Myths of Oil


We have so many headlines that grabbed our attention on this year 2008; a new Iphone, the first black presidential candidate, the war on Iraq, and many others, but nothing have grab the front pages of the newspaper like Oil.

Oil has been the every day subject not just for the media, but also for the political debates of these coming presidential elections. Among this political debates, we have hear so many arguments, from both sides (Democrats and Republicans), and is amazing how much myths surround their statements. I must admit, that I used to repeat, the same typical statements about the prices oil, like: “It’s all Bush fault that the price of Oil is like that”, “It’s all about Iraq war that the prices are like that”, “Gas stations are making so much money with high oil Prices”, and the best one “Speculators are the reason why Oil prices are so high”.

I must admit, that I was one of those that used to repeat this statement, but once I got involve in the daily trading of Oil and energy in general, I literally opened my eyes.

Let me breaking down:

A little of Economics 101: It’s all about offer & demand. We are facing the effects of the globalization where all the markets are opening up to a free trade plus we have to include a more industrialized China that is growing every day more, and India. These countries are Oil hungry, implying a big grow in demand, with a limited supply in a long term. To this we have to add that we are facing a “weak” dollar against currencies like the euro specially. Crude Oil is value on dollar; weaker the dollar the higher the price of Oil.

Having said that you probably will ask why is the dollar so weak? Well we have a couple of factors: The main factor is the trade balance. It’s not a secret that the trade balance deficit between United States and China is in record numbers. A good way to improve and alleviate this trade deficit is to make our currency weaker, so it makes our products more attractive overseas. If you notice one of the countries that its against a strong Euro is Germany, because Germany is the biggest Exporter in the world over China, with a strong Euro, it makes their products less attractive. Besides the trade balance we have the turmoil of the finances and real state, the Fed and the government believes that lowering the rates will save some Banks from all those write-downs and the burst of the subprime mortgages.

Now that we have established the price of Oil lets disqualify with facts the statements that I brought up in the first paragraph:

“It’s all about Iraq war that the prices are like that”

We have been in Iraq since 2003, the prices of Oil made a huge spike between 2006 and 2007.

“Speculators are the reason why Oil prices are so high”

This one is my favorite. It’s a famous phrase between libertarians and traders that goes: “Market fixes it self”. First of all for any buy position on trading oil it should be a selling position. If I am buying at a certain price it must be someone that it’s willing to sell me at that price. The main reason of trading is to establish a fair price, and control the production of certain commodities. Early in the 1900 if I had 30,000 bushels of corn (bushels is the way that all grains are measure and trade on the commodities market)it was no way for me to find out if the will sell, now with months in advance you know how many bushels of corn, rice, etc, etc, you have to deliver, and avoid losses for the producer.

Even better one of the only products that do not trade on the trading floor is Onions, it stop trading on 1953 under the argument that speculator drove their price higher that it was supposed to. Well Onions between 2006 and 2007 has the biggest spike of all commodities with a 317% above crude Oil and Natural Gas.

“Gas stations are making so much money with high oil Prices”

Unlike what people believe, most of Gas Stations except Exxon (They are also an offshore company) make their revenues as refineries, which mean they buy the barrel of oil and refine to get gasoline out of the oil , this relationship between gasoline and Oil is called “crack spread”. This term well known among traders on NYMEX (energy trading platform), which is the difference between the price of 3 barrel of oil and 42,000 gallons of gasoline which is what you get out of. As I explained that we should understand that the higher the price of Oil, the less profit, a refinery could take out of a barrel of oil, and if you notice, the price of gasoline hasn’t increase as much as the price of barrel of Oil in terms of proportion, the best prove of that is that once the price of Oil hit 147$, stocks like Valero, drop more than 25% of their value.

We all have to understand once and for all that what has been running the price of oil in this last months has been the dollar. I leave here a chart of the relationship of the Oil and dollar in 2008. You could see how they approach opposite directions.

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