Skousen: Oil Prices—Market and Manipulative Forces at Work

World Affairs Brief, June 13, 2008. Commentary and Insights on a Troubled World.

Copyright Joel Skousen. Partial quotations with attribution permitted. Cite source as Joel Skousen’s World Affairs Brief

OIL PRICES: MARKET AND MANIPULATIVE FORCES AT WORK

The price of oil and gasoline continues to rocket upward even as demand for gasoline wanes. Miles driven by American motorists have actually dropped over 4% compared to last year.  High gasoline prices are having their effect and there is still a lot more cost cutting to come as people scramble to buy more fuel efficient vehicles.   Overall, demand for oil is increasing, but the rate of increase is slowing, even in China and India where the masses are finally now beginning to have access to personal vehicles.  Sadly, the budding personal car movement in third world countries is about to be snuffed out as rising prices threaten to dampen demand for all but the wealthy.  There are definitely some pernicious, non free-market forces at work here as the demand curve for oil is nowhere near as steep as the rising price of oil.  This week I’ll help you analyze what is happening.

According to CNN Money, “The U.S. Department of Transportation said Monday that Americans drove 11 billion miles less in March 2008 than a year earlier, marking the first time that estimated March travel on public roads fell since 1979. That 4.3% decline is the sharpest year-on-year drop for any month in the history of the agency’s reporting, which dates back to 1942.

“According to the Energy Information Administration (EIA), a unit of the U.S. Department of Energy, gasoline demand has fallen 0.6% so far in 2008. The trend began in October 2007, and gas consumption has trailed year-ago levels in every month since, except for a very slight bump up in November. As a result, the EIA is forecasting the first year-over-year decline in U.S. gasoline demand since 1991.”

So, if demand is falling, why are prices still rising almost 10 cents a week, and in such a coordinated manner?  As I explained a few weeks ago, most drivers are not in a position to change their commuting habits.  It is locked into our suburban lifestyle.  The manipulators who are driving prices upward are doing so knowing that buyers have little choice but to keep buying at almost any price.  We are hostages to our work and living habits, which we don’t really want to change.  Even though urban living close to work has it’s advantages, it is a death trap during major crises when urban services fail and panic ensues as people have no fallback position for personal self-sufficiency.

For almost 10-20% of the US population, that limit of fuel affordability is fast approaching or is already past.  I fully expect to see a rash of credit card defaults in the next two to three months. Everyone is putting their gasoline purchases on their credit cards and they will not be able to pay these bills at the end of the month.  Their revolving credit will keep rolling over at 18-21% interest rates until they cannot make the payments.  I estimate that most commuters are having to add $150 to $200 a month to their accounts.  That’s on top of their normal $400-500/month they are already paying for fuel.  How long can this last?

Gasoline purchases are eating into the disposable income of even the middle class.  The retail economy is starting to feel the pinch as buyers get more scarce and have less to spend.  The only exception seems to be teens who are still spending with abandon on their parents’ dime.  Their time will come too. One older friend mentioned that it felt like the 1920s to him–with people still living “high on the hog,” but just a few years away from having to make radical changes in lifestyle that will last for decades and ultimately end in another world war.  He may be right.

So, who sets the prices of oil? Yes, sellers are demanding huge premiums for oil, using “peak oil” as an excuse.  Yes, peak oil does exist as far as existing oil fields are concerned, but as I have also written elsewhere, there are huge deposits here in America that the government, in collusion with environmentalists, is keeping off the markets.   That’s one side of the manipulation. Even though it is a seller’s market, both sellers and users set the price–and there is yet another demand factor that is part of the manipulation: speculation.  Almost 70 percent of those who bid on oil contracts are deliberately trying to drive it upward in a mass speculative move to use otherwise falling dollars to gain a profit.  For this we have our own government to blame for debasing our currency.

Oil prices are more affected by the futures market than direct purchases by consumers based on current needs. Futures markets were developed a long time ago as a way to hedge against shortages and price volatility of commodities like oil.  Users whose entire business model depends on a steady supply of oil such as refiners and manufacturers who turn oil into byproducts like plastics, tires, and hundreds of other products, cannot afford to run short.  They buy futures contracts to ensure that supply.  Southwest airlines, for example, has done better than other airlines precisely because of the prudent use of futures contracts giving them a cheaper supply of aviation fuel.

