Streetwise Professor

July 30, 2013

Confusing Correlation and Causation: Shale Oil Edition

Filed under: Commodities,Derivatives,Economics,Energy — The Professor @ 8:03 pm

The FT raises the alarm that hedging by US oil producers will undermine the shale oil boom:

As the US shale revolution transforms global trade in oil, it is also causing upheaval in the derivatives market – and making life harder for America’s shale producers.

The companies behind rising US crude production are selling more of their output in advance to guarantee revenues. That is putting downward pressure on future oil prices – making it harder for those companies to enter crucial hedging contracts.

. . . .

The principal reason for the downward drift in prices, say analysts and traders, is the hedging activities of shale oil producers themselves. As the volume of production in the hands of independent producers grows – EOG, a bellwether independent oil producer, doubled crude and condensate production between 2010 and 2012 – so does their hedging activity.

Um, no.  This is a classic case of someone confusing correlation for causation.  What’s driving down prices is the rise in output: the rise in output is also leading to more hedging activity. Yes, there will come a point where price comes down to a level that some producers will find it better to keep the oil in the ground.  That’s the market in action.

There’s also this fascinating detail:

“There has always been a mismatch between producers and consumers in the futures market, but the increase in production by independents has made it worse,” says Jonathan Whitehead, global head of commodities markets at Société Générale.

Hmm.  Buys and sells are equal in equilibrium.  So just who balances that mismatch?  Think. Think. Think.

Let me venture a wild guess: Speculators?  So you mean that speculators are needed even more now than ever before?  That without speculators hedging would be even more costly, and that would depress oil production?

Who knew?

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5 Comments »

  1. yeah, speculators..

    Comment by Saeco — July 31, 2013 @ 4:11 am

  2. I suppose it is possible but a lot of backwardation is hard to see in this non perishable market, barring stupidities like Keystone induced transport or logistics / storage problems – too much and a lot of independents will just take on spot risk and the users will hold things up in the forward physical market. BTW, if forward prices are lower, and refiners take that up, doesn’t that lower prices for all? Isn’t that a good thing?

    Oh, I forgot: AGW and having your wallet dragged through your GI track at the pump is a GOOD THING, at least according to those who have money or have their jets (Air Force 1) fueled at taxpayer expense.

    Comment by sotos — July 31, 2013 @ 6:49 am

  3. “There has always been a mismatch between producers and consumers in the futures market, but the increase in production by independents has made it worse,” says Jonathan Whitehead, global head of commodities markets at Société Générale.

    The only plausible explanation of what he is trying to say that I can think of is that there has always been mismatch between the risk aversion of producers and consumers, which can explain the volatility skew in most of the commodity markets.

    Otherwise I don’t understand what he is trying to say.

    Comment by MJ — July 31, 2013 @ 7:49 am

  4. He’s right, surely?

    If you look at oil, almost every offtaker is a hedger with the exception of ExxonMobil. But by no means all producers are hedgers – the Russians don’t hedge and neither does any GCC member of OPEC last time I looked. So maybe 80% of the buy side wants to hedge but only 55 or 60% of the sell side wants to.

    Ignore the %ages, they’re indicative. You get the gist.

    So yes, the natural long opposite the surplus of futures sellers is the speculator.

    If there are more gas sellers coming along, and few hedge, then you’re going to see what he envisaged.

    Comment by Green as Grass — August 1, 2013 @ 10:08 am

  5. @Green – the short side hedging imbalance has been the conventional wisdom since Keynes. It’s different in electricity, but in most storables the imbalance is on the sell side.

    The ProfessorComment by The Professor — August 1, 2013 @ 8:33 pm

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