[corp-focus] Behind Skyrocketing Oil Prices

[robert weissman]

Links and forum to comment on this and other columns at:
http://www.multinationalmonitor.org/editorsblog

Behind Skyrocketing Oil Prices
By Robert Weissman
May 30, 2008

Yesterday comes the news that the Commodity Futures Trading Commission 
(CFTC) is investigating potential manipulation of the oil trading market.

That's a good thing, though the CFTC is not exactly the most aggressive 
regulator around. (Says Judy Dugan of Consumer Watchdog: "On its face, 
the investigation smacks of the fox investigating a hen shortage in the 
chicken coop.")

Market manipulation may be contributing to the recent oil price spike -- 
though even in the worst case, it is only part of the story. The most 
important factor is supply and demand: supply is having trouble keeping 
up with unabated demand growth.

Are Wall Street firms and hedge funds in fact manipulating the oil 
market? Perhaps. There are certainly enough conflicts of interest, and 
unregulation, to make such activity plausible. These aren't exactly guys 
with an honorable track record.

Whether speculation is driving price up is a separate issue from 
manipulation. Investment dollars are pouring into oil futures, pretty 
clearly driving up price. This reflects supply and demand for oil 
futures as an investment tool, more than available supply and demand for 
actual crude oil. Some nontrivial portion of the recent run-up in price 
is almost certainly due to this speculative activity, which is fueled by 
leveraged buying (use of borrowed money).

At the end of 2007, with oil prices around $100 a barrel (a shocking 
height, just half a year ago), Jennifer Wedekind, my colleague at 
Multinational Monitor, interviewed roughly a dozen oil analysts about 
the price of oil. They were divided on the reasons for high oil prices 
of $100, with some agreeing that speculation -- but not manipulation -- 
played a role and others fiercely denying it.

Among those attributing some role to speculation was Linda Rafield, a 
senior oil analyst, with Platts: "We have seen money market funds and 
asset managers and portfolio managers definitely putting money to work 
in the commodities sector, and that certainly has bolstered prices, 
since most of those people notoriously will trade from the long side." 
Against speculation as a factor was Jeff Rubin, chief economist and 
chief strategist, CIBC World Markets. Asked what factors were driving 
the price spike, he said, "Certainly not Middle Eastern instability or 
speculation or so-called geopolitical factors."

Six months later, it seems like speculation has become increasingly 
important. It's just very hard to identify what has happened in the last 
half year to jump prices by a third.

A second key factor in rising prices is the decline in the value of the 
dollar. A barrel of oil today is worth a barrel of oil tomorrow. If the 
dollar is worth less tomorrow than today, then the dollar value of a 
barrel of oil will be higher tomorrow. Against a basket of currencies, 
the dollar has fallen by 25 percent since 2003, and considerably more 
since its peak in 2001.

But, whatever the allocation of blame for today's price, the most 
important factor in the big picture is supply and demand.

Global demand is growing at a steady clip, thanks to very rapidly rising 
oil use in China, India and the Middle East.

Global supply is stretched thin. Some argue this is because the world is 
at or near "peak oil production," a tipping point when half the world's 
oil has been extracted, and yields begin to decline, with very major 
price effects.

A different view is uncomfortable with the apocalyptic element of peak 
oil theory. From this vantage point, more oil -- or close substitutes, 
like tar sands or shale -- is available, but it is harder and more 
expensive to get. This is the preferred view of the oil industry 
analysts (many of whom note that much oil that is easily attained from a 
technological standpoint -- for example, in Iraq -- is hard to reach for 
political reasons).

Either way, the supply challenges combined with rapidly growing demand 
means the world is going to see steadily higher prices. Additionally, 
very tight supplies will inevitably lead to price spikes that appear 
irrational from a close-up view.

Says Charles Maxwell, senior energy analyst at Weeden & Co: "So long as 
capacity utilization in the world crude oil producing system is running 
at 98 percent, which it is today, and so long as perhaps one-and-a-half, 
2 percent, that’s excess, is in the form of Saudi heavy, sour crudes, 
which the typical American refinery can’t use any more of -- they use 
some, but they can’t use any more of because it has very serious effects 
in pitting the insides of these pipes and then requiring the refinery to 
shut down for a long time and the redoing of all the pipes -- we’re 
going to have these periodic price rises of this sort."

Explains Maxwell: "Any system needs to have a little cushion between 
adversity that strikes -- weather factors or cut-offs for political 
purposes or political struggles from civil wars. We don’t have in this 
system enough of a cushion. Normally, capacity utilization is considered 
ideal around 94 to 95 percent. So our 98 percent capacity utilization is 
well above that and we can’t get it down, because it takes 5 to 7 years 
to create it and we aren’t spending the money today that would create it 
5 to 7 years out."

So, by all means, forward with a robust investigation of market 
manipulation, and yes to re-regulating oil markets that are now too 
financialized and removed from the buying and selling of real oil.

But the supply-demand challenges facing the world are much more serious 
than the speculative and other factors contributing to the present 
run-up in price.

It's hard to imagine why the United States -- or the world -- would need 
more incentive than responding to climate change to invest in 
renewables, mandate much tougher efficiency standards for cars and a 
switch away from the internal combustion engine, and massively scale up 
public transportation. But climate change doomsday scenarios have, so 
far, not proven enough. Perhaps the prospect of $200/barrel oil will.


Robert Weissman is editor of the Washington, D.C.-based Multinational 
Monitor, <http://www.multinationalmonitor.org> and director of Essential 
Action <http://www.essentialaction.org>.

(c) Robert Weissman

This article is posted at: 
<http://lists.essential.org/pipermail/corp-focus/2008/000291.html>