It's been awhile--I had an overwhelming semester...
There are a few articles I came across over the past two months that I want to address at some point in the next few weeks, but for now I simply wanted to review my 2017 oil price forecast.
I started the year off with a fairly conservative range of $30 to $70 for WTI oil, but as I gained more confidence in my overall assessment of the market, I tightened that range to $40 to $60 in this February 15th post. WTI hit a low of $43 in late June, and a high of $59 November 24th. I think it's safe to say I nailed it.
Within the next month I will provide my forecast for 2018. I do think there is a solid floor in the low $50 range, but more on that later.
Cowabunga and Happy Holidays!
Wednesday, December 20, 2017
Friday, October 13, 2017
The Political Economy of Food & Finance
It's been awhile...
Just a quick note to say my book is now available in paperback HERE.
Just to add, while it may seem that "it's the end of the world as we know it..." given hurricanes and political turmoil, WTI remains close to $50, and should stay in this range for the remainder of the year. I will provide a more detailed update in the near future.
Just a quick note to say my book is now available in paperback HERE.
Just to add, while it may seem that "it's the end of the world as we know it..." given hurricanes and political turmoil, WTI remains close to $50, and should stay in this range for the remainder of the year. I will provide a more detailed update in the near future.
Sunday, May 7, 2017
A quick note related to the Fire post....
I just came across this Bloomberg piece, Five Charts That Explain Crude Oil's Sudden Nosedive Toward $45, which provides some charts and data on last week's oil market panic. The charts include a look at technical analysis, showing that WTI broke through some low measures which would cause technical traders to sell; action in the options market focused on puts with strike prices of $45 and $46; and a change in the forward price structure from contango to backwardation, which they suggests shows a move from bullish to bearish sentiment.
It should be another interesting week. Will prices break lower, or will OPEC and Wall Street be able to defend the current low?
It should be another interesting week. Will prices break lower, or will OPEC and Wall Street be able to defend the current low?
Saturday, May 6, 2017
"Fire!"
Someone screamed "Fire!" in the oil theater, and the Hedge Funds headed for the exits.
As predicted, the weight of "pork oil" finally broke the back of Hedge Fund long bets, and some big players were forced to go defensive over the past couple of weeks. According to this piece from SeekingAlpha, Pierre Andurand liquidated much of his long oil position last week, with others followed suit, citing "stop loss" triggers and "risk management requirements." The article states that Andurand's fund is down 15.4% for the year.
As I've mentioned, Hedge Fund long bets in futures peaked at the end of February, and they were slowly declining for the past two months, but the trickle became a flood over the past two weeks. According to this Ft.com article, Managed Money positions fell by 26% the week prior to Tuesday (that's when Andurand closed his position). That scramble continued the rest of the week, leading to volatile price swings; for example, WTI experienced price moves in a 7% range yesterday.
Here's how dramatic the sentiment has changed: according to this Bloomberg.com article, some trader(s?) made a serious bet(s) yesterday (Friday 5/5) that WTI will drop below $40, as 14,000 July puts @$39 were sold, almost 20 times the number of contracts previously outstanding! The price of the option was somewhere between 15 and 20 cents per contract, so that amounts to almost a $3 million wager.
Will it pay off...? I'll stick with my call here that WTI will stay above $40, as both OPEC and Wall Street banks will try to prevent that from happening. In addition, if the price does approach $40, it will most likely cause the bulls to jump back in, especially since inventories have declined over the past two weeks. Note, that doesn't mean the huge wager won't pay off, as the option premium will increase in value if the price does fall lower.
Now, I could be wrong on that price floor, and the condition for a price collapse is the unraveling of OPEC, which is certainly a possibility given every country's need for oil revenues. Interesting times...
As predicted, the weight of "pork oil" finally broke the back of Hedge Fund long bets, and some big players were forced to go defensive over the past couple of weeks. According to this piece from SeekingAlpha, Pierre Andurand liquidated much of his long oil position last week, with others followed suit, citing "stop loss" triggers and "risk management requirements." The article states that Andurand's fund is down 15.4% for the year.
As I've mentioned, Hedge Fund long bets in futures peaked at the end of February, and they were slowly declining for the past two months, but the trickle became a flood over the past two weeks. According to this Ft.com article, Managed Money positions fell by 26% the week prior to Tuesday (that's when Andurand closed his position). That scramble continued the rest of the week, leading to volatile price swings; for example, WTI experienced price moves in a 7% range yesterday.
