The Schork Report : Why does Washington
blame speculators for high oil prices,
to credit speculators for low natural gas prices?
Are speculators the cause of high prices or are speculators the
effect of poor policy?
Speculators cannot cause high prices any more than they can
cause low prices. Speculators can exaggerate moves in either
direction, but they cannot cause those moves.
Today North America enjoys an abundance of natural gas.
One of the anecdotes from last week's release of the Federal
Reserve Bank's Beige Book underscores this fact:
On the other hand, low natural gas prices have been a boon to U.S.
industry. A contact in the industrial membrane industry reports that a
multimillion dollar project to switch to natural gas has already led to
millions of dollars in savings. A petrochemical contact points out that
the equivalent price of natural gas in terms of oil is approximately $25
a barrel, making the U.S. a low cost producer of petrochemicals; as he
put it, we are "exporting natural gas in the form of ethylene and
However, it wasn't always that way for gas. Ten years ago all
the best analysts' money-could-buy were telling the world that
North America was running out of natural gas. This “reality”
prompted a tremendous amount of investment into the gas
On the NYMEX, the spot gas contract for delivery at the Henry
Hub rose from a low of $1.760/Mcf in September 2001 to
$15.780/Mcf by December 2005… i.e. a 797% return in less
the 4½ years.
Today, NYMEX natural gas is on a path to the test those lows
How can this be? How can the price of a commodity that
was allegedly dwindling in supply ten years ago, now be
worth less today (inflation adjusted) then it was worth
The answer is easy, the market was allowed to respond to
the imbalance between demand and supply, i.e. prices
surged and producers figured out the economics on LNG
and the technology on shale fracking. In other words,
high prices became the cure for high prices.
To this effect, speculators serve a key role by signaling
the market's perception of potential shocks to this balance
of supply and demand.
Ten year ago in North America a large disconnect between
natural gas production and demand existed. That fact
was not created by speculation. However, speculators did
recognize this disconnect and figured, rightly, that a shift
in the demand curve to the right and a shift in the supply
curve to the left would obviously push the point at which
these two curves meet higher along the y-axis. As such,
they placed their bets (or they “signaled”) accordingly.
Today, speculation in the natural gas market is surging.
For instance open interest (20-day moving average)
through the rally from 2001 to 2005 was 846,000
contracts. Open interest over the last year is 1.49 million
Yet, with robust speculation, prices are moving lower! Why?
Because a shift in the demand curve to the left along with a
shift in the supply curve to the right pulls the point at which
these curves meet lower on the y-axis. As such, speculators
are wagering in accord with a market that has too much
supply and not enough demand.
When it comes to oil, speculators are also placing their bets.
With a looming showdown with Iran and a virtual
disintegration of the downstream market in the U.S.
Northeast, speculators are wagering on a potential sudden
shift in the supply curve to the left.
Speculators are sending a message, but Washington does
not want to listen. Thus, as we progress through this
election season we will begin to hear calls from politicians
and their minions in the media to the effect of “… the
Congress should pass a law to clamp down on speculation…”.
Bottom line, any attempt to curb speculation will never
work. Speculation is a symptom of the much large issue of
the fundamental imbalance between supply and demand in
the oil market. If you eliminate speculation all you are doing
is deleting the message, you are not addressing the issue of
why speculators are betting on higher prices in the first
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The Schork Report is a daily newsletter that provide clients the benefits from a reliable range of tangibles -- daily reports that include a "game plan" on how to approach each trading day, commentary and analysis illustrating key supply/demand factors driving energy prices, and long-range price forecasts. Petroleumworld does not necessarily share these views.
Editor's Note: This commentary was originally published by The Schork Report, on
Tuesday, March 06th, 2012
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