Oil Down 11% in First Days of 2007 – It’s Not All Due to the Weather

It has been a rather enjoyable winter here in Boston.  I know several people who still have their golf clubs out and are playing as much as possible.  Although, I am certain that the courses are empty today as there is a nice nip in the air.  Oil has been in a free fall since the summer. The powers to be were intent on getting gas prices down before the elections.  Lower gas prices, they thought, would translate into happy voters.  They were successful in reducing gas prices, but were still thumped in the elections anyway.  Oil prices have accelerated once again to the downside.  It started in mid-December and is down 11% in the first 8 trading days of 2007.  It is easy to blame the mild winter reducing the demand for oil.  However, that is only part of the story.

Apparently, the good folks of Goldman Sachs are at it again.  This summer’s free-fall started around the same time Goldman rebalanced its gasoline weighting in the Goldman Sachs Commodity Index.  A friendly favor to their former boss Hank Paulson? I am sure that they want him look good in his new position as Treasurer Secretary.  In the old days, it was when E.F. Hutton speaks people listen.  Although, Goldman Sachs doesn’t do much talking – when it in moves its creates a mad rush out of the door.  There are large institutional investors like pension funds and endowments that invest according to its allocation model.  “If Goldman’s model tells them to cut their energy exposure by half, they do it,” says Warren Mosler, president and chief investment strategist of Valence Corp., a multi-billion dollar hedge fund. That is exactly what has happened according to this report from the New York Post.

It might be a better idea to thank Goldman Sachs, not the weather, for the recent plunge in oil prices. While recent balmy temperatures have certainly played a role in last week’s dip in oil prices, a lesser known, but equally powerful, move by Goldman at the start of the year might bear some responsibility as well.

Goldman cut the energy portion by as much as 50 percent in some of the sub-indexes that comprise the widely followed Goldman Sachs Commodity Index, tamping down moves to buy them by large investment funds who mimic Goldman’s index.

The changes took effect this month and apply for all of 2007, a Goldman spokesman said. Crude oil futures plunged 9 percent Wednesday and Thursday to $55 a barrel, before settling Friday at $56.31. The two-day decline was the sharpest since December 2004.

The GSCI is influential because large institutional investors like pension funds and endowments invest according to its allocation model.

I am sure that Goldman has made a mint on oil’s free fall.  After all, they will need to top their last year’s bonuses of a measly $16.5 billion.