I've Got Gas

^{nota bene: Chicago Dyke had something very similar yesterday.}

I came across an interesting quote today whilst reading my usual gamut of market commentary that made my political antennae shoot up into the air:

As we understand it, back in late July Goldman Sachs decided it was going to reduce the weighting of gasoline in its widely followed commodity index (GSCI). Participants wanting to dissect the entrails of that decision may refer to The Financial Times story dated August 29, 2006 titled “Market Insight: Index shifts follows oil decline.” Suffice it to say, Goldman took the gasoline weighting in its commodity index from 7.3% to 2.5%, for pretty mysterious reasons, in a gasoline-centric economy (IMO). Goldman even went so far as to scale-in those reductions at intervals between August and November. Accordingly, the billions of institutional dollars that “mimic” (read: invest) the GSCI have had to periodically SELL those gasoline futures contracts to stay in-sync with the index’s new weightings. Unsurprisingly, unleaded gasoline prices peaked on August 3rd at $2.35/gallon, basis the NYMEX November future’s contract, and crashed into last week’s lows of $1.46/gallon for an eight-week price decline of 38%

Let's unpack this. A goodly portion of the reason gas prices have plunged lately, and a 38% decline meets my definition of a plunge, is due to the fact that Goldman Sachs tweaked the weighting on their commodity index. So what, right? Well, all the folks out their running managed futures funds, hedge funds and other various and sundry financial types, all had to go out and change their weighting of actual holdings in gasoline because that's the benchmark their performance is measure by.

More after the jump.

Here's another analogy. The Dow 30 is composed of 30 stocks. There are a lot of mutual funds that own "the index" as we call it. All 30 stocks. But what happens when the Dow 30 changes the stocks that make up the index like they did in 2002. They removed AT&T, Kodak and International Paper and replaced them with AIG, Pfizer and Verizon. Now, all the stocks the index dumped took a dive, right? Because all the mutual funds, hedge funds and asset managers that hold the index dumped those stocks.

It's the same with Goldman's Commodities Index. If they reduce the percentage of gasoline in the index all the folks who follow the index's weightings do the same and voila! Gas plunges.

Great timing too.

Which leads to three questions: what's the economic rationale of making gasoline a smaller portion of overall commodoties in such a gasoline centric economy?

Why now?

And finally, who made the call to do so?

Might it have anything to do with the fact that the new Treasury Secretary used to be the Chairman of Goldman Sachs?

Just askin.

Sean Paul Kelley October 3, 2006 - 4:31pm

Sean Paul Kelley's diary | printer friendly version |

( categories: Economics )

Call me a conspiracy theorist

but I also noticed how Chevron released findings of some huge field in the Gulf of Mexico that will solve all our domestic oil problems, and how the leak in Alaska wasn't so bad after all.

People are sheep and easily led and misled.

Watch how oil prices rebound after the November election.

I did inhale.

Don October 3, 2006 - 5:14pm

US, world reserves can offset Iran oil for 18 months

REFILE-US, world reserves can offset Iran oil for 18 months
03 Oct 2006 21:36:10 GMT

By Tom Doggett

WASHINGTON, Oct 3 (Reuters) - U.S. and world emergency crude oil reserves could replace a complete shut-off of Iranian oil exports for 18 months, avoiding an estimated $201 billion in damage to the American economy, the Government Accountability Office said on Tuesday.

There has been concern among energy traders that tough action by the United States and other western countries against Iran's nuclear program could cause Tehran to retaliate by cutting off the country's oil exports. Iran is the world's fourth biggest oil exporter, selling about 2.7 million barrels a day.

Such a disruption would remove close to 1.5 billion barrels of crude from the market over an 18-month period, according to the GAO, which is the investigative arm of the U.S. Congress.

UPDATE: U.S. Oil Reserves Not Big Enough For Worst-case Scenarios
Tuesday October 3rd, 2006 / 22h44

By Rex Nutting
WASHINGTON (Dow Jones) - International petroleum reserves are large and nimble enough to replace all the lost oil capacity in all but the most catastrophic scenarios, the Government Accountability Office said in report released Tuesday.

International reserves and excess capacity - including the 727 million barrel U.S. strategic petroleum reserve - could replace all the oil supply lost from a hypothetical Gulf of Mexico hurricane, or a lengthy strike in Venezuela, or an 18-month embargo of Iranian oil, or a major terrorist attack on oil facility in Saudi Arabia, the GAO said.

