Archive for May, 2008

Maphacker 2

Saturday, May 24th, 2008

Ever heard about Arthur Anderson Accounting? The story of Arthur Anderson is quite ironic, as the founder was a believer in high ethical standards. He, however, passed away in 1947. After auditing Enron, Arthur Anderson collapsed as a company in 2002. The company had 85000 employees worldwide.

The big question is, are the Enron and Arthur Anderson scandals isolated events, or are they typical to the industry? I’d say the latter, and what we’ve seen so far is only the tip of the iceberg. Many accountants have become cover-up specialists and agents of negligent or willfull fraud.

The system is broken because companies pay an accounting firm of their choice to certify their statements. Would you trust someone who is paid by me, to tell you the truth about me? Didn’t think so. But if you’re to trust any public company’s earnings report or financial statement, that’s exactly what’s happening. Accounting students learn that “conflict of interest” is a bad thing during their education, yet their entire industry is based upon it!

What should be done about this atrocity? The companies should pay an accounting tax, which the government should use to pay accountants to verify company book-keeping. A random firm is picked to audit every company. The company cannot choose to ignore the audit results and pick another auditor. No more conflict of interest by design. The fraud must end.

Until such a system is implemented, I hereby add The Accounting Industry to the glorious list of maphackers. Reason: It is based on a system that introduces conflict of interest by design, even though a three-liner fix is available. Failure to embrace such an improvement can only be attributed to maphacker attitude.

A note to investors: Protect your money. Don’t trust statements, even though they are endorsed by reputable accounting companies. Arthur Anderson was once reputable too… Think for yourself! There’s a lot of over-stated earnings and mark-to-model assets out there, and those that are supposed to be watchdogs have joined the maphackers. Nevertheless, companies based on hot air and creative accounting will eventually fail.

Maphacker!

Sunday, May 18th, 2008

Maphacker (noun) – A player who uses a hack to see the entire gaming field, giving him an unfair advantage.

The word maphacker is so catchy, though, that I would like to apply it in a much broader sense. I will try to start a trend, and have maphacker become part of our common vocabulary. Also, I will list maphackers as I encounter them.

Now, for the first maphacker I nominated. The American Chronicle printed an article today, which I think deserves to be included into the maphacker category. The reason is simple, failure to look into basic facts that contradict their claims. The article is harmful, since it gives people a false sense of security by claiming there is no underlying problem with oil supply. And thus no reason to change lifestyle.

First, the article claims that oil is no longer traded in a free market that relies on supply and demand. Why? Where are the facts to support this claim? Look at the data from the International Energy Agency: world oil demand Q4 2007 was 88.4 million barrels per day. Supply was at 87.3 mbpd. A shortfall of 1.1 mbpd, which means that inventories are being drained somewhere.

I thought this quote was funny: “Firstly, the Iranian government is hell bent on constructing a nuclear reactor and repeatedly states it craves to destroy the state of Israel. This propaganda accounts for 50% of the price rise in oil and puts a floor under any falls. ” Where did you get your 50% number, Mr. Levy? By the way, I haven’t heard many of Ahmadinejad’s ramblings lately. They were much more frequent in 2006, with the whole Lebanon mess and in the following winter, when several western soldiers were captured by the Iranian coast guard. The oil price was around $60 at the time. You will need to present more hard evidence to make me believe the $65 per barrel increase since then is because of Iran.

“Secondly, expert opinion states China and India are booming and although there is no shortage at the moment, in five years time there will be. Even though most Indians and Chinaness ride bikes or walk.” Consider that 1 300 million Chinese used 7.5 mbpd of oil in 2007, while 300 million Americans burned 25.5 mbpd that same year. Assuming China’s cars have twice the fuel efficiency and that Chinese drive half as much Americans, that still means that most Chinese don’t drive. Imagine what a mess we would be in if they did!

He goes on: “What the so called oil experts do not take into account is economies do not boom forever and recession or inflation will come along and dampen the growth substantially.” Exactly,  recession and inflation will decrease demand. In order for demand to go down, the price must go up. Substantially. At $120 / barrel, we are hardly seeing demand destruction at all. We need to kill at least 1.1 mbpd of demand. However, demand in the oil exporting countries, such as Russia and Saudi-Arabia will probably go up rather than down, since they get wealthier because the price goes up! I agree that the so-called oil experts have a poor track record, though. They have consistently under-predicted the price of oil since 2004, when I started to pay attention to the price of oil.

