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Hell Is Freezing Over

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I would have said it would be a cold day in hell before I would agree with something Daniel Yergin said. Mr. Yergin is the chairman of Cambridge Energy Research Associates or CERA. Normally I would not have kind words to say about Yergin or CERA but tomorrow I will agree with him.

Daniel Yergin won a Pulitzer Prize for a history of the oil industry. He has turned that into a cash cow with CERA and makes a fortune advising client countries on the future of oil. Unfortunately he is normally wrong and in fact grossly wrong on most issues but he is normally seen by the news community as an expert on oil. I guess nowhere in the job description does it require he be right.

To get back to the point of this commentary Mr. Yergin is going to testify before the panel of witch hunters looking for a scapegoat to blame for high oil prices. The draft of his comments surfaced Tuesday night and it appears Yergin is actually going to be right for once. He is going to tell the congressional committee that traditional economic factors were responsible for most of the run-up in oil prices and caution against looking for simplistic solutions to one of the worlds most complex markets. 

He is going to pour cold water on the idea that speculators are responsible for the record prices. Since Yergin always plays loose with the truth I applaud him for taking the unpopular stance in front of this committee. My only nagging thought is why? It would have been so easy to join the crowd currently claiming that speculators were bankrupting the country by investing in oil. His would have been the recognized voice of an "expert" in the field. Instead he is applying that expert moniker to the fundamental reasons for the increase in prices. For whatever your reason Mr. Yergin I agree with you.

In recent days speculators have become the prime target of the congressional committee and some are even proposing that pension funds and institutional investors be prohibited from investing in commodities at all. That is just like lawmakers to go overboard with the remedy and burn the barn just to get rid of a few mice.

One thing everyone does agree with is that large numbers of positions go unreported as to size and nature because of different rules covering the various exchanges. Changes to those rules are already in progress so that is really a mute point.

What Yergin is going to repeat to lawmakers tomorrow is that rising demand and shrinking supplies has reduced the world's excess capacity to only 1.6 million barrels per day. That is down from 5 mbpd in 2002. What will not be reported is that almost none of that excess is light crude but almost all is heavy high sulfur crude that most refineries cannot use. That appears to be too complicated for lawmakers to understand.

According to his draft he will explain simple economic rules to the panel. "In a tight market prices go up. A tight market is also a market that is more crisis-prone, more vulnerable to the impact of disruptions."

Committee member, Bart Stupak, Democrat from Michigan, claims the number of contracts held by speculators has risen to 71% this year from 37% in 2000. At the same time contracts held by traditional oil users has fallen to less than 30% from more than 60%. Stupak blames speculators for having a devastating effect at the gas pump and a severe drag on the entire country.

Unfortunately the U.S. Commodity Futures Trading Commission disagrees with those numbers and as the regulatory agency they should know the facts. According to the CFTC speculative positions on the oil markets are currently close to their lowest levels in nearly a year.  In fact, the positions held by noncommercial traders, meaning investors that were not seeking to actually take delivery of oil each month, have been net short since Feb-2007.  The CFTC also pointed out that the figure cited by Stupak substantially overstates the pressure that these speculative positions have on pushing prices higher. For example the percentage counts swaps dealers who are in the market both as buyers and as sellers as speculators when they are actually in the market for clients who are not speculating.

Barclays Capital said this week, "Politicians are lining up to blame speculators but the most recent CFTC data suggests otherwise." They are just one of many who have pointed out the errors in the data but whose points fell on deaf ears.

Roger Diwan, an energy analyst at PFC Energy said in his testimony, "The financial players understood what was happening to the supply-demand balance and have bet - correctly - that prices would have to move up and that consumers would be willing to pay higher and higher prices without significantly altering their usage patterns." 

Those usage patterns have changed slightly due to higher prices but not enough to change the supply-demand picture. Year-to-date gasoline consumption in the U.S. is down -1.99% but that is a minor drop compared to the 35% rise in gasoline prices over the last 12 months. The amount of money consumers pay for gasoline has fallen dramatically from the percentage seen back in the prior oil shocks. Sure the high prices still hurt but many countries have been paying more than double today's prices for many years.

It you think $4 gasoline hurts just wait until the summer of 2010. Odds are very good U.S. gas prices will be over $6 by then and $10 by 2012. That 1.6 mbpd of excess heavy crude is all that stands between us and a doubling of gasoline prices. When there is excess demand rather than excess capacity it will be an entirely different witch hunt.

Jim Brown

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