Hoarding in Plain Sight: did Strategic Oil Reserves trigger Oil's Parabolic Move?

There is a fierce debate going on at across a number of economic and financial blogs about the most recent price spikei in oil. After years of seemingly orderly increase, the price of oil took off dramatically in February 2007 and even moreso in early 2008, rising from $55 a barrel only 16 months ago to $140 a barrel now -- a percentage equivalent to the move from $20+ a barrel to $55 a barrel in the entire decade from 1997 to 2007.
Clearly, something happened in the last year and a half to cause the price of oil to go "parabolic" -- the straight to the heavens chart that we have seen before in the 1920s stock market and the Nasdaq tech bubble.
For some, it's a simple matter of supply and demand. Others have blamed "speculation." In response to the "speculation" argument, Prof. Paul Krugman asserts that in order temporarily to cause a product to spike in price and try to hold it there, somebody(-ies) must remove physical product from the market. There must be hoarding. No hoarding = simple supply and demand.
Krugman's argument got me thinking: if there were hoarding of oil, where would it be? The answer, surprisingly or unsurprisingly enough, seems to lead directly back to one George W. Bush.

I. Introduction

Prof. Paul Krugman argues that

Speculation can affect spot prices because it takes physical stuff off the market. Argue, if you like, that the inventory data are unreliable, or that stuff is being held in the ground; but don’t tell me that physical quantities are irrelevant.

Although I'm not totally convinced, Krugman's point seems an excellent one. Speculation on Cisco or Google stock didn't cause any actual difference in the price of PCs, routers, or internet usage. Betting on the future price of a physical asset shouldn't intuitively affect the actual price of that physical product.

Usually, the argument about "hoarding" centers on speculators in the futures market, where except for the last week of any futures contract, nobody has to take actual possession of the oil being speculated on. Recently Congress heard testimony from a number of witnesses, some of whom said that current prices were strictly a matter of supply and demand, and some who said that up to $90 of the current price reflected shear speculation. Why the stark differences? Several reasons:
Several reasons

[1] the data on oil stink.
[2] oil is in a completely different category: It's a strategic resource bought and sold internationally. Many countries, either by indifference or design, simply don't provide reliable information.

II. Recent examples of hoarding

But "hoarding" doesn't have to be financial market betting. It can and usually does take the more frequent form of panic buying. For example, a few months ago there were riots in Asia over the soaring prices of rice. And the panic wasn't limited to Asia:

Remember this?:

The panic over global food shortages and rising prices gripping developing nations has spread to the world's wealthiest countries, with giant US-based retailer Wal-Mart rationing rice sales.

Wal-Mart's warehouse chain Sam's Club became the second retailer in
the US to limit bulk purchases of rice this week, citing "recent
supply and demand trends". Earlier in the week, Seattle-based Costco
Wholesale Corporation imposed limits in some stores on bulk rice

It wasn't only rice that was being hoarded. So was wheat:

In the wheat price surge this week, the leading wheat contract in Minneapolis, US, has risen by more than the entire worth of the contract just months ago. Prices rallied by $5.75 a bushel on Monday, being up by nearly 30pc at one point compared with Friday’s close.
Eight months ago on June 19, the lead Minneapolis wheat contract settled at over $US5.00 a bushel.
Panic over commodity shortages continues to emerge as the dominant factor in the global markets, with both end user and speculative buyers of corn, soybean, cotton, rice and a host of other commodities taking note of what’s happening in the wheat pit.
The net result on Monday was new all-time record high prices for corn, soybeans and wheat on the same day.
Sentiment in the marketplace is changing from, 'buying just-in-time' to one of, 'buy what you need at any price' and then to 'buy even more to restock the shelves'.

Those folks who live in areas prone to winter storms are familiar with the pattern: the local weatherman announces ominously that the area might expect 3 to 6 inches of snow, and immediately supermarket supplies of bread and milk are sold out! That is panic buying; that is hoarding.

So, who is a hoarder? A hoarder is somebody who purchases a product not because they need it immediately, but because they fear the price will go up later, the product may be unavailable, or because they want to resell the product to somebody else at a higher price later. That last example is the true "speculation".

In addition to the food panic of a few months ago, there was another example of the hoarder during the housing boom. Now, Prof. Krugman thinks the "hoarding" argument doesn't apply to the housing bubble:

some readers have asked me why my inventory argument didn’t apply to the housing bubble. The answer is that a house is a durable good, which unlike oil, which you have to burn, isn’t used up by the consumer; what we consume are housing services — in effect, consumers rent houses, from themselves if they happen to be homeowners.

But Krugman is, pardon my saying so, simply wrong here. There was in fact evidence of hoarding during the housing bubble: it was all of those flippers who went out and bought multiple condos, intending to turn around and re-sell them all later. Those flippers drove inventory down and prices up to incredible levels, by removing supply from the market. Take away the flippers, and the last couple of years of price increases during the housing bubble simply don't happen.

