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Seems the liquidation may be ending, but just guessing.

Vitol Reclassified by CFTC as `Non-Commercial’ Trader, WSJ Says

by Alexander Kwiatkowski

(Bloomberg) Vitol Group was reclassified by the Commodity Futures Trading Commission as a “non-commercial” trader, the Wall Street Journal reported, citing people it didn’t identify.

The U.S. regulator changed the status of “one of the largest traders” in July, without identifying the company, the newspaper said. People familiar with the matter have now named the trader as Vitol, according to the Journal.

The change meant that bets by non-commercial traders, or speculators, represented half or more of all outstanding crude oil futures contracts on the New York Mercantile Exchange, the newspaper said.

Vitol hasn’t been contacted by the CFTC or by Nymex with regard to its trading status, a Switzerland-based company official said today by phone, declining to be identified. Vitol remains classified as a commercial trader, the official said.

Vitol “is not in the business of taking large positions speculating on the rise or fall of market prices,” the company said in a May statement on its Web site.

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Saudi Oil Output

The Saudi production increase tells me world demand was up, even at the higher prices.

Yes, US demand was down 800,000 bpd vs last year, and yes other world demand may fall.

Only when demand for Saudi output falls sufficiently will they be dislodged from being swing producer and price setter.

That is not to say they won’t continue to disguise their role as best they can, and allow volatility as various world inventory positions (cash and futures) are being liquidated, as is probably the case currently.

Saudi output is also getting very near capacity of maybe 11 million bpd.

If demand goes above that they lose control of price on the upside.

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Hope they don’t dig it up and take it home!

Lost Sovereignity

Oil-rich Fund Eyeing Foreclosed US Homes

By Teri Buhl

There’s a new land grab starting in America.

Foreign money, which up to now has focused its attention on investing in iconic commercial real estate - like Barneys New York and the Chrysler Building - is now moving to scoop up tens of thousands of discounted foreclosed homes across the country.

One sovereign fund, said to have earmarked $29 billion to purchase foreclosed residential real estate, recently hired a West Coast mortgage broker and is starting to search for bargains, The Post has learned.

The search, which is being carried out, in part, by Field Check Group mortgage consultant Mark Hanson, who was retained by the broker, Steve Iversen, is concentrating on single- and multi-family REO (real estate owned) homes, or homes that have already been taken over by the mortgagee.

Neither Iversen nor Hanson would disclose the name of the client, but sources told The Post it’s a sovereign fund.

The unidentified fund joins individual US investors, hedge funds and Wall Street banks in kicking the tires of REO homes, which have fallen in value so much that they are now tempting investments.

A sovereign fund would have two distinct advantages over other investors - the depressed value of the US dollar makes the homes a bargain, and sovereign funds have deeper pockets.

The sovereign fund of Abu Dhabi, for example, has a reported $875 billion in assets, while Norway has $391 billion, Singapore has $303 billion and Kuwait has $264 billion in their sovereign funds, which are funded by proceeds from oil sales.

The Abu Dhabi Investment Authority is expected to announce next month what type of US distressed assets they will be investing in and real estate is at the top of the list, according to a report in Financial Times last week.

ADIA did not respond to an e-mail question about REO investments.

So far, prices on bulk sales of REO properties vary based on location and are selling from 60 cents to 80 cents on the dollar. Hanson started out offering 40 cents on the dollar for about $2.5 billion worth of California properties owned by IndyMac and Washington Mutual but was turned down. The banks refused to comment.

Hanson is now willing to pay 50 cents to 60 cents on the dollar for a collection of California REOs worth at least $500 million.

In fact, this week Hanson’s team negotiated a $2 billion package mixed with homes across the country for 31 cents on the dollar. While progress seems slow, Hanson reminds us this is only a nine-month old industry.

Some market experts think such deeply discounted REOs, like the deal Hanson just closed, are more fiction than fact.

“The size and discount of that type of deal isn’t the norm yet,” said Robert Pardes, with Recourse Recovery Management Services, a provider of mortgage advisory services.

“The critical mass of bulk REO is in well-capitalized institutions that don’t need to sell yet in bulk at a deep discount because they are better off not taking substantial hits to the capital just to get the assets off their books,”

This may change, should the market become more crowded with bank failures and distressed institutions, he said.

