Cable news channels are buzzing about the third leg of the GOP focus group recipe for Campaign 2012, Gas Prices*, which brings the usual onslaught of LTE’s from Nevadans concerned about “OMG there’s pain at the pump…” that must be proof beyond doubt that the current administration is at least ineffective with regard to energy policy. There is room to discuss Administration energy policy, any administration’s energy policy, but all such discourse has to acknowledge one crucial point: Oil prices are set in a global market. In less academic terms, we could drill the North American continent into something that looks like a miniature golf course inhabited by a large pack of gophers, but if the oil is ultimately sold to higher bidders in Brazil, China, India, or where-ever, then domestic prices are not going to decrease.
Factors in Pump Pain
The U.S. Energy Information Administration reports that approximately 68% of the gasoline price at the pump is driven by the price of crude oil, complete with a graphic gas pump to illustrate the components of gasoline pricing:
The factors illustrated above inform the prices paid by consumers at retail outlets: Distribution/Marketing; Refining; Taxes; and the price of crude oil.
Thus we know what goes into the prices shown on a 48 month average retail price graph for gasoline in Nevada:
If crude oil prices inform approximately 68% of these prices, then what informs the price of crude oil?
#1. The Supply and Demand Factor: Here’s a hint about who’s demanding (buying) the crude oil – “China is the world’s second-largest oil consumer and its demand growth is one of the biggest drivers for global crude markets. Its implied oil demand matched record levels in February, when customs data showed China imported a record 5.95 million barrels per day of crude oil, up 18.5 percent on the year.” [Reuters] Then there’s this nugget about other sources of demand: “Ten million barrels of Nigerian crude was placed into India and Indonesian end-consumers via buying tenders for delivery from May onwards, underpinning values for the key Nigerian benchmarks, Qua Iboe and Bonny Light. Spot cargoes have also been mopped up by traders and Asian buyers, leaving far fewer Nigerian April liftings for key grades, traders said. Angolan spot cargoes are already almost entirely placed with end-users. ” [Reuters] Translation: Buyers from Asia are “mopping” up all the crude oil they can purchase in the West African market.
With India becoming the 5th largest petroleum refining nation on the planet [IBEF] the nation is poised to surpass both Russia and Japan as the third largest consumer of petroleum products by 2030. [IBEF] This, in itself, is enough to amplify the pressure on crude oil prices.
Increasing demand from China, India, Indonesia, along with consumption demands from the United States, Russia, and western Europe, means more upward pressure on crude oil prices, and thence to your neighborhood gasoline pump. What’s happening on the supply side of the equation?
Here’s the official version: “Non-OPEC supply fell by 0.2 mb/d to 53.2 mb/d in January, on lower global biofuels output, an escalation of conflict in Syria and between Sudan and South Sudan, and continuing outages in the North Sea. North American light tight oil production and NGLs, as well as increasing production in Latin America, offset declines elsewhere, supporting an expected 0.9 mb/d rebound in non-OPEC supply in 2012.” [IEA] The summary might read as follows — Non-OPEC supplies of crude oil were off because of problems in Syria, Sudan, and South Sudan, along with problems with North Sea sources. More oil production in North America and Latin America offset some of the scarcity created by these issues. And, we’d better be watching what’s happening in Nigeria. Statistics for oil production by nation are available from Nationmaster. The following graph shows oil production from non-OPEC sources:
To make a very long story a little shorter — yes, there is increased production of crude oil for the global market, BUT there is also increased demand from developing nations and from China and India. Making the point even shorter — yes, U.S. production has increased, BUT we don’t have the reserves to make a major dent in the global market, and that is where the prices are set.
