Oil Slick

May 9th, 2008

Usually, when I write about oil, it’s Extra Virgin. But today I mean the stuff that comes out of the ground. I have a close friend, a travel consultant, who arranges high-end gastronomic tours in the Mediterranean. She has a client who has asked her to investigate the possibility of flying to Turkey by private jet. Having been a private pilot for a few years, I’ve had some exposure to this rarefied level of travel. So I was only too happy help her with a little “aviation consultation,” Googling to see what was available.

Travel by private jet has always been expensive. It used to be that the airfare for the type of jet that could get you from Minneapolis to Istanbul with minimal impact on your Circadian rhythms would set you back an amount about equal to the price of a semester at an elite private college in New England. Today, the airfare has risen enough to see a student through Freshman, Sophomore, and most of Junior year.

Esso Station, Portland, Me.

“Well, oil is $124.00 per barrel. What do you expect?” say the folks who ordinarily travel coach on tickets they got online with 21-day advance purchases. But it got me thinking about why oil—and thus, gas—has become so expensive.

In an election year, it’s easy to place blame on “foreigners.” When it’s a question of discretionary travel, we know some zany Saudi sheiks who leave their Gulfstream Vs in the hangar in favor of their personal Boeing 747s. Or, we could keep our criticisms focused on the über consumers who bought Hummers and SUVs, just to be sure their little nippers had enough room to stretch out to watch DVDs in the back seat on the way to soccer practice. Meanwhile, the green and lean among us maintain we’re driving too much anyway.

But consider the following news item from Thomson Financial News Service: speaking at a conference in Vienna yesterday, the Secretary General of OPEC said, “…commercial oil stocks remained above the five-year average. Meanwhile, U.S. crude inventories rose about 6 million barrels last week, which showed that the oil market was well-supplied.” He went on to say that in tracking recent oil shipments, member countries couldn’t even find buyers for OPEC’s additional oil supply.

As for SUVs, Americans finally seem to have gotten the memo. Ford has recently made dire predictions about expected earnings shortfalls because of a 28% drop in sales of their SUV line. And are we driving too much? Maybe, but we’re certainly driving less. Unless you drive for a living, you’re very likely motoring as little as possible because of how much more it costs to “fill ‘er up.”

So what IS moving the price of oil? Would you believe me if I said, “an orthodontist in Dayton, Ohio? A school principal in Idaho? A retired CPA in Hilton Head?”

Well, for those of you who remember when we actually had to sit across a desk, face-to-face with our stockbrokers, think back. In the 50’s, we loved Xerox and IBM. In the mid-60’s, we had turned our affection to ‘plastics.’ By the late 70’s and early 80’s, we were agog with Apple. By then, investment bankers were whistling the tune of leveraged buyouts while the kid next door learned to trade stocks online. The guys who used to guffaw over pin-ups at the local Texaco station were now bragging about when they’d bought Intel. Anyone could belong to the investment club and lots of people joined when there was no longer anyone to tell them they couldn’t—or shouldn’t.

We rolled into—and out of—junk bonds and sexy high-tech companies with spectacular “burn” rates, but no tangible products or earnings. We danced in and out of real estate bubbles, and over the past nine months, we’ve skidded along with the mortgage meltdown.

Now, allow me to introduce the ETF, or Exchange Traded Fund. Yes, the ink is barely dry on the bailout deal with Bear Stearns and J.P. Morgan, and here comes another “derivative investment vehicle.” (Actually, the ETF has been around since 1989. But with the Dow fluctuating like a seismograph near the top of an active volcano, and common stocks having lost their luster, and mutual funds about as exciting as watching mime, the ETF has been rejuvenated as a glamour investment tool that gives the average Joe the illusion of running with the big dogs.)

Our orthodontist in Dayton, and a lot of his golfing buddies are now directing their investment cash into crude oil ETFs. They are speculating on the rising prices and this means that they, too, have a piece of the action when commodity traders are shouting in the pits at the New York Mercantile Exchange. Of course, our boys could buy ETFs for green coffee, pork bellies, or frozen orange juice concentrate, but none of those provides the high testosterone rush of OIL. Right now, oil is a straight shot—upward. Viagra for your beleaguered portfolio. Oil will get you that new Mercedes, pay for the Lasik surgery vacation in Cabo San Lucas, or simply make you feel like a Master of the Universe. If the creators and buyers of ETFs know how precarious the market is, they don’t seem ready to bail out. But if they don’t, they could drown in the very commodity that is currently keeping their Chris Craft afloat.

Just as a great many real estate investors got mortgages on houses they never intended to inhabit, many oil investors are buying ETFs for quantities of oil that will never go into the family furnace or mini-van.

Producers—and that includes American oil producers in Texas, California, and Louisiana—couldn’t be happier. In an ideal world, a futures contract is a tool enabling a producer or grower of a commodity to plan ahead by locking in a future market price. Oil producers have locked in prices that are making them very happy indeed. So happy, in fact, that they can begin to slow their production. And when they do, the demand—even normal demand—will cause prices to rise further, because there will be lower reserves. And the cycle will repeat itself until we reach some kind of tipping point. Then, investors like our orthodontist will begin to go the other way—cashing in or bailing out—as they sell their futures contracts. That is, they’ll begin betting that the price of crude oil will go down at some time in the future, as it surely will. And when it does, guess what? Gas will still be expensive, because producers and refiners will have scaled back; supplies will be low.

Everyone from the NYMEX trading pits to Peoria and Pasadena was listening when the suits at Goldman Sachs recently predicted the price of crude will reach $200 per barrel. But even if prices don’t reach that level, we should recognize that we’re in yet another bubble. And when it bursts, I foresee a protracted mop-up. In any event, I offer the following, infallible advice to the economists planning our future: “if you’re going to predict, do it often.”

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