£75

£75 is how much it cost to fill up our C5 a few days ago; with diesel at 1.29 per litre, you could work out our tank size, if you were bored.

Current fuel prices are clearly causing some pain, or at least some squealing, all around the world (as Maribo notes, “we are approaching the elastic part of the gas price equation”). It would be nice to think that this will lead to a reduction in consumption, although the hike in prices is caused by increased consumption so the rise is more likely to just redistribute the consumption. And it will lead to more coal-to-oil plans, like this by the US airforce (thanks to G). As they say: “We’re going to be burning fossil fuels for a long time, and there’s three times as much coal in the ground as there are oil reserves,” said Air Force Assistant Secretary William Anderson. “Guess what? We’re going to burn coal.” Of course there is another sie, ziv Tempering that vision, analysts say, is the astronomical cost of coal-to-liquids plants. Their high price tag, up to $5 billion apiece, would be hard to justify if oil prices were to drop. In addition, coal has drawn wide opposition on Capitol Hill, where some leading lawmakers reject claims it can be transformed into a clean fuel. Without emissions controls, experts say coal-to-liquids plants could churn out double the greenhouse gases as oil. “We don’t want new sources of energy that are going to make the greenhouse gas problem even worse,” House Oversight Committee Chairman Henry Waxman, D-Calif., said in a recent interview. I wonder who will win? Of course if current oil prices are a bubble and the price falls, coal becomes uneconomic again. According to that article, its even uneconomic at $60 bbl.

Maybe this will be enough to make CO2 air scrubbing attractive: the grauniad has another article on another proposal (thanks L). But details on coast and efficiency are lacking, and/or secret.

Comments

  1. #1 Bob O'H
    2008/06/01

    A Sinclair C5 would be a cheaper alternative.

  2. #2 Nick Barnes
    2008/06/01

    It’s not a bubble. If it was a bubble the speculators would have to be hoarding oil to keep the price high. That’s how commodity bubbles work. But there’s no hoarding going on.
    http://www.nytimes.com/2008/05/12/opinion/12krugman.html

  3. #3 mugwump
    2008/06/01

    Nick Barnes, don’t believe everything Krugman says. As with most things, he is wrong on this one.

    Krugman’s analysis is based on free-market assumptions, specifically the assumption that any producer can enter the market and offer oil and hence drive the price back to equilibrium. But most oil production is controlled by OPEC – a cartel – whose response to rising prices is to do what is in the best interests of the cartel, not any individual producer.

    That doesn’t prove the current price is a bubble, but nor does Krugman establish that it is not.

  4. #4 Andrew Dodds
    2008/06/02

    Beat you – last fillup of my 406 (diesel) cost £85..

    I did think there was a large speculative element, but just have a look at last weeks’ US stock report..

    http://tonto.eia.doe.gov/oog/info/twip/twip.asp

    Showing some nasty-looking stock drops. If that does not turn around in the next few weeks, things could be interesting.

  5. #5 sent
    2008/06/02

    You should be happy that diesel is so cheap in England. In Germany we have to pay more than 1,5 € per litre diesel, which is about 1,9 £/litre.

    [Drive over here and buy some :-))) -W]

  6. #6 Nick Barnes
    2008/06/02

    mugwump: your ad hominem attack on Krugman doesn’t interest me. Krugman: professor of economics at Princeton, author of the standard textbook on international economics, originator of much of modern trade theory, and deadly accurate critic of Bush/neocon voodoonomics. mugwump: nada.

    Of course I don’t believe everything Krugman says. But he’s right on this issue. If this was a bubble (inflated price), demand would drop. To keep the prices up in the bubble, speculators would have to prop demand up by actually *buying oil*. What are they doing with it? Or they would have to reduce supply. Which OPEC could do, in theory (and within quite stringent limits in fact, as several members of OPEC would be happy to pump more if they could). But in practice, they are not doing so: the taps are wide open in most OPEC and non-OPEC oil producers.

