Pointing to a chart of randomly selected commodities that included crude oil, wheat and cooper dating back to 2000, David M. Arseneau, senior economist in the Division of International Finance at the Federal Reserve Board, said, “that’s insane volatility in a short time.”
Arseneau was speaking on a panel titled, “Short-Term Energy Prices: What Drivers matter Most?”, in Washington, D.C. last week at the Energy Information Administration’s annual conference that was cosponsored by The Johns Hopkins University School of Advanced International Studies.
He said we don’t understand speculation, and that “we are making policy on assumption.”
Disagreeing somewhat, Edward L. Morse, managing director and head of Global Commodities Research at Credit Suisse, said tight supplies due to underinvestment triggered last decade’s commodity price volatility. Morse used the refining system as an example, saying that it took 20 years to work off excess capacity. Meanwhile, strong demand for distillate fuels by developing nations for power generation was unexpected, with supply tightness starting in 2002.
The commodity boom, Morse said, was “propelled initially by a rapid, nearly simultaneous reduction in energy, base metals, agricultural and bulk commodity inventories and by production supply constraints.”
He said this situation coincided with the development of new financial products for commodities that didn’t exist in 2003 which drove up trading volume in short-order. Morse said index funds, exchange traded funds and black box traders likely account for 30 percent of the market now.
Since this group of investors trade primarily on momentum, which supply tightness drives, they added to the volatility, he said. The long-only strategy employed by index funds for example is also likely to bring profits during a bull market, which is what we had from 2003 through 2008.
“But the ‘super cycle’ was the invention of sloppy thinking and an accident of history,” contends Morse.
He said “profiting from commodity exposure requires more micro analysis,” and that better supplied markets would likely knock this group of investors out of the market.
Guy F. Caruso, senior adviser in the Energy and National Security Program at the Center for Strategic and International Studies and former administrator of the EIA, said it’s very difficult to explain the current price rise in crude oil towards $90 bbl using old tools for analysis, such as fundamental factors.
Caruso added that since Dec. 1, 2009, money managers increased their energy positions by 70 percent.
He also offered a list of several factors, including questionable supply and demand data from China and other developing nations, and misplaced confidence in the Organization of Petroleum Exporting Countries’ production quota compliance. He listed fear of longer-term capacity constraints in countries including Nigeria, Iran, Iraq, Mexico, Venezuela, as well as reduced output triggered by climate control regulation. And, he said too, what is the “real” replacement price for oil? He said oil’s discovery and development costs are now being recalibrated.
Caruso said that the price for oil development was in the $20 bbl range during the 2008 period, so “clearly there are other things at play.” There is a “need for improved data systems from around the world.”
Chris Ellsworth, who follows natural gas in his work in the Division of Energy Markets Oversight at the Federal Energy Regulatory Commission, said, “At times we see things in the market that are difficult to explain with fundamentals.”
He said trading at key natural gas hubs frequently have more to do with financial positions than physical underpinnings. For an example, he said in September 2008, after hurricanes took out 12 percent of production capacity, natural gas prices kept falling.
Ellsworth’s next example isolated the May 6-8, 2009 period in which natural gas futures prices at the Henry Hub delivery location rallied 70cts. He said in this case, spot prices followed futures, so fundamentals were not driving price.