Enoch Lawrence, senior vice president of CB Richard Ellis, says “This type of bulk buy would make an impact on the market. They are in a unique position because they have a long time horizon to invest and a cheap cost of capital. It’s actually a perfect time for them to acquire these REO assets.”

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My current assessment is that the crude sell-off has caused the USD’s strength.

Lower crude prices make the USD ‘harder to get’ as oil producers get fewer USD for the same volume of crude (and product) exports to the US.

Likewise, this also brings down the US trade gap which is about half directly related to oil prices, so nonresidents have fewer USD to meet their USD financial asset savings desires.

Crude has been brought down by technical selling, which also brought with it technical buying of USD as trend following trading positions were unwound.

The crude market has gone into contango as would be expected with a futures sell off and tight inventories.

Tighter US credit conditions made the USD ‘harder to get’ while increased deficit spending makes the USD ‘easier to get’ resulting in GDP muddling through at modest rates of growth.

The Russian invasion probably helped the USD today.

Eurozone credit quality erosion with the onset of intensified economic weakness may be triggering an exit from the euro. The lowest risk euro financial assets are the national governments which carry similar risk to US States, and are vulnerable in a slowdown that forces increasing national budget deficits that are already in what looks like ‘ponzi’ for credit sensitive agents.

Eurozone bank deposit insurance is not credible and therefore the payment system itself vulnerable to an economic slowdown.

With the Russian army on the move, public and private portfolios may not want to hold the debt of the eurozone national governments that they accumulated when diversifying reserves from the USD.

I expect the Saudis to resume hiking crude prices once the selling wave has passed. I don’t think there has been an increase in net supply sufficient to dislodge them from acting as swing producer. And I also expect them to continue to spend their elevated revenues on real goods and services to keep the west muddling through at positive but sub-trend growth.

And the Russian invasion will linger on and help support the USD as a safe haven in the near-term

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Comments about this post from email:

MIKE:

Again, its very likely you have permanently damaged demand at prices that are still over 100-

It’s possible the growth of crude consumption has slowed, but I still think it’s doubtful if consumption had declined enough to dislodge Saudi price control. July numbers still not out yet.

in addition asset alligators around the world are actually or synthetically short the dollar after 8 years of dollar selling…

Agreed. The question is the balance of the technicals, and if the CBs no longer buying USD has been absorbed by others.

For now, yes, short covering has mopped up the extra USD sloshing around from our trade gap, but it’s still maybe $50 billion per month that has to get placed. Not impossible for non-government entities to take it but it’s a tall order.

The Russian invasion helps a lot as well. That could be a much more important force than markets realize. Looks like a move to further control world energy supplies. A middle-eastern nation could be on the bear’s menu. I doubt the US could do anything about a Russian takeover of another neighbor. Certainly not go to war with Russia. and they know it.

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(an email exchange)

>   
>   On Thu, Aug 7, 2008 at 7:15 AM, Scott wrote:
>   
>   crude moves further in backwardation.
>   

Right, indicating futures buying subsiding and inventories not above desired levels for commerce.

>   
>   CL vs brent now 160 over vs 120 under 2 weeks ago!
>   

Also indicating any excess inventory is gone, thanks!

Might be near the end of the second Master’s sell off.

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(an email exchange)

>   
>   On Wed, Aug 6, 2008 at 4:45 PM, Craig wrote:
>   
>   It seems that the ‘right’ price for them to set oil at is not
>   necessarily the highest price possible.
>   

All the 911 passports were Saudi; so, they might have other agendas.

>   
>   If I were them it would seem like the best policy to maximize
>   the total value of their oil holdings over the life of those
>   holdings. By cranking the price up ‘too high’, they incent
>   substitution and potentially kill their sales in the long term.
>   

Right, classic monopoly analysis.

>   It would seem their goal would be to keep the price as high
>   as they could w/o setting off a chain of
>   substitution/invention/philosophy which would move the world
>   meaningfully away from oil (or towards increased oil exploration
>   or towards invading them). There is also the little matter of
>   how much money do they really need (a somewhat silly question
>   but this situation does create an embarrassment of riches/market
>   dislocations in excess of where a rational accumulation might lie).
>   

Yes, understood.

