Tuesday, June 24, 2008

Sorting Out High Gas Prices


Whom do we blame for soaring gasoline prices? Central governments including our federal government, direct the finger of blame at oil companies. They use the fact that these companies are making record profits as proof they are doing something unethical, as if making a profit selling people something at a price they freely (if not happily) agree to pay in a free market was somehow immoral.

(I'm going to need room for this one. For the rest of it click TUESDAY below and scroll down).

14 Comments:

Blogger Mark Moore (Moderator) said...

Ed Wallace in Business Week points the finger at speculators for rising oil prices, but shrugs off the role of loose fiscal policy in government.

He writes…
“Moving on to the weak U.S. dollar as a primary cause for skyrocketing oil prices—there is "some" truth in that statement. But consider this: The dollar has depreciated 30% against the world's currencies since 2002, while the price of oil has gone up 500%.

So is it the weak dollar that has caused a 500% increase in the price of oil, or is it the extra $241 billion worth of speculation? You can make the call on that one.”


My call is that the 30% depreciation of the dollar is being measured against other phony fiat currencies that are themselves depreciating. When you compare the dollar to real stuff, and not just another phony fiat currency that is not quite as badly managed as the dollar, then the 500% rise in oil prices since 2002 don’t look so out of line.

Wheat prices in 2000 were about $3 a bushel, now wheat is selling for over $15 a bushel and going nowhere but up. That is over 500% inflation too. In 2003, copper was selling for less than a dollar an ounce. Now it’s brushing $4, an inflation rate of over 400%. Gold, despite the best efforts of central banks to hold it down, has gone from $278 an ounce to over $900 and even $1,000 an ounce. That is a better than a 300% price increase. Silver has gone up by even greater percentages in this period.

Even humble lead has tripled, and at times quintupled, in price over the last five years. Quit blaming the oil companies or the speculators. The government, in collusion with the Federal Reserve Bank, is responsible for the increase in the price of gasoline and the increase in the price of every other real item that you buy. Gasoline prices are just more noticeable because we buy it far more often than we do metals and we spend far more on gasoline than we do on bread, so a quintupling of bread prices over the years does not hurt us as bad.

You will note that food prices are going up too, but food is so diverse an industry that there is no one set of villains to blame, as there is with oil companies. This makes the food industry a less convenient scapegoat for government apologists who are attempting to misdirect onto anyone except the guilty party- government and the quasi-private Federal Reserve Bank.

And speaking of misdirection, it is the politically connected banks that are reaping the windfall profits in these strange times we live in. Terrance O’Hara wrote in the Washington Post (October 2005), “Exxon Mobil's gross margin of 9.8 cents of profit for every dollar of revenue pales in comparison to Citigroup Inc.'s 15.7 cents in 2004. By percentage of total revenue, banking is consistently the most profitable industry in America, followed closely by the drug industry.”

Sure Exxon makes a lot of money, but it also invests a lot of money and ties up a lot of capital. The return on its capital is hardly excessive. The big profits are because it legitimately acquired assets that many people want, and because big companies tend to have big profits. Per dollar invested, its returns are not that great.

I realize the data is a few years old, but is anyone prepared to argue that the politically connected banks and investment houses have it any worse now? The Federal Reserve continues to collect interest payments from the taxpayer on money which it creates out of thin air. The government has infused well over $500 billion dollars to pump up the banks. Can anyone imagine them doing that for the oil companies? How about for you and your family?

The big banks keep the profits when they have good years, then expect the government to cover their losses when their own poor decisions blow up on them. Government is the problem, but if you must have a corporate villain, the big banks, especially the Federal Reserve, is much more worthy of the moniker.

I agree with Thomas Jefferson on this one when he said, “"I believe that banking institutions are more dangerous to our liberties than standing armies . . . If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] . . . will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered . . . The issuing power should be taken from the banks and restored to the people, to whom it properly belongs."

Back to Ed Wallace and the role of speculators for high gas prices: ”As for the speculators, in 2000 approximately $9 billion was invested in oil futures, while today that number has gone up to $250 billion. Now, if any publicly traded company had an additional $241 billion put into its stock in the same period, its stock would rise out of sight too—even if the company was not worth anywhere near that amount of market capitalization.”

True enough, but if there was not a fundamental reason to justify the cash infusion, those who infuse the cash will eventually loose a good chunk of it. They would lose it that is, unless they were the big banks who have bought and paid for our politicians. I think we have seen with the housing bubble, that when financial bubbles pop the government rushes in to rescue the industry, even if certain disfavored players in that industry get the ax.

What can this do except prompt the big players to encourage speculation? They buy up oil futures. If they are correct and oil really does go up, they reap a windfall. If they are wrong and oil goes down, they get a government bailout. Why not gamble if you get to keep the money when you win, and the house taxes people to bail you out when you lose?

Other speculators are honest ones who will bear the cost of the loss if they are wrong. Why don’t they have every right to speculate? Speculators are simply betting against the dollar and it looks like a pretty good bet. When they do that it sends a signal via economic reality that governments are being too promiscuous with printing and spending money.

