by Jack Lee
There was a long procession of notables appearing before Congress who swore under oath the price of gasoline was so high because of supply and demand, plain and simple. Even Jim Cramer on Mad Money assured us it was all supply and demand. I like Cramer although I don’t trust his advice; I’ve disagreed with his stock choices too many times and was right. However, in the midst of the pump price rip-off there were a few of us who stood our ground and said, “THIS IS A TOTAL RIPOFF. IT’S NOT ABOUT SUPPLY AND DEMAND!
Unfortunately, we were patted on the head and told to sit down.
Remember this often repeated line….there’s no speculation, there’s no big conspiracy no manipulating anything, speculation has little to do with the price, this is just the market we live in now with all the new oil customers in India and China.
The piling on by speculators drives up the price and you can argue well so what, thats the same for stocks too and this all works up to the point where supply and demand cross and then the price comes down. The point of change is what people are willing to pay. This works on corn flakes, but when you have a national security item, and certainly energy to move the needs of the nation is a national security issue, then it becomes more what is acceptable extortion. You could push pump prices up $20+ a gallon and there will still be people out here willing to pay it! Now whether its affordable or not is not the issue, they have to have it to survive… and that is the big difference between speculating in energy verses virtually all other commodities like corn, soy beans, etc.
And it’s only supply and demand if you stretch it to include wild speculation as a function of supply and demand. I would argue this was never intended to be part of the equasion. At its peak pump price for every one barrel of oil being sold for gasoline there were 27 barrels being traded back and forth by speculators trying to run up the price! This is not what we mean when we talk supply and demand, its not part of the India-China factor, we were actually getting taken to the cleaners by speculators (I said so early on) and we were being lied too by people who said, “That’s just the way it is from now on so get over it! Your oil is in short supply and we should expect $5 a gallon pump prices soon.” Then the bubble burst.
If you didn’t watch 60 Minutes last night, get this story on their pod cast or catch it on line. There was no supply and demand problem, it was an energy speculator problem. It was not Exxon, it was Merrill Lynch.
60 Minutes excerpt…”(CBS) About the only economic break most Americans have gotten in the last six months has been the drastic drop in the price of oil, which has fallen even more precipitously than it rose. In a year’s time, a commodity that was theoretically priced according to supply and demand doubled from $69 a barrel to nearly $150, and then, in a period of just three months, crashed along with the stock market.
So what happened? It’s a complicated question, and there are lots of theories. But as correspondent Steve Kroft reports, many people believe it was a speculative bubble, not unlike the one that caused the housing crisis, and that it had more to do with traders and speculators on Wall Street than with oil company executives or sheiks in Saudi Arabia.
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To understand what happened to the price of oil, you first have to understand the way it’s traded. For years it has been bought and sold on something called the commodities futures market. At the New York Mercantile Exchange, it’s traded alongside cotton and coffee, copper and steel by brokers who buy and sell contracts to deliver those goods at a certain price at some date in the future.
It was created so that farmers could gauge what their unharvested crops would be worth months in advance, so that factories could lock in the best price for raw materials, and airlines could manage their fuel costs. But more than a year ago those markets started to behave erratically. And when oil doubled to more than $147 a barrel, no one was more suspicious than Dan Gilligan.
As the president of the Petroleum Marketers Association, he represents more than 8,000 retail and wholesale suppliers, everyone from home heating oil companies to gas station owners.
When 60 Minutes talked to him last summer, his members were getting blamed for gouging the public, even though their costs had also gone through the roof. He told Kroft the problem was in the commodities markets, which had been invaded by a new breed of investor.
“Approximately 60 to 70 percent of the oil contracts in the futures markets are now held by speculative entities. Not by companies that need oil, not by the airlines, not by the oil companies. But by investors that are looking to make money from their speculative positions,” Gilligan explained.
Gilligan said these investors don’t actually take delivery of the oil. “All they do is buy the paper, and hope that they can sell it for more than they paid for it. Before they have to take delivery.”
“They’re trying to make money on the market for oil?” Kroft asked.
“Absolutely,” Gilligan replied. “On the volatility that exists in the market. They make it going up and down.”
He says his members in the home heating oil business, like Sean Cota of Bellows Falls, Vt., were the first to notice the effects a few years ago when prices seemed to disconnect from the basic fundamentals of supply and demand. Cota says there was plenty of product at the supply terminals, but the prices kept going up and up.
“We’ve had three price changes during the day where we pick up products, actually don’t know what we paid for it and we’ll go out and we’ll sell that to the retail customer guessing at what the price was,” Cota remembered. “The volatility is being driven by the huge amounts of money and the huge amounts of leverage that is going in to these markets.”
About the same time, hedge fund manager Michael Masters reached the same conclusion. Masters’ expertise is in tracking the flow of investments into and out of financial markets and he noticed huge amounts of money leaving stocks for commodities and oil futures, most of it going into index funds, betting the price of oil was going to go up.
Asked who was buying this “paper oil,” Masters told Kroft, “The California pension fund. Harvard Endowment. Lots of large institutional investors. And, by the way, other investors, hedge funds, Wall Street trading desks were following right behind them, putting money – sovereign wealth funds were putting money in the futures markets as well. So you had all these investors putting money in the futures markets. And that was driving the price up.”
In a five year period, Masters said the amount of money institutional investors, hedge funds, and the big Wall Street banks had placed in the commodities markets went from $13 billion to $300 billion. Last year, 27 barrels of crude were being traded every day on the New York Mercantile Exchange for every one barrel of oil that was actually being consumed in the United States.
“We talked to the largest physical trader of crude oil. And they told us that compared to the size of the investment inflows – and remember, this is the largest physical crude oil trader in the United States – they said that we are basically a flea on an elephant, that that’s how big these flows were,” Masters remembered.
Yet when Congress began holding hearings last summer and asked Wall Street banker Lawrence Eagles of J.P. Morgan what role excessive speculation played in rising oil prices, the answer was little to none. “We believe that high energy prices are fundamentally a result of supply and demand,” he said in his testimony.