A non-conspiratorial explanation of oil's price history

As you're probably aware, oil this year surged to $147 a barrel and then fell to, as of today, about $40 -- over a 2/3 drop in less than six months. And its peak was over a 100% increase from the previous year. With a lot of the decline shortly before the election, this roller-coaster ride has prompted quite a lot of conspiracy theories.

Well, recently on another (private) forum, I summarized the significant reasons why oil acted like that, without reference to any conspiracy. I'll repeat it here:

1) China was buying a lot of oil and stockpiling it. Unlike the general "growth in emerging markets", this actually came as a surprise to a lot of speculators, which is why it was such a fast rise instead of a gradual one since 2000. China was doing this in order to burn less coal and make the air cleaner for the Olympics. Now that that's over, a significant source of demand is gone.

2) Because of the credit crunch, speculators were significantly less able to borrow and bid up the price of oil. Once it hit, they had to significantly unwind their positions.

(Now, I'm all for the right of people to make speculative purchases; however, what we had there was *far* from a free market. For one thing, the government's bailing out of banks that had hedge funds doing the speculating, eliminated the strong negative downside to hype-based, stupid speculation. Also, a lot of the *naked* shorts and longs were very corrupt where if one party lost money, the brokerage would act like it can't find the original contract and try to reverse the sale. Things like this artificially amplified the price premium due to hype [as opposed to rational estimations of future developments] and crowded out wiser investors.)

3) The global economic downturn significantly revised investors' estimates of future oil demand.

4) The president's, and then congress's, termination of the ban on offshore drilling also significantly changed expectations about future oil availability. These helped prod oil down.

So why aren't you shorting GM, liar?

With all my doomsaying about GM, all my warnings about the emptiness of their warranties, shouldn't I be taking action based on this certainty? Well, good point. In strategizing about the implications of my pessimism for my next portfolio decisions, I forgot to include GM, mainly because I associate "short-selling" with "risking being screwed by a dead cat bounce.

But you don't have to do it that way. Instead, I can just buy some long-term, far-out-of-the-money puts. Check out this list for GM options expiring in January '08. My eyes are on the $2.50. Bonus: I can dump the options if some news temporarily makes the value surge.

Another bonus from using this method: No ill will from my brother :-P

And to *double* the stakes on oil ...

Well, a little googling got me a blog post from Pacific Park Financial that lists leveraged oil ETFs, which they warn as being "not meant for buying-n-holding; rather, they are meant for making a calculated bet and exiting when you've reached your profit target or stop-loss." (emphasis mine)

A calculated bet? Oh, we can do that.

The one I'd be interested in here is DXO, which makes a leveraged long bet on oil, attempting to replicate 2x the gain/loss of oil. Unfortunately, it hasn't been around long (just over a month), but this chart, which I hope you can see okay, shows it neatly getting double the return on the security OIL.

If oil (no caps) merely returns to what it was three weeks ago, that's a nice 30% return for me. But of course, the whole point of the bet was that fate doesn't work like that, and my bad luck will thus drop oil's price even more forcefully.

Perhaps with a li'l work, I can find a different oil ETF that amplifies the return, but has a longer history. Or, switch gears entirely and try to use my luck to bring down an entire commodity index, rather than just oil.

Stay tuned. (archaic expression from they days of radio when they wanted you not to tune to a different station)

To invest in oil, invest in OIL

A reader who wished to remain anonymous suggested to me that if I want to go long on oil (so as to make its price collapse and end the suffering), I should take the route in plain sight: buy the ETF with ticker symbol OIL. Apparently, its value stays very close to 1.68 times the current spot price of oil. In fact, since neither Yahoo nor any of the finance sites I go to actually let you chart the history of the price of oil, you should use that chart when you want to compare something to oil's price history.

(The reason is that the quoted price of a barrel of oil is actually the price for a delivery in the near future, so expanding the time history of that just gets you the price of a briefly-traded security. But when you want the *history* of oil's price, you don't want a plot of the price of an "August 08 delivery"; you want a plot of "August 07 delivery as valued in July 07, September 07 delivery as valued in August 07 ...".)

Why you'd want to remain anonymous about that, I have no idea. :-/

Should Silas hammer down oil prices?

If you haven't been living in a cave for the last six months, you've heard the big debate about whether we're in a speculative oil bubble. Whether the claims linked (which should guide you to a good discussion of the issue if you follow the links contained therein) are true, I will not comment on.

However, I do have good reason to believe that I have natural "bad luck". I won't get into any specifics, but I have been in the following scenario too many times to have kept count:

Helpful person: Oh, you want to accomplish X? Oh, just do Y, no problem.
Me: I did Y, and Z happened.
Helpful person: WTF????? That's supposed to be like a one in a million event!! That's just not supposed to happen, no no no, I refuse to believe that. That sure must have sucked if it did, but you must be making that up.

So, I was thinking ... should I channel this bad luck for the good of humanity? For example, all I'd have to do is take a good chunk of my portfolio, and use it to go long on oil (i.e. invest in such a way so that it increases in value if oil's price goes up and vice versa). Then, my bad luck attractor would cause oil's price to collapse.

Pros: End pain on the billions of people who buy oil-related products, including the people in countries suffering food riots.
Cons: Would cost me a few thou.

So far, not doing it looks like the more attractive option.

Now, there's a clear potential for pareto improvement here (I take paypal, thanks), but then, maybe creating an explicit contract with me to make up my investment losses would "tip off fate" and make the trick not work. So perhaps I need only vague, unofficial promises to treat me like a king for killing the oil monster? Share your thoughts.