Here's how dramatic the sentiment has changed: according to this Bloomberg.com article, some trader(s?) made a serious bet(s) yesterday (Friday 5/5) that WTI will drop below $40, as 14,000 July puts @$39 were sold, almost 20 times the number of contracts previously outstanding! The price of the option was somewhere between 15 and 20 cents per contract, so that amounts to almost a $3 million wager.
Will it pay off...? I'll stick with my call here that WTI will stay above $40, as both OPEC and Wall Street banks will try to prevent that from happening. In addition, if the price does approach $40, it will most likely cause the bulls to jump back in, especially since inventories have declined over the past two weeks. Note, that doesn't mean the huge wager won't pay off, as the option premium will increase in value if the price does fall lower.
Now, I could be wrong on that price floor, and the condition for a price collapse is the unraveling of OPEC, which is certainly a possibility given every country's need for oil revenues. Interesting times...
Tuesday, May 2, 2017
On shale hedges and oil prices
Catching up on the oil news of late....
Several recent pieces on the impact of shale producers on prices. Liam Denning's article from Bloomberg.com looks at the use of hedges by shale producers and how it's restraining OPEC's attempt to raise prices (as I've mentioned in quite a few of my previous posts). Denning provides data that essentially confirms how shale producers use hedges to lock in prices a year out when WTI oil rises above $50 per barrel, which then puts a cap on any price run up. His conclusion:
The data provided by Denning provides some interesting information concerning the history of oil prices and the impact of financial players. In particular, there is a figure that shows the net shorts of the swaps positions (includes options and futures) in NYMEX oil. According to Denning, "This is a proxy for hedging activity by E&P [exploration and production] companies (which generally use swaps dealers to establish their hedging positions). The lower the number, the more oil sold short, or hedged." His explanation is consistent with what former Goldman Sachs COO [and current chief economic adviser to Trump] Gary Cohn stated about the creation of Commodity Index Funds (CIFs):
The latest development, according to this Bloomberg piece, is that Hedge Funds have lost patience and have dramatically reduced their long bets on crude. As I have recently argued, the banks have been preaching patience to the Hedgies, and even though US inventories have declined the past few weeks, they simply won't stand by any longer and lose money:
Several recent pieces on the impact of shale producers on prices. Liam Denning's article from Bloomberg.com looks at the use of hedges by shale producers and how it's restraining OPEC's attempt to raise prices (as I've mentioned in quite a few of my previous posts). Denning provides data that essentially confirms how shale producers use hedges to lock in prices a year out when WTI oil rises above $50 per barrel, which then puts a cap on any price run up. His conclusion:
"In other words, if shale producers can live with oil at $50 or thereabouts, then others will have to adapt themselves to that level. Moreover, if OPEC "succeeds" in pushing up price expectations with extended supply cuts, Permian producers will thank them in the only way they know how. Namely, by laying on more hedges for 2018, using the cash to produce more oil -- and thereby pulling those prices back down."This shouldn't be news to anyone who has been following my blog.
The data provided by Denning provides some interesting information concerning the history of oil prices and the impact of financial players. In particular, there is a figure that shows the net shorts of the swaps positions (includes options and futures) in NYMEX oil. According to Denning, "This is a proxy for hedging activity by E&P [exploration and production] companies (which generally use swaps dealers to establish their hedging positions). The lower the number, the more oil sold short, or hedged." His explanation is consistent with what former Goldman Sachs COO [and current chief economic adviser to Trump] Gary Cohn stated about the creation of Commodity Index Funds (CIFs):
"We had clients that wanted to sell future production forward. So we had many clients that wanted to go drill oil wells, but they needed some predictability of the price of oil they were going to receive out of the well to go borrow money. They tried to enter the market and sell oil. There was no natural long in the market. The consumers are so fragmented that they don't amalgamate to a big enough position. So we actually, as a firm, came up with the idea in the early 1990s to create a long only, static investor in commodity markets. We created the commodity index where we could allow people that were willing to commit large pools of capital into the market for a very long period of time to facilitate the actual producers and allow them to be able to hedge their production forward to increase their production."Goldman Sachs and other Wall Street banks sold CIF swaps to pension funds as a way to invest in commodities long term; however, the banks (swap dealers) then had to buy contracts on the exchange to hedge their payouts on the CIF swaps they sold. These long-term commodity investments held by pension funds allowed oil exploration firms to lock in prices over a longer time horizon to cover their investments, just as Cohn argued above. However, the flexibility of the shale producers is changing the nature of hedging as discussed in this FT.com article:
"The number of outstanding oil contracts for delivery years into the future has plummeted on the New York Mercantile Exchange. Since 2012 open interest has declined by more than 75 per cent for benchmark West Texas Intermediate crude expiring in three or four years’ time. During the same period the entire WTI market has expanded by 40 per cent."Shale oil producers are able to rapidly ramp up production with new rigs, and costs are sufficiently low enough that they are profitable whenever the futures price exceeds $50. In addition, as the data show, long term hedges (3 and 4 years out) have declined significantly yet overall hedging is 40% higher. The bottom line is the shale producers are making it nearly impossible for OPEC to raise prices through production cuts because of their ability to rapidly open new rigs, lock in prices a year out, and it is profitable for them to do so when the price of WTI exceeds $50.