But reserves could not replace the lost capacity if the vital Strait of Hormuz were blocked for a month or if all Saudi oil production were shut down for 18 months, the report said.

"The SPR is an extremely valuable asset, and releasing oil from the reserve during oil supply disruptions could greatly reduce the damage to the U.S. economy," GAO said. "The SPR can currently release up to 4.4 million barrels of oil per day--about 44 percent of U.S. daily oil imports--for 90 days, and can release a diminishing amount of oil for an additional 90 days."

If all Saudi production were shut off for 18 months, the average quarterly price of crude oil would likely rise by $54 to $87 per barrel even if the global community threw all its reserves into the market, the GAO said. Saudi Arabia produces about 10 million barrels of crude oil a day.

A one-month closure of the Strait of Hormuz at the entrance to the Persian Gulf would likely raise the average quarterly crude oil prices by between $11 and $24 per barrel. About 17 million barrels of crude pass through the strait each day.

The price response to a supply disruption is very uncertain, with the two models used by the government giving very different results. One model, used by the Energy Information Administration, assumes the impact of the disruptions not only on supply but also on market psychology.

"Disruptions caused by violent events would have larger price impacts than disruptions caused by peaceful events, such as a strike or natural disaster," EIA told GAO.

U.S. to delay buying emergency oil through winter
02 Oct 2006 19:19:50 GMT

WASHINGTON, Oct 2 (Reuters) - The U.S. Energy Department said on Monday it will hold off buying replacement oil for the nation's emergency petroleum stockpile through the upcoming winter heating season in order to keep more supplies on the market.

To help make more oil supplies available for producing gasoline over the summer and help lower then-soaring pump prices, U.S. President George W. Bush in April ordered the Energy Department to delay deliveries and purchases of oil for the Strategic Petroleum Reserve until this autumn, which began on Sept. 22.

In these times you have to be an optimist to open your eyes when you awake in the morning. ~ Carl Sandburg

Tina October 3, 2006 - 5:42pm

Without price controls

Without price controls that's all just BS - the price of oil would skyrocket. And since, as everyone keeps trying to claim, the oil market is global, that wouldn't happen.

Moreover, Iranian oil is pretty decent quality, a lot of the replacement stuff is the equivalent of scraping ashphalt off the road.

Ian Welsh October 3, 2006 - 5:49pm

I have no doubt at all it was political

as Paulson has long been a good Republican.

It just reminded me that people in power can manipulate numbers any way they want, because the numbers derived are so now unrelated to the real thing, even with oil, and manipulation no longer seems to carry a moral value.

On the other hand, the sentence, "There's no more oil anywhere, for any price" will have weight.

That's why our ancestors believed in keeping their gold as close to their bodies as possible.

_{"at some point I'm hopeful I'll figure out something to put here"}

nymole October 3, 2006 - 5:52pm

Upcoming collision of two systems of valuation;

capitalism, in which the value of an item is determined by what another person is willing to pay for it, and the scientific concept of "energy budget" which is the actual cost of an action or artifact in energy.

Escher Sketch October 3, 2006 - 7:03pm

ES, please elaborate on this. Very intriguing idea. eom

Sean Paul Kelley October 4, 2006 - 12:38am

If I may...

I think what he is saying is that, ideally, the capitalist/market system values goods primarily based on what people are willing to pay for them and incorporates true energy and social costs to a much lesser extent when determining pricing. It is based on the availability/value or perceived availability/value of goods and services that are held by people.

An alternative system would be one in which the value of goods and services is determined by 1) how much energy it takes to make them, 2) how much waste is produced when making them, and 3) the social costs of using them. With a bit of effort, we can very accurately measure 1) and 2) in terms of kilojoules and kilograms (perhaps with added parameters for biodegradeability, toxicity of waste, and climate-change). 3) would be a bit more hand-wavy but some sort of standard index might be possible to create.

Doing this would, for the most part, create a more precise and scientific standard for valuation. Pricing would rely more heavily on units of energy put in versus units of waste coming out, with demand informing the system in a lesser (but still important) capacity.

This is what I assume Stirling and others mean when they speak of transitioning to an economy based on units of energy and not oil, gold, etc. A system based on the amount of energy consumed will be a more accurate tabulation of an individual's economic, ecological, and social footprint.

As a side note, the notion of capitalism = "what people are willing to pay" and this new system = "scientific measurement of energy budget" seems to me to be a parallel with the "country of men vs. country of laws" observation from politics. Perhaps I'm oveanalyzing a bit :).

