The price of oil has diverged from fundamentals in such a dramatic way that it is placing our economy at grave and immediate risk, not to speak of the consequences of the enormous, unprecedented transfer of wealth that is taking place.
There are no crude oil shortages. Commercial inventories of crude oil, even excluding our Strategic Petroleum Reserve are 9% higher than they were at the end of last year. Crude inventories increased in seven of the last eight weeks. This past week crude oil inventories jumped by 6.2 million barrels far more than the 1.7 million barrels forecast. Yet prices barely budged below their all time highs of $111/bbl. Gasoline inventories are at their highest levels in the past 18 months.
Geopolitical concerns, though always present and forever overplayed are no more problematic presently than they have been in years past. Supply and demand? Largely adequate supply and diminishing demand. Yet, the price for crude oil continues to escalate to ever higher highs.
Turn on the television or read the papers and the reasons are always the same. The falling dollar (rarely a mention that the price of oil has increased by over 120% over the past 15 months, far more than the dollars the 18% fall over the same period (see "A Short Tutorial on the High Price of Oil and the Falling Dollar," 10/19/07). The dollar weakness can be blamed for much, but hardly the massive and disproportionate increase in oil prices. In addition the economy is slowing markedly and gasoline consumption is being impacted appreciably by higher prices as well as the weakening economy -- Economics 101 prescription for lower oil prices which just isn't happening (today's overall turbulence excepted but still to levels that are historically steep highs).
To better understand what is happening we need a time warp moment. With a tongue in cheek heading -- "Oil Baron Longs for Past, Not Futures" -- Newsday reported on November 2, 1990 -- (yes, 1990. Leon Hess, erstwhile owner of the New York Jets, was Chairman and Founder of Hess Oil & Chemical now known as the Hess Corporation -HES-):
"Leon Hess, whose oil company made more than $200 million by trading oil futures during the Persian Gulf crises..."I'm an old man, but I'd bet my life that if the Merc (the NY Mercantile Exchange) was not in operation there would be ample oil and reasonable prices all over the world, without this volatility" Hess said at a hearing the Senate Committee on Government Affairs held on the role of futures markets in oil pricing."
Ah, but, we are told, hedge funds, speculators, individual investors and even conservative institutional investors such as the CalPERS (the California Public Employees Retirement System) given the risks of the stock market and the disastrous bond markdowns are pouring significant funds into commodities as an asset class. As quoted by Reuters, "the financial flows have been overwhelming the fundamentals of the oil market." The inflows are large and the aforementioned groups are forever cited as the source of liquidity flooding the commodity pits. Yes, but oil continues to go up, up, up while other commodities such as grains have occasional and significant retracements.
But wait, there is a conspicuous absence in virtually all these analyses. Let me explain. In an eye-opening article that surprisingly received little or no attention by our forever somnolent press on issues of oil pricing, London's Financial Times headlined "Brazil Sovereign fund to target currency" 12.10.07. According to the FT Brazil's finance minister Guido Mantega Brazil is to create a sovereign wealth fund with the primary aim of intervening in foreign exchange markets to counter the appreciation of the country's currency.
Now consider the following. The vast transfer of wealth to oil exporters, most especially members of the OPEC cartel are accumulating enormous currency surpluses, permitting them in their own manner, to create sovereign wealth funds, deep reservoirs of cash without oversight, without transparency, without regulatory constraints, without operational standards, without disclosure requirements including conflicts of interest, without being subject to due diligence. This staggering accumulation of wealth has resulted in the formation of such behemoths as the United Arab Emirates with its $875 billion fund, Kuwait $250 billion, Qatar, Libya, Algeria, (coincidentally or not, all members of OPEC) among others and then of course Saudi Arabia whose sovereign fund according to the FT is expected to dwarf that of the UAEs.
Now given the lesson learned from the candid Brazilians, it doesn't take an advanced degree in Rocket Science to begin to discern a relationship between these opaque pools of capital and the otherwise inexplicable price moves in the energy trading pits. Are there valid reasons that underlie high oil prices? One could certainly put forward reasons supportive of strong pricing. But nothing either in demand nor supply nor market dislocation that in any way could reasonably substantiate the exacerbated degree of current price increases other than concerted manipulation toward ever higher prices, pure and simple. If Brazil presumes they can control the value to the Real on world currency markets through their sovereign wealth fund, influencing the price of a commodity, even one as widely traded as oil, would be equally plausible.
Can one reasonably suggest that these massive holdings of capital would not seek to support the price of the primary resource which is the mainstay of their economies by underpinning the price of oil on commodity exchanges around the world? Remember, trading on these exchanges is largely opaque and barely regulated. Anonymity of buyer and seller is easily achieved, especially so in the commodity exchanges outside the U.S. and over electronic traded markets. The way the price of oil is now traded provides it perfect cover to those who have the means and the objective of gaming the system.
Circumstantial evidence, circumstantial presumption? Perhaps. But certainly the logic is inescapable and cries out for congressional hearings on the role of the futures markets and the sovereign wealth funds and their offshoots in determining oil pricing.
Of course, there are many in this oil addled administration who are content with oil prices as they are, given the riches being visited on colleagues, friends and supporters in the oil industry no matter the crocodile tears now, at long last, being shed at the current level of prices. The same is true for too many in Congress especially those from states closely related to the oil and energy industry.
To expect much from this administration and the Congress given its craven obeisance to the oil industry these past years is wishful thinking at best. What is needed is an entirely new approach that needs be defined, ideally in the upcoming presidential debates whereby each candidate defines clearly his policies toward energy, and its consumption.
Certainly a way needs be found to divorce oil pricing from the commodities futures pits or at the very least, that trading on those exchanges become transparent and represent freely functioning markets that are not riddled with conflicts of interest or purposeful manipulation.
Some further thoughts of what might be done in future posts.