The latest development, according to this Bloomberg piece, is that Hedge Funds have lost patience and have dramatically reduced their long bets on crude. As I have recently argued, the banks have been preaching patience to the Hedgies, and even though US inventories have declined the past few weeks, they simply won't stand by any longer and lose money:
Investors had been expecting prices to rise to $55 or $60 a barrel in light of the OPEC deal and prices never reached that level, Tariq Zahir, a New York-based commodity fund manager at Tyche Capital Advisors LLC, said by telephone. “You started the year with longs. They’re giving up on the trade to a certain point.”If oil inventories continue to decline, then I am sure the Hedge Funds will be tempted back in; however, to reiterate my argument once again, prices will rise too high, too fast which will both raise supply through the shale producers' reactions and curtail demand. Oil prices will certainly stay in the range of $40 to $60 for the rest of the year.
Thursday, April 6, 2017
Notes from the FT's annual global commodities summit
Last month the Financial Times hosted its Sixth Annual Commodities Summit, where industry leaders gather to discuss the state of the markets. The mood was slightly better compared to the previous year's summit, with the consensus among oil traders being "the worst has passed." However, consistent with my own arguments, most analysts believe oil prices will remain subdued, stating the re-balancing of the market will take quite some time, despite OPEC's production cut.
Two points worth mentioning. The first relates to longer term prices. Traders and analysts stated that low prices have significantly curbed long-term investment which could create a supply disruption 3-4 years down the road. Much of the current investment in production is focused on shale and existing sources rather than new discoveries, which require higher prices to cover higher overall costs. I don't have a crystal ball to forecast medium and long term prices of oil, but prices will reflect the battle over alternative energy sources: will the rapidly growing impact from renewable energy countervail the declining sources of cheap fossil fuels? I'd bet on the former.
The second issue relates to a point I made recently: oil traders stated that the increase in prices (WTI) above $50 a barrel has decreased counter party risk. As I argued, bankers also have an interest in maintaining higher prices in order to reduce the risk of default on their loans oil producers. According to one of the FT articles, all commodity traders/producers came under increased scrutiny by banks due to the bankruptcy filing of a commodity trading house in December:
A final point in order to toot my horn a bit. In perusing the FT articles from this year's commodity summit, I came across an article from the previous year's summit (April 2016) with a quote that supports my central thesis which is a series of speculative bubbles created the belief that higher commodity prices were the "new normal," creating false signals for producers who expanded production into riskier projects (across all commodity products).
According to Oscar Landerretche, chairman of Chile’s state-owned copper producer Codelco,
Maybe oil traders are right, and the worst is past them, but the "drug dealers" in the form of Hedge Funds and ETFs will continue to haunt the markets....
Two points worth mentioning. The first relates to longer term prices. Traders and analysts stated that low prices have significantly curbed long-term investment which could create a supply disruption 3-4 years down the road. Much of the current investment in production is focused on shale and existing sources rather than new discoveries, which require higher prices to cover higher overall costs. I don't have a crystal ball to forecast medium and long term prices of oil, but prices will reflect the battle over alternative energy sources: will the rapidly growing impact from renewable energy countervail the declining sources of cheap fossil fuels? I'd bet on the former.