  7. #7 Nick Barnes
    2008/06/02

    sent: you have your currency conversion backwards. 1,5€ is only £1.18. Diesel here is 5-10% more expensive than that.

  8. #8 James Annan
    2008/06/02

    Surely someone has swapped a division for a multiplication…I’m sure that your feeble euros are not worth more than our strong manly pounds.

  9. #9 David B. Benson
    2008/06/02

    Who is Manly Pound? I only know about Ezra.

  10. #11 mugwump
    2008/06/03

    Nick Barnes, you’re entitled to your opinion, but “mugwump: nada” is quite off the mark.

    Krugman’s line is nearly always the standard knee-jerk lefty academic economist one. He is like most lefty economists: he thinks a little bit of mathematical knowledge makes him a friggin’ genius. On oil he is simply obviously wrong. If demand was exceeding supply, why haven’t we seen queues at the pumps?

    No, the price increases are caused by a relatively new kind of speculative inflow to the futures markets – index speculators. Index speculation largely arises from portfolio allocation, so it is not price sensitive, the perfect recipe for a bubble. Also, the futures purchased don’t need to be backed by purchases of physical oil – they can be continually rolled over *provided* there is more money coming into the market, which there currently is. Speculative index positions in the market now dominate whereas even 5 years ago they were a negligible portion of the trade.

    Just like any bubble, the oil bubble will burst when the cash inflows stop. For example, the US housing bubble burst when institutions stopped buying CDOs backed by subprime mortgages, because they finally woke up to the fact that maybe the CDOs were not AAA rated after all. Once they stopped buying the CDOs, the lenders could no longer write subprime mortgages, which means Joe Public on $50,000/year could no longer get a mortgage on a $500,000 house.

    What’s going to stop the cash inflows and hence the price rises in oil? The only thing will be a drop in physical demand since OPEC has little motivation to boost supply, and the fund managers will keep pumping up the bubble while it is still growing. Physical demand reduction is already happening in the US – tried selling a second-hand SUV lately? I have – not pretty.

    BTW, the same phenomenon is occurring in other commodity markets.

    Wall Street is designed to create bubbles, because the money managers make out like bandits while the bubble grows, but never have to give back the gains when it bursts. I didn’t much care when those bubbles tended to be isolated to virtual goods such as equities. But now they’ve managed to work out how to create bubbles over stuff I actually need to live, like houses, gas and food. This is not good.

  11. #12 Nick Barnes
    2008/06/03

    Today’s oil price is set by what people are prepared to pay for actual oil today, not by the futures market. A $100 premium per barrel is $3tn/year, real money paid out for today’s oil.

    Metal commodities have seen huge price rises due to actual demand, mostly from China, to the point that people are stealing man hole covers to sell as scrap. That’s real metal, bought today for real money, apparently to make rebar in China.

    A futures market unsupported by current demand soon collapses.

    Why aren’t there queues? Because of the price, of course. People queue for two reasons: to get a bargain or to stockpile against scarcity.

  12. #13 Dunc
    2008/06/03

    If demand was exceeding supply, why haven’t we seen queues at the pumps?

    It’s a global commodity. There are plenty of queues at the pumps – just not in the US and Europe. India, China, and Pakistan are a rather different matter, as a quick Google News search shows.

    But most oil production is controlled by OPEC

    No, it isn’t. OPEC controls approximately 40% of world oil production.

  13. #14 guthrie
    2008/06/03

    Mugwump has finally said something I agree with- that financial markets with bubbles in thing people need to live on are a bad thing. Of course this was visible a decade or more ago, but lots of people ignored it, in the name of market deregulation.

    [Well the UK - and the US - have had bubbles in things that people need to live *in* :-(. I'm still unclear on whether this can be blamed on speculation, though. I'm inclined to think not -W]

  14. #15 mugwump
    2008/06/03

    A futures market unsupported by current demand soon collapses.

    Right. But it all comes down to how long “soon” is. The US housing bubble lasted 5 years before it collapsed. The current commodity/oil speculative runup is only a couple of years old.

