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EducateWorthington.org

The 912 Project - Glenn Beck

912 Group of Central Ohio

Please let me know if you'd like your link added

["Who sets the price of oil & gas, anyway?"]

For the Democrats, liberals, socialists, etc., yes, I already know that George Bush sets the price of oil, and he's screwing all of us to help his buddies in the industry! :huh:

With that out of the way, we can now move on to other possibilities.  

I hope this can be an informative discussion, with the goal of focussing on where the "price" of oil, and the "price" of gas, are primarily determined.  (I'd really like to know.)

In considering this question, it might be helpful to recognize some of the various parties that are involved:

Oil producers
Oil futures markets
Oil Futures traders
Oil refiners
Gasoline futures markets
Gasoline futures traders
Gas stations
Consumers
(Aside from George W. Bush, who have I missed?)

NOTE: For the sake of this conversation, it is probably unnecessary to talk about gasoline taxes, etc, as they are not associated with the daily changes in the price of oil and gasoline.

So now, back to the question:  "Who sets the price of oil & gas, anyway?"

  I know, "Its the market, stupid!", but could we be a little more specific?

(Another way to look at this might to be to ask ouselves what has changed, to drive oil from $25/barrel to $100/barrel?)

Seems like everyone in the proverbial pipeline makes out real well when Chavez and Ahmedinijad rattle their sabres.

I think it might be interesting to tweak (not Tweet) the question a bit and ask who influences the price of oil.  One of my biggest complaints is the role of the politician.  I believe it is the politician who ties our hands and won't let us build a new oil refinery, drill in oil-rich regions, and decides it is important for each state to have a different blend of gasoline. All of which drive UP the price of this once commodity.

[investors]

While I will agree with that, I'm not sure the governmental portion of the cost has changed much as we have watched oil quadruple in price.  

Yes, it would have been helpful to implement policies like drilling ANWAR, and adding a refinery, the lack of these changes really isn't at the heart of the current rise in the commodity is it?

The following is a very interesting article on the daily news in the oil market from last Wednesday--Oil Jumps On Surprise Supply Drop --Yahoo Finance-3/5/08  

Here are some interesting excerpts:

Oil surged Wednesday, rising a remarkable $5 a barrel to a new record over $104 after the government reported a surprise drop in crude oil stockpiles and OPEC held production levels steady.

Most analysts had expected...oil supplies (to rise) last week for the eighth straight time. Instead, they fell by 3.1 million barrels.

While investors chose Wednesday to focus on last week's decline in oil supplies, analysts noted that oil inventories are at historic highs.

The EIA report and OPEC announcement fed a new frenzy of investing in oil futures...

AT THE SAME TIME:

Falling demand for overall petroleum products, which was down 3.4 percent over the last four weeks...

Gasoline demand is off about 1 percent over the last six weeks....  At the same time, gasoline supplies rose last week to a 15-year high, Evans said.

"Clearly, refineries have enough crude oil to produce an abundance of gasoline," Evans said

DESPITE THIS:

"There's an ongoing stampede to be a part of the crude oil rally," said Tim Evans, an analyst at Citigroup Inc., in New York.

Oil pulled other energy futures higher Wednesday.

I encourage you to read the entire article (which isn't long), but here is my take on it:

So there is a "stampede" of investors interested in outbidding each other for the right to control an oil futures contract, driving the price up $5 in one day.  There are three factors cited as contributing to this "remarkable" price spike:

1) Despite our oil inventories being at historic highs, our inventory went DOWN by 3.1 million barrels.  So, we only have approx. 300 million barrels in inventory this week, instead of....300 + 3.1 million= 303.1 million barrels??? (I guess that matters...a lot...to oil investors?)

2) OPEC decided NOT to increase oil production.  OK, so what does this tell us?  One, that they are not pumping at capacity, which is true.  Why?  Because there is already plenty of oil on the world market, which is also true.

3) "Crude futures offer a hedge against a falling dollar, and oil futures bought and sold in dollars are more attractive to foreign investors when the dollar is falling."