The second issue relates to a point I made recently: oil traders stated that the increase in prices (WTI) above $50 a barrel has decreased counter party risk. As I argued, bankers also have an interest in maintaining higher prices in order to reduce the risk of default on their loans oil producers. According to one of the FT articles, all commodity traders/producers came under increased scrutiny by banks due to the bankruptcy filing of a commodity trading house in December:
Transmar Commodity Group filed for Chapter 11 in the US last December, owing its creditors more than $400m. Its collapse has had an impact beyond “soft” agricultural commodities such as cocoa and coffee, with leading independent oil and metals traders facing increased questions about risk and compliance from their banks.In a competitive, non-manipulated market, I believe oil prices would fall below $40 under the current market glut; however, there are too many vested interests who support maintaining prices near the current $50 WTI crude sweet spot: if prices go too low, bankruptcy risks rise; if prices go too high, the glut will be exacerbated. It's steady as she goes for the rest of the year at least.
A final point in order to toot my horn a bit. In perusing the FT articles from this year's commodity summit, I came across an article from the previous year's summit (April 2016) with a quote that supports my central thesis which is a series of speculative bubbles created the belief that higher commodity prices were the "new normal," creating false signals for producers who expanded production into riskier projects (across all commodity products).
According to Oscar Landerretche, chairman of Chile’s state-owned copper producer Codelco,
“Things might have to get a little bit worse before it gets better,” claiming too much output had been fueled by speculators boosting the price of the metal. The Codelco chairman said the spectre of non-commercial traders was haunting markets and compared them with drug dealers, arguing funds had inflated prices during the boom years and led mining companies into risky behaviour.Speculative influences across the commodity spectrum, initially fueled by Commodity Index Funds, created a similar response in oil and grains. Given that financial traders continue to dominate markets, the shake out is taking much longer, and is more drawn out because they will not let prices fall far enough for long enough for markets to re-balance--when a new low is perceived, speculative money pours in, which pushes prices back up before the necessary reduction in supply can occur.
Maybe oil traders are right, and the worst is past them, but the "drug dealers" in the form of Hedge Funds and ETFs will continue to haunt the markets....
Wednesday, March 15, 2017
The Bankers are getting worried
In my February 15th piece Strange Brews in Oil, which looked at the recent phenomenon of a price bump immediately following the EIA's weekly oil inventory announcement (positive builds for the past nine weeks), I suggested the following possible explanation:
I have another theory: Wall Street banks have billions of dollars in loans outstanding with US shale oil producers and prices at $40 or less was pushing many toward bankruptcy. Between the banks and OPEC, these are two very powerful forces with interest in maintaining higher prices.Deep down, I wondered if I was being a bit "conspiratorial?" Recent news gives me more confidence in this position. First a little contextual reminder of the current oil market situation: with global supply outpacing demand, oil inventories were reaching record highs; (so) OPEC and Russia agreed to reduce output in December; (which led to) record long futures positions held by Hedge Funds at the end of February (they have since been pared down a bit); with prices reaching the mid-$50 range, US shale producers could profitably lock into contracts a year out (they were the sellers to the Hedge Funds buying); and finally, big Wall Street banks have serious loan exposure in the US shale oil market. Let's start there.
This MSNBC piece from January 2016 provided some detail (from a Goldman Sachs report) on the loan exposure of the banks:
Bank of America leads the list with $21.3 billion. Citigroup is next at $20.5 billion. Wells Fargo is third at $17 billion. JP Morgan Chase is at $13.8 billion. Morgan Stanley is at $4.8 billion, PNC Bank has $2.6 billion and US Bancorp is at $3.1 billion.
How much is that, as a percentage of the bank's total loans?
Morgan Stanley leads the way at 5%, followed by Citi at 3.3%, Bank of America at 2.4%, Wells Fargo at 1.9%, JP Morgan Chase at 1.6%, PNC at 1.3%, and US Bancorp at 1.2%.While the Goldman report didn't list their position, the MSNBC piece quoted Goldman's CFO who said they had $10.6 billion in oil loan exposure.
So, here's the deal: as recent articles pointed out, OPEC, while previously castigating Hedge Funds for their speculative activity, is now courting them, and they have to because the HF long positions are what's propping up oil prices, at least until last week.
It didn't take a genius to see the situation was untenable: relying on the speculative bets of Hedge Funds to maintain prices is a fool's bet. This brings me to yesterday's piece from Bloomberg.com: Citi tells investors to stop worrying and learn to love oil. Citi analysts came out with a report urging investors to take advantage of the recent price drop because the Saudi's are likely to defend the price. The article also mentioned that Goldman Sachs analysts "called for investors to be patient and said they should go, or stay, long on oil."