    To put things in perspective: the amount of oil “owned” by the index speculators has increased by about a billion barrels over the last 5 years. That’s also the amount by which China’s annual consumption of oil has increased. So anyone who thinks the oil price has risen because of increased Chinese demand has to concede that an equal amount of the price rise is due to speculation.

    It’s a global commodity. There are plenty of queues at the pumps – just not in the US and Europe. India, China, and Pakistan are a rather different matter, as a quick Google News search shows.

    Those countries have government price controls. So the queues have nothing to do with shortages. Anyone with oil is going to sell it to the highest bidder. If the retarded governments of India, China and Pakistan choose to set the price such that the oil owners sell it elsewhere, more fool them.

  15. #16 Munin
    2008/06/03

    I find the debate on the impact of speculation on current oil prices fascinating.

    The Economist (like Nick above) dismisses the argument as “plain wrong.”
    http://www.economist.com/research/articlesBySubject/displaystory.cfm?subjectid=381586&story_id=11454989

    George Soros (like mugwump) disagrees: “the institutions [index investors] are piling in on one side of the market and they have sufficient weight to unbalance it.”
    http://www.ft.com/cms/s/0/5dbd0ffe-30ef-11dd-bc93-000077b07658.html

    Perhaps I’m missing something, but I would have thought this would be a rather basic argument for an economist to solve. Either speculators *might* be responsible for current high oil prices, or they can’t possibly be.

    Where’s Richard Tol when you need him?

  16. #17 mugwump
    2008/06/03

    Perhaps I’m missing something, but I would have thought this would be a rather basic argument for an economist to solve

    You’d think so. Forgive my cynicism, but in my experience most economists view the world through the idealized prism of their oversimplified models (not unlike climate modelers).

  17. #18 Andrew Dodds
    2008/06/04

    Dunc -

    Yes and no. OPEC in theory controls much more than 40% of world export markets. However, OPEC’s quota discipline is notoriously lax, since all of the countries involved have a strong incentive to cheat. So they can’t really be said to control anything..

    Mugwump -

    There may not be queues at the pumps in the west, but US stocks are around 30 million barrels below this time last year and dropping. If (big if) this trend continues we will see spot physical shortages this year.

  18. #19 Munin
    2008/06/04

    Some more views on speculators, investors and oil prices:

    See the first two testimonies to a recent Senate hearing on the subject – the first by the market regulator, the second by a hedge fund manager.
    http://hsgac.senate.gov/public/index.cfm?Fuseaction=Hearings.Detail&HearingID=3fe95f08-0b7d-45d0-94ea-4c4346c353de

    If I read him correctly, the latter argues that investors are “stockpiling” futures, and that this has a similar effect to hoarding real commodities. The FT thinks otherwise: “If financial forces were to blame there would be a large increase in physical inventories. There is no evidence of this.”
    http://www.ft.com/cms/s/0/fe2f21e0-2ffd-11dd-86cc-000077b07658.html

    FWIW I think the hoarding question is key. There’s no doubt that hoarding increases prices. The question is whether it is a necessary condition and if so whether, why and where it is occurring.

    The article and comments below appear to synthesise the opposing views: futures demand has risen for monetary reasons and commodities are being hoarded in various ways – in particular, by producers keeping oil underground (i.e. not increasing supply despite price being above the marginal cost of production).
    http://unenumerated.blogspot.com/2008/04/hoarding-and-speculation-of-commodities.html

    This is the most convincing argument I’ve yet seen, though I don’t understand all of it, and change my mind on this every second day.

  19. #20 Dunc
    2008/06/04

    Andrew Dodds:

    Yes and no. OPEC in theory controls much more than 40% of world export markets.

    Oh, absolutely – but that’s not what mugwump said. He said “production”, not “export capacity”. Totally different things, and it’s very important to distinguish between them.

    mugwump:

    Those countries have government price controls. So the queues have nothing to do with shortages.

