Various news sources feeding the Wired Web Press Network have been reporting on the $25 / barrel jump in oil prices September 22nd.
Considering a few days ago the price was under $100 / per barrel and on the 22nd they reach $130 / barrel, the point should be strikingly, indisputably clear:
The price of oil no longer has anything at all to do with the supply of oil.
This past summer I wrote a three part series on the structural lack of competition in the oil industry and the disengagement of commodities trading from the real world users of oil. Among the responses I received were several that underscored the vital role that speculators play in providing “liquidity” to the commodities markets.
There is fact behind the claim — markets are better when there is good liquidity. Basically this means that someone who has oil to sell will be more likely to make that sale if there is an abundance of buyers, whatever their motives. The contracts for sale can be “liquidated” thus generating cash flow for real world enterprises.
I am unimpressed with this argument despite the strong shade of truth.
When the economy can experience a 25% - 30% change in price in a single day it has to be obvious even to the most stubbornly ignorant that nothing dramatic has happened to the supply.
Similarly when prices went from well over $120/barrel down to just over $90, there was no shocking increase in the supply of oil.
Supply and demand are simply and clearly not at play in the oil industry.
Further, if any stronger evidence were required to support my summer series setting out the structural lack of competition, we have that evidence in spades.
When oil prices dropped from their lofty heights, gasoline prices did decline. But they did not decline in anything like the amounts they increased. I am not informed of the U.S. gasoine market, but in Canada, there is at least a 30 cent/litre gap if retail prices genuinely reflected oil prices. In other words, Canadians are paying 30 cents more per litre as compared to the amount of decrease in the price of oil.
So the evidence is not fuzzy. When commodity markets drive the price of oil up, retail prices are moved up in lock step. When commodity oil prices decline, retail prices decline at a rate of less than half.
I genuinely wonder if the forces behind the wild increase in commodity oil are not driving those increases to protect the no-longer justified retail margins. One thing is certain, that money is going somewhere and sure is not to consumers or to wild-cat independents searching for new oil.
I also do not believe liquidity is a real challenge for commodities that are known to be experiencing absolute declines in supply and in any case liquidity can be had for a much smaller share of speculative activity than is currently the case in our casino capitalism, anti-competitive model.
Glenn Caleval is a consultant and entrepreneur who writes widely. This article is distributed by The Wired Web Press Network. All Rights Reserved. Permission for reuse is granted provided that this attribution paragraph, with the link, is included.
Comments (2)
Colin Ladyka
September 28th, 2008 at 2:54 am
Hi Glenn, In my view, the volatility in a market simple reflect uncertaintity. Speculators may drive the price up or down, but there are probably speculators who are losing money as well as those who are making it. I think the best way of analyzing the situation is to draw a curve running through the average of the highs and lows (over time). Such a curve would best represent the market value of the product, not at a point in time, but through a particular period. Secondly, there is an empirically provable correlation between volatility and bear markets. Volatitly increases in bear markets, and decreases in bull markets. An additional explanation for volatility (now I am talking about the current stock market) is related to the securitization of mortgages. This process has increased the informational distance between the people who own the mortages and the people who are making (or not making) the payments, leading to greater uncertaintity about the value of the security. Finally, Wall Street has seen continuous deregulation of financial markets under the Bush administration. This has allowed companies to hide deteriorating balance sheets. This last comment is, of course, partisan so feel free to reject it. I have debated this with my boss at work. He lays much of the blame on a change in American culture (and Canadian, to a lesser degree) which has normalized increasingly larger amounts of consumer debt. I am sure this is part of the explanation, but I also think that unregulated and unscrupulous sellers of differential rate mortgages are largely responsible. When I bought my house, I believe (it was a long time ago) that I needed 10% down before CMHC would insure the sale. A CMHC representative actually physically inspected my house to determine that the collateral (the house) was enough to cover the mortgage. I now wonder if 10% is too low, and 15% might be a better number (now that I am turning into a grumpy old man). Don’t get me wrong. Every political movement has both successes and failures. One of the successes of the Thatcher revolution was to emphasize the importance of home ownership. I truly believe that people who own their own homes have a stake in their neighbourhood and will work to make it better. I just don’t believe we should promote home ownership by encouraging people to take on debts that they cannot service. Home ownership is best supported by making it available the the economic tier just under the current minimum. A way of promoting this would be to lower the mill rate on homes less than a certain appraised value. Unfortunately, this is the opposite to a movement in Regina city council which would like to createa “minimum property tax” so that owners of modest homes pay the full cost of the city services they receive. Here I go getting partisan again… Take care… Colin
Glenn Caleval
September 30th, 2008 at 10:32 pm
You make some good points, however I think the blurring of stock markets with commodities markets is a mistake.
