Tuesday, April 14, 2009

Wall street fueled own demise with commodities trading

In an interesting article James Hamilton explains a paper he presented to the Brooking s institute.

Consequences of the Oil Shock of 2007-08

Eventually, the declines in income and house prices set mortgage delinquency rates beyond a threshold at which the overall solvency of the financial system itself came to be questioned, and the modest recession of 2007:Q4-2008:Q3 turned into a ferocious downturn in 2008:Q4. Whether we would have avoided those events had the economy not gone into recession, or instead would have merely postponed them, is a matter of conjecture. Regardless of how we answer that question, the evidence to me is persuasive that, had there been no oil shock, we would have described the U.S. economy in 2007:Q4-2008:Q3 as growing slowly, but not in a recession.

This is a clear example of how speculators try to "Double up there bets" as they entered the commodities area following substantive losses in the equity arena and how we discussed here.

How a Schoolboy Howler Fueled the Peak Oil Fallacy and Caused a Global Recession

The secretary general of the Organisation of Petroleum Exporting Countries (Opec), Rilwanu Lukman, says the world oil market is held captive by the derivatives markets. The old rules of supply and demand have been distorted, he says, by the creation of what he calls "paper barrels" of oil.

The physical ("wet barrel") market is awash in oil. Saudi Arabia, the world's top exporter, had to cut production from 9.5Mbpd level of the past 2 years down to 9.1Mbpd (-400,000 barrels per day) since April-06, because it can find no buyers for it, The Wall Street Journal quoted Oil Minister Ali Al Naimi as saying on 5-Jun-2006.

All "demand" keeping prices at these absurd levels of $70+/bar is happening in the futures derivatives markets, off which real physical oil is priced. Derivatives is what OPEC calls "paper barrels", with open contracts just in NY futures market being ~1.6 BILLION "paper barrels". Nearby month futures contracts in NYMEX and ICE trading about ~250 million "paper barrel

But the gamblers with MBA etc still failed to understand the ST Petersberg Paradox the law of diminishing returns

The IEA in the graph shown have set new forecast of oil being around 2.4 mb day off the 2008 mean and around 5mbbld off the heights of 2008,so stability of pricing will be seen to 2010.

This of course means emissions are also less across the OECD as similar trends are seen in combustion electricity production around 13% on December month on month figures as industry slows.This in turn should see carbon offsets trend lower.

This of course allows one to ask the important questions,

1)Do we require a cap and trade or emissions trading market.
2)To what extent will this defacto tax burden exasperate the economic contraction.
3)Do we want financial markets playing in a defacto tax market.


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