III. A massive worldwide program of hoarding oil is ongoing, right in plain sight

So, let's accept a few premises: (1) Peak Oil is a correct hypothesis, but (2) even with a long term rise in price, there may or will be countertrend moves (such as the decline in the price of oil from $80 to $55 in 2006); and that (3) there is no inherent reason why the price of oil should suddenly spike parabolically; but (4) to explain oil's parabolic move, there must be evidence of hoarding.

So, is there evidence of hoarding in the oil market? Are there players who are either panic buying for fear that the price will continue to go up, or the resource will be depleted; or else want to hold the product for resale at a higher price later? The answer is a resounding, "Yes", and what' more, the hoarding is going on in plain sight -- and it is a direct response to a move made by George W. Bush.

After releases from the strategic oil reserves following Hurricane Katrina helped to alleviate a vicious price spike that had seen prices rise from $2,50 a gallon to $3.50 a gallon almost overnight, in January 2007 Bloomberg reported that

George W. Bush's decision to double the emergency oil stockpile in the U.S. may help to stem a six- month slide in prices as China, India and South Korea also add to demand by bolstering their defenses against shortages.

Oil gained the most since September 2005 yesterday after the U.S. Energy Department said it will boost the Strategic Petroleum Reserve to 1.5 billion barrels over 20 years. China, where imports rose 15 percent last year, began to fill its reserve in October. India also plans to double its inventories.

The U.S. plan ``helps puts a floor in the market,'' said Antoine Halff, head of energy research at Fimat USA Inc. in New York. ``It creates competition for the same barrels. It tightens the market on top of the strategic reserve builds elsewhere such as China.''

And tighten the market it did:

Oil is trading higher after the U.S. Energy Department announced plans to double the US' emergency oil reserve to 1.5 billion barrels by 2027. Beginning this Spring, this would involve a demand of 100,000 barrels a day. This announcement may just have what it takes to cement the bottom for oil prices.

And indeed rapidly growing nations in Asia emulated the US move:

Several Asia Pacific countries have begun to develop their strategic oil reserves. China plans to have a 800 million barrel strategic reserve to be stored at four facilities to be fully operational in 2008. Reports suggest that China had completed filling a 16 storage tank facility at Zhenhai in October 2006. Japan has a total of 171 days of consumption reserve. Unlike China which specifies the quantity of reserves i.e. millions of barrels, Japan does not report the actual number of its reserves. It is believed that at current consumption rates, 171 days of oil for Japan would correspond to nearly 980 million barrels. India is a new comer in the community of strategic oil reserve holders. It has begun the development of a strategic crude oil reserve expected to be pegged at 40 million barrels. South Korea has a reported size of 43 million barrels, Taiwan 13 million barrels and Australia some 90 days of reserves in addition to over 200 days held in private reserves. Among the ASEAN countries, Thailand recently increased the size of its strategic reserve from 60 days to 70 days of consumption. Singapore has an estimated storage capacity of 31.8 million barrels of crude oil and 64.5 million barrels of oil products.

In January 2007

China has begun operating its first strategic oil reserve, an official in the National Development and Reform Commission said. "China's first strategic oil reserve has been filling with oil and begun operations..." Xinhua said,

The government approved the construction of four national strategic oil reserve bases in 2004....
It has been reported that the government plans to have a reserve of some 150 million barrels of oil.

China added 1.21 bln tons of oil reserves and 697.4 bln cubic meters of gas reserves in 2007, the Ministry of Land and Resources said in a report

China has expanded its plans to include a fifth reserve

The first of a planned nationwide network of tank farms was filled in December in Zhejiang province south of Shanghai.

Once the reserve is fully filled, it is meant to store the equivalent of 30 days of imports, or about 70 million barrels of oil, according to state media.

China's goal is to build strategic oil reserves equivalent to 30 days of imported oil by 2010, says China's top economic planning administration. That's about 100 million barrels based on China's current import level and about 120 million in 2010 based on estimated growth rates.

In addition to the official government reserves,

Under the energy reserve blueprint, a commercial reserve system will be mandated alongside the government's reserve to optimize the structure, Ma said, adding that the government will help State-owned oil companies build the reserves

This new joint government/enterprise strategic reserve plan is the followup to a March 2007 announcement on the construction of a second strategic reserve with an additional 209.44 million barrels.[


The unusual relationship between China's government and China's major oil companies could play to China's advantage in developing reserves. By taking advantage of existing commercial storage capacity, China would require that Chinese oil importers hold a 40 day forward cover.

