Real Reasons for $88 a Barrel

Every time the price of oil goes up $3 or $5 a barrel, analysts point with alarm to Iraq, Iran, Venezuela or Nigeria.
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Oil briefly touched $88 a barrel today with Turkey poised to approve military raids inside Iraq against Kurdish rebels. Oh, what rubbish.

Every time the price of oil goes up $3 or $5 a barrel, analysts point with alarm to Iraq, Iran, Venezuela or Nigeria. In today's case, no incursions have happened yet, Turkey is still subject to international pressure and the oilfields of Kirkuk are as far from the Turkish border as you can get inside Iraqi Kurdistan (even if Iraq was providing a dependable oil flow to the rest of the world, which it isn't).

The finger-pointing at unrest here and a worker strike there is just avoidance of the fact that oil is far more expensive than market fundamentals can support. (I do credit the analysts who are finally saying this, if not getting to the root of it.)

So what is this upward race about?

Start with speculative trading.

During a Senate hearing on oil prices last year, the Senate Subcommittee on Investigations concluded that speculative energy trading drives up the price of oil, and a staff report endorsed analyst estimates that speculation may account for $20 of a $70-per-barrel oil price.

The subcommittee chairman, Sen. Carl Levin (D-NY) is backing a bill repeatedly submitted by Sen. Dianne Feinstein (D-CA) that would restore oversight of unregulated energy trading. The bill, fittingly titled the "Close the Enron Loophole Act," has only a snowball's change until the White House changes hands, but would sharply cut speculative trades if enacted.

Even if the trading in futures markets were benign, the trades themselves add to price. Every trade has a cost built in, and every gallon of oil is being traded multiple times.

From the NY Mercantile Exchange website: "Crude oil is the world's most actively traded physical commodity. ...The futures contract is the most liquid trading instrument for crude oil, with daily trading volume averaging the equivalent of 230 million barrels of crude, approximately three times physical daily output."

I'm sure the numbers are up from whenever that was written, since the Nymex just reported 13% year-to-year increase in business. Aside from the transaction cost, the dollars thrown into futures trading keep rising, and the amount of oil available is pretty much static. Econ 101 says that prices rise as more money chases less product, and I'd be happy to hear why that's not even partially true in the futures markets for a physical commodity.

Even more interesting is a theory I heard from Marc Cooper, the deep-digging energy analyst for the Consumer Federation of America: It's also OPEC and the Big Oil oligarchy going back and forth over who's taking whose profit.

I'm leaving out some of the technical language and doing some paraphrasing, so apologies to Marc if I get any part of this wrong. But it goes like this:

OPEC is a cartel that asks themselves what they can charge for oil that comes out of the ground for maybe $10-$20 a barrel. They see U.S. oil refiners pushing up the price at the gasoline pump and keeping $30 a barrel for profit, as they did this spring, and figure, "Hey, the refiners are taking our share."

So now, OPEC has taken back a significant 25 cents a gallon worth of the economic rent that the oil companies were collecting--and the oil companies and refiners have reduced their windfall share of last spring. That'll obviously be reflected in lower 3rd quarter oil company profits. Americans will pay $3.00 for gasoline and not like it, but there won't be barricades in the street or global recession--the things that would scare the Saudis.

That is not commodity trading at work but it's not simple competitive market behavior either.

It's a back and forth between OPEC, the cartel, and oil, the oligopoly. All of it is effectuated by the mechanism for setting the economic rent, the Nynex spot market.

There are not economic fundamentals behind the price of oil. If there were not a crude oil cartel and an oil-company oligopoly, the cost of producing a gallon of gasoline would be about $1.50 including a decent refining profit. Anything above that is baloney.

Tight oligopolies (like the oil business) and cartels price politically, as with last year's election pricing. Since next year is an election year, it's not clear how hard the oil companies will push to restore their big refining margins.

No matter what mix of these forces is pushing up the price, it isn't economic fundamentals, it isn't a competitive market and it isn't Turkey's saber-rattling over the Kurds.

We may get a clue to how much of the price of oil and gasoline is politically determined in the reaction to today's mild little White House statement: "There is no doubt that energy prices are too high. They disproportionately hurt low-income families that have to spend so much of their money on energy. We watch it closely, we're very concerned."

Where was that statement in May, when gasoline was $3.25 (higher, of course, in California)? Tucked away, perhaps, until the White House could blame it on OPEC.

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