[Pops]

All is not as it appears in the global oil markets, which in my view have become entirely dysfunctional and no longer fit for its purpose. I believe that the market price is about to collapse as it did in 2008 and that this will mark the end of an era in which the market has been run by and on behalf of trading and financial intermediaries.

In this post I forecast the imminent death of the crude oil market, and I identify the killers; the re-birth of the global market in crude oil in new form will be the subject of another post.

Read this at TOD and then let's talk...

[kublikhan]

If that really does happen, that would easily put Midessa in first place in our 2012 Oil Price Challenge. Hmmm, maybe I should have accounted for more volatility....

[SeaGypsy]

In my view there is little or no chance of military action against Iran, and having been to Iran five times in recent years, and as recently as two months ago, there is much I could write on this subject.

While financial sanctions have been pretty smart, and increasingly effective so far, the medium and long term effect of the proposed EU oil embargo – which will in fact affect only a pretty minimal and easily accommodated amount of demand which is evaporating anyway – is more apparent than real.

While there would undoubtedly be a short term price rise – cheered on by the usual suspects – in the medium and long term the embargo will act to reduce oil prices. This is because Iran will necessarily have to sell oil at below market price to China and others, and since the market is over-supplied, particularly in Europe, this will undercut market prices generally.

Pure speculation.

As the price collapses we will see producer nations generally and OPEC in particular once again going into panic mode, and genuinely cutting production. We will also see the next great regulatory scandal where a legion of risk-averse retail investors who have lost most or all of their investment will not be pleased to hear that they were warned on Page 5, paragraph (b); clause (iv) of their customer agreement that markets could go down as well as up.

At this point, I hope and expect that consumer and producer nations might finally get their heads together and agree that whereas the former seeks a stable low price, and the latter a stable high price, they actually have an interest – even if intermediaries do not – in agreeing a formula for a stable fair price.

Wishfull thinking.

One of the comments said something about the foolishness of listening to geologists when they talk economics. It's a well written article, a good read, but way off the mark. Oil producing countries' governments are already at risk, what happens to Saudi production when half the basis of their already unsettled state gets pulled out?

I don't buy the guy's argument at all and if I were a betting man, I'd put $$$ on it.
Things are both fluid and stuck the way they are for a much more complex set of reasons than the article even begins to look at.

[rockdoc123]

I agree with much of what is said in the article. You have to remember that he is referring to transient conditions in the market where current demand has been hammered very hard in the main consuming area (US) and has also had an impact on the second in line consuming area (Asia). The Saudis have been saying for sometime that the market is well supplied and have hence resisted entreaties to increase production in order to bring Brent prices down. If you pay much attention to Bloomberg the economy in China is not growing at the rate it once did and the European economy is now thought to be in recession. So, yes there are a lot of things lining up to suggest oil price reality should be quite a bit lower than it is now.

[SeaGypsy]

Obviously Roc, you haven't been to Asia recently.
The place is humming with positivity, exactly the opposite of the West.
The article is wrong because it assumes that all growth has the same ambition.
Whilst it is somewhat difficult to get transparent figures out of many countries in the region, those we do get are coming from the top end of town and they are certainly playing a lot of games with the information they put out. I am looking at Asia on the street level. Entrepreneurship is going gang busters from the micro level up. Regulation is virtually nothing compared to our countries. Wages are a pittance, but there is still plenty of room for profit for small/ medium business.

[Pops]

The outcome would be a financial ‘lease’ of oil by BP to GSCI investors and the monetisation of part of BP’s oil inventory. Such agreements in relation to bilateral physical oil transactions are typically concluded privately, and are invisible to the organised markets. However, any risk management contracts which an intermediary such as Goldman Sachs may enter into as a counter-party to both a fund and a producer are visible on the futures exchanges.
Due to the invisibility of the change of ownership of inventory ‘information asymmetry’ is created where some market participants are in possession of key market information which others do not have. This ownership by investors of inventory in the custody of a producer has been termed ‘Dark Inventory’

So basically he's saying BP rents out an amount of oil that's still in the ground to someone - monetizes their reserves - and buys back the oil at some future date when it is actually out of the ground in a pipe somewhere. This is a private transaction that creates "dark Inventory" as opposed to a futures contract that all can see.

From comments by the OP

What will happen is that market players sell BFOE/Brent forward physical contracts, and OilCo buys them.

The market players sold because they believed the price will fall, in the expectation that they can buy back similar contracts cheaper in this 'over the counter' market and make a profit.