Hmmm....with $30 billion in loan exposure (though I'm sure they've reduced positions some since last year), do you think there might be a little conflict of interest for Goldman and Citi? Interestingly, according to this piece by William Engdahl, banks also "support" the trading of Hedge Funds:
Goldman Sachs and Morgan Stanley today are the two leading energy trading firms in the United States. Citigroup and JP Morgan Chase are major players and fund numerous hedge funds as well who speculate.According to the data above, these four banks had a combined $50 billion loan exposure to the US oil industry last year. This is more than enough incentive for the major players to "rig" the market. However, the Hedge Funds are getting antsy, and have started to pare down their long positions. Given their herding propensity, there is a very good chance of a market rout, which is why the big banks are now publicly urging them to "hang in there."
The current oil market situation is akin to the prisoners dilemma of Game Theory: it's in the best interest of all to collaborate and maintain higher prices (HFs benefit because falling prices will cause significant losses on their long bets); however, individual HFs may view their best option is to run for the exits (to minimize their losses) before an expected crash. I'm thinking the exit run is going to win out...
Friday, March 10, 2017
The Pop!
After weeks of continued inventory gains, oil prices finally succumbed to the weight of pork oil. The EIA inventory report showed a crude increase of 8.2 million barrels and prices promptly dropped on the news. WTI crude declined by $4 (7.5%) over the next two days, with most of the loss coming on the day of the inventory news.
A good piece from FT.com highlights the main issue, the significant long bets of Hedge Funds as captured in the Commitment of Traders category "Managed Money Traders." Even though OPEC and Russia have agreed to limit output, the dominance of money managers in price determination pushed prices high enough for US shale drillers to lock in prices out along the futures price curve. As the FT article points out, the number of shale rigs has nearly doubled since last May. This puts everyone else in a tight spot, as it's in everyone's interest to keep prices from tanking. The Hedgies now have to protect their long bets, and they are most likely doing so through option contracts on WTI, which experienced its second highest volume ever, according to this Bloomberg.com article.
Bad news for investors and producers, however, is good news for we consumers. I expect the vested interests will continue to try to prevent prices from collapsing, so prices will probably fall a bit more, but they will resist at $40.
A good piece from FT.com highlights the main issue, the significant long bets of Hedge Funds as captured in the Commitment of Traders category "Managed Money Traders." Even though OPEC and Russia have agreed to limit output, the dominance of money managers in price determination pushed prices high enough for US shale drillers to lock in prices out along the futures price curve. As the FT article points out, the number of shale rigs has nearly doubled since last May. This puts everyone else in a tight spot, as it's in everyone's interest to keep prices from tanking. The Hedgies now have to protect their long bets, and they are most likely doing so through option contracts on WTI, which experienced its second highest volume ever, according to this Bloomberg.com article.
Bad news for investors and producers, however, is good news for we consumers. I expect the vested interests will continue to try to prevent prices from collapsing, so prices will probably fall a bit more, but they will resist at $40.
Thursday, February 16, 2017
Quick update on yesterday's post
An article on Bloomberg.com this morning highlights most of the issues I discussed in yesterday's post: Hedge Funds with historic levels of long positions; OPEC's attempt to rein in supply; prices stuck in a range of $53 +/- $2--something's got to give!
The hope of the speculative long positions is that the production cuts will balance current supply with current demand; however, if supply is not curtailed significantly enough to start a draw down on the glut of inventory, then the overhang will persist, keeping a lid on prices for the next year. And, even if prices are pushed up higher, US producers will jump in quick, adding new rigs and simultaneously selling futures to hedge production for the next year. There simply isn't a sufficient basis of support for the bulls in the short run.
The hope of the speculative long positions is that the production cuts will balance current supply with current demand; however, if supply is not curtailed significantly enough to start a draw down on the glut of inventory, then the overhang will persist, keeping a lid on prices for the next year. And, even if prices are pushed up higher, US producers will jump in quick, adding new rigs and simultaneously selling futures to hedge production for the next year. There simply isn't a sufficient basis of support for the bulls in the short run.
Wednesday, February 15, 2017
Strange Brews in Oil
I've been trying to write about other markets, but oil just keeps pulling me back. The price of WTI oil has traded above $50/barrel since the OPEC-Russia production agreement in early December last year. However, despite the attempt to cut production and stabilize prices, global oil inventories have continued to rise. Global inventory (OECD countries) stocks are at an all-time high no matter how one measures them. OECD stocks currently stand at 3.1 billion barrels and US privately held inventory is at 508 million barrels. An article from OilPrice.com, Why sub $50 oil is more likely than $70 oil, looks at comparative measures of inventory, and no matter which way you slice it, the world is drowning in oil.