China isn't the only country to respond to increasing concerns of oil scarcity by creating its own "strategic oil reserve." So has India:

New Delhi: India has raised the size of the first phase of a planned strategic crude oil reserve by 33%, a government source close to the project said on Monday. But an earlier 2010 deadline to raise the storage capacity would be difficult to meet.
A 10-member consortium, comprising firms from Iran, Japan and China, have been shortlisted to build the underground caverns.
“Last week, we took a decision to raise the capacity of (initial) storages to 1.33 million tonnes (9.75 million barrels),” the official, who did not wish to be identified, said.

And so has South Korea, whose oil minister made a prescient prediction:

At the end of last year, South Korea's state oil company had 76 million barrels, or 57 days of demand, in its emergency stockpile. Local refiners had 95 million barrels, or 67 days. The state oil company plans to hold 141 million barrels by 2010, said Koo Cha Kwon, head of Korea National Oil Corp.'s global oil research team.

``The U.S. has taken the initiative and may cause competition among other nations to increase reserves,'' Koo said.

And then there's this:

Iran is in discussions to store strategic oil reserves in China and to build refineries around Asia, Iran's oil minister, Kazem Vaziri-Hamaneh, said Monday, as the country seeks secure outlets for its crude in the face of Western economic sanctions.

Vaziri-Hamaneh said Iran was in discussions to store crude in China, which has been building up reserves in the past year.

"We have some plans," he said at the Asia Oil and Gas Conference in the Malaysian capital. Discussions have revolved around China having a role in storing the strategic reserves, he said.

IV. The Natural Consequences of Oil Consuming Nations simultaneously creates hoards of storage:

In November 2006, The Oil Drum said:

if the US starts to fill it's SPR at 100,000 bd, and the Chinese start filling theirs at 100,000 bd, and this is added to current incremental growth in demand, and the change in purchasing practices of those nations now in depletion, then the drivers to higher gas prices may already be falling into place.

In conclusion, let's bring this right back around to oilman/president George W. Bush, who respondedto Congressional actions to stop adding to the Strategic Oil Reserve (since enacted) as follows:

Bush has resisted calls to suspend the delivery of about 70,000 barrels a day to the emergency stockpile, contending it would have little effect on prices in a nation that uses about 21 million barrels a day, while weakening the nation's energy security. Instead, Bush has criticized Congress for not doing enough to spur domestic production.

To summarize: With the exception of Japan, the 4 of the largest oil-consuming nations of the world, whose total imports approach 50% of the worldwide total, in the last several years simultaneously decided to create or greatly add to national hoards of oil, called strategic oil reserves. By trying to add or create hoards equal to at least 3 months' consumption over a 5 year period or less, they may have added a crucial 2.5% to global demand for oil exactly at the point where supply was beginning to be constrained by the already existing demand.
Considered objectively, the answer to Professor Krugman's question may be hoarding in plain sight.




One thing Krugman said was that Congress finds witnesses to testify before Congress to tell them what they want to hear. Well, that might be true in terms of who they invite but I sincerely doubt experts put their reputation on the line to go before Congress and simply lie (unless they are a corporate lobbyist, then they sure do!)

From the House Subcommittee on Oversight and Investigations they held a hearing, Energy Speculation: Is Greater Regulation Necessary to Stop Price Manipulation? – Part II.

I found in Mr. Fadel Gheit's, Oppenheimer Oil analyst, testimony he addresses these other causes point by point. For example, he says the weak dollar is attributable to about a $10-$15 increase in a barrel of oil. He goes through India/China increased demand, speculators in his analysis.

Then, I hesitate to comment on this part, because I haven't even traded commodity futures, let alone understand this market, but he points out the massive increase in volume of futures trading. Myself, I don't see the correlation to say a tech stock bubble in a company versus their actual product prices increasing for the company is not a physical commodity per say. I also don't see how playing the futures trading game requires someone to hold inventories. I know that's a physical commodity so maybe there is something I'm missing here on oil, but I don't see how the two must follow considering all of the futures trading vehicles. I'll let someone else answer this one but it seems that there are multiple layers of abstractions with all of the methods to trade commodities to separate out the physical commodity from the actual price points out there. To me it's like water in a global oil based economy and when you must have something, you'll be willing to pay anything for it, esp. if a cartel like situation is creating an extortion fee to get it. But does that follow that one must have massive inventories built up somewhere?


Back to the hearing and other reports:

Oil.com analysis paper by Lehman Brothers, has actual supply and demand numbers at the bottom (last page) and they seem fairly inline with each other with certain points supply exceeding demand (a few where demand exceeded supply too). From the title of their analysis, you can see what they think this is, a speculative bubble.