    Price controls do not magically create queues all by themselves. The reason there are queues is that they can no longer secure sufficient supplies at the necessary price. Which is how supply and demand are re-balanced when demand outstrips supply – it’s called “demand destruction”. The market participants who are unwilling or unable to pay higher prices are excluded from the market until supply and demand are balanced. Since the US and Europe are more able to bear high prices (by virtue of having more money) we will be the last to experience shortages.

    [Errrm. In countires with price controls, there will effectively be excess demand, because the price is artificially low. There will also be a strong incentive for suppliers to divert the oil to countires without the controls who will pay more. Hence queues. Why sell petrol at 3c in Venezuala when you can sell it for $3 in the US? -W]

    Anyone with oil is going to sell it to the highest bidder.

    That’s something of an oversimplification. It is better to sell at a lower price than not sell at all. Storage costs money, and there is no evidence that I am aware of that production is being stockpiled or shut-in to artificially maintain higher prices.

    [Agreed. But according the economist, Iran is storing oil off its coast in tankers, but only because its the too-heavy type and there aren't enough crackers to convert it to a useable state -W]

  20. #21 Munin
    2008/06/04

    I think this is the article William refers to cf Iran’s tanker storage.
    http://www.economist.com/finance/displaystory.cfm?story_id=11453090

    As usual, the Economist argument sounds eminently reasonable. But then I remember how they inadvertently called the bottom of the oil market in 1999: “Consumers everywhere will rejoice at the prospect of cheap, plentiful oil for the foreseeable future.”
    http://www.economist.com/world/displaystory.cfm?story_id=E1_TRRTRT

    I believe the article was accompanied by a cover suggesting oil prices could hit $5 a barrel. Last week’s cover featured an $135 oil barrel. It would be ironic if this time they inadvertently called the top.
    http://www.economist.com/printedition/displayCover.cfm?url=/images/20080531/20080531issuecovUS400.jpg

  21. #22 mugwump
    2008/06/04

    As William alludes, there may be a short-term refinery capacity problem, but that is unlikely to persist.

    More news from the coal-face. Bought a new car today. Asked the salesman at the Honda dealership whether he’d noticed any changes in buying patterns. He said they had changed overnight. In the space of a few weeks the most popular car had gone from the Odyssey (minivan – lot’s of middle-class families around here) to the Civic – the smallest Honda sold in any numbers in the US. People were trading in their SUVs for the smaller car. He said they were going to run out of civics for the first time ever (this is a *big* dealership – they had every color/trim combination on the lot for the vehicle we were buying).

    Looks like US$4/gallon gas is the magic number where demand suddenly becomes elastic.

  22. #23 Dunc
    2008/06/05

    Errrm. In countires with price controls, there will effectively be excess demand, because the price is artificially low. There will also be a strong incentive for suppliers to divert the oil to countires without the controls who will pay more. Hence queues. Why sell petrol at 3c in Venezuala when you can sell it for $3 in the US? -W

    Entirely true. However, up until fairly recently, there was a sufficient difference between supply and demand to sell as much petrol at $3 in the US as anyone was buying, and sell to Venezuela too at whatever price they were paying.

    But according the economist, Iran is storing oil off its coast in tankers, but only because its the too-heavy type and there aren’t enough crackers to convert it to a useable state

    Which is also a symptom of declining oil supply. Given then choice, you would only produce the lighter, sweeter grades as they are significantly easier and cheaper to refine. The fact that production is increasingly coming from heavier, sourer grades is a clear indication that the good stuff is much harder to get in sufficient quantity.

    Also, while the ~28 million barrels stored off the Iranian coast sounds like a lot, it’s still only about one third of one day’s worth of global oil demand.

  23. #24 mugwump
    2008/06/05

    Entirely true. However, up until fairly recently, there was a sufficient difference between supply and demand to sell as much petrol at $3 in the US as anyone was buying, and sell to Venezuela too at whatever price they were paying.

    Venezuela is not a good example. They are more than self-sufficient in oil, and the state controls the industry, hence can sell at whatever price they wish and to whomever they wish.

