Bloomberg, 24-May-2010
Review by James Pressley
With the NOC constantly in financial crisis because of elevated oil prices, it might be worthwhile to understand how the oil price is set in the global markets. This book argues that the price is a function of fund flows/asset allocation/trading rather than supply-demand imbalance.
Dan Dicker could be forgiven if he hooted in vindication as crude plunged 15 percent in the first week of May. He concluded long ago that petroleum prices have become “just nuts,” as he says in “Oil’s Endless Bid.”
Oil markets are defying the normal laws of supply and demand, he argues in this timely book, and a large share of the blame belongs to Goldman Sachs Group Inc., Morgan Stanley and other banks. A longtime floor trader, he brings valuable insights to bear on a contentious subject that affects us all.
Dicker spent 25 years trading crude, natural gas, unleaded gasoline and heating fuel at the New York Mercantile Exchange. Bit by bit, he saw Goldman -- “the devil to be feared,” he says -- and its Wall Street brethren muscle into a sleepy market that was once dominated by oil companies seeking to hedge the risks of physical assets.
Soon a flood of “dumb money” from investors was gushing into funds pegged to the Goldman Sachs Commodity Index, he says. This high tide of cash, totaling billions of dollars, exerted an upward price pressure on oil that burdens American business and threatens to derail a U.S. economic recovery.
“We are all invested in oil, whether we like it or not,” he writes.
‘Peak Oil’
Dicker understands the prevailing wisdom about high oil prices yet remains unimpressed. Has he noticed how the rise of China and other emerging nations has driven up demand? Yes, he has. Is he ignoring evidence that the planet will one day run out of cheap, easily tapped black gunk? No, he’s not.
He says he believes in “peak oil,” the theory that petroleum production will inevitably peak, plateau and decline. Yet when he examines this and other explanations for recent energy-price spikes -- a falling dollar, for example -- he concludes that they amount to “a bad alibi.”
His argument, brutally compacted, goes like this: Oil today is overpriced, driven ever higher by the new flow of money funneled through investment banks, energy hedge funds and exchange-traded and index funds. Feeding the frenzy are bets from the same kind of American investors who moan about paying almost $4 a gallon to fill up their SUVs.
This new dynamic has led to wild fluctuations, Dicker says. Remember how oil surged in 2008 to more than $145 a barrel in July, only to plunge to less than $34 by late December?
“Nothing proved a speculative bubble more convincingly than the rapid price collapse we saw then,” he writes.
‘Assetization’
In swaggering prose, Dicker marches us through momentous changes that began rocking oil markets a decade ago. Chief among them is “the assetization of oil,” his infelicitous term for new instruments -- think commodity index funds --that make investing in petro prices as easy as buying stocks.
Dicker frowns on this. Just because everyone can now trade oil -- Mom, Pop and Aunt Erma, too -- doesn’t mean they should, he argues, determined to dissuade the very people who are most likely to buy his book. The notion that we can invest in oil as if it were a stock or bond is “the single most diabolical source of our pricing problem,” he writes.
Oil isn’t a stock or a bond. You don’t get dividends, interest or a way to reinvest profits and compound returns, he explains. All you get is a wager on oil prices -- a futures contract with a short shelf life. Your bet “self-destructs every 30 days,” as Dicker says.
Barrels on Doorsteps
Many people, heeding the growth of emerging nations, peak- oil arguments and the upheaval in Libya, are betting oil will go up. Being accustomed to stocks, they want to buy and hold. The only way to do that, unless you want a contract for 1,000 barrels of oil delivered to your doorstep, is to roll your position over by retiring an old contract and initiating a new one with a later expiration date.
This may expose you to a tax liability, not to mention commissions and fees on two trades (for getting out and getting back in). Imagine, too, what happens when commodity index funds roll their positions all at once, as they do on certain days each month. This mechanical reset is called the Goldman Roll, after the Goldman Sachs Commodity Index. It winds up amplifying any fundamental arguments for higher prices, Dicker says.
Can this be fixed? Yes, says Dicker, though his solution would mean forbidding most individuals from trading oil (and handing some clout back to pros such as himself). If he had his way, commodity index investing would be banned, along with exchange-traded funds that engage in futures.
Nostalgia for “the good old days of oil trading” tinge this book, which is enlivened with memories of “standing shoulder to shoulder with another 120 sweaty, smelly traders.” Yet it’s the future, by this account, that may really stink.
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