Daily Speculations

The Web Site of Victor Niederhoffer & Laurel Kenner

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A note from the patch, by Mick St Amour

"Is Oil In The Process Of Making A Cyclical Top?"

I have concerns regarding the oil patch and why it may be a good idea to begin taking just a little money off the table.

Ernest Hemingway once said that during a bull fight you should step back and watch the crowd lost in its emotions. I find that comment particularly interesting within the context of today's oil markets and S&P 500. Many seem to think that there is no risk when it comes to investing in oil companies and that trees grow to the sky. All you have to do is watch CNBC or read an analyst report. Just about every analyst on the street is tripping over themselves to issue a strong buy on energy stocks. Quite frankly the sector has become over invested in and over loved by wall street.

Don't get me wrong, energy is in a secular move upwards but I suspect a cyclical pullback is in the making that will take off some 15-25% off the value of your average energy stock which will provide you with a much better buying opportunity than today.

Now to put this into even more perspective for you. The good folks at GMO Asset management have studied every asset bubble out there. Whether it is tulip bulbs, gold, real estate, stocks, fine works of art, they've studied past booms and boosts and have some pretty interesting facts to back up my argument. They manage $90 Billion and clients include the likes of Dick Cheney, Exxon Mobil, and just about every other pension and endowment fund you can speak of. Their results over the years have been quite impressive and they know how to exercise risk management in order to achieve steady results.

According to GMO's Jeremy Grantham, your average speculative bubble, (and this includes studies on 29 different asset classes covering at least 100 years), reached it's peak when the price reached 2 standard deviations above trend growth. As far as oil goes, that means at roughly $65 per barrel we are at 1.3 standard deviations above the mean or trend line growth. 2 standard deviations occurs when oil hits the $75-$80 per barrel area. So as far as statistics goes we have a little more room for oil to advance up. But the odds are the bulk of the move has already occurred.

Consider that within the context of a slowing global economy, the prospect that Greenspan will invert the yield curve, and the fact that China just raised their interest rates 50 basis points in order to soften demand and curtail inflation. Odds are we see a cyclical pullback within the next 6-12 months where oil stocks basically go nowhere to down for additional 6-12 months before resuming the uptrend. Might want to keep your powder dry.

Just my humble opinion.

St. Mick

Mr.Ckin Adds

There are other more subtle signs of this in the bond market. For instance, last week, I noticed that I could sell a particular OxyPete bond with a TWO YEAR approximate maturity at the relatively rich level of Libor minus 18bp (on an asset swap equivalent basis). I could then invest the proceeds in a newly issued ONE YEAR Federal Home Loan Bank instrument at Libor minus 15bp (also on an asset swap equivalent). Now I know that Oxy is making gobs of money right now, and their financial situation has improved greatly over the past 10 years, but should their securities be trading tighter than GSE debt with half the duration?

Clearly this isn't a market for the typical speculator, and I doubt that one could implement this trade for more than a couple of million dollars, but it sounds like the masses are clamoring for all sorts of energy related securities. I'll stick with the Home Loan Bank, thanks.

Oil, by Sushil Kedia

If one were to throw a frog into a pot of boiling water, one could reasonably expect the frog to jump out. The thermal shock triggers the survival instinct.

However, if one were to put the frog in a pot of lukewarm water and continued to gradually heat the water to higher and higher temperatures, beyond the boiling point also, the frog is likely to let itself burn. [Disclosure: I have not conducted this experiment but am relying on the folklore.]

So, do the same two key operative words throw and put from this example apply to moves in oil and the rest of the markets? Possibly yes, though a testing is necessary. At 30 Dollars a barrel the world's markets, economists, philosophers were as concerned as they were at 40 or 50 or 60 or now closer to 70. The concerns were certainly from when the price felt lukewarm yet heating up further. But then at 40 or 50 or 60 or 70 it still has continued to feel the same. That was for feelings such as these that might have actually saved so many markets in the globe from a consensus building up regarding their rise adding only further to the up moves across the board more than three years!

However, during this mercurial rise whenever the gradual has jumped up by a few degrees (to be counted how much) it has caused the thinkers, the philosophers, the strategists and perforce the trend-following traders in everything except oil too to twitch, nudge, scratch-their-foreheads as well as allow their emotions to inflict dents in their p&ls.

So, if it is the frog in the boiling water where and when would it die? Fortunately, the boiling point of water is known to be a 100 degrees Celsius. But each frog can choose to or be forced to die at any other temperature.

