This is an interesting piece in the New York Times coming off some potential regulation coming due to the wickedly volatile action in the energy markets [Jun 17, 2009: CNNMoney: Obama v the Oil Bubble] I am sure there are simple solutions such as raising margin requirements and a few other technical items that those more versed in the commodities market could suggest, but since that might curtail profits of those who line the pockets of politicos its going to take a long time to get to that point where any change happens. Until then we'll have oil rocket up as oil tankers sit packed with merchandise the world over as we hear the chants it's all about supply and demand baby!. I would assume the truth is more along the lines of supply of paper dollars thrown into the system chasing after fixed amount of smallish markets that are commodities. The wickedly devised ETFs for oil and natural gas also don't help one bit.

  • The extreme volatility that has gripped oil markets for the last 18 months has shown no signs of slowing down, with oil prices more than doubling since the beginning of the year despite an exceptionally weak economy.
  • The instability of oil and gas prices is puzzling government officials and policy analysts, who fear it could jeopardize a global recovery. It is also hobbling businesses and consumers, who are already facing the effects of a stinging recession, as they try in vain to guess where prices will be a year from now - or even next month. (ask Government Sachs)
  • Volatility in the oil markets in the last year has reached levels not recorded since the energy shocks of the late 1970s and early 1980s, according to Costanza Jacazio, an energy analyst at Barclays Capital in New York.
  • To call this extreme volatility might be an understatement, said Laura Wright, the chief financial officer at Southwest Airlines, a company that has sought to insure itself against volatile prices by buying long-term oil contracts. Over the past 15 to 18 months, this has been unprecedented. I don't think it can be easily rationalized.
  • People do not like that kind of volatility, they want to know what their costs are going to be, said Bernard Baumohl, the chief global economist at the Economic Outlook Group.

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  • While the movements in the oil markets have been similar to swings in most asset classes, including stocks and other commodities, the recent rise in oil prices is reprising the debate from last year over the role of investors - or speculators - in the commodity markets.
  • ... unlike most of 2007, when the economy was still not in recession and demand for commodities was strong, the world today is mired in its worst slump in over half a century.

I will end this piece by saying on some small chance that the oil price today is correct with most portions of the world economy in tatters just imagine what happens when the economy recovers. I'd expect a constant gyrating between recession and spikes of recovery based on energy prices, since each recovery would lead to massive price swings up ... which in circular fashion would lead to dampening of economies.

That said, I am sure there is a lot more behind the scenes going on to explain the pricing. I'll let smarter people than I debate the particulars, but for now oil is just another correlated asset that can be pushed around by computers bidding and asking away. [Jun 30: Correlation Among Asset Classes Highest Ever] Remember economics 101 is now very out of fashion [Jun 8: Dennis Gartman - Short Term Bearish in Oil] instead, now we have a central bank whose main role is to engage speculators in between creating bubbles.

  • Recently, commodities bulls have been aided by the Federal Reserve keeping rates low and banks' short-term funding flowing. As cash flows into oil futures, their prices rise relative to spot prices. That makes it profitable to buy physical oil, store it and sell it forward.

Here is my favorite quote from the story - good ole supply and demand? Meaningless. Economics 101 apparently does not work with all the new fangled financial innovations we've created - Frankenstein style.

  • Yet the indicators that would traditionally signal lower prices - like high oil inventories or OPEC's large spare production capacity - do not seem to hold much weight today, analysts said. Crude oil prices appear to have been divorced from the underlying fundamentals of weak demand, ample supply and high inventories, Deutsche Bank analysts said in a recent report.

Summed up differently in this short piece in the Wall Street Journal

  • But its moves are reminiscent of last summer, when the sheer amount of money chasing crude overwhelmed the supply-and-demand equation. Says Michael Korn, president of brokerage Skokie Energy Corp.: It's the same play going on. For many, that play was a tragedy.

If we're not going to have actual productive businesses anymore, I guess this is how we make an economy thrive! Speculation on asset classes based on easy money. Why not? It's a lot easier than actually trying to make something; we'll leave that non innovative stuff for the 3rd world countries. We're post modern baby! And if that speculation screws up the last remaining industries that need oil, we can offshore you too. Stop your complaining Southwest!

As for the consumers crunched by the speculation? A necessary byproduct of prosperity for a narrow sliver of society. The consumers job is to show up with their grandchildren's piggy bank at appropriate times (when our innovation goes too far - then Main Street = Wall Street), and otherwise be silent and let us do our work. Thank you for your participation.