Masters testimony requests a hording investigation, due to referencing a report which he summarizes:

It has come to my attention that some Wall Street Banks are offering commodity swaps based on actual physical commodities

I must recommend this hearing testimony. I've been reading it and there are arguments for all elements in this debacle. Prof. Greenburger, Center for Health and Homeland Security, is the one who lays out the most detailed legislation and policy fixes. I sure don't think they just went and "said" what "Congress wanted to hear", each witness presents some in depth analysis and when you look at all of the commodities futures trading graphs, from almost every witness, it brings home the argument on speculation driving up prices.

I have a side comment, perhaps Krugman, an economist, who lives in the real Supply/Demand world just isn't in tune with fictional money world of wall street complex investment vehicles? Krugman is one intellectual powerhouse, (plus a blogging fool!), but I notice that those debating the causes on oil price spikes on the blogs, well, I'm not seeing too much awareness on all of these new credit swaps and other investment techniques in commodity futures trading. I for one have little clue on all of it, maybe that's the overall case here?

new models

I'm over reading these latest models Krugman and Economists view are working on and also looking at the idea that physical inventories must exist somewhere. I found a pretty good analysis of that on Econ browser from about a month ago.

Then they are saying there is "paper oil" versus the actual commodity and here is their argument for driving up the futures. They are also blaming Iran tankers plus a series of refineries "shut down for maintenance".

I'm now completely confused

another analysis, the convenience yield, but no one so far has convinced me it's not being caused by unregulated speculation, more now I'm just looking at all of the models/math wondering how someone can hide excess supply or manipulate production to make it all fit and can they do that on paper, vs. not in reality.

Speculation nonsense

I trade oil for a lving, and from my perspective, Krugman's argument is correct. You can have all kinds of speculation in futures markets, but when the contract becomes the prompt contract and settles at a price, somebody is taking delivery at that price or a price somehow related to that price.

In markets where there is tons of bullish speculation, the market should be in contango, as players bid up future futures in speculation that prices will rise. At the moment, the oil market is actually in backwardation, at least beyond the end of 2008. That suggest the speculative fervor is actually not that high right now.

Only two things can happen to delivered oil. It can be burned or stored. This post makes an excellent argument that there are significant amounts of storage taking place, and if it is correct, all other things being equal, when those efforts conclude, prices should drop as that marginal demand disappears.

When countries store commodities, they are acting as speculators, but my sense is that the finger-pointing at speculators is not about national reserve efforts but rather some nebulous and evil hedge fund managers someplace. It is silly, and I frankly think politicians use it as an easy scapegoat to escape responsibility for their own contributions to the problem. To that end, the pending legislation to tighten up futures markets is incredibly dumb, and if passed, will only serve to limit liquidity and increase volatility, defeating the purpose of a futures market as a mechanism for price discovery. You won't be able to see it directly, but by weakening the price discovery mechanism, you will create all kinds of bad decison-making and malinvestment.

Incidentally, I thought Masters' testimony was absolute nonsense. He simply doesn't know what he's talking about.

Anon 19:18

I appreciate your compliment regarding this diary's "excellent argument" about hoarding. I gather your criticism is directed towards one or more comments above.

I purposely stayed away from the "speculation" argument regarding futures markets, because I have no expertise whatsoever, whether professional or as an educated layperson, in that area. In various places I have read comments just like yours, and I have also read/heard traders talk about how the futures market "informs" the spot market about price. Personally, I have no clue about that and would welcome any cites to any articles or source material that you may feel is helpful in that regard.


me too

Let's here this other side.

NDD, the reason I put those comments in the first place is the premise of the supply/demand only argument is there must be inventories (or not), so I went looking around trying to determine if this is true or not. We need a futures commodities trader expert on here for I couldn't figure it out so far and more I want an answer for myself.

I don't see the issue of closing the Enron loophole generally. It wasn't there before 2000 and the world was fine. At this hearing we have the CFTC testifying that even in the regulated areas of futures trading they are understaffed and cannot handle the magnitude.

So, what is the issue?

Note that this argument suggests that the ...

... Bush administration decision can be readily defended.

If the actual market for oil is in a position where adding 2.5% to world demand can add something on the order of $50 to the price of crude oil over the marginal cost of production, then shifting the strategic reserve from three months to six months supply is one prudent action to take.

After all, that is just shifting forward the growth in world demand for crude oil by a year or two ... and shifting is forward to a time when total exports are higher than they are likely to be in one or two years.

Hi Bruce

Welcome to EP. Just a reminder if anyone wants to post (anything, including a blog post) and not go into a moderation queue on comments just create an account and stay logged in.

I see you stop by and post and have good insight, we'd love to see more of your thoughts.

Iraq's Reserve

Iraq holds the second largest reserve in the world. At present, about 200 billion barrels of oil. Saudi holds the very largest reserve in the world. Iraq has an abundance of oil and natural gas. Perhaps they can begin to pay back their freedom from Hussein with oil and natural gas.