It used to be that only oil companies and end-users bid in these markets, but now fully 70% of the market is dominated by speculators who deal anonymously through special confidentiality rules created by the Commodity Futures Trading Commission (CFTC).  We are also dealing with a group of “index traders” like pension funds, university endowments and other big institutional investors who look for markets that are going in one-direction for long periods of time. They move in with long positions to capitalize on the proposition that a “rising tide lifts all boats.”

According to the Washington Post, “Hedge funds and big Wall Street banks are taking advantage of loopholes in federal trading limits to buy massive amounts of oil contracts, according to a growing number of lawmakers and prominent investors, who blame the practice for helping to push oil prices to record highs.  The federal agency that oversees oil trading, the Commodity Futures Trading Commission, has exempted these firms from rules that limit speculative buying, a prerogative traditionally reserved for airlines and trucking companies that need to lock in future fuel costs [This was not accidental.  The CFTC is staffed by people hand picked by Wall Street insider brokerage firms–the same ones that have insider dealings with the secretive US plunge protection team].

“The CFTC has also waived regulations over the past decade on U.S. investors who trade commodities on some overseas markets, freeing those investors to accumulate large quantities of the future oil supply by making purchases on lightly regulated foreign exchanges. Over the past five years, investors have become such a force on commodity markets that their appetite for oil contracts has been equal to China’s increase in demand over the same period, said Michael Masters, a hedge fund manager who testified before Congress on the subject last month. The commodity markets, he added, were never intended for such large financial players.”

One of those lightly regulated foreign exchanges operates right out of the US in Atlanta, Ga. According to Kevin G. Hall of McClatchy News,  “Much of Tuesday’s [Congressional] discussion focused on the unregulated oil market in London, the Intercontinental Exchange, or ICE, which is an electronic trading platform that is actually headquartered in Atlanta. About 30 percent of global crude oil trading happens there, and despite U.S. ownership, the CFTC has chosen to let England regulate that market. England’s regulatory scheme is far weaker, and critics contend that this so-called ‘dark market’ allows prices to be driven up.”

The key leveraging factor for driving up futures prices is market instability.  Futures markets are based on uncertainty. When uncertainty goes up, so does the price one is willing to bid to ensure a supply of fuel in future contracts.  Prices can be bid up to many times their value, especially if you have countries and speculators entering the markets with large caches of dollars.  Add to this the ability to buy on tiny margins of 2-3% created by the CFTC in late 1999 and the speculators can sway the markets in a massive way.

How is the rise in oil prices related to the rise in money?  How can inflation of 3% explain a 7 fold increase in the price of oil since 2001?  It can’t–even if you take into account the government’s purposeful manipulation of the CPI downward to hide the true inflation rate, approaching 10% per annum.  There is a difference between price inflation and monetary inflation.  Price inflation lags monetary inflation.  Also, in past years when the world economy was loading up on dollars, our government was able to export inflation abroad without affecting domestic prices much at all. Now that the world is awash in dollars, its value is falling fast and inflation is hitting home with a vengeance.  The more world-wide holders of dollars seek to unload excess dollars by buying American products, property, or oil futures, the more we will see growing price inflation.  But the ultimate cause is government dilution of the dollar by money and credit creation.  Blame government for rising prices–not the free-market which is only responding to a devalued monetary unit.

In addition, we are having to deal with the speculator’s future expectations of monetary inflation.  Speculators don’t really believe all the calming assurances of the Treasury Department and Federal Reserve relative to the current debt crisis.  They know that the US will keep pumping billions into the faltering economy and that spells a weak dollar-so they are betting against it.

As Paul Craig Roberts noted, “By pumping out money in an effort to forestall recession and paper over balance sheet problems, the Federal Reserve is driving up commodity and food prices in general. Yet American real incomes are not growing. Even without jobs offshoring, US economic policy has put the bulk of the population on a path to lower living standards.”

