The Weekly Wrap — April 20, 2012

The million-reason volatility of oil prices: Ever wonder why oil and gasoline prices seem to go inexplicably up, and just as mysteriously down? One reason you are so baffled is that experts themselves provide definitively certain yet quite distinct explanations for these phenomena. Take yesterday at FP for example. On this blog, I suggested that supply, demand and geopolitics are the prime movers. In a piece just a few column inches away, though, three academics — Bernard Haykel, Giacomo Luciani and Eckart Woertz — asserted categorically that Saudi Arabia decides prices and, if it wished, could take them lower.

Following these pieces, other experts naturally emailed with their own explanation of what we are seeing (such as high prices in Pakistan, the scene of a protest pictured above). Below I am reprinting a sampling with the authors’ permission.

Philip K. Verleger, PKVerleger LLC:

You are looking for the forces moving crude prices in all the wrong places.

The individuals who buy crude know that product prices [such as gasoline and diesel] are set not by crude, but by supply and demand [for products themselves] in the marketplace. Thus, they will look to the value of crude as evidenced by the marketplace [for products] to determine how much they will bid for crude. When product prices rise, they bid up crude prices — especially the crudes that produce the most desirable products such as diesel. For example, the European Union shift to ultra-low sulfur diesel pushed up diesel prices in 2008.  Then Nigerian [oil] production fell. Nigeria produced the crudes that produced the most diesel. Product prices rose, and bidders chased crude higher.

This year it has been gasoline. In case you missed it, gasoline prices are plummeting in the spot market — and crude is following.

Let me add that these traders do not chase crude up unless they have a buyer. A cargo can cost $100 million to $150 million. At these prices no one — and I mean no one — chases crude higher. You need to sit at the desks with physical traders at a trading company for a day.

Now I know my view does not conform. However, I have pushed it since 1981 and have been right most of the time. If you go to www.pkverlegerllc.com, you will see our estimate of the value of light sweet crude. We post it every day. This is the value of Brent crude. This forecast is generated on a daily basis using only changes in product prices. The model has no error correction, and the last information on crude prices I fed to it was for January 1, 1997.  Wednesday’s forecast was the 3,833rd data point.

Crude tracks products closely except when there is a refinery upset. The model corrects when the upset ends. The only way to send crude higher is to put out a fear of shortages, and panic consumers into buying more gasoline.

Go to the Jump for more on oil prices, and the rest of the Wrap.

Chris Weafer, chief strategist Troika Dialog Bank (Russia):

The oil price is going down because OPEC and Saudi Arabia are paranoid that the price will spike up and collapse, as in 2008 and in 1997. And they are desperate to get it back towards what they see as sustainable $100-a-barrel Brent. That also suits Russia.

Saudi is afraid about a repeat of the second half of 2008 — that high oil prices encourage big investments in alternative fuels. But they don’t have a single barrel of spare [production] capacity irrespective of geology. And they do not want to spend another dollar [to build more capacity] without an investment case. Without knowing U.S. plans for shale gas [development], i.e. what demand will be in the long term, Saudi cannot justify high capital expenditures over the short term. It is all about the normal demand-supply formula — you can’t justify spending to raise supply unless you have surety about demand.

So [Energy Minister Ali] Naimi is trying to scare the price lower. But traders know the reality. The market is a lot tighter than OPEC is saying.

Being Aubrey McClendon: Chesapeake Energy has long seemed a strange beast. Its shark-like founder, Aubrey McClendon, led the massive U.S. push into shale gas, then oddly stiff-armed Washington’s clean-energy lobby, which promised long-term demand support for the fuel, as we have discussed. Now we learn through a Reuters scoop that McClendon has been playing his own parallel investment game in his publicly traded company (think Russia, think oligarch): He has used his position as CEO to buy 2.5 percent personal stakes in every well that Chesapeake drills (the stakes are bought under a company covenant called the "Founders Well Participation Program."). Over the last three years, he has also borrowed $1.1 billion from Chesapeake partners to finance his holdings. Though his spokesmen and lawyers deny it (statement below), this is a prima facie conflict of interest: McClendon is 52, meaning that he arguably could retire in the next 13 or so years, while the investment decisions of oil companies are generally made on three- and four-decade timelines. McClendon is a gambler, and not always a good one — he has required bailing out by Chesapeake’s board: In 2008, he had to sell out of $569 million in company shares bought on margin, after which the sympathetic board granted the financially bruised CEO a $75 million bonus, plus $12.1 million for his neat map collection.

The market is punishing Chesapeake: After the Reuters piece hit, the company’s share price plunged by almost 10 percent before recovering to just a 5 percent drop. Traders sometimes, but do not always, appreciate an energy company operated at times according to the eccentricities and personal interests of its CEO. For more, read this piece by Forbes’ Chris Helman.

I emailed Chesapeake spokesman Jim Gipson, and asked whether McClendon might have a conflict of interest since his investment horizon and that of the company might differ. Gipson replied: "Greetings Steve — I can’t speculate with you today. What we have to say about the issue, including answers to dozens of questions, can be found here: http://www.chk.com/Reuters."

For convenience’s sake, here is a statement from Henry J. Hood, Chesapeake’s general counsel, as posted at that site:

The Founders Well Participation Program (FWPP) has been in place since the company’s founding and was reapproved by shareholders by a wide margin in 2005. The terms and procedures for the program are clear and detailed in every proxy for all shareholders to see. Mr. McClendon’s interests and Chesapeake’s are completely aligned. In addition, there are numerous third-party participants in the company’s wells, including some of the largest energy companies in the world, that monitor the actions of the company through a number of processes, including well audits, reporting, governmental filings and hearings, participation in development plans and marketing of production. The suggestion of any conflicts of interest is unfounded.

The Board of Directors is fully aware of the existence of Mr. McClendon’s financing transactions and the fact that these occur is disclosed in the proxy. Additionally, the total amount of his cost obligations and revenue attributable to the FWPP for each year are detailed in the proxy. The Founders Well Participation Program fully aligns the interests of Mr. McClendon with the company and the Board of Directors supports this program as does the majority of its shareholders.

The new world for clean energy: A new report by the Brookings Institution remarks on an inflection point for U.S. clean-energy technology — either the American public renews its support for cleantech subsidies, or numerous companies will fail, the U.S. will cede "this major 21st century industry to competitors in Asia and Europe," and reliance on dirtier fossil fuels will go on as far as the eye can see. Called Beyond Boom and Bust, the report (put out in conjunction with the Breakthrough Institute and the World Resources Institute) urges Congress to reform and extend billions of dollars in subsidies, two-thirds of which are to expire by the end of 2014.

Clean-tech is under a perfect storm of challenges around the world: Subsidies are under threat or have already been withdrawn not just in the U.S., but in Spain; U.S. and German companies are in trouble because of competition from China; meanwhile, a surge in oil and natural gas discoveries has undermined the peak-oil rationale for cleantech development. Solar and battery companies are dropping like flies.

Only in China do cleantech companies seem safe. Otherwise, cleantech does seem at an inflection point, which is that it must establish a rationale on its own merits. It must persuade the public not that the world is running out of oil, that China is about to eat the West’s lunch, or that cap-and-trade is needed to save civilization. Instead, the industry must show that clean is simply better.