>   
>   It looks to me that on the highs they got everybody’s attention.
>   There may still be political responses towards
>   innovation/substitution/conservation at these levels, but it seems
>   likely that at or above the old highs, US folks will be making their
>   next car a hybrid, beating their government to get prices down
>   (including pluggables/nuclear – a long term threat to Saudi
>   dominance) and the like. Then there’s China’s slowdown and food
>   riots. I’d have thought quietly bleeding the world would be better
>   business than actually setting it on fire.
>   

Yes, but again, it’s their ‘political choice.’ There is no ‘market price’.

Also, with only 1.5 million bdp in total excess capacity, it might be too close to the line for them, and they might want to get prices high enough to build their excess capacity by a million or two bpd.

Otherwise they risk losing control of price on the upside, as happened a couple of years back when output briefly hit 10.5 million bpd when the funds were buying intensely enough to cause builds of physical inventory and a large contango as storage went to a premium.

>   
>   Of course, even if this is all true, they may be looking at it
>   differently.
>   

Worst case for us is they understand that they can hike all they want if they spend the extra revenues on imports of real goods and services. This keeps foreign GDPs muddling through in positive territory as they exact ever higher real terms of trade and they increasingly prosper at our expense.

And out leaders think more exports and less consumption is a good thing and are encouraging more of same.

Almost seems from the data this is exactly what they are up to?

Think they read my blog???

:)

warren

>   
>   Craig
>   

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Russel asks:

Any reason why the Saudi’s are allowing the price of oil to slide?

Just a guess. The futures liquidations were large enough such that holding spot prices up and letting futures free fall would have made it obvious the Saudis are price setter.

There also could be some liquidation of physical inventory going on in which case they would have to let inventories fall before resuming control of prices, or else actually buy in the spot markets which is out of the question of course.

It’s like if some pension fund had a hoard of NYC subway tokens and decided to sell them ‘at the market’. The price would go down from the current $2 price until that selling pressure abated. Then the price would go back to whatever NYC was charging.

So most likely they just let this inventory liquidation run its course, and then work prices higher again.

Much like happened in Aug 2006 with the massive Goldman liquidation and again in a smaller way at year end back then.

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(an email exchange)

>   
>   
>   On Wed, Aug 6, 2008 at 12:25 AM, Prof. P. Arestis wrote:
>   
>   Dear Warren,
>   
>   Just received the piece below. The situation over here is getting
>   worse but pretty much as expected.
>   
>   Recession signalled by key indicators of British economy
>   
>   
>   Best wishes, Philip
>   

Dear Philip,

Yes, seems tight fiscal has finally taken its toll and is now reversing the ugly way - falling revenues and rising transfer payments.

Without support from government deficit spending, consumer debt increases sufficient to support modest growth are unsustainable.

And with a foreign monopolist setting crude oil prices ‘inflation’ will persist until there is a large enough supply response,

It’s the BoE’s choice which to respond to, though ironically changing interest rates is for the most part ceremonial.

All the best,
Warren

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(an email)

>   
>   W
>   you can tell everyone it is vitol but don’t give the source.
>   looks like traditional speculation; not the masters index speculation.
>   
>   

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(An email exchange)

