Tuesday, February 12, 2008

Attention: Oil Is Fungible

I believe that the oil price will soon increase as the market's fear of the effects on oil demand of the U.S. recession will turn out to be exaggerated (as it overlooks the continued strong demand in China and elsewhere), and so do not really think that the oil price increase of the last few days is unjustified per se, I do think that one of the cited reasons is nonsensical. It seems that all too many people fail to grasp the concept of fungible.

There is currently a battle between Venezuela's infamous ruler Hugo Chavez and the company of Exxon. Chavez has nationalized Exxon's assets in Venezuela, which prompted Exxon to retaliate by seeking court orders freezing Venezuelan assets in other countries. Chavez is so upset by this response from Exxon that he has now threatened to cut of oil exports to the United States, a threat which is now causing the market to bid up the price of oil.

What Chavez fail to grasp is that the only way this is going to have any affect at all on the U.S. is if he refrains from selling the oil he now sells to the U.S. to anyone, which is to say if he sharply reduces overall exports and production of oil.
And even then he will hurt himself a lot more than he hurts the U.S. as his socialist state is dependant for its survival on oil revenues while the U.S. would only be slightly damaged by this (And they would really be no more damaged than other oil importers such as the EU, Japan and China). If on the other hand (as seems likely) he starts selling that oil to someone else, all this will mean is that some other oil importer will buy less from other oil exporters. These other oil exporters will then sell their oil to the U.S., causing no net change at all in the U.S. access to oil.

It is perhaps not surprising that someone like Chavez doesn't understand such basic economic principle. Slightly more surprising is the fact that market participants does not seem to understand it.


Anonymous pinus said...

In addition to that, Chavez does not have too many counterparties to seel to. U.S. is one of the few countries which can process the lower-quality Venezuelan oil in their refineries.

1:32 AM  
Anonymous pinus said...

seel = sell, sorry for the typo ;-)

1:33 AM  
Anonymous newson said...

i'm not sure that oil is as fungible as you'd like to imagine. refineries are geared to specific types of crude oil, and the us is particulary geared to the venezuelan grade of heavy and sour crude. changing grades is extremely costly and requires re-jigging cracking processes.

5:57 AM  
Anonymous Anonymous said...

I hope the next US move will be to tell Chavez "you will no longer take advantage of our monetary policies because we are going to be serious about monetary expansion even at the cost of a recession". Foreign policy is nice: China is funding US interventionist policies worldwide and the US are pushing up the revenues of Chavez, Ahmadinejad and Putin... :-)


10:31 AM  
Anonymous newson said...

postscript: i should have said that that the us is particularly vulnerable to these sort of threats because of the tightness in their refinery capacity. changing grades would necessitate lead times and might see huge spikes in domestic gasoline prices.

3:28 PM  
Blogger stefankarlsson said...

Actually, there's plenty of sour crude oil outside of Venezuela. Most oil from the two biggest oil producers, Saudia Arabia and Russia is sour too, making the Venezualan sour crude quite fungible.

10:46 PM  
Anonymous newson said...

it's not the sourness, but the heavy, tarry nature that distinguishes the lower grade, venezuelan crude. during the 2002 strike in venenzuela's national oil company, heavy grades of maya crude were substituted. these days, with mexico's cantarell field hitting a brick wall, this would be difficult.
also the middle east is 45 days from houston versus 6 from caracas. could make for a squeeze in us gasoline market. obviously, chavez' madness will be accomodated, but short-term it could get interesting.

12:36 AM  

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