As I previously argued, there are two actions taken by investors who dominate futures markets (and price determination) that will maintain the current glut of oil inventory and its persistent anchor to higher prices: first, they do not allow prices to fall to a level that will restore balance via a significant shake out of producers because they tend to pile right back in and make bets on rising prices when oil prices fall significantly--a price drop creates a good "buying opportunity;" second, the stories of "peak oil" and rising demand from China, which provided the foundation for the price peak of $140/barrel in 2008, have left a persistent hangover, a belief that prices WILL again reach those levels at some point in the near future, therefore any news that provides ammunition for the bulls creates a flood of buying, pushing prices up too quickly.
Given the continuous rise in inventory one would expect a sharp pull-back in prices any day now, however there appears to be a new force or player in the market preventing the drop. An article in the Financial Times this morning, "In oil mystery, traders resort to 'buy the build' mantra," discusses a market phenomenon that has occurred for the past few months:
The bottom line: there is no change in my 2017 forecast that prices will not fall below $30 nor will they rise above $70. In fact, I believe we can tighten that range to a minimum of $40 and maximum of $60, though the chances are better they will hit the low range (very soon!) rather than the high. While it's possible the price will drop below $40, any price drop of that magnitude will simply offer the bulls another opportunity to jump back in. The more interesting story is the long term outlook and alternative energy's impact on oil, but that's a story for another day...
As I previously argued, there are two actions taken by investors who dominate futures markets (and price determination) that will maintain the current glut of oil inventory and its persistent anchor to higher prices: first, they do not allow prices to fall to a level that will restore balance via a significant shake out of producers because they tend to pile right back in and make bets on rising prices when oil prices fall significantly--a price drop creates a good "buying opportunity;" second, the stories of "peak oil" and rising demand from China, which provided the foundation for the price peak of $140/barrel in 2008, have left a persistent hangover, a belief that prices WILL again reach those levels at some point in the near future, therefore any news that provides ammunition for the bulls creates a flood of buying, pushing prices up too quickly.
Given the continuous rise in inventory one would expect a sharp pull-back in prices any day now, however there appears to be a new force or player in the market preventing the drop. An article in the Financial Times this morning, "In oil mystery, traders resort to 'buy the build' mantra," discusses a market phenomenon that has occurred for the past few months:
Over the last five reports US commercial crude oil stocks rose by a total of 29.6m barrels. Each weekly rise surpassed expectations. While declining immediately after each report, the price of the West Texas Intermediate oil benchmark was trading higher 20 minutes later, often accompanied by a burst of volume. WTI prices also settled higher after four of the past five releases.This morning's EIA inventory report created a similar reaction. The report is published at 10:30 a.m. (EST) and showed another build of 9.6 million barrels, pushing US private crude stocks up to 518 million barrels. The reaction at 10:30 was a slight drop of 10 cents per barrel; however, 25 minutes later, the price was pushed up by 40 cents to $53.41(it is currently trading close to $53). As the FT article points out, these actions have many market traders wondering who is behind the push to keep prices afloat? From the piece, suggested suspects:
- Hedge Funds who hold record long positions need a burst up before they can exit without taking serious losses.
- OPEC who has cut production and needs higher prices to support budgetary needs of various countries.
- The possibility that the behavior has influenced other traders to follow the strategy.
The bottom line: there is no change in my 2017 forecast that prices will not fall below $30 nor will they rise above $70. In fact, I believe we can tighten that range to a minimum of $40 and maximum of $60, though the chances are better they will hit the low range (very soon!) rather than the high. While it's possible the price will drop below $40, any price drop of that magnitude will simply offer the bulls another opportunity to jump back in. The more interesting story is the long term outlook and alternative energy's impact on oil, but that's a story for another day...
Wednesday, February 1, 2017
The farmland bubble: sowing the seeds of pain and destruction....
My original thesis about commodity markets suggests, in addition to rising global demand, financialization of the markets allowed for a series of bubbles which propped up commodity prices much higher, and for much longer, than the global fundamentals would have dictated. This gave rise to a belief (in all commodity sectors--fuel, minerals, and food) that high prices were here for the foreseeable future. Huge sums of capital flowed in, fueling an expansion in all sectors. Most of my analysis has focused on oil, but I have mentioned mining and farming a few times. This post focuses on farming and the plight of farmers.
