Speculators and the Price of Gasoline - Discussion

This is an issue that I had not originally intended to discuss. But since it is one of the favorite hobbyhorses of the Left and since Eric Offner of Manhasset Hills, NY has been raising this issue forcefully, I discussed it in my post of March 29, under the heading "Control of the Weather (Discussion)." Offner has now chosen to pursue this, which prompted me to do a fairly long dissertation on the subject. I now want to share my analysis with my readers.

Offner wrote:

First see the article in Business Week entitled "Why Obama's Crackdown on Oil Speculators Won't Work." 

Then answer these questions:

1.) If a crackdown on oil speculators won’t work, does it not imply that there are oil speculators?

2.) Is it possible that Wall Street oil speculators affect the price of oil?

3.) The bigger question is whether speculation on food, water and other necessities exists and whether such action is ethical?

4.) Is failure to restrict unethical behavior unethical?

My response to his questions is set forth under corresponding numbers:

1.) Yes of course there are. The question should not be whether there are speculators but whether it is ever possible to eliminate them and whether they are bad. The answer is that it is not possible to eliminate them and in many cases not even possible to regulate them. Sometimes they are bad, sometimes good, most often neither.

2.) It is not only possible, it is probable. But that is not necessarily bad. Look at the article you sent me. He argues convincingly that speculators even-out the speed at which prices change. Without them, as happened some years ago the price can quadruple almost over-night and a more gradual rise is better for the economy and consumers.

3.) Yes and Yes. Let me take this down to basics. There is a rumor that sugar, or for that matter water, will be in short supply. Most people, i.e. consumers upon hearing this will head for the markets and hoard it. The result is the price goes up and soon the shelves are empty. A self-fulfilling prophecy. Now let us suppose a larger speculator wants to take advantage of the situation and so he goes out and buys many tons of sugar, puts them in a ware house (or he buys futures) and then taking advantage of the rising prices resells it at a hefty profit. As he and others begin to sell the price goes down. Is he/she now a good speculator? How do you stop this? Do you make it illegal for anyone to buy more than a certain amount? How do you determine the amount? How would this effect a legitimate store or a legitimate wholesaler, who by the nature of their trade must buy large amounts?

The way to stop this is price controls and rationing which brings about a black market, where the price is even higher and even less sugar in the stores. We are now seeing this in Venezuela.

Are there times when rationing and price controls are appropriate? Yes!!! But only in extreme cases, such as war-time, when the evils of the black market are preferred to letting hoarding control, but it is always a close question. Where the hoarding is by a limited group, intent on creating shortages and raising prices, it falls afoul of the anti-trust laws and definitely should be prosecuted.

Is Obama's approach sound? I don't know, but it is good politics. He is doing something!!!

Raising the margin price on commodities speculation seems like a sensible thing to do, but it takes someone more knowledgeable than I to analyze the consequences. The article you sent me seems knowledgeable and objective.

I will say this. When Allan Greenspan talked about the stock market suffering from irrational exuberance, the obvious thing to do, as far as I could see and still believe, was to raise the margin requirement, which was within the power of the Fed, but because of Greenspan's hostility to all regulations this was not done - ditto for so many other things that could have headed off the crash.

But I don't know the commodities market - We apparently have regulations but we need money to enforce them. Everything else is shooting in the dark. Simplistic answers whether from Left or Right rarely have any merit.

The article in Business Week appears to be an intelligent one. It recognizes that regulations are important and need enforcing by the CFTC. Thus it is apparent that we have regulations in place that are not being enforced, or at least not being enforced adequately. But the Republican Congress will never appropriate the money needed. Instead, they will make sure that what can be done is not done, and then blame the President, who can only do so much without Congress' help.

There are many problems with the world's food supply that are exacerbated by US policy.

The use of US ethanol as an additive to gasoline has created a shortage of corn and driven the price higher, but the corn lobby will prevent Congress from changing this.

Our foreign aid program with food is counter-productive. The law requires that we not give money to aid organizations for food aid, but rather buy the food from American farmers at much higher prices than we could buy it on the world market and it must be shipped in US vessels. If the law would allow our aid to be by buying the food from African farmers, we would save money both in the price of the food and in the shipping costs and we would aid the African economy. Now it enriches the American corporate farmers and hurts the African economy because it competes with the African grown food and drives that price down.

4.) No and the question is irrelevant since I have said such action is not unethical. But even where it is unethical there is always a weighing of unintended consequences. Simplistic questions and simplistic answers to complex problems are, well, simplistic.

I then added:

The oil market is a world market. How do you regulate trades made outside the US? If you rationed gasoline in the US, it would have no effect on the price of oil on world markets. If you had price controls on gasoline that were below the world price of oil, no one could afford to sell gasoline, since they would lose money on every gallon. World markets and globalization make a new ball game. But we can no more change it than we could stop the industrial revolution and now the technological revolution that brought about globalization.

Furthermore a high price of gas is not bad. It makes clean energy and conservation much more competitive

Even boycotts have limitations. We put a boycott on Iranian oil. But if China does not join the boycott, can it be effective? The boycott might force the price of Iranian oil to go down, in which case China gets a windfall. How do you stop this? Only with a full fledged blockade of Iran, an act of war, which would put us in conflict with China and get Iran to try to close the Straight of Hormuz. Can you imagine what the price of oil would go up to? Speculators will make a lot of money, but they are not causing the price rise - they are taking advantage of it. Is there anything we can do - yes, but I am not smart enough to know what. Ask Barney Frank - he understands these things better than I do, and while I am talking about Barney Frank I commend to you an interview of him, which appeared in New York Magazine.