>   (3) The reclassified trader is quite a special one:
>   
>      (a) The reclassified trader has interests in only a few
>   commodities (I have highlighted the reclassified ones in the
>   chart).
>   
>      (b) The trader is heavily focused on crude oil. The
>   reclassified positions include 330 million bbl of WTI contracts,
>   45 million bbl WTI calendar spread options, 20 million bbl of
>   crude oil calendar swap options, 15 million bbl of European style
>   crude oil options and about 15 million bbl of financial WTI crude
>   oil futures and options.
>   
>      (c) In some of these contracts, the trader’s reclassified
>   positions are enormous. For example, in the WTI contract, the
>   traders 330 million bbl of reclassified positions amounted to
>   about 11% of all the open interest in this contract. In the WTI
>   calendar spread options, the trader’s 45 million bbl position was
>   equivalent to about 35% of all open interest. So the trader was
>   a very big participant in these markets.
>   
>      (d) The trader has a few other reclassified interests, mostly
>   in natural gas, with little or no reclassified interest in electricity
>   derivatives or petroleum products such as RBOB gasoline. But
>   the reclassified positions in these markets are tiny in relation to
>   open interest and the trader does not appear to have been a
>   significant participant, at least from its reclassified positions.
>   
>   The CFTC has not revealed the identity of the reclassified trader
>   – which remains confidential. But given the scale of positions
>   which the CFTC has reclassified, there are only a few types of
>   institutions which could be running this type of book: oil
>   companies, refiners, distributors, merchants, banks, index funds
>   and swap dealers.
>   
>   
>   And the CFTC staff obviously examined the numbers and concluded
>   that “commercial hedging or risk-management activities did not
>   constitute a significant part of the overall trading activity”. In other
>   words, the CFTC concluded that this was all or almost all
>   speculative.
>   
>   Now we don’t have full information about the revisions going all
>   the way back to Jul 2007 for all the contracts. But we do have
>   information about the basic WTI position for this trader. Back in
>   Jul 2007, this trader had a position of about 180 million bbl that
>   has been reclassified. But by Jul 2008, this traders’ reclassified
>   position had grown to 330 million bbl. This traders’ positions
>   have been growing faster than the market as a whole so its
>   share of total open interest in the WTI contract has risen from
>   9.1% in Jul 2007 to a massive 11.5% in Jul 2008.
>   
>   The reclassification is so large it affects understanding of the
>   whole market. Under the old classification, non-commercial
>   traders accounted for about 38% of the total open interest in
>   the WTI contract. But now that one large trader has been
>   reclassified, non-commercial traders account for 49% of the
>   market — half rather than one third.
>   
>   Assuming that one individual trader did increase their already
>   large 180 million bbl position in the WTI spreads in Jul 2007 to as
>   much as 330 million bbl in Jul 2008, and that the additional
>   positions were not hedging an underlying exposure, it seems
>   impossible that the massive accumulation would not have
>   disturbed the market at least somewhat.
>   
>   It is interesting, though perhaps coincidental, to note that
>   crude oil prices peaked around Jul 4-14, a few days before the
>   CFTC announced its reclassification on Jul 18.
>   
>   These positions are so large that they clearly exceed the
>   NYMEX position limits by a substantial margin (no more than
>   20,000 contracts in all months; no more than 10,000 contracts
>   in any one month; and no more than 3,000 contracts in the last
>   three days of trading in the spot month). Presumably, the
>   holder of these positions has received a waiver from NYMEX and
>   the CFTC on the basis that it is hedging under the normal
>   hedging exemptions. But if the CFTC no longer believes that the
>   holder of these positions is using them for “hedging or risk
>   managing” to any significant extent, will they still be allowed to
>   qualify for the waiver (a question I am not qualified to answer).
>   
>   

thanks,

any idea who holds that large position?

A liquidation of this size is more than sufficient to drive down futures prices and even cause a liquidation of some portion of spot inventories.

The Saudis could keep prices high as this happens but that would make it obvious they are setting prices as swing producer.

So instead, as in Aug 06 during the Goldman liquidation, they instead lower their prices as futures prices fall, but with a small lag, until the liquidation is over.