    As for the other countries like India that are not self-sufficient and have price controls, the change that caused the shortages was not the supply/demand differential but the price differential between the fixed price in those countries and the open market price.

  24. #25 mugwump
    2008/06/05

    Following the link munin gave above, this is 100% spot-on: http://hsgac.senate.gov/public/_files/052008Masters.pdf

    FTA:

    It is easy to see now that traditional policy measures will not work to correct the problem created by Index Speculators, those allocation decisions are made with little regard for the supply and demand fundamentals in the physical commodity markets. If OPEC supplies the markets with more oil, it will have little affect on Index Speculator demand for oil futures. If Americans reduce their demand through conservation measures like carpooling and using public transportation, it will have little affect on Institutional Investor demand for commodities futures.

    Index Speculators’ trading strategies amount to virtual hoarding via the commodities futures markets. Institutional Investors are buying up essential items that exist in limited quantities for the sole purpose of reaping speculative profits.

    Think about it this way: If Wall Street concocted a scheme whereby investors bought large amounts of pharmaceutical drugs and medical devices in order to profit from the resulting increase in prices, making these essential items unaffordable to sick and dying people, society would be justly outraged.

    Why is there not outrage over the fact that Americans must pay drastically more to feed their families, fuel their cars, and heat their homes?

    Index Speculators provide no benefit to the futures markets and they inflict a tremendous cost upon society. Individually, these participants are not acting with malicious intent; collectively, however, their impact reaches into the wallets of every American consumer.

    I recommend reading the whole thing. It explains why Krugman is wrong and Soros (and mugwump :-) ) are right.

  25. #26 Munin
    2008/06/05

    I’m leaning towards Soros’ argument, but I’m still not convinced. As I understand it, it relies on “virtual hoarding”, and I don’t know what that means.

    If the spot price reflects today’s price for a barrel of real oil, then the futures price should approach the spot price on the day of delivery. In fact, the futures price should equal the spot price + storage costs (ignoring transaction costs and interest rates).

    Otherwise you have a riskless arbitrage opportunity: buy a barrel of cheap oil today on the spot market (for $100, say); sell someone a future for delivery next month (for $120); pay the storage costs ($10); hand over the barrel on the delivery date and pocket the difference ($10).

    So investors can’t push the futures price much higher than the spot price – i.e. the price the marginal supplier is willing to sell his oil for – unless somebody is hoarding real barrels of oil (or ratcheting up storage costs).

    As I understand it, there’s not much evidence of hoarding. Of course the cheapest way to hoard oil is to keep it underground, and OPEC might be withholding supply to push up prices. However the blame then lies with OPEC, not the investors. And I don’t know how anyone could prove that OPEC was hoarding, short of them suddenly turning the taps on.

    There must be something I’m missing, because a lot of smart people (and mugwump :-)) are blaming institutional investors. Can anyone enlighten me?

  26. #27 Munin
    2008/06/05

    One final link: here’s a Professor of Economics at the LSE who thinks speculators are driving the oil price. Surely he knows what he’s talking about?
    http://www.ft.com/cms/s/0/3b4930d8-3301-11dd-8a25-0000779fd2ac.html

  27. #28 Munin
    2008/06/06

    Actually, I think I might have cracked it: OPEC are effectively hoarding oil beneath the ground by sticking to their output quotas.

    In an ideal market price would reflect the marginal costs of production, but the oil market isn’t anything like ideal. No-one but OPEC has the spare capacity to respond quickly to high prices. OPEC refuse to, because they are keeping to their agreed quotas (for whatever reason).

    The price of oil futures are essentially set by whatever someone is willing to pay for them – institutional investors or otherwise. And the futures price is tied to the price of real oil, as I’ve argued above.

    If OPEC did respond then we’d see hoarding above ground and would recognise this as a speculative bubble. Since they don’t, there’s always the possibility that they can’t, in which case today’s price is reasonable.

    How does that sound?