uses about 15 million barrels a day.  A 10% increase in the price of oil results in – wait for it – a decrease of 1050 barrels of oil per day. Increasing the price of oil from $90 to $99 results in 1000 less barrels of oil demanded.  That is 1 futures contract at the CME/NYMEX.  A 1 lot.  To put this in perspective, 319,000 contracts traded yesterday.

What level of interest rates – in the standard model- could be high enough to push down oil prices 20% or so, back to$90 a barrel? The demand for oil will not change in the slightest even if rates were increased to 5% tomorrow.  People won’t say “Oh, this quarter point increase in the Fed Funds rate makes me want to use less gasoline – or at least pay a lower price for it.”   A 10% increase in the actual price impacts demand by an amount so small it is a rounding error.  Tiny movements in interest rates will have zero observable impact on the price we are willing to pay for gasoline.

Why in the world are people shouting about energy inflation?  Even smart people can make this mistake, like Kevin Drum.

A self-inflicted cure of higher rates in response to high oil prices would be far worse than the disease.   We know what it takes to get the price of oil down to $40 a barrel.  It takes a global depression. It takes losing 500,000+ jobs a month in the U.S.

This is another reason to fight the Hyperinflation Hoax.

[Update: Seems the people over at Reason do not have quite as much reason as they might have thought.]

 

[Update: I made a mistake in oil demand.  The actual numbers are a 10% increase in the price of oil causes a drop of .2% in demand after 20 years.

This translates to a decrease of demand of about 30,000 barrels a day.  It does take 20 years for this to happen.  So if we assume a linear drop, then it’s a drop of about 125 barrels/day a month, every month for 20 years.  This is still very small.  I wonder how this number is significantly different than zero – it seems impossible that such a small effect would have an error term that’s even smaller, considering the data used. ]

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Oil prices already near highs when priced in GDP

March 1, 2011 Comments off

I was thinking along the same lines, but I didn’t have the full day to devote to this.  Glad to see I don’t have to now! The price elasticity of Oil is low, and remains low. This means that demand does not change much ever for large differences in price in the short term.

We’re used to pricing oil in USD.  But another really good way to look at the oil is “How much of our work is devoted to purchasing energy?”  The reason this is a good question is because the amount of energy demanded doesn’t change even when the price for this energy changes. So asking how much “money” this energy costs is not as useful ask asking how much work it costs.

For this, you translate the total cost of oil USD into GDP terms.   This is what BAML did! Nice one. It turns out that in terms of Global GDP, the price of oil is already nearing the 2008 highs.

Then they point out that this demand elasticity has a huge kink.  It is strongly linear until a point, but at that point the world capitulates and destroys a huge portion of demand.  This dynamic was one of the triggers of the 2008 Lehman Crisis – remember $4.50/gallon gas?

Apparently, we are very near that point with the current prices of oil.  Ouch.

First, the part that demand elasticity causes huge jumps in price for minor disruptions in demand.    (h/t to the FT Alphaville blog):

the price elasticity of global oil demand will ultimately determine how high oil prices go. Broadly, we would argue that a 10% increase in oil prices pushes down global oil demand by about 0.5%. In other words, a 600 thousand b/d production disruption should impact Brent crude oil prices by about 15% or $15/bbl, in our view. This calculation is consistent with the jump observed in recent days in response to Libya’s output disruption. Worryingly, it highlights the risk of further price rises if more production is shut in.

Then worry that we are really close to the discontinuous break point for demand destruction:

In our opinion, if Brent crude oil prices hold at around $110-115/bbl in 2011, energy as a % of GDP would remain close to record levels (Chart 14), suggesting that the point of demand destruction is in short sight.Even when looked at on a quarterly basis, we find that oil prices are already very close to the exceptionally high levels observed in 2008 (Chart 15).

While this suggests to them that we have a spike and crash scenario coming, I think it is already here.  I am waiting on the “Crash” part. Combine this with any few random posts from Gregor.us and you can see a spiky future for oil.

By the way – you need to setup an RSS feed for both the FT Alphaville blog and for Business Insider.  These are some of the best sources for information on the web.  Plus you’ll find a good amount of quality IB reports.

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Saudi’s fill output gap as predicted

March 1, 2011 Comments off

Saudi pumped 8,425 but appear to be pumping 9,000+ now

At least according to them and an unidentified source!  We’ll see how this really turns out, but as of now, it looks like Saudi Arabia is able to fill the output gap.

From Reuters:

Saudi Aramco CEO Khalid al-Falih told reporters the demand caused by violent unrest in Libya had been met. [ID:nLDE71R0DG]

Saudi Arabia is pumping around 9 million barrels per day and has spare capacity of around 3.5 million bpd, a senior Saudi source told Reuters, confirming a figure given by an industry source last week

I wrote a few weeks ago already that Saudi Arabia had the capacity to pump much more, and then last week again said they were turning on the spigot.  The latest official data is Saudi Arabia was pumping 8,425 a day for January, but here are a few claims they are pumping 9,000 or more in February.

I’d be surprised if they don’t up it past 10,000/day just to show the world it can. It would take a few months, but I think they are very worried about the price of oil being too high.

Also, I guess I should have guess I should have known Jim Rodgers was turning into a crank when he started wearing bow ties.  It’s a pretty good predictor of Crankery.

 

 

 

 

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Saudi Update: They are turning on the spigot

February 24, 2011 Comments off

Incredible claim from the Saudis:

“Right now, there are active talks in order to implement what is needed,” the Saudi oil official added. He stressed that the kingdom retained spare capacity of some 4m barrels a day – more than than double Libya’s entire output which totalled 1.58m b/d in January, according to the International Energy Agency.” [Italics mine]

Wow. “Stressed” – usually people aren’t lying when they stress they can do it right away.  It almost sounds like he is begging people to take more crude oil.  The 4m barrels is far beyond the estimates of spare capacity that I’ve seen.

And that isn’t all:

“Traders believe Saudi Arabia has the capacity to boost production by at least 1m b/d with just 24 hours notice, meaning that if a decision was adopted now, the oil tankers could be arriving in Europe within 10 days.”

Wow.  Just wow.  24 hours notice.

Iraq: Where is the oil?

Also, why isn’t Iraq just pumping out the oil right now?  A few trillion, and this is what we get? No oil extra oil during an oil crisis?

 

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