They then go back to setting/hiking prices

Warren

>   
>   
>   The CFTC has published revised Commitment of Traders data
>   back to 3 Jul 2007 to take account of the reclassification of one
>   or more positions from the commercial to the non-commercial
>   category.
>   
>   CFTC has published both the original and the revised data for a
>   single point in time (15 Jul 2008) to help users understand the
>   impact of the change. It is has NOT published identical
>   historical data sets of both original and revised data. However,
>   I still have the complete data as originally reported — and of
>   course the revised numbers from the CFTC website. Comparing
>   the two series gives a fascinating insight into what the CFTC
>   has done (this is a little sneaky because I don’t think the CFTC
>   staff meant to identify the position of an individual trader quite
>   so publicly).
>   
>   (1) The revisions over the entire period from Jul 2007 onwards
>   affect just one very large participant in the crude oil market
>   each week (and presumably the same participant over time).
>   
>   (2) In each case, the positions seem to have been almost
>   entirely in the time spread. A large number of positions that
>   were originally reported as separate “long” and “short”
>   commercial positions are now being reported as a combined
>   non-commercial “spread” position with a small balance reported
>   as an non-commercial short position each week.
>   
>   (3) The attached chart gives some indication of the impact of
>   the reclassification back through Jul 2007 (as far back as the
>   CFTC staff have so far been able to recalculate the data). The
>   scale of the reclassified position is very large (see chart) and it
>   has been growing over time. The position which CFTC has
>   reclassified has grown from around 190,000 contracts in Jul
>   2007 to 320,000 contracts in Jul 2008. By the middle of Jul this
>   year, this one massive trader held spread positions equivalent to
>   about 25% of the entire market for non-commercial spread>   positions.
>   
>   (4) Interestingly, we can also look at the residuals — ie the
>   part of the commercial long-short position that was not
>   reclassified as a commercial spread position. The residual has
>   varied over time between about 1,000 contracts (1 million bbl)
>   and 11,000 contracts (11 million bbl) and every week it was a
>   residual short position rather than a long one. None of the
>   CFTC reclassifications affect the non-commercial long side of
>   the market at all. It doesn’t necessarily imply that this trader
>   was always short overall (they might have had offsetting long
>   positions somewhere else). But interestingly, those short
>   positions have been gradually cut over time (see chart)
>   although as of the middle of last month (15 Jul 2007) the
>   reclassified trader was still net short almost 4,000 lots (4 million
>   bbl).
>   
>   

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>   
>   On 8/3/08, Craig wrote:
>   
>   Ok. And the irony is as prices fall, demand increases again.
>   Until consuming governments get their head around that fact
>   and put some kind of floor under crude prices to incent
>   substitution (which may be beyond their thinking and/or impossible
>   politically), it seems like crude prices are gonna play rope-a-dope
>   with consumers.
>   
>   
>   Craig
>   
>   

Crude will be rationed as is everything else (scarcity, etc.).

The question is how. Ration by price or by other things?

Rationing by price is the most pervasive and means the wealthy (by definition) outbid the less wealthy for the available supply.

Make you wonder why the Democrats support higher prices, as that means they support their supporters going without while the wealthy drive any size SUV they want. Much like wondering why Obama supports Bernanke after Bernanke explained to Congress how he’s keeping inflation down by keeping a lid on inflation expectations after explaining the main component of inflation expectations is workers demanding higher wages, meaning Obama, Kennedy, and the rest of the left is praising Bernanke for doing a good job of suppressing wages.

Non-price rationing is less common but not unfamiliar, such as mandating cars get an average of 27 mpg, minimum efficiency standards for refrigerators, windows, etc. This takes an element of rationing by price away and results in the wealthy consuming less and leaving some for the less wealthy to consume a bit.

So seems to me the logical path for the Democrats would be something like my 30 mph speed limit for private transportation, which is ‘progressive’ and also drives the move towards public transportation with non price incentives as previously outlined. But there hasn’t even been any discussion of a progressive policy response. All seem highly regressive to me.

So I expect the world’s new and growing class of wealthy will continue to outbid our least wealthy for fuel and other resources.

Also, there may be limits to how high we want world consumption/burning of fuels for all the various ‘green’ reasons.

That would mean drilling and other production increases are out, as would be increased use of coal via the electric grid for electric cars.

And, again, it would be the world’s wealthy outbidding the less wealthy for consumption of the allowable annual fuel burn, as somehow allocation by price continues to rule.

Most paths keep coming down to the continuing combination of weakness and higher prices.

