Thursday, July 03, 2008

Petroleum Price

Petroleum Price
Andre Willers
3 July 2008

Why did it suddenly rise steeply?
The well-publicised concept of peak-oil production as per Hubbert created an expectation of rising prices .

The oil-producing nations did not throttle production back , but every producer in the downstream line (ie pipelines , storage facilities , tankers at sea , refineries , hedge funds ) hoarded petroleum product s in the expectation of an enhanced profit .

There is no conspiracy , but every company trying to maximize it’s shareholders profits and with access to the same (nearly) perfect data , makes the same decisions .
Nations with depleted strategic reserves rush to fill up with oil at lower prices .
A self-realising bubble .

Bubbles in general .
Liquidity in a free market presupposes imperfect information flow .
Who wants to buy the no 2 for the next quarter ?

The internet makes information flow closer to perfect .

If the information flow is perfect , everybody will know the best investment and bid it up accordingly . Liquidity vanishes . A monopoly product like oil or nutmeg rockets , funnily ,usually inside a very small group of speculators .

Cf the Tulip-mania , when the number of active speculators were a small number of professionals (this is data from the actual sales ledgers still available , as published by “History Today”)

This is why bubbles are more frequent recently .
All the parasites like governments have learned to use it .

The Oil-bubble .
This leads to a bubble .
Some very approximate figures are instructive .

Oil per barrel at the well-head : $5 - $10
Transport per barrel anywhere on-planet : about $5
Total cost per barrel at refinery : $10 - $15
Profit about 200% : cost per barrel about $40
Reserves for exploration about 40% of this gives cost per barrel about $56
Reserves for exploration about 100% of this gives cost per barrel about $80

The price at selling point (note globalization effects) at 3 July 2008 is about $145 .
This is a zero-sum game , so where does all the money go ?
Well , at the present moment it is not going anywhere because it only exists as potential money (raw oil) . An awful lot of tankers are sailing in slow circles .
The volume of money transactions are low because of the hoarding effect . There is a lot of masking wash in the futures markets .

The bursting of the present oil-bubble .
The question is at what price . Inventory of physical product cannot be hoarded forever , especially if national legislatures are sniffing around . An upper boundary of $160 =2x $80 seems reasonable . A very sudden collapse down to about $50 , then a rise to $80 per barrel seems likely . Stock markets will rebound in sympathy .

What does this tell us ?
1. The Bubble as financial tool .
It is impossible to educate each human generation of investors at a gut level to beware of bubbles or “ exuberant optimism” . So why not use it . The present understanding of human economic systems is sufficient that Greenspan or Bernanke can use bubbles in conjunction with control of interest rates to get a better control of business cycles .

Instead of trying to smooth cycles , certain ones are encouraged in a controlled environment (usually interest rates , but basically a legislative environment)

The price shocks can be precisely targeted without destroying vital industries and jobs . The reserve systems of credit can take up the slack of re-tooling .

This has happened in history (Rome , China) , but their understanding of economics was insufficient to use it to maximum effect . Sooner or later they hit a down-draw below survival level , and bye-bye .

Example :
The US has to cut back on oil-usage . The government can try to legislate it (unpopular) , increase prices (unpopular) , or administer a series of price shocks (up and down) that gives the system time to adapt .

Human systems adapt magnificently to shocks they can survive (much better than a slow increase in costs)

Has it ever been different ?
No .
The only difference is that present rulers have better theoretical systems to advise them .
Humans are poor at absolute judgements .
They stack problems according to priority , but have poor relative judgement of the present items at the top of the stack compared to previous items at the top of the stack .

This can lead to some spectacular cock-ups .
A recent one was the British support of the Jacobins in the French Revolution .
The idea was to prevent the Habsburg children of Marie-Antoinette unifying Europe . The British strategy was to keep Europe divided .
So , they got Napoleon , a predictable result .

Remember long-term goals ?
Something governmental civil-services are supposed to do . Out lasting short-term political administrations .

Remember Progress?

It is no longer slow and steady , but bubble-to-bubble .
Is this worse in the long term ?
Funnily enough , no .
It is closer to how present systems with high-interconnectivity act.
It seems like institutionalised crisis-management .

At a brute level , if the draw-down of a bubble is above survival level , bubble systems expand faster than steady-state . Evolution systems will select for this .

Though I have to state , the difference is small . About 0.2 % per year .

Mathematically :
Regardless of the mechanism of change , the divergence from the center is measured by (N)^0.5 . Random Walk , where N is the number of steps . This can only get back to the center if the step sizes decrease by (N)^(-0.5) . Also known as the Riemann hypothesis .

Another way of putting it , is that an infinite number of elements must exactly obey the rule of (N)^(-0.5) at every iteration .
This has a probability approaching 0 , especially if you are thoughtfully chopping off the worst down-draws .
This is the same as the Second Law of Thermodynamics
You cannot go back except with extreme difficulty and if it is very craftily constructed.

Remember Obsolescence ?

Ah , when we were young .
The obsolescence of an young heart .


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