Friday, May 13, 2011

The oil pantry effect

Crude oil supplies are plentiful. Use has not spiked, yet prices did? What's going on?

Well, the common explanation is "speculators". But, I'm familiar enough with speculation to know that paper trading of commodities one never takes delivery on cannot cause sustained price increases. It must be something else. So what?

What do you do if you believe food prices are going to go up substantially in the near future? You stock up your pantry and your freezer. I have to believe that large corporations and governments that consume a lot of petrol do the same.

The U.S. government publicly discloses figures for the U.S. strategic oil reserves, but private companies, the military and most other governments do not. If they see uncertainty ahead in the market, it is only prudent that they fill their reserve storage. This would explain how you get a spike in prices even without a spike in actual usage.

It also explains why the price of crude sometimes falls like a rock. When end users stop filling reserves, demand falls. If they actually start drawing from them for their day to day use, demand plummets. Prices follow.

This is the most logical and simple explanation for the behavior of oil prices, and according to Occum's razor, the most likely.

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