A Round Oil Peg in a Square Hole

A child’s mind is simple. When being presented with a game that requires a hammer to pound objects into specific slots, children often turn to force rather than intelligence. They will use all their might to try and hit an object into an unreceptive position, ultimately realizing either another tactic must be used or moving on to their next immediate interest.

In the last couple of months, I feel like many Americans have tried to smash oil pricing theories into holes with which they do not fit. Too many articles, blogs, op-eds, etc. have been narrowly focused, placing blame on one of many popular subjects. Expectations of a quick fix have also drenched the connotation of many authors’ rhetoric. If we have learned anything from the contagion induced by this past year's credit crisis, it is that several catalysts can add up to cause a problem bigger than each contributing piece. Additionally, several solutions will be necessary to clean up the mess.

Why is our energy crisis any different? In today’s global economy, there are too many issues to tackle each one individually, so people categorize the sum of many smaller issues into a broader theme. In regards to the “Oil Crisis of 2008”, there seem to be three general arguments at which people have been pointing their fingers: supply and demand imbalances, speculation, and the weak dollar. All three arguments contain valid points.

Supplies of oil have been falling globally while demand has been increasing creating obvious supply and demand imbalances. China and India are usually the two countries referenced to the global increase in demand, but for some reason, the increase in consumption from oil producing countries has gone unnoticed. Middle Eastern countries pose just as serious a threat to high oil prices. They have been widening the supply and demand gap - and will continue in the future - because they play on both sides of the fence. Not only has their production decreased, but their internal consumption and reserves have been increasing, further straining global supplies. There are too many other examples that can be given confirm supply and demand fundamentals causing an increase in price.

However, for prices to increase, something or someone must be setting this price. This is where the commodity markets come in to play. These markets are what have driven the price of oil to go up. Forms of speculation go on in every financial market, but commodities speculators have gotten a bad rap because people use the term in a very generic manner. Arguments over whether speculators are responsible for the high prices ensue because lumping all of these speculator classifications into one assumes all of their intentions, and correspondingly, their effect on the overall market, are the same. Index speculators have been the most recent entrant to the market and have caused the largest disruption. They use the commodities markets as an asset allocation decision and are not price sensitive. This group’s tremendous influx of cash began flowing into commodities markets around 2002, around the same time prices consistently rose at outrageous rates.

Is it a coincidence or causation? Prices in the 1970’s also experienced a massive increase, but prices then were not determined by the market, but by distributors (mainly OPEC). Comparing the two is erroneous. Some index speculators roll over their contracts which have contributed to the problem, but are not its sole reason.The commodities market has also been used by index speculators as an asset allocation hedging against the weak dollar. The movement of the dollar is very negatively correlated to the movement of the price of oil, but, it is important to understand that this is not a perfectly related negative correlation. In the past five years, said correlation is close to -.75. Is this another coincidence? The point I am trying to make is that the fundamentals and the weak dollar are reasons behind what is driving prices higher, but speculators are literally the ones driving the price’s direction. All three are working in tandem! Trying to place blame on any single reason is a waste of time.

Similarly, trying to come up with a solution for any one reason will also be a waste of time. In an election year, the candidates will prey on single arguments because they must speak to perceived realities of the general public. There will be a lot of conjecture before November as to what each candidate will do, but most of it will be political lip service.

Whatever issues and solutions are spoken by the candidates, this country cannot escape from the reality that (1) we will be dependent on oil in some capacity in the next two decades, (2) oil prices (in the long term) are going to be high because its supply is limited, and (3) there is a need for alternative sources of energy.

Each problem can be solved in many ways, some of which we have yet to conceive, but binding our ideas into individual solutions will only compound the problem and be as fruitless as the time that has already been wasted looking for only one cause to the conundrum.

Comments

[rthynes:]

To make things even simplier, think about this! It takes 26 pounds of our corn to make 1 gallon of ethnol and yet we're selling 60 pounds of this to OPEC for $7.00!

Just the simple "raw material cost" of corn to start making ethnol is more than $3.00 gal! So our "lame brained" US Congress are really the ones who have clearly identified to OPEC that we Americans have nothing to compete with their OPEC oil supply until OPEC starts charging us at least $165/barrel!!!!! And all other alternative fuels or green energy sources are even less competive than biofuels!

Sure the 2nd & 3rd order elements you mentioned come into play, but the number one element is simply Congress and the special interest enviromental community has denied the rest of us US citizen to become oil independant!!! We need to simply start "kickin ass" in Washington DC and insist that our Congressional representatives tackle this urgent energy problem by focusing on nuclear for “power generation” and oil “for mobile transport”! Both are technically as well as extremely safe to has up and fully operational within the next 10 to 15 years, given American individuals or resourceful US companies are allowed to move forward ASAP like we did during WWII!


What say you?

Bob Hynes

2008 Jun 27 09:46 AM