Politicians don’t like to hear such signals, so they simply declare the messengers to be evil.

To justify his thesis that there is no oil shortage, Mr. Wallace does a bit of cherry-picking of data. He argues that the United States is using less oil now, not more. Even so, the other countries have more than made up the difference over the last five years.

Even if people in your house are ordering less pizza than they did last year, total demand for pizza at the local Pizza Hut can still be up if ten more pizza-loving families move to your neighborhood. As more and more people in more countries “move to the neighborhood” of a first-world economy, demand for energy will increase no matter what happens in the United States. We are competing against the world in bidding for those barrels of oil, not just our fellow citizens.

Mr. Wallace also argues against a supply problem by pointing out that in the last quarter world demand increased by 2% while output increased by 2.5%. While that may be true of the last quarter, it is not true of the last five years, where the vast bulk of the price increase occurred. If output continues to exceed demand for a long time rather than a single quarter, you will see a drop in oil prices relative to the price of other real goods, but perhaps not in dollars as the real problem is government-caused overprinting of dollars.

His argument also fails to take into account the nature of oil production. A barrel of oil does not cost a uniform amount to produce. Each well has its own cost per barrel. There are many wells where the oil is difficult to extract. It may cost $20 a barrel to extract the oil at one well, $50, or even $100 at another. When the price of oil is $140 a barrel, it makes sense to activate even the high-cost wells.

If prices drop, then producers would lose money selling the oil so they cap that well. In other words, if the price of oil were not so high right now then the production of oil would not be either. It is these prices that are permitting the production. A reduced price for oil would cause producers to shut down their marginal wells, resulting in a shortage, which would once again boost up price. This last quarter we finally have reached a situation where there is not a shortage, where supply exceeds global demand. But that is only because we are going full-bore, opening up inefficient wells that have been capped for years.

When a coworker recently expressed the opinion that the government should force the oil companies to reduce the cost of gasoline I asked him, “Has any oil company ever used the threat of imprisonment in order to force you to buy gasoline, or any other product, that you did not wish to purchase?”

“No” he admitted.

“And they did not have any hidden charges on your credit card. You understood what the agreed on price was when you exchanged your dollars for their gasoline?”

“Yes” he said.

“And yet you want the government, who routinely and institutionally takes your earnings under threat of imprisonment for things which you never agreed to support, and in many cases actually oppose, to “punish” the oil companies. Again these are companies which have never taken a single penny from you that you did not agree to give them and the money is exchanged for a product that you personally use and want.”

“Yes” he said, without elaboration.

“America is doomed.” I said dejectedly.

11:21 AM, June 24, 2008  
Anonymous Rick said...

Mark,

Bravo on a great article. Politics is playing a part in the price of oil increasing. The Democratic Party for the last 40 years have been against off shore drilling, drilling in Anwar, drilling in the gulf, drilling anywhere in the states. They are against nuclear energy and to be honest the Democratic Party is in the pocket of tree hugging, granola crunching wacko’s who would like to see oil prices sky rocket if it means everyone will go back to riding a horse.
You can’t go 40 years without an energy policy and see demand increase without repercussions. This election will be partly about high gas prices. Obama has promised an increase on winfall profits tax. Can you say Jimmy Carter? He did the same thing in the ‘70’s and it produced gas shortages and long lines at the gas station. Do we want to go back to those days?
Its interesting that congress has their dog and pony show by bringing oil executives in and accuse them of price gouging. As you pointed out the oil companies make less than 10% profit per gallon of gasoline while the government receives about 15% per gallon in taxes. So you tell me, who is price gouging?

12:07 PM, June 24, 2008  
Blogger F. Prefect said...

While the falling dollar can account for some of the price increases, I believe speculation accounts for a lot more:

http://www.spiegel.de/international/world/0,1518,559550,00.html
http://www.globalresearch.ca/index.php?context=va&aid=8878

Oil is not the only commodity traded, wheat, corn, gold, and copper futures are also traded.

"My call is that the 30% depreciation of the dollar is being measured against other phony fiat currencies that are themselves depreciating."

So the dollar is depreciating 30% in relation to the pound, euro, or mark, which depreciated how much exactly?

"To justify his thesis that there is no oil shortage, Mr. Wallace does a bit of cherry-picking of data. He argues that the United States is using less oil now, not more. Even so, the other countries have more than made up the difference over the last five years."

However, he does provide some data, instead of just theorizing.

12:36 PM, June 24, 2008  
Blogger Mark Moore (Moderator) said...

Prefect,

The Euro is the only one of those that matters. I gave rough data for wheat, gold, silver, copper, and lead. If the average change in dollars was +350% and the dollar lost 30% relative to the Euro then the Euro lost about 350% - (350% * .3) = 245% relative to those things. That is back of the envelope stuff, but is this what you wanted to know?

And I addressed the issue of speculation. Again, speculation of this sort is because people who hold currency think that the commodity will be worth more as measured in that currency rather than less. In other words, excessive issuance of currency fuels excessive speculation because the smart money knows those dollars will be worth even less next year. The root cause again is promiscuous printing and spending.

1:16 PM, June 24, 2008  
Blogger Grand Intellect said...