Warren

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(comments from my brother, Seth, who was cc’d)

>   
>   I think democrats have lots of business and profits waiting
>   in govt subsidies for wind and solar. If oil prices fall that goes
>   away for now and they can’t produce on the subsidies for
>   them-cynical view but probably true
>   
>   There are also a lot of wealthy democrats and they want their
>   votes. Poor people all vote for democrats anyway-even with
>   declining lifestyles they are not going to McCain. So I think
>   Obama is pandering to the wealthy-it might be who he is-no
>   one really knows.
>   
>   With all of their green talk I have not seen any of them reduce
>   air travel, suv caravans or turn off the a/c in the capital. Just a
>   way to get votes and sound concerned. I saw a tv program
>   about how the chinese olympic swimming building is a green
>   sustainable building. It is 7 acres, pools, 25,000 people.
>   they finally said it uses about 25% less energy than a comparable
>   building would have. That is not green or sustainable, especially
>   since the building was not needed in the first place. I think “green”
>   is about making money, not the environment.
>   
>   
>   Seth
>   

I just can’t allow myself to be that cynical like you new yorkers!

:)

Warren

>   
>   
>   I think I am cynical usually, but this green thing drives me nuts
>   it started 30 years ago but is now all about money
>   when I see some lights turned off in Times Square (even in the
>   daytime) or the 5 huge spot lights on the CBS building lighting up
>   Katie Couric’s 50′ x 30′ poster which are on 24 hours a day turned
>   off, then I will believe it is about resources and not money.
>   there is a long way to go.
>   they advertise expensive green buildings here-I am not kidding-the
>   big thing is thermostats with timers on them and bamboo floors-didn’t
>   we have those 30 years ago??
>   
>   they talked about the oscar ceremony being green this year-the
>   celebrities were all giddy about it-what they did was use red
>   carpet made of recycled fibers????? what is that?
>   absolutely nothing-
>   anyway, time to calm down. too much excitement here
>   seth -
>   
>   

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It was deregulated back in the 1970s, which brought out vast supplies causing utilities to substitute gas for oil and eventually break OPEC.

I don’t see that kind of supply response lurking today.

The Natural Gas Policy Act of 1978

In November of 1978, at the peak of the natural gas supply shortages, Congress enacted legislation known as the Natural Gas Policy Act (NGPA), as part of broader legislation known as the National Energy Act (NEA). Realizing that those price controls that had been put in place to protect consumers from potential monopoly pricing had now come full circle to hurt consumers in the form of natural gas shortages, the federal government sought through the NGPA to revise the federal regulation of the sale of natural gas. Essentially, this act had three main goals:

• Creating a single national natural gas market
• Equalizing supply with demand
• Allowing market forces to establish the wellhead price of natural gas

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Looks like it was a likely substantial contributor to the last run up and the subsequent quick sell off. ‘Demand destruction’ isn’t yet anywhere near enough to dislodge the Saudis from setting price as swing producer:

REFILE-SemGroup a small factor in oil price drop -experts

by Matthew Robinson and Robert Campbell

(Reuters) SemGroup’s collapse from the 12th biggest U.S. private firm into bankruptcy was only a small factor in the $23 per barrel drop from oil’s record high over the past two weeks, energy experts said on Thursday.

The Tulsa-based company declared bankruptcy this week after racking up $2.4 billion in losses shorting crude oil futures on the New York Mercantile Exchange, including a $290 million loss owed to SemGroup by a trading firm affiliated with former Chief Executive and co-founder Thomas Kivisto.

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Just saw that the house just rejected this.

Looks like it was one more reason for technical weakness in crude, along with the vote to limit speculation and the oil storage company’s futures and cash market issues and bankruptcy.

White House threatens veto on bill to sell govt oil

by Tabassum Zakaria

(Reuters) The White House on Thursday threatened to veto legislation that would require the government to sell 10 percent of the oil in the nation’s emergency petroleum stockpile.

The House of Representatives was expected to vote on the bill later on Thursday. Democrats hope the legislation will lower oil prices by putting on the market more of the Strategic Petroleum Reserve’s light, sweet crude that is sought by refiners.

“Drawing down our emergency oil reserve in the absence of a severe energy disruption is counter to the purpose of the SPR, and offers the nation a quick fix instead of much needed long-term, responsible energy solutions,” the White House said in a statement.

The bill would require the government to sell 10 percent of the emergency stockpile’s oil, or 70 million barrels, in the open market. About 40 percent of the stockpile’s oil is light sweet crude.