“Also, many new discoveries of oil will emerge in the next five years that will add to the already enormous amounts of oil still in the ground.” I strongly disagree with this. Have a look at the following graph which shows global oil discovery by year.

Global Oil Discovery and Production by Year

This chart makes things look rosier than they are, because a big fraction (30-50%) is not recoverable, even with enhanced recovery methods and proper oil field management.

“What is the simple answer to end the craziness? The USA government should pass a law that declares every oil contact bought on the mercantile exchanges must be delivered to the buyer and held in storage no longer that 6 months.” In my honest opinion there is no simple answer to this craziness. If the proposed regulations were introduced, I think you would be disappointed with the result. As discussed in my previous post Who’s Driving the Price of Oil Up, the traders who can’t take physical delivery of oil have little influence over the price.

“The fear of enacting the law will be enough to drive the speculators away from the oil market in double quick time. As oil prices crash to around $40.00 a barrel, improving most corporations profits, the stock market prices will go through the roof, helping pension funds and public sentiments. Once again the open road will become the delight of the people that is an intrinsical part of the American way of life. The family can enjoy a car ride out in the countryside or beach without watching in dread as the fuel gauge drops.” Ah, $40 a barrel. I remember seeing that magical mark in the news in May 2004. That was what sparked my interest for this issue. My best guess as to the outcome of your new laws would be that oil would be traded in a different exchange, perhaps in London or Dubai, and perhaps even in a different currency. That could only hurt the US dollar more.

Who’s Driving the Price of Oil Up Part 2

Saturday, May 17th, 2008

Maybe the weak US dollar can explain the recent increase in the price of oil? If this is the case, then the price of oil measured in a stronger currency, such as for instance the euro, should remain roughly the same.

Let’s have a look at it:

From January 1, 2007 to May 1, 2008, the price of oil is up a stunning 86% in dollars. In the same period, the price rose 57%, measured in euros. From this we can deduce two things. First, the weak dollar is clearly an accomplice in the matter. However, we need to find another explanation for the remaining 57% increase measured in euros.

The biggest villain is still at large!

Who’s Driving the Price of Oil Up?

Saturday, May 10th, 2008

I have to admit it: I’m a speculator. I own shares in the United States Oil Fund (USO). I even own call options on USO. Needless to say, I have made a nice return so far.

You have probably heard that speculators are driving the price of oil up.  It’s all over the news. The recent run-ups have nothing to do with fundamentals, it’s all speculation, they say. And it’s not hard to believe. Oil is seen as a safe haven, a hedge against inflation and an ever sinking dollar. Crowds of investors are even buying oil merely a speculative play, in hopes of parabolic price-increases.

But those investors have little influence over the price of oil, because of the way oil is traded. Oil, unlike gold, is not a commodity which is traded directly. You buy contracts for delivery of oil at a specific place and time. The contracts settle at a specific date, at which time you have to take physical delivery of the oil. The current oil price quoted by most media is the June 2008 contract. It settles on May 20. If you’re a speculator, that means you have a few days left to sell your contract.

In order to drive the price up, you need to strangle supply or increase demand. There is no way the speculators can do this. They can get a free ride up along with the price, but they do not affect the settlement price, unless they refuse to sell by the expiry date. One contract is 1000 barrels, so unless you have an enormous basement, this is not a scenario you’d want. In fact, I’d be pretty desperate to sell at any price as expiry closes in.

The only real customers of the oil are the refiners. If they refuse to buy oil at the prices demanded by the speculators, the speculators will surely cave. The reason they don’t have to is that actual demand for oil is high enough that all contracts are bought by refiners.

To sum it all up: No speculator is taking oil out of the market and storing it up for later in some giant tank farm somewhere. It’s the drivers who are driving, literally, the price of oil up. I am biking the price of oil down.

Why am I doing this? The average American is using close to 25 barrels of oil per year (Wikipedia), either directly or indirectly through their lifestyle. That sums up to 1950 barrels over the average life expectancy of 78 years. The good news is that you only need two contracts to cover this. The bad news is that those two contracts are trading at more than $125 000 each. In practice you are shorting a huge amount of oil, and have taken 6 digit losses already. Oil was $60 last year. When I started monitoring it back in 2004, it was because it had broken up above $40, and this made me worried. I’m merely buying protection, and at the same time cutting my own oil costs, because I’m too wimpy to keep shorting my own lifestyle.

The question is: Do you feel lucky?