So, if there is currently enough oil being supplied to meet and exceed demand, why is the price $100/bbl?

(HINT:  The most common terms in this article refer to "investors"and "analysts".)

Theory:  There is currently enough oil being supplied to meet the world's demand for actual oil.  Unfortunately, there are not enough oil futures contracts to meet investors' demands for this profitable investment option.  And the more investor money that chases these contracts, the higher the price will go.

So the price of oil is market driven..."supply and demand", but it is more a result of investor demand for the futures contracts than for the oil itself, as the last thing a commodity investor wants to do is to take actual delivery of 1,000 barrels of crude oil!

BTW: No, I am not a socialist, and I am not opposed to free markets and capitalism.  At the same time, can we at least seek to honestly answer the question "Who sets the price of oil?"

[influences]

Counter suggests:

I think it might be interesting to tweak (not Tweet) the question a bit and ask who influences the price of oil.

I think that is well worth considering.  

As you do so, also watch for daily articles like the one I referenced from last Wednesday, and look for what important facts "influence" the price of oil futures contracts on any given day.

Then ask yourself, does the fact that a pipeline burst and shut down 65,000 bbl/day for 3 days, or that a Nigerian oil worker was kidnapped, really warrant a spike in the oil futures contract price.  (Did it materially impact the flow of oil in a meaningful way?)

As you are reading for evidence of what drives up futures contract prices, i.e. what "influences" investors to bid up the futures contracts, be aware that global oil production is around 90 million barrels...per day!  Thus, 65,000 bbb/day lost isn't even a drop in the bucket!

3) "Crude futures offer a hedge against a falling dollar, and oil futures bought and sold in dollars are more attractive to foreign investors when the dollar is falling."

A most important factor.  The spike occurred as the dollar was falling to its lowest against the Euro.

In turn, the falling of the dollar can be traced to the ever increasing fiscal deficit in this country both in trade balance (here the consumer impacts) and in the Federal budget deficit.  Every time the Fed lowers the interest rate to solve our domestic problems and other countries do not (he EUCB did not, their rate is 4% vs our 3%),there is less demand for the dollar.  A free market situation.

Reducing consumption in the US can do little in the face of increasing consumption in China and India.  In addition, the dollar reserves of those countries are at risk because of the falling of the currency.  I don't know but they may well be hedging with oil contracts.

Listening to the just concluded "Summit of (the group of) Rio" where the events between Venezuela, Colombia and Ecuador were thrashed out you would have seenthat there is a very good possibility that Chavez will (can) disrupt in some form the supply of oil to the US.  The first thing he said (paraphrase) was (gloating) "Oil hit 105 dollars today".  The previous day he promised the president of Argentina (a woman) that Argentina would have all the oil and gas it needs for the forseable future.

Correa (President of Ecuador) an acolyte of Chavez who also has oil but no refining capacity was also rattling his saber.  He gets his gasoline (at subsidized prices) from
Chavez.  After the meeting in Santo Domingo Chavez traveled to Havana.  Chavez is a real danger to this country.

Bottom line the Shadow believes that the price of oil is controlled by the free market of dollar hedging plus the political machinations of the likes of Chavez and others.

Drilling in ANWAR would be a temporary solution

Reserves: The U.S. currently gets 58% of its oil from foreign sources and this is forecast to hit 70% by 2020. ANWAR reserve estimates are in the neighborhood of 16 billion barrels, which would replace the equivalent of what we currently import from Saudi Arabia [about 1.5 Mbpd] for 20 to 30 years. In 1999 the U.S. imported 0.7 Mbpd from Iraq.

http://www.mines.edu/Research/PTTC/newslet...204/v4n2p4.html

so The Shadow believes  :ph34r:

 

Whatever the source for the historic rise in the price of oil, it seems clear that the only prudent policy is to establish energy independence as quickly as possible.

 

"Energy Independence" is THE KEY concept!

It should start on several fronts simultaneously: Utilizing our own reserves (i.e. ANWAR, gulf coast), alternative energy, consumer driven conservation, reducing regulatory bottlenecks, accomodating needed refinery capacity increases, American made nuclear power, ...