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Lehman cuts oil demand forecast

by Richard Valdmanis

(Reuters) Investment bank Lehman Brothers (LEH.N: Quote, Profile, Research, Stock Buzz) said Wednesday it slashed its forecast for 2008 world oil demand growth due to a steeper-than-expected slowdown in energy consumption in the United States and other OECD countries.

Lehman added it believes the oil market is “approaching a tipping point” with prices expected to decline to an average of $90 a barrel in the first quarter of 2009.

“We now forecast annual oil demand for 2008 at 86.3 million barrels per day, a growth of 790,000 bpd from 2007. The growth has been revised down from projections of 1.5 million bpd in December,” Lehman said in a research note titled ‘Demand Demolition’.

If true, and non-Saudi supply remains about flat, Saudi production might fall to about 9 million bpd and the price would still remain wherever the Saudis set it.

There has been some talk that the Saudis may have agreed to lower prices after the last round of meetings with US officials. Could be, but with their output running within a million or two bpd of their total capacity, it seems doubtful they would do anything to increase demand before they have the excess capacity to meet it. But there could be other factors (including the US 7th fleet and concerns about a united Iran/Iraq threatening them) that might be influencing their decision. Only time and prices will tell. Should be more clear in a week or so.

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Published letter to the editor in FT.

Expect public-sector deficits and oil prices to go on rising

by Prof Philip Arestis, Dr John McCombie and Mr Warren Mosler.

Sir, Public-sector deficits and crude oil prices will probably both continue rising. Chris Giles’ reports, “Treasury to reform Brown’s fiscal rules” and “Treasury sees storm clouds gathering” (July 18), recognise the inevitability of growing deficits due to economic weakness while also implying public-sector deficits are per se a “bad thing”.

What the articles fail to appreciate are three dimensions to the argument: the first is that public-sector deficits do not present a solvency issue, only an “inflation” issue. Second, public-sector deficits equal total non-government (domestic and foreign) savings of sterling financial assets and are the only source of non-government accumulation of sterling net financial assets. Third, public-sector deficits provide the net financial equity to the non-government sector that supports the private-sector credit structure.

It is the case that the public-sector deficit will increase in one of two ways. The “nice” way would be pro-actively with sufficient tax cuts or spending increases (depending on one’s politics) that support demand at desired levels. The “ugly” way is from a slowing of demand that reduces tax revenues and increases transfer payments. If, instead, the government tries to suppress the current deficit with any combination of tax increases or spending cuts, the resulting accelerated slowdown of the economy will then increase the deficit the “ugly” way.

In any case, the current “inflation” is the result of Saudi Arabia acting as swing producer as it sets the oil price at ever-higher levels and then supplies all the crude demanded at that price. Our institutional structure then passes these prices through the entire economy over time, and there is nothing interest rates or fiscal policy can do to change these dynamics.

The ability to set crude prices can only be broken by a sufficiently large supply response, such as in the early 1980s when net supplies increased by more than 15m barrels per day, helped considerably by the US deregulating natural gas production, which allowed substitution away from crude oil products.

In sum, the deficit will go up either the nice way or the ugly way, as it always does when markets work to grant the private sector the desired net financial assets, which can come only from government deficit spending. “Inflation” will continue higher as long as the Saudis remain price-setter and continue to post ever-higher prices to their refiners.

Philip Arestis,
University Director of Research,
Cambridge Centre for Economic and Public Policy

John McCombie,
Director,
Cambridge Centre for Economic and Public Policy

Warren Mosler,
Senior Associate Fellow,
Cambridge Centre for Economic and Public Policy,
University of Cambridge, UK

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(an email exchange)

>   
>   On Sun, Jul 20, 2008 at 10:46 PM, Russell wrote:
>   
>   Brad Setser, at Follow the Money, presents a couple of graphs on changes in
>   oil export revenue: The Oil Shock of 2008.
>   
>   The following graph shows the Year-over-year change in oil exports as a
>   percent of world GDP (and in billions of dollars).
>   
>   

>   
>   Year-over-year change in oil exports
>   
>   This calculation assumes that the oil exporters will export about 45 million
>   barrels a day of oil.
>   
>   Each $5 increase in the average price of oil increases the oil exporters’
>   revenues by about $80 billion, so if oil ends up averaging $125 a barrel this year
>   rather than $120 a barrel, the increase in the oil exporters revenues would be
>   close to a trillion dollars.
>   
>   Assuming oil prices average $120 per barrel for 2008, the increase in 2008 will
>   be similar to the oil shocks of the ’70s.
>   
>   

Right, the notion that oil is a smaller % of GDP and therefore not as inflationary was flawed to begin with and now moot.

