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2011 Energy Prices and the Speculator’s Role in Oil Trade

by | published December 28th, 2010

As we wind down 2010 and look at the structure of the energy markets looming for 2011, this seems the perfect time to address several very pertinent questions from subscribers about what is coming.

Q: 1) Do you see the U.S. dollar eventually being replaced as the world’s reserve currency? What effect would that have on oil and gas prices?

2) In light of the current unemployment situation in the U.S. and the potential move to austerity by national and state governments in order to shore up the fiscal situation, do you see an economic downturn in the near or longer term reducing current levels of demand for oil and gas (both domestically and via contagion internationally)? If so, what effects would such a scenario have on prices? ~ Rocky H.

A: Rocky’s questions go to the center of a traditional oil market view – the price of crude ought to reflect exchange rates and demand.

Let’s tackle the first part of his question…

Given the structure of global oil trade, there is little likelihood that the dollar will be replaced any time soon. There are too many assets worldwide denominated in dollars to move from the dollar system easily. And the euro – the most likely replacement alternative – has problems of its own.

There are contracts emerging from places like the Dubai Exchange, Singapore, Iran, and Caracas that are denominated in euros, dinars, and even yuan. However, they continue to trade against dominant dollar contracts, not instead of them.

When it comes to denominating oil contracts – actually a result of a then-secret agreement between Secretary of State Henry Kissinger and SAMA (the Saudi Arabian Monetary Agency) in 1974 – the current position of euro-based European retail contracts actually offers advantages to European oil importers/refiners, who then provide a wide range of exports to the oil-producing countries at a premium.

Put simply, it would take a massive change in the global market to displace the dollar. And neither the Eurozone nor rapidly advancing economies (such as the Chinese or Indian) want the destabilizing pressures that would accompany moving the currency base away from the dollar.

Now, what will happen – and what has already been underway for several years – is the move toward a “basket” of currencies in several countries as a way to better reflect a more accurate valuation of domestic currencies. Here, a combination of foreign currencies determines the exchange rate for the local money.

In such an approach, the overall use of the dollar is offset by other trading currencies – the euro, yen, and others – or a new script is developed, such as the trading currency to be introduced by the (Persian) Gulf Cooperation Council members.

Even in this case, however, nothing is poisedto replace the dollar. Replacing the greenback would undermine the weight of assets worldwide held in dollars.

There is another move developing to emphasize the use of Special Drawing Rights (SDRs) as a reserve currency. In fact, the International Monetary Fund (IMF) established SDRs almost 40 years ago to do just that. The SDRs are based on a currency fund representing the IMF reserves (themselves contributed by the member nations).

China has been rapidly increasing its contributions to that fund as a way of increasing leverage over IMF policy. But even Beijing is not prepared for a move away from the dollar – it owns too much dollar-denominated debt, and SDRs would put too much weight on the Chinese currency.

As for Rocky’s second question – whether economic conditions will depress demand – the answer is much simpler: Already been there, already experienced that.

We are actually coming out of a lowered demand curve right now. That was the problem from the fourth quarter of 2008 through the first three quarters of 2009.

The recovery has already hit in other parts of the world and is slowly coming back in North America and western Europe. OPEC just increased its global demand forecast for the third time in less than nine months.

In addition, the International Energy Agency (IEA), the U.S. Energy Information Administration (EIA), and the U.S. and German military, along with every other forecast released in the last six months, points toward accelerating demand for both crude and oil products.

Remember, the primary demand projections are not coming from the U.S. and Europe. The rising demand levels are led by developing parts of the world. The U.S. recovery will play itself out in 2011, but the usage and pricing will already have increased due to events elsewhere.

Q: Thank you for your informative comments on the oil and gas industry and recommendations for investment. I have heard oil people say that there is ample oil to meet demand at the current time and that the high price is not a result of demand but is caused by speculators. Can speculation be stopped? ~ Ian M.

A: First, I need to explain why speculation is necessary for oil trading.

Oil is both a commodity and an asset in its own right. That means futures contracts – the agreement to buy consignments at a certain price and time – have a value in themselves, beyond the market value of the underlying oil for delivery.

For this futures market to work, we need investors who are prepared to take a financial risk on the other side of a trade. Put directly, if there is no counterparty prepared to take a financial risk, a trader cannot exercise a future contract.

The speculators provide necessary liquidity and usually (since they are in this for a profit) take the more extreme positions. That actually stabilizes the market for everybody else.

This is trade in paper barrels (the contracts), rather than wet barrels (the underlying crude). As such, it is normal to blame the speculators for the problem. But they are not the cause.

Speculators ply their approach by the thousands in locations all around the world. Without the profit motive that spurs their involvement, there would be no way to balance the market. Trade would be controlled by a few very large sources of money – sovereign wealth funds, hedge funds, and related clones.

Coming down heavily on speculation in the U.S. trading market would merely move those operations abroad, outside the ability of American regulators to control it at all. (Not a particularly good idea, when the American market is dependent on the rest of the world for upwards of 70% of daily crude oil needs.)

The problem is not the speculators, but the trading system itself – and the rising inability of that system to determine a correct range for the hedging of the contracts (the options). That produces volatility, and that uncertainty will be ushering in a major problem for the oil sector…

My next book, “The Vega Factor: Oil Instability and the Next Global Crisis,” will be out in a few months to explain in detail what is about to happen. It will discuss the issues raised by the questions we’ve just discussed, along with a range of other concerns.