As I previously stated, the mining sectors went through a crunch, but with highly concentrated industries, the big firms can simply shut down facilities and weather the storm. In the farm sector, while there may be many producers on the sell side, there is a monopsony on the buy side for the major global food commodities. The likes of Cargill, ADM, Bunge, and Continental dominate US grain markets and own most of the storage and milling facilities. While farming is often touted as a "competitive market," the truth is farmers focused on the markets for global grains (corn, wheat, and soy) are captive sellers to the big grain merchants who dictate prices paid, much like Walmart dictates prices it will pay to its suppliers.
Regardless, farmers were swept up by the same whirlpool of speculation in commodity prices, and borrowed to expand operations. In addition, financial interests have literally "bought the farm" in a big way. Private equity funds were created to invest in farmland (cerespartners), pension funds added farmland to their portfolios (TIAA-CREF), and commodity ETFs allowed anyone to bet on almost any commodity just like betting on a company's stock price. The commodity price bubble beget a bubble in farmland values as well.
As I previously stated, the mining sectors went through a crunch, but with highly concentrated industries, the big firms can simply shut down facilities and weather the storm. In the farm sector, while there may be many producers on the sell side, there is a monopsony on the buy side for the major global food commodities. The likes of Cargill, ADM, Bunge, and Continental dominate US grain markets and own most of the storage and milling facilities. While farming is often touted as a "competitive market," the truth is farmers focused on the markets for global grains (corn, wheat, and soy) are captive sellers to the big grain merchants who dictate prices paid, much like Walmart dictates prices it will pay to its suppliers.
Regardless, farmers were swept up by the same whirlpool of speculation in commodity prices, and borrowed to expand operations. In addition, financial interests have literally "bought the farm" in a big way. Private equity funds were created to invest in farmland (cerespartners), pension funds added farmland to their portfolios (TIAA-CREF), and commodity ETFs allowed anyone to bet on almost any commodity just like betting on a company's stock price. The commodity price bubble beget a bubble in farmland values as well.
As the figure above shows, and as I mentioned in a previous post, farmland values have been falling for the past two years and farmers are hurting, not unlike the 1980s farm crisis. Since August 2012 the price of corn and wheat have fallen by 55%, and soybeans by 40%. One unfortunate indicator of how this collapsing bubble is hurting farmers was given in a recent article with the following title: Safety Watch: suicide rate among farmers at historic high. As mentioned in the article, suicide rates among male farmers is 50% higher than in 1982, the worst year of the last farm crisis.
For investors, the worst thing that can happen from the collapse of the food commodity price bubble is a loss on their portfolios; for farmers, the impact can be a matter of life and death....
Friday, January 13, 2017
Mainstream Crap-o-nomics and Milton Friedman
An article published on Bloomberg.com yesterday by Noah Smith (Milton Friedman's Cherished Theory is Laid to Rest) brought back memories of my early endeavor and research in economics. Smith discusses some recent research on consumption theory that "proves" Milton Friedman's theory was wrong. If these people who live in ivory towers simply read some of the real world heterodox research, it wouldn't have taken this long to figure it out!
One of the reasons I was attracted to what we call heterodox economics was because I found too many instances where traditional, or mainstream, economics seemed so unrealistic. My original area of research was on US wealth distribution and related theories used to explain household consumption and saving, the source of wealth. Mainstream theory was dominated by Milton Friedman's Permanent Income Hypothesis (PIH) and Franco Modigliani's (and Brumberg) Life-Cycle Hypothesis. Both of these theories argued that we base our consumption (and therefore savings) on our permanent or life-time income. That is, we are so smart that we base our consumption today on what our income will be over our lifetimes.
As a champion of limited government, Friedman's theory conveniently suggested that temporary government policies used to stimulate the economy during recessions will have no additional impact (the multiplier is zero) because we consumers will view the income as temporary, not permanent. According to Friedman, since the income generated from a stimulus would be viewed as temporary, most of it would be saved; and, therefore, there would be no impact from expansionary fiscal policy.
Having grown up in a middle class household and worked in the hotel industry for some six years, I couldn't think of anyone who acted this way. The people I hung out with, middle class and poor, spent most of their income--and it certainly didn't matter if it came from our weekly paychecks or winning $500 in the Super Bowl pool!