Also we do have laws on the books and the Commodities and Exchange Commission, which needs more funding as recommended in the article you sent me to enforce the laws and regulations. But the Republicans will never authorize this. What can we do? Get rid of them to whatever extent we can.

But I get tired of the Left and their "it’s the speculators.”

Finally allow me to add that while normally a two party system benefits the country, now a defeat of the Republican Party to the point where we have only one party has the best hope of reforming the system. Now it is broken and can't be fixed. In our system a one party system would not last long. The Democratic Party would split in two.

Talk of a third party in our system is very counter-productive. It would make sense if we had run-offs as e.g. the French and most of the world do.

Comments, questions, or corrections, are welcome and will be responded to and distributed with attribution, unless the writer requests that he/she not be identified.

The Price of Oil

I have decided to address this issue because so little is understood about this phenomenon. 

Even before the present spike in the price I was receiving circular e-mails that apparently were getting wide circulation. One of these urged boycotting Venezuelan oil by not buying any oil at Citco gas stations. Another urged boycotting gas stations bearing the Exxon-Mobil banner as a way of forcing their gas prices down. Another propounded by John McCain and seconded by Hillary Clinton suggested a two month suspension for the summer of the federal excise tax on gasoline. Barack Obama opposed it. I am glad to say that neither McCain nor Clinton actually introduced legislation to that effect and no such legislation has been introduced.

Unfortunately, none of these proposals has any merit. They all show an incredible lack of understanding of how markets operate and what effect our actions have on markets.

Basically, prices are set by the law of supply and demand. This is true whether we are talking about prices on the stock market or of commodities. When there is more demand than supply of any given commodity the price of that commodity will rise until supply and demand come into balance. If there is more supply than demand the prices will fall until supply and demand come into balance. 

The only way that prices can be effected artificially other than price controls, which creates other evils, is by changing one side or the other of the equation. Thus OPEC was formed to control the price of oil by controlling supply. During the Carter administration OPEC decided to drastically reduce supply causing long lines at gas pumps and driving the price of gasoline up drastically. This time, however, OPEC is pumping at, or very near to capacity, and so they, even if they wanted to, cannot increase supply. Some may say why would they want to? The answer is simple and is the reason why in the past OPEC has increased supply when prices have gone up. The more that the price of oils escalates the more alternate fuels become competitive and the more incentive there is for the world to take steps to find alternative energy and or find means for conservation. This is something that OPEC, all the oil producing states and the oil companies fear, for if and when that happens their days of wealth inflow drops and eventually stops.

At the moment the world has a capacity to produce eighty-five million barrels of oil a day. Demand is at eighty-seven million barrels. The price will keep rising until supply and demand are in balance. 

Some believe that the US can solve this problem by accessing its own reserves, which have been off limit because of their environmental sensitivity. But this is totally false. If ANWR were opened to drilling it would increase the profits of the oil companies because they would have slightly more to sell, but it would not have a noticeable effect on oil supply. It is estimated that it would take ten years to bring this oil supply to fruition and then “it would result in additional oil production of a peak 780,000 barrels per day in 2027, according to the mean case developed by the Energy Information Administration in a revised assessment of ANWR potential. That would result in trimming $0.75 (in 2006 dollars) off the projected cost of a barrel of oil, according to the EIA”

Thus only a decrease in oil consumption will bring the price down. A reduction in the excise tax as advocated by McCain/Clinton would discourage the reduction in gas consumption thus keeping the market from coming into balance and cause the price of gas to increase by the amount of the tax. Thus the price of gas would remain the same, but instead of the money going into the Highway Trust Fund to keep our roads in repair, it would go into the pockets of the oil companies. Taxing the oil companies as Clinton advocates would keep them from profiting from the windfall, but would have no effect on the price of gasoline. Some benefits from the high prices have already occurred. “General Motors Shifts Focus to Small Cars in Sign of Sport Utility Demise” says the headline at page one of this last Wednesday’s Business section of the New York Times.

As it happens, as painful as the price of gas is to consumers and truckers the world over may be, it is the result of the failure to anticipate this crisis. Had taxes been raised, or had CAFE fuel standards been increased years ago, gas consumption would have gone down and the spike we now have might have been avoided, but even that is questionable because in a globalized market the price is set by world wide demand and unless the whole world demand goes down prices will go up.

It is interesting to note that T. Boone Pickens who made his fortune in Texas oil is now investing in Wind Turbines. Here is a quote from Market Watch, 

“Billionaire T. Boone Pickens said Thursday he's placing an order to buy 667 wind turbines from General Electric as part of an estimated $2 billion in start-up costs for his four-phase Pampa Wind Project. Pickens' Mesa Power LLP will buy the GE turbines, which will be capable of generating 1,000 megawatts of electricity, enough for 300,000 average U.S. homes. When complete, the Pampa Wind Project will cover some 400,000 acres in the Texas Panhandle. 'You find an oilfield, it peaks and starts declining, and you've got to find another one to replace it," said Pickens, who once operated one of the largest independent oil and gas production companies. "It can drive you crazy. With wind, there's no decline curve."

Finally, some have suggested that the weak dollar is at least partly responsible for the high cost of gasoline. Again this is a misconception. Since the price of oil is denominated in Dollars it makes no difference how weak the dollar is for the price of oil in the US. If oil were denominated in Euros it would be a different story. As it is the weak dollar is making oil more expensive in non-dollar countries, but not for the US.

It is time to come to grips with reality!