Only one thing you need to know at this point: This crisis will provide the average investor with opportunities to make a great deal of money.

So stay tuned.

Sincerely,

Kent

Please Note: Kent cannot respond to your comments and questions directly. But he can address them in future alerts... so keep an eye on your inbox. If you have a question about your subscription, please email us directly at customerservice@oilandenergyinvestor.com

  1. Ron Edwards
    December 28th, 2010 at 12:29 | #1

    Dr. Moors:

    Can you give some guidance related to Allis Chalmers? Should we be selling. I see the larger volume of trading today. Should accept the shares of Seadrill?

  2. John Cooper
    December 28th, 2010 at 13:00 | #2

    Sir,
    I recently came across some promotional material for the Russian Oil Fund. Their advertised rates of return are short termed and very high. I know that the business environment in Russia is a little unusual from a western perspective. Are you able to comment on whether this is this a legitimate company ?
    Your newsletters are very informative. Thank you for writing them.

  3. Robert
    December 28th, 2010 at 13:05 | #3

    question for Dr. Moors:
    I’ve heard it said that the shale gas wells, because of the nature of the shale itself, will have a productive life of only about one-third to one-half as long as the conventional gas wells. Is there any truth to this?
    Thanks.

  4. ferdy Penna
    December 28th, 2010 at 13:13 | #4

    I have been told that USA is preparing a law that will tax “capital gains” of foreign holder of US securities. Clearly if this law is approved I will sell all my US securities and accurately avoid to invest in USA anymore. I am swiss. In switzerland there is no capital gain tax and I do not understand why I must pay such a tax to Mr. Obama & Co.
    I have also been told that swiss banks are already avoiding US securities.
    Your offer is interesting and I probably would have subscribed. Should you offer a similar service on HK, Brasil, Canada , Australia I will surely subscribe.
    Best regards.
    Ferdy Penna

  5. Richard Beaulieu
    December 28th, 2010 at 13:44 | #5

    Dr.Moors,
    I heard and read your comments and reseach on the energy shift, was very impressed by your great knowledge and intellect,paid my dues to receive your comments and names of the upcoming industries, but have not received any yet.
    Please advise,
    Richard Beaulieu

  6. mike sondgeroth
    December 28th, 2010 at 14:39 | #6

    thanks dr.moors, i am invested in oil and mining stocks this year and going forth into next year. thanks for the information you have provided to us .

    mike/alaska

  7. Louis Reveron
    December 28th, 2010 at 16:18 | #7

    Dr. Moors,
    Can you update us on the situation in Iraq? I understand they are
    setting some very aggressive production targets for the next few years. Do you think they can achieve them given the improved political
    situation?
    Thank you,
    Louis Reveron

  8. Enrique Gutierrez
    December 28th, 2010 at 18:34 | #8

    Ihave recently subscribed to your service but the recommendatios so far are not giving any ressults, despite the fact the markets has been bullish, Yours truly. Enrique Gutierrez M.D

  9. Val Holms
    December 29th, 2010 at 10:00 | #9

    Dan,
    We are small cap oil and gas exploration company that has just finished up an IPO and will be trading in late January. We are operating in the Williston Basin Bakken Shale. We have just finished drilling one well and waiting on completion because of the bad weather. We are also in the process of getting ready to drill two more wells in January. If you have any questions I can be reached at val@bakkenresources.com or go to our web site at bakkenresourcesinc.com. Kindest Regards,Val Holms

    @Dan Biern

  10. DAVID BREEN
    January 1st, 2011 at 18:45 | #10

    I HAVE SOLD MY EXISTING COMPANY AND NOW WANT TO INVEST THE GAINS FROM THE SALE. THESE HIGH RETURNS ARE VERY ATTRACTIVE YOU HAVE MENTIONED. I HAVE INTEREST IN THE MINING YOU MENTIONED IN A PREVIOUS REPORT THAT HAS A UNIQUE WAY OF EXPLORING AND PROSPECTING. I WOULD LIKE TO INVEST IN THAT MINING COMPANY STOCK. HOW DO I GO ABOUT DOING THIS? AFTER INVESTING, HOW DO I KNOW WHEN TO SELL IT? AND IS THIS A STOCK TO HOLD FOR A SHORT OR LONG TERM?

  11. Food network
    January 8th, 2011 at 13:47 | #11

    I have been told that USA is preparing a law that will tax “capital gains” of foreign holder of US securities. Clearly if this law is approved I will sell all my US securities and accurately avoid to invest in USA anymore. I am swiss. In switzerland there is no capital gain tax and I do not understand why I must pay such a tax to Mr. Obama & Co.I have also been told that swiss banks are already avoiding US securities.Your offer is interesting and I probably would have subscribed. Should you offer a similar service on HK, Brasil, Canada , Australia I will surely subscribe.Best regards.Ferdy Penna
    +1

  12. Aubrey Todd
    January 18th, 2011 at 13:21 | #12

    Dr. Moors, what is the name of the small company that has app. 500 miles of Greenland’s earth [very valuable ] minerals??

  13. clyde
    February 5th, 2011 at 18:30 | #13

    EVER HEARD OF A SMALL FIRM NAMED TERRA RESOURCES? FROM ARKANSAS. NOT THE ONE ON THE NET—BUT DOING BUSINESS WITH CHINA/EXPLORATION? INVOLVED WITH EXPLORATION FOR OIL/GAS.

  14. blengas
    March 30th, 2011 at 06:14 | #14

    Hi, thank you for your post, it helped me a lot figuring out many things.

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