In studying heterodox economics I was introduced to alternative explanations. For example, Ed Wolff, probably the premier researcher on US wealth inequality, showed that the consumption-income relation depended on what income or wealth class one belonged to. Using data on US wealth distribution, he suggested four "class types": the richest 1% (who own 35-40% of all wealth), whose consumption was more closely tied to changes in the value of their wealth rather than changes in income; a professional class (doctors, lawyers, college professors, et al) who followed the PIH/Life-Cycle model because their income was more certain and stable; the working class who spent most of their income; and an underclass, dependent on government programs, who tended to spend even more than any income they earned or were provided.
The policy conclusion is straight-forward: if your aim is to provide a stimulus to the economy by raising consumption demand, then increased spending or tax cuts should be targeted at the bottom two classes (representing approximately the lower 80% of the income distribution) because they will spend almost all of the increase in income, whether or not you call it permanent or temporary. While this may be obvious to those who live in the real world, it's astonishing and frustrating that it has taken so long for the mainstream economics discipline to reject the PIH theory.
One of the lessons to learn from this is there are many in the economics discipline who claim to be objective but, in fact, have an ideological bias. Friedman's theory was constructed to support his personal/political bias against government intervention. In his original article he provided "supporting" evidence, but he had to fudge the data to get that support. He did so by assuming spending on consumer durables--refrigerators, microwave ovens, and color TVs--was not consumption, rather it was a form of savings. In other words, once he took out that big chunk of consumption spending (and counted it as savings), then--voila!--he "found statistical support" for his theory.
So, next time you are lucky enough to win a few hundred bucks from a football pool or lottery and you use it to buy a new iPad or Sous Vide, comfort yourself knowing you are not engaging in frivolous spending, rather you are padding your savings account...
One of the reasons I was attracted to what we call heterodox economics was because I found too many instances where traditional, or mainstream, economics seemed so unrealistic. My original area of research was on US wealth distribution and related theories used to explain household consumption and saving, the source of wealth. Mainstream theory was dominated by Milton Friedman's Permanent Income Hypothesis (PIH) and Franco Modigliani's (and Brumberg) Life-Cycle Hypothesis. Both of these theories argued that we base our consumption (and therefore savings) on our permanent or life-time income. That is, we are so smart that we base our consumption today on what our income will be over our lifetimes.
As a champion of limited government, Friedman's theory conveniently suggested that temporary government policies used to stimulate the economy during recessions will have no additional impact (the multiplier is zero) because we consumers will view the income as temporary, not permanent. According to Friedman, since the income generated from a stimulus would be viewed as temporary, most of it would be saved; and, therefore, there would be no impact from expansionary fiscal policy.
Having grown up in a middle class household and worked in the hotel industry for some six years, I couldn't think of anyone who acted this way. The people I hung out with, middle class and poor, spent most of their income--and it certainly didn't matter if it came from our weekly paychecks or winning $500 in the Super Bowl pool!
In studying heterodox economics I was introduced to alternative explanations. For example, Ed Wolff, probably the premier researcher on US wealth inequality, showed that the consumption-income relation depended on what income or wealth class one belonged to. Using data on US wealth distribution, he suggested four "class types": the richest 1% (who own 35-40% of all wealth), whose consumption was more closely tied to changes in the value of their wealth rather than changes in income; a professional class (doctors, lawyers, college professors, et al) who followed the PIH/Life-Cycle model because their income was more certain and stable; the working class who spent most of their income; and an underclass, dependent on government programs, who tended to spend even more than any income they earned or were provided.
The policy conclusion is straight-forward: if your aim is to provide a stimulus to the economy by raising consumption demand, then increased spending or tax cuts should be targeted at the bottom two classes (representing approximately the lower 80% of the income distribution) because they will spend almost all of the increase in income, whether or not you call it permanent or temporary. While this may be obvious to those who live in the real world, it's astonishing and frustrating that it has taken so long for the mainstream economics discipline to reject the PIH theory.
One of the lessons to learn from this is there are many in the economics discipline who claim to be objective but, in fact, have an ideological bias. Friedman's theory was constructed to support his personal/political bias against government intervention. In his original article he provided "supporting" evidence, but he had to fudge the data to get that support. He did so by assuming spending on consumer durables--refrigerators, microwave ovens, and color TVs--was not consumption, rather it was a form of savings. In other words, once he took out that big chunk of consumption spending (and counted it as savings), then--voila!--he "found statistical support" for his theory.
So, next time you are lucky enough to win a few hundred bucks from a football pool or lottery and you use it to buy a new iPad or Sous Vide, comfort yourself knowing you are not engaging in frivolous spending, rather you are padding your savings account...
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