Bolo October 4, 2006 - 12:01pm

Parecon

These are great ideas with potential of transforming the current capitalist/market system to a more humane one. Here is some more:

http://en.wikipedia.org/wiki/Participatory_economics

http://www.zmag.org/parecon/indexnew.htm

One possible reaction to these ideas is pessimism about how hard it will be to be implement them, how the current system is powerful and widespread with all the momentum of last centuries.

When I feel like this I always remind me that the French revolution came after centuries of discomfort with the system of that time, how ideas float for decades about change. So I guess it is time to give these ideas a serious look. May be not for ourselves or our children but eventually for a better life for the humanity and our home the Earth.

pembeci October 4, 2006 - 5:53pm

oh, sure

i put this up days ago and what response do i get?

*crickets*

/being naughty/

i'm glad that as a not economist my instinct was right to note this. more details about this from you experts are always welcome.

chicago dyke October 3, 2006 - 10:33pm

great catch and great instincts. You'd probably have made

a good money runner.

Sean Paul Kelley October 3, 2006 - 11:18pm

I'm just glad I've got all of you to read.

I read a diary a while back that claimed to demonstrate that the fall of gas prices couldn't be related to manipulation. I'll admit to being clueless on this stuff and I wouldn't mind hearing what folks have to say about this:

There is NO manipulation of gas prices. An explanation.
by Jerome a Paris

Sun Sep 17, 2006 at 12:39:31 PM PDT

The sharp drop in gas prices in recent weeks has given birth to many diaries or comments suggesting that this is a BigOil pre-electoral trick (too many to link to, in fact). I'd like, with the help of HiD, a former oil trader, to guide you through the explanations as to what is happening, which is perfectly understandable under normal market mechanisms under the current international context.

(...)

link

Escher Sketch October 3, 2006 - 11:01pm

Jerome underestimates

the power of that derivatives, hedge funds, etc. . . have on the markets now. He doesn't even list them. And hey, don't believe me, go read my source. Saut may work for a smallish, regional firm, but his performance the last ten years has been FUCKING golden. And in the end, with these guys, what you got in the bank is the ONLY scorecard.

Sean Paul Kelley October 3, 2006 - 11:17pm

Good, that's exactly what I wanted to know.

It's difficult for the uninitiated like myself to assess convincing-sounding arguments and counterarguments, but my gut says the economic savvy here at the Agonist is a cut above. I'll take that as authoritatively refuted.

Escher Sketch October 3, 2006 - 11:43pm

ACTUALLY, ES,

Jerome makes the argument I just made explicitly. He says in his post, Big Oil has almost nothing to do with the price of gas. He's absolutely right. It's the traders, the hedgehogs, the arbatrageurs, et. al. that control the price of gas and they all look to this Goldman Index for their cue cards, might be a good analogy. So, this isn't about Exxon, or any of the oil pumpers. It's the more downstream folks, refiners and after that are in on this.

Sean Paul Kelley October 3, 2006 - 11:46pm

A lot had to do with other

A lot had to do with other trading activities. A lot of people had sold futures, bought oil on the spot market and stuck it in storage. That drove spot up and futures down. When the two converged, and it became clear that there wasn't going to be a late surprise, that oil go released back into the market in a big way, depressing prices. Likewise, there's a huge glut of summer gas that has to be sold off.

Gas at the pump was selling at an enhanced markup for most of the summer. They couldn't get rid of that inventory overhang and are now selling it just for the normal markup. That looks like a big reduction in prices, but it's actually just going back to standard profit margins.

And that, by the way, has a lot to do with the majors.

People tend to take the oil prices as proxy for gas prices as Sean-Paul notes below. They aren't. (Take a look at the spread between gas and diesel prices, for amusement.)

Ian Welsh October 4, 2006 - 6:34pm

Would the "tweak" have anything to do with war in Iran?

Surely closing the Straits of Hormuz would affect oil futures?

Just asking....

lambert October 3, 2006 - 11:35pm

Lambert, as I just wrote to ES, this isn't about

oil, per se, this is about gasonline, a highly refined oil product that has a market cycle all its own that is almost, but not totally divorced from the price of oil. It's like in the aftermath of Katrina we had plenty of oil coming into the US but because refining capacity was off line, refining that makes gasoline, the price of gas spiked hard, like a Mofo.

Sean Paul Kelley October 3, 2006 - 11:48pm

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