Crude Control, by James Tierney

Maybe the problem is our assumption that a barrel of oil is a barrel of oil is a barrel of oil. As a result we look at the numbers that represent gross production without examining the quality of the product pumped. With much of the world buying into the Kyoto Accord, the quality of oil purchased and the flexibility of refiners has become more important as light sweet crude burns cleaner and is easier to transform into acceptable industrial and domestic fuels.

But much of the product shipped out of the Mid-East is of a heavier, more sulphuric content. (In fact, the quantity of light sweet crude pumped annually continues to fall.) This presents no problem for a refiner like Valero which specializes in refining sour crude. Others, most notably, the Chinese lack Valero's refining capability. As a result, we have less of the most desirable crude produced coupled with the inability of a major consumer to effectively refine poorer grades.

So until China (and possibly India) solves its refining problem the much-watched daily oil quote will continue to be high. Additionally, this inability to use lesser grades of oil could well explain that while oil prices continue high, the daily rates of bulk carriers drop - why buy it if you can't refine it?


Don't expect prices to diminish much at all if a collection of East Coast blue states is successful in its attempt to implement their own Kyoto Accord.

Gregory Van Kipnis added

Discussions and reports we are beginning to see suggest someone may be cornering the oil market. One analyst points out that crude oil production is up this year, as is consumption, but aggregate production exceeds consumption. Therefore inventories must be growing. Problem is no one can identify where those physical inventories are. Certainly not in the US.

The Department of Free Markets receives a contribution from Gibbons Burke

How To Create A Shortage

by William Anderson
[Posted on Monday, August 29, 2005]

People are not happy about this latest round of gas price increases; and, not surprisingly, they are demanding answers and "solutions" from the wrong people: the political classes. At the cutting edge is Hawaii, where gas prices will soon be controlled by law, not markets. Hawaiians are about to find out in the near future that the "solutions" they have supported are going to have the opposite effect of what supposedly was intended.

People in the Aloha State pay more for gasoline than anyone else in the United States, and anyone with even a basic understanding of economics understands why this is so. Hawaii is a group of islands located thousands of miles from the continental US, and Hawaiians who purchase gasoline must be willing also to pay for the high transportation costs of bringing fuel to that state. (At more than 57 cents a gallon, Hawaiians also pay the highest gasoline taxes in the USA, a penny more than their California counterparts and about 13 cents more than the national average, according to the American Petroleum Institute.)

Hawaiians believe this to be a most unfair set of circumstances and have turned to their legislature for what they believe to be relief. Yes, even though the high prices that people in Hawaii pay for gasoline are due to that pesky thing called the Law of Scarcity, citizens of that state are convinced that the politicians there can do away with scarcity by fiat. They are about to discover just how wrong they really are....

Continued here

Gas Majeure, by Kim Zussman

Henry Hub
Made a flub
Took a pass
Now passing gas

A mighty storm
Was taking form
Made us queasy
Then skipped Big Easy

I expects
That many specs
Got it wrong
They were not long

Blue Hawaii, by Jim Sogi

The Public Utility Commission just capped this week's wholesale gas price at $2.15, to be adjusted each Wednesday based on New York, West Coast and Gulf Coast prices, under Hawaii's foolish new gas price caps. What those prices have to do with the price of gas here is unclear. Gas price at the pump is ~$3.00. The cap takes effect on Monday and is set each week. I'll report back when people start walking, biking and sailing and canoeing to get around. (Maybe not such a bad idea!) It appears that pump prices will stay the same and the cap will merely transfer money from the refiners to the retailers. Will research further. The law of unintended consequences about to kick in big time here.

Dr. Bud Conrad adds:

I was a consultant in the Economic Phase II price controls energy division, under the Economic Stabilization Act of 1970. We barely knew what we were doing. The controls had loopholes, where crude was sold back and forth several times with the limited add-on increment to price. A few got around the game but I never heard of any big penalties. There was little discussion about long term theoretical economics. It was mostly just writing regulation, monitoring price, putting stickers on pumps. Lot of bureaucracy, consultants, meetings, and interviews with curious press, but little useful output.

Crude oil went from $3 to $10. Nixon's plan, cutting speed limits, lengthening Daylight Savings, didn't work very well. But now at $65 we don't have any obvious plan or ideas what to do. That is probably better than doing the wrong thing.

Tom Ryan Explains Oil Inventories

Inventory numbers in many countries are so notoriously unreliable that the overall consumption figures cannot be relied upon. On the production side there are several countries that are prone to almost always over-report, including one on the Caribbean coast of South America. Our experience is that all of the state controlled operations tend to over-report production. It's a natural result of the incentive systems in place in a state controlled bureaucracy.

Also, don't forget there are losses in the system of transport. It's not entirely zero sum and the largest "storage" in the overall system is in tanker holds and that can fluctuate quite a lot from month to month.