This comment has been removed by the author.

2:14 PM, June 24, 2008  
Blogger Grand Intellect said...

The Federal, State, and Local Governments of the United States of America are simply Warlords, united with Multi-National Corporations using lies, fear, coercion, violence, and all around terror to effectively enslave the general populace. Regardless of the method they use to corrupt the name of America, We must focus on our method of deposing the despicable despots!

4:56 PM, June 24, 2008  
Blogger F. Prefect said...

"The Euro is the only one of those that matters. I gave rough data for wheat, gold, silver, copper, and lead. If the average change in dollars was +350% and the dollar lost 30% relative to the Euro then the Euro lost about 350% - (350% * .3) = 245% relative to those things. That is back of the envelope stuff, but is this what you wanted to know?"

Yes. Is that your honest opinion, then, that the euro fell 245% over 6 years? That the dollar fell 350%? Is this reasonable? If the euro has remained fairly steady with the rest of the world's currency, does that mean the entire world's currency has fallen in value around 200-400% over 6 years?

I propose we use a slightly less stretchy measuring stick.

5:21 PM, June 24, 2008  
Blogger Mark Moore (Moderator) said...

Ford buddy the CURRENCIES are the stretchy measuring stick. An ounce of gold has not changed in its properties in the last 5-10 years. A bushel of wheat has not changed. A barrel of oil has not changed. Those are measuring sticks that have not changed. The currencies are what has changed. What a "dollar" or a "euro" means in buying power is what has changed, and in a way inversely proportional to the number issued relative to the size of the economy issuing them.

They are fiat, their only value is the faith people have that the government will not overprint them and that trust has been broken. Governments love to over-print money. It is a hidden way to raise taxes. That is why the Founders banned it in the Constitution. The so-called Federal Reserve is a way around that prohibition.

7:22 PM, June 24, 2008  
Blogger Grand Intellect said...

"Ford buddy the CURRENCIES are the stretchy measuring stick. An ounce of gold has not changed in its properties in the last 5-10 years. A bushel of wheat has not changed. A barrel of oil has not changed. Those are measuring sticks that have not changed. The currencies are what has changed. What a "dollar" or a "euro" means in buying power is what has changed, and in a way inversely proportional to the number issued relative to the size of the economy issuing them."

There is no "measuring stick" that does not change. The properties of wheat change all the time. Corporations create geneticly modifed wheat crops and then copyright them. People find new ways to mine and treat gold- it's the same for oil. Everything is always changing.

1:24 PM, June 25, 2008  
Blogger F. Prefect said...

The demand for gold, and the futures market for gold change constantly, it's value isn't a constant. It's a traded commodity. Neither wheat nor oil is free from speculators or demand driving up the prices.

Nobody is arguing that inflation is negligible, merely that inflation isn't the only culprit in driving up prices.

1:27 PM, June 25, 2008  
Anonymous Anonymous said...

Mark,

You are fighting a losing battle. Too many people are too lazy to study the concept so they understand it. They think that there is some inherent "time-value of money" and fail to distinguish "interest" from "inflation". The fail to realize that the reason that we pay interest on a loan is NOT because the money is constantly deflating. Sigh, see... I am trying to explain something that people don't want to understand, because if they did, they would be burdened with actually doing something about it.

2:50 PM, June 27, 2008  
Anonymous Anonymous said...

All commodities are going up dramatically because speculation in all commodities has increased dramatically. If you want to know why, do some research on "ICE Futures" and its introduction of electronic trading in oil futures and no US regulation. Over 50% of the world's oil is now bought through ICE. That's a huge increase for something that didn't even exist several years ago.

Free markets only work if they are not manipulated.

4:00 PM, June 29, 2008  
Anonymous Anonymous said...

This lack of regulation makes us very vulnerable to terrorist manipulation of the world oil prices. If something is not done soon, our economy is going to collapse due to oil prices. Hiding your head in the sand and ignoring the effect of speculation only helps the terrorists.

4:03 PM, June 29, 2008  
Blogger Mark Moore (Moderator) said...

GI- if so then why bug me, bug Prefect for demanding something that does not (according to you) exist, a "non-stretchy" measuring stick? Sure, wheat changes a bit, new ways are found to mine for gold, but those changes are negligible compared to the power of the Fed to magically create more money out of thin air effortlessly.

Prefect- "speculators" are not just driving up prices for the fun of it, if there is no underlying market reality to justify their speculations they will lose their hind-quarters. Speculators are sending suppliers and consumers a message- unfortunately brain-dead consumers are ignoring that message and crying for Ceasar to make the price of bread go down by government magic.

And calling for the government to regulate even more of life "or the terrorists are going to get us" is a non-starter. Our government is the one causing oil prices, as measured in dollars, to go up. They created the problem, and yet you want to entrust them with even more power in order to "fix" it.

I have cited facts for gold, silver, copper, wheat, and lead. They are ALL going way up. Wake up and quit blaming this on "speculators". Those are rational people who are betting that the greedy idiots in the government will continue to destroy the dollar- and that has been a winning bet each year since 1913!

6:27 PM, July 09, 2008  

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