Two more thoughts for today:

First, the second Mike Masters sell-off may have run its course. The first was after his testimony in regard to passive commodity strategies which I agree probably serve no public purpose whatsoever. The second was last week as markets expect Congress to act to curb speculation this week, which they might. Crude isn’t a competitive market (Saudi’s are the swing producer) so prices won’t be altered apart from knee jerk reactions, but competitive markets such as gold can see lower relative prices if the major funds back off their passive commodity strategies.

Second, just saw a headline on Bloomberg that inflation is starting to hurt the value of some currencies.

Third, the Stern statement will continue to weigh on interest rate expectations up to the Aug 9 meeting.

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Seems like a sale ahead of possible Congressional action to limit ’speculation’.

Not sure how big the dip might be, but yet another buying op as the choice remains - pay the Saudis their asking price or shut the lights off.

The price only goes down if the Saudis cut price, or if there is a supply response of more than 5 million bpd that dislodges them from being swing producer.

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This is the deflation argument.
(See below)

Never seen a split quite like this with calls for both accelerating inflation and outright deflation.

Which will it be?

My guess is inflation for the US as our friendly external monopolist continues to squeeze us with ever higher crude prices.

The political process is ensuring they will be passed through as sufficient government ‘check writing’ (net government spending) is sustained to support real growth.

(Bear Stearns, housing agencies, fiscal rebates, fiscal housing package, etc.)

And the dollar continues to adjust to the sudden, politically induced shift in foreign desires to accumulate USD financial and domestic assets.

Various private Q2 GDP estimates are now up to 2% - more than sufficient to support demand and pass through the higher headline prices.

Government is never revenue constrained regarding spending and/or lending.

The limit to government check writing is the political tolerance for inflation, which grows with economic weakness.

This inflation looks to me to be far worse than the 1970s.

Back then, we were able to muster a 15 million bpd positive supply response in crude that broke OPEC by deregulating natural gas.

We don’t have that card to play this time around.

From HFE:

July 14, 2008

WORLDWIDE:

• Global Disinflation Is Going To Be The Next Big Move For The Bond Markets - Weinberg
• Commodity And Oil Prices Cannot Rise Forever… There Is No Inflation - Weinberg
• Bonds To Benefit - Weinberg

UNITED STATES:

• STOP PRESS: Treasury, Fed To Make Credit Available To GSEs; Treasury To Seek Authority To Buy Their Stocks - Shepherdson
• This Is A Lifeboat, Not a Bailout; Aim Is To Prevent Uncontained Failure - Shepherdson

CANADA:

• We Cannot Rule Out A Rate Cut Tomorrow - Weinberg

EURO ZONE:

• Core CPI Shows No Medium-Term Inflation Risks - Weinberg
• Production Data Will Be Really Soft - Weinberg

GERMANY:

• Core CPI Still Under 2% And Steady, ZEW At New Record Low - Weinberg
• … Tighter Money Is Unhelpful Here - Weinberg

UNITED KINGDOM:

• Starting Point For August QIR Forecasts To Emerge In This Week’s
• Reports: Most Inputs To The Forecasts Will Be Stronger - Weinberg

FRANCE:

• Not-Too-Scary Inflation Report Exported: Core Prices Are Steady - Weinberg

JAPAN:

• Three Soft Report This Week Will Keep Investors Moving Out Of Stocks, Into Bonds - Weinberg

AUSTRALIA:

• CPI Report For Q2, Due Next Week, May Rekindle Inflation Worries - Weinberg

CHINA:

• Exploding Foreign Borrowing Diminishes Foreign Currency Reserve Adequacy; Trends Suggest Further Decay - Weinberg
• GDP Will Be Below Recent Trend In This Week’s Report - Weinberg

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Saudi Oil Production

Demand increasing even as they hike prices.

Good luck to us!

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