The problem is that OilCo already owns some or all of the inventory/rights to production available, and this means that the hapless seller finds himself 'squeezed'. He therefore has to buy the spot oil necessary to fulfil his forward sale contract from the only seller - ie Oilco.

And the spot price 'pops' upwards (and is distorted) as a result.

When we argue about speculation I always take the position that producers are really the only ones in a position to manipulate the market by leaving oil in the ground. With the OP's scenario the producers don't even need to forego the cash flow.

Beyond that, I can't follow him as to why he thinks this is coming to a head right now, my brain is too puny.

[rockdoc123]

I am looking at Asia on the street level. Entrepreneurship is going gang busters from the micro level up. Regulation is virtually nothing compared to our countries. Wages are a pittance, but there is still plenty of room for profit for small/ medium business.

I was last in SE Asia last summer (Malaysia, Indo and Vietnam) and I agree it looks like it is booming. What I am referring to is the relative notion of activity versus projections. According to almost all of the measures that are generally reported on Bloomberg in various articles Asia in general is expanding but expanding at a lesser rate of growth than it had been. That is likely a good thing for them but as the article suggests a slowing economy in Asia will likely have an impact on energy demand. So rather than Ming running out and buying his whole family a Ford escort he might instead buy himself a Ford escort and a couple of motorbikes for his sons....i.e. still expanding but not at the rate it had been predicted back when the global economy was booming.

[seahorse3]

Pops thanks for linking. I like articles like this that go contrary to popular opinion. Like you it's hard for me to understand but it's premise is that our existing system tradin oil allows prices to be manipulated by the majors. He in fact says he's testified for a change to this system. Let's assume he's right and the system of pricing is manipulated by the majors leading to higher prices. By his own definition, that system is so entrenched why or how would it change? It didn't change after the 2008 crash and I can think of no regulatory system which could change the "dark inventory" method of manipulation he complains of. So if he's right, there maybe short-lived price declines as in 2008 but the long term trend (even by his own argument) is up for two reasons, bc of PO and the system of manipulation. He's saying we may have another crash in prices in early 2012. That maybe so. If so, based on his same reasoning it would be a buying opportunity for the investor just as it was in 2008 when prices dropped to unsustainable levels for majors to invest and make a profit. The long term trend is higher. This is by admission a trader predicting a drop in prices this quarter.

[ColossalContrarian]

I thought this was going to be about grape seed oil....

Actually, what I find fascinating about this article is that it sheds light on the difference between real demand and financial demand. I never put that together with commodities until just now. So from not just the oil side of things, but silver and gold. I learned something today not that manipulation is anything new but how it can work to change markets.

[ColossalContrarian]

This is a thread I would like OF2 to comment on.

[seahorse3]

If this manipulation is true it's not shocking. As commodities get more scarce there is more gouging or manipulation by the players with the most access. Why would anyone be shocked that annoil major and a financial company would team up to manipulate prices for profit? In fact I would be shocked if, during PO or it's plateau as we are on now, if all the people of the world held hands and worked together. That's not the way anything about human history has ever worked. I don't think it will get any better. It's a precursor of things to come. There will always be the haves and have nots. The desparity between the two will increase and not decrease.

[rangerone314]

Demand will be dropping in NA and Europe but not Asia.

North America and Europe are reverting back to what they have often been for thousands of years... an irrelevant backwater to Asia.

In a few decades, we'll count ourselves lucky if our men can polish their boots for a few coins and if our women can earn some money whoring for unmarried Chinese tourists.

[SeaGypsy]

So rather than Ming running out and buying his whole family a Ford escort he might instead buy himself a Ford escort and a couple of motorbikes for his sons....i.e. still expanding but not at the rate it had been predicted back when the global economy was booming.

Yeah right, when Ming was going to be able to jump on the western consumption/ debt bandwagon, bummer that never happened hey? How quick would peak everything arrived if all those 125cc scooters had been 'Escorts'?

My 125 gets about 100 mpg with a sidecar loaded. Multiply that by about a billion throughout Asia over the last few years and the next few add another billion. It matters not at all in terms of overall consumption/ market resilience, whether its half a billion escorts and massive disparity, or 2 billion and growing 125cc scooter driving population. Upward pressure will be maintained. Unlike Americans/ Aussies/ Euros etc, Asians will put on a raincoat and ride to work in the sleet/ snow/ ice to get 100mpg.

[ralfy]

Notable points by Westtexas in the comments.