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Reality Check for Japanese Commodity Price Estimates

by: Darrel Whitten July 21, 2008 | about stocks: DJP / EWJ / GSG / USO    

Darrel Whitten

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The big debate about commodity prices is of course how much speculative/investment inflows have distorted current market prices. According to estimates by Japan's METI and Institute of Energy Economics, the speculative premium is between 30% and 40%.

Using what they call a structural vector price autoregressive model (whatever that is) to analyze the correlation between crude oil supply, demand and crude oil prices, Japan's Institute of Energy Economics and METI (Ministry of Economy, Trade and Industry) has estimated in their 2008 Energy White Paper that the price of crude oil based on the "fundamentals" (i.e., underlying supply-demand) in Q3, Q4 2007 was $50~$60/barrel, while the "speculative" premium was $30~$40/barrel. In othe words, at $125.5/barrel, supply-demand factors accounted for $74.7/barrel of the price, while non-demand factors (speculative premium) was $50.8/barrel, or some 40%.

Using the same methodology, wheat at $7.8/bushel had a speculative premium of $2.7/bushel (34%), corn at $6.0/bushel had a speculative premium of $2.8/bushel (47%), and copper at $8.4 had a speculative premium of $2.0 (29%).

Related Links:
2008 Energy White Paper (in Japanese)
http://www.enecho.meti.go.jp/topics/hakusho/2008/1-1-1.pdf [pdf file]

Japan's Institute of Energy Economicshttp://eneken.ieej.or.jp/en/publication/index.html

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This article has 4 comments:

  •  
    Jul 21 09:37 AM
    Thank you for these insights into METI's thinking.

    The Japanese oil industry seems to have some kind of collective disfunction on its thinking about oil prices. Both of the listed oil producers (Inpex 1605 and Japex 1662) have forecast their earnings this year on prices of $85/bbl and $80 /bbl, respectively, and neither have revised their earnings upward, despite the fact that oil has been above $120 for the entire reporting period (now in its fifth month). I wonder why Japanese oil industry leaders are making analyses so far away from the market price. Can they really hope to prove this is a temporary peak?
    Reply
  •  
    Jul 21 03:59 PM
    ...because when the Japanese oil execs annouce earnings, they can surprise to the upside with oil at $120+ instead of oil at $85, and rake big bonusses.
    Reply
  •  
    Jul 22 03:26 AM
    A couple of points to remember about the Japanese oil industry.

    1) While Inpex forecasts assume a Brent benchmark oil price, the actual benchmark for Japan is Dubai crude. Relative Brent, Dubai crude averaged $118.90/bbl, for a discount to Brent crude of over $4/bbl.

    2) In FY08, of the JPY233 bln increase in sales for Inpex, unit prices accounted for JPY216.6 bln, volume increases JPY48.6 bln and exchange rates (stronger yen) minus JPY31.0 bln. Every $1/bbl annual appreciation in Brent crude oil gives a JPY2.2 bln boost to the company's net income, while every JPY1 appreciation slices JPY2.2 bln off of earnings, i.e., a JPY1 appreciation and a $1/bbl Brent crude appreciation would be a wash.

    3) Nominal earnings are also significantly affected by inventory gains/losses. Inpex uses lower of cost or market average, with cost being calculated by the moving average method.

    Japanese oil firms are notoriously conservative about oil price projections, believing that low balling earnings and beating street expectations is better than high balling earnings, missing street expectations, and then getting beaten up by investors. Unlike European and US oil execs, the top guys do not get megabucks in total comp. In Inpex's case, 13 inside directors (management) got an average of JPY46 million/director, of $460,000 per director (including bonuses). Compare this, for example, to Donald Humpreys, CFO of Exxon Mobile, with 2007 comp and bonus of $2.689 mln and total stock option and other calculated comp of $9.1 million
    Reply
  •  
    Jul 23 10:19 PM
    "Using what they call a structural vector price autoregressive model (whatever that is)..."

    I stopped reading past this point. This is poor journalism at best. If you don't know what the heck they're talking about, there is no use in repeating the information if you can't even vouch that you understand it.
    Reply
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