We have thousands of big dollar speculators moving into the oil market and creating another bubble there as they exit the falling debt bubble.  They may even be using bailout money from the fed to do this.  They are joined by agents of China, Europe and Japan who are also looking for places to dump dollars fast before it devalues itself even more. There’s a multiplier effect working here as well.

However, this oil bubble can’t go on forever.  The speculative portion will burst at some point, even if real demand is still increasing.  Like all bubbles, it will someday leave a some of the speculators holding the bag of high priced contracts and a temporary oil glut.  But before that hits, you can bet the insider traders will pull out at the high point in the market.  Indeed, if there is coordinated speculation by insider traders, they can even precipitate the fall by exiting the market. Sadly, even with a significant correction in the price of crude, I can’t see gasoline prices retreating more than 10-20%.  People get used to high prices, and will think they are getting a “bargain” if gasoline drops back down 50 cents or so.

There are other manipulation factors as well, especially in gasoline prices.  The major oil companies have purposely kept refining capacity low so they could eventually manipulate the price of fuel.  Now that demand is dropping, rather than keeping the output high so that prices can come down, they are cutting refinery output.  Refining capacity is down in the 80-85 percentile level, compared to 95% plus just last year.  Refiners have also stopped importing gasoline so as to keep supplies tight.  There is a surplus of gasoline refining capacity in other countries–which are switching over to diesel.  But, the US isn’t buying this excess gasoline.

I don’t think we can expect anything but verbal outrage from Congressional investigators–if their dismal performance at a hearing before  big oil company executives is any example.  Despite all their blustering on behalf of consumers, this week Senate Republicans killed legislation that would have eliminated billions of dollars in federal subsidies for the oil and gas industry.  Incredible! Few Americans realize that despite record profits the oil companies are still receiving subsidies which Congress refuses to cut.  Sure, the bills contained all kinds of unwise incentives to force companies to invest in “renewable fuels” like ethanol–perhaps the worst of the interventions in the markets we have seen to date.

Ethanol production is gobbling up over 30% of corn crops in the US and depleting food supplies to dangerous levels–and it takes more than a gallon of fuel to produce a gallon of ethanol.  Other food products like wheat are also rising in response to the corn shortage.   Farmers are still clamoring for their subsidies even as crop prices rise dramatically.  Of course, the price they are paying in increased diesel fuel is probably offsetting those subsidies substantially.

As Kevin Hall reported, “The announcement [of a Congressional investigation] came as a special advisory committee went before the Commodity Futures Trading Commission to discuss ways to make the oil markets more transparent. Increasing reporting requirements and other transparency measures would reduce concerns that oil traders are manipulating the trading of contracts for future delivery of oil, called futures, in ways that drive up oil prices.

“Critics dismissed the task force as a public relations move that won’t lower prices. ‘That’s a great way to appear to be doing something when you are not,’ said Michael Greenberger, a University of Maryland law professor who was the CFTC’s director of trading during the Clinton administration.”

More telling of the control insiders will exercise in this so-called investigation is in who will make up the committee. “The new task force will include representatives from the Federal Reserve, the Treasury Department, the Securities and Exchange Commission and the Departments of Energy and Agriculture.”  The foxes are guarding the hen house.

In summary, we are dealing with market forces, speculation, and outright manipulation in the oil markets, and I suspect government is part of it–looking the other way.  Bill Chilton, one of the few honest CFTC commissioners, also suspects something is wrong as well when he says that “The leaders of Saudi Arabia have said that today’s high prices aren’t justified by market fundamentals–and I think the Saudis know a little bit about the oil markets.”  So do I. But they are not free to tell all.

The Saudis and other Arab leaders were allowed to stay on the throne after expropriating and nationalizing Anglo-American oil interests by promising to always keep the West amply supplied, and to do their financial dealings with American and British controlled banks in dollars.  That is one of the reasons why Saddam still had 50 billion dollars in US banks when the US invaded. That money is still being held hostage to force the current Iraqi government to bend to US wishes in the region.

Related:

Joel Skousen discusses how oil prices are determined & manipulated with Dr. Stan

Skousen: Gas Price Manipulation—Public Needs to Demand Opening of the Gull Island Oil Field (Alaska)