P.S.  I can't prove this, but I believe most of this activity can and will be beneficial to America's economy as well, as we start to rely on American efforts to solve our own energy problems.  American industry can and will be the source of the solution, but we must first have a majority agreement that we have a problem that must be solved.  (Maybe that will require $5.00/gallon gasoline???)

Again, we are "allowed" to do these things and we should.  We cannot and should not be caught "over a barrel" any longer.

Shadow says:

A most important factor. The spike occurred as the dollar was falling to its lowest against the Euro.

Yes, and while this has only been cited as a factor very recently, I'm sure it has been a part of the issue for some time now.  

The point I would make, is that it is the HUGE increase in investment/speculation by non-market participants (traders who don't want the oil or the gasoline...they are no part of the oil/gas supply chain) which has created $100/bbl oil.  

Anyone have a thought on that?

[Institutions have been piling into crude -- along with other commodities -- to flee not just sagging stocks but also the flailing U.S. dollar.]

Another interesting article...Oil Rally May Be Economy's Undoing-3/8/08

A few things in the article that I don't agree with, but here are some points worth noting:

Wall Street has all but ignored the relentless rise in oil prices that has taken a barrel of crude to a once-unthinkable $106

I have to disagree.  As the quote below clearly acknowledges, it is Wall Street (investors), looking to oil, gas and other commodities for investment returns, that has fueled this multi-year rally (and the massive daily/weekly volatility in oil, gas, etc., IMO.)

Institutions have been piling into crude -- along with other commodities -- to flee not just sagging stocks but also the flailing U.S. dollar.

Those (oil/gas) prices, which have sent the cost of almost everything in the economy higher, are expected to translate into a further increase in inflation. A growing number of economists are becoming concerned that the Federal Reserve, which has been cutting rates in hopes of reinvigorating the economy, will be forced to stop because of the overall effect of more expensive energy.

I don't buy much of what I hear in the media, but it sounds like a "perfect storm" may be brewing(?)

Why oil prices will not go down soon:

http://news.yahoo.com/s/ap/20080313/ap_on_...e/diving_dollar

The Shadow worries  

[Yet negative supply and demand fundamentals don't seem to matter to oil investors as long as the dollar keeps falling.]

I see your point, Shadow.

QUESTION: Didn't oil double and triple in price BEFORE traders started investing in oil as a result of the falling dollar?  (Just curious.)

Here's the daily news on oil prices, Wednesday 3/12:Gas Prices Jump, Oil Hits $110

The highlights:

Gasoline and oil prices extended their record-setting streaks Wednesday, with gas at the pump reaching a new high of nearly $3.25 and crude surpassing $110 for the first time.

 Yahoo!!!!

...crude supplies jumped by 6.2 million barrels last week, more than three times the 1.6 million barrel forecast of analysts...

...gasoline supplies rose by 1.7 million barrels last week, well above the expected 300,000 barrel increase...

...distillate supplies dropped by 1.2 million barrels, less than the expected 2 million barrel decline.

Wednesday's EIA report offered more evidence demand is falling: Gasoline consumption fell 0.7 percent last week compared to the same week last year. Normally, gas consumption grows about 1.5 percent year-over-year, just to keep pace with population growth.

"Product demand remains quite weak," said Tim Evans, an analyst at Citigroup Inc., in a research note. "This was another set of consistently bearish data."

Yet negative supply and demand fundamentals don't seem to matter to oil investors as long as the dollar keeps falling.

So, back to the question "Who does set the price of oil?"

Yes, it is "the market", but it may be more accurate to say it is "the stock market", in this case it is specifically the futures market.  

The oil price today does not appear to be a simple function of supply and demand for the actual  commodity.  Rather, it seems to be more a function of supply and demand for futures contracts as an investment, as a stampede of oil investors has massively increased the demand for oil and gas futures contracts.  (This particular aspect of "the market" has changed more than anything relating to actual oil supply and demand, as we have watched oil go from $25 per barrel to $110 per barrel.)  