Volatility in stock markets is well documented in bear trends. The reason this happens is actually not at all complicated. Stocks do not represent single physical material goods. Instead they are by design “derivative” in the sense that they reflect expected profit performance by specific businesses operating in the real world. Bear markets reflect expectations that one or more economic sectors are going to perform negatively. At the same time no one knows exactly how negative the performance will be so there are investors who will see value once stocks fall below a given price. When they jump to make value buys, others frequently follow, until the next sneeze and the stocks tumble again.
Financial markets are even further removed from physical reality and hence are susceptible to the abuses now afflicting much of the world. I think it is ludicrous to blame such things on “American culture.” Trying to maximize self-interest is a normal aspect of human behaviour and psychology.
Commodities are not at all like stocks; and they are (or should be) entirely removed from financial derivatives. For a commodity like oil, there is in fact widespread recognition of what is called “the floor.” The floor is the price below which oil should not fall because the physical volume simply required to continue operations at last year’s status quo would require that minimum price. We are of course speaking of world wide operations that consume oil. Recent work has been done that suggests the floor price is significantly lower than the current volatile prices and is hypothesized by some as being around $70 per barrel. (Business News Network and U.S. Congressional hearings).
Commodities are real, physical substances required for a great variety of economic activity. Base minerals are thought to have no real base price because the majority of essential activity can occur absent new iron ore, for example. Economies will reduce demand for products that require iron and stretch existing iron products into ever longer service.
The idea that oil prices decline in response to sensible projections regarding the increase or decrease in the supply-demand balance of oil due to economic growth or recession is irrefutably established as fantasy.
No one. No one at all, projects the supply of oil to shrink by 25% in the near term, let alone on the long market. Similarly no one at all, no one, suggests it is reasonable to project a 25% increase in demand for oil, particularly not on the short market where these wild rides have been experienced.
So I do not believe your comments are on point.
I do not think it necessary to make discussion about regulation “partisan” when it is perfectly capable of a good exchange on its merits. I watched a former Treasury Secretary from the Clinton administration last night on CNN. He stated that the deregulation of the financial markets started under Clinton and were exacerbated under the Bushes. It is irrelevant what administration did what, if I am accurately understanding your purpose, to weigh the need for more or different kinds of regulation.
I happen to strongly believe that there is a pressing need for more regulation. Further, I make the case in my earlier three part series that regulation such as being discussed are not properly called “infringements” or “intrusions” on the competitive free market. Such regulations are required precisely to address the absence of competition.
“Free market” has never been put to mean an abstract freedom to do as one pleases. The term includes within it, body and soul, the entire concept of competition.
When a firm gets to the size that over 80% of all mortgages are under its insurance coverage (AIG), it is not even an oligopolistic market. It is by definition a monopoly.
Any time a firm “gets too big to fail” it is prima facie evidence of the existence of at least an oligopoly.
I unambiguously recognize competition as the highest ideal for economic growth and economic allocation of resources. The problem is that too many sectors of the world economy and certainly the Canadian economy, are not engaged in real competition. I advocate intervention to break up the oil industry the same way the telecommunications industry was broken up. I have a similar view regarding the massive oligopolies of the agriculture supply sector.
The clamour for ever larger and the fear of being too small have been songs reducing us to a single economic refrain. It’s a monotone.
We have become ingrained with secret deals and “confidential terms of sale” when the key priority for a free market is the free and transparent exchange of information. Price discovery is no longer the goal of commodities markets and we find entire sectors of economic production where price discovery of any kind is at best elusive. In financial markets today it is entirely impossible. No one knows what any of those derivatives are worth, much less what the mortgages they ultimately securitized are worth. We believe that vertical integration equals free marketeering when it has resulted in many examples of top-down monopolization and expropriation of resources that would be otherwise allocated in the presence of competition.
My belief is that diversity in our economy, just like diversity in biology, is the best and most successful road map to propagation (of wealth or life).
Finally, you bring home ownership into the equation with a hint of the moralist. I think it is absurd to believe that seven million American families woke up one day and decide to go buy houses they knew they would end up losing to foreclosure. There are a million of those families already put out their homes. They may have been uneducated, even stupid or foolish. But they do not make their livings measuring risk, balancing ability to pay and approving mortgages. Others have that job. To have walked millions of people through this process is criminal in every sense of the word.
I want to know who’s going to jail.
Somebody better.
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