(This seems a strange twist to the "supply and demand" economics that most people learned in school(?)

Bottom Line: It is becoming increasingly apparent that oil's current price is NOT a function of fundamentals of supply and demand.

One last point:  Consider the likelihood that the most recent rise in oil prices is largely a result of the falling US dollar.  

QUESTION:  How much does the falling US dollar have to do with the SUPPLY of oil from producers, or the DEMAND for oil by consumers?

(And yes, I am full of dumb questions! )

But, we should not be surprised at anything that is going on right now. We have been unloading cargo planeloads filled with pallets of U.S. $100 bills in the Middle East for years now.  China is sitting on so much U.S. cash they don't know what to do with all of it.

Commodities like gold, silver, and oil, among others, are going through the roof because of our devaluing of the U.S. dollar. We even import gasoline, so it will be affected by the falling value of the dollar.

I agree with you that speculators compound the problem just as they have in the securitization of home loans and the stock market in general. We prefer short-term profits and are willing to ship every decent manufacturing company overseas if it will help our next quarterly bonus.

We prefer debt to cash and we prefer appreciation to dividends.

We are doing this all to ourselves.

FII

I believe that focusing on supply and demand of oil misses the real point.  I still believe that the flight from the dollar is behind the surge in commodity prices.  The "speculation" is really such a flight.  Why hold dollars which depreciate rather that gold, oil, etc. which would only depreciate if the dollar gets stronger (not likely in the short term)?  Where supply and demand comes into play is too many dollars swishing around the world (deficit spending both in the fiscal and current account area) and not enough demand for them.

Counter wrote:

We are doing this all to ourselves.

Yes we are, fiscally (govt. deficit) financially (all the shenanigans of Wall Street) in current accounts (cheap products from abroad) and credit card spending at the consumer level.  Pogo (may be before your time) said something like "we have met the enemy and it is us".

The Shadow has seen this before  :ph34r:

Counter is correct. We are doing this to ourselves.

OPEC sees that we are unwilling to solve the energy crisis, so why not manipulate the price of oil to $110. Yesterday, our two Republican senators from Alaska introduced a bill that would open ANWAR to drilling if the price of oil goes to $125. They expect a huge fight from environmentalists.

We need refinaries and nuclear power plants. Merely announcing that construction will start on these facilities would reduce the price of oil because the suppliers want to make sure that it doesn't pay to invest in those facilities. What they do say over at OPEC is an American political climate that inexplicably blames the President rather than OPEC, so why not raise oil prices through the roof?

The dollar is directly tied to US Debt. Here again, it is the American political climate that is to blame. McCain introduced legislation to ban earmarks for a year. It failed 71-29, and who really believes that Obama and Clinton, part of the 29, really believe that we should ban earmarks. We need to cut federal spending across the board by 10% and we need to do it now, and before Shadow protests, simply make it across the board. Eliminate the politics. I don't agree with Voinovich on much, but he is the right that the ongoing, predictable, costs of the Iraq war need to be moved into the budget. We can't tax enough rich people to make up these ongoing deficits, the only practical solution is to cut spending and do it now.

Of course, none of this will happen. Most Americans don't care about the price of the dollar and most americans are recepients of federal spending (including the misguided and foolish rebate policy). If I was OPEC, I would be raising prices until there was some resistance. Why use guns and bullets for your holy war when you can bring America to its knees this way?

 

Many good and interesting points.  The bottom line is that we are doing this to ourselves to a large degree.  Right now it is clear that, as for oil and gas, the oil futures market is doing it (to us?), also.

Question: I'm not suggesting this, but what would happen to the product cycle for oil/gas if there was no openly traded futures market for it?  (BTW:  The oil futures market was created in the last few decades, so it isn't like it has ALWAYS been around.)

At what point does it become economically feasible to go back to domestic oil sources such as shale in Wyoming and abandoned oil fields in Texas and begin to claim that oil?  When oil was much lower per barrel I recall hearing that if oil reached a certain price point producers would return to higher cost areas to extract oil?  Is that happening?