#2. The Speculation Factor: The McClatchy papers report the increasing amount of speculation in global oil markets as follows: “Historically, financial speculators accounted for about 30 percent of oil trading in commodity markets, while producers and end users made up about 70 percent. Today it’s almost the reverse.” This is not a good trend. The Commitment of Traders Report reveals more. Producers and traders made up about 36% of the CFTC trades for the week ending last February 14th, meaning that speculators composed the remaining 64% of the trades. Efforts to curtail pure speculation, and worse still market manipulation are tough rows to hoe. Witness the continuing drama surrounding the manipulation of four traders and trading firms who attempted to squeeze some ill gotten gains out of the 2008 oil price skyrocket. [LATimes] The gory details of this suit launched in 2011 are available in the complaint issued by the CFTC. (pdf)
It’s also difficult for the CFTC to get a grip on the speculators. “The Commodity Futures Trading Commission (CFTC) is charged with creating new rules to reign in the effect of speculation on the price of oil and other commodities. Part of its job is expanded supervision of the highly complicated $600 trillion “swaps” markets.” [Heating.com] So, the Commission is tasked with writing rules to curb speculation, but what’s been the outcome thus far?
Those infamous “swaps” are supposed to be curbed by new CFTC rules pertaining to those financial instruments [Bloomberg] which a Reuter’s article further explained: “The bulk of existing swap products and transactions would be defined as swaps under the proposals issued by the CFTC and the Securities and Exchange Commission. Products designated as swaps are subject to clearing requirements and must trade on exchanges or swap execution facilities.” OK, the rules are up, and here come the speculators’ lawyers. It take some time for litigation on limiting the oil positions to wind its way through the courts, but there are some hints.
On February 27, 2012 McClatchy reported:
A federal judge on Monday refused to halt efforts by a key regulator to limit excessive speculation in the trading of oil contracts — which is driving up oil and gasoline prices — but hinted that he might soon rule in favor of Wall Street and let speculation go unchecked.
Robert Wilkins, a judge on the U.S. District Court for the District of Columbia, declined a request for a preliminary injunction to halt the Commodity Futures Trading Commission from implementing a congressional mandate to limit how many oil contracts any single financial speculator or company can control.
What we have now is the unpleasant situation in which there is an historically high level of speculation in crude oil which is not controlled by either the producers or traders, but by those engaged in pure speculation. There are rules in place to limit the number of positions these speculators may control, but the rules could very likely be tossed depending on current litigation.
There may be other factors at play here such as the intent of Wall Street speculators to chip away at the provisions of the Dodd-Frank Act.
Dennis Kelleher, president of the advocacy group Better Markets, sat through the court hearing and emerged concerned that the financial sector was chipping away at the intention of Congress.
“This is all about the industry trying to protect large dark (unregulated) markets,” he said, referring to the so-called over-the-counter markets, which are much larger than the regulated futures markets. Under Dodd-Frank they are slated for first-ever CFTC regulation. [McClatchy]
The fact that there are rules, doesn’t guarantee that there will be enforced rules:
The CFTC’s rules cannot take effct until the agency defines the over-the-counter products, called swaps, since the private bets involve swapping risk. That is scheduled to happen in April, which means limits on next-month contracts for oil could take place soon after that. Speculative limits on oil futures contracts that go out several months or even a couple of years would take effect somewhere around this December or early in 2013. [McClatchy]
#3. Production, distribution, and taxes. If we look back at the little gas pump graphic shown above it’s obvious that production and distribution costs are relatively stable, and taxes have actually declined. Thus we can discount these as major factors in the Pain and The Pump felt recently.
The Visible and Invisible Hands
If we want the Not Quite So Invisible Hand of the Market to weigh in then it would be reasonable to call for both increased production and decreased demand — after all a surplus in any market is supposed to have a salutary effect on consumer prices. We are now exporting more petroleum products than we are importing for the first time in 60 years, [EIA] and U.S. production of crude oil has increased for the last 3 years. [WH, EIA] If we can continue to ease domestic demand, there should be less upward pressure on the price at the pump.
We can also hope that the rules set in place by the CFTC to require greater accountability and transparency in speculative markets aren’t pitched because Wall Street interests have convinced the judicial branch that more rigorous oversight and more financial sector scrutiny are “onerous burdens” on highly profitable trades, and that “cost/benefits” analyses are the end and be all of regulatory frameworks. It seems difficult to see how the “cost” of implementing the CFTC regulations are such a burden on the financial sector that they could possibly over-ride the “benefits” of curtailing more pain at the pump for average American consumers.
Finally, no solution which can be reduced to a t-shirt slogan or bumper sticker is going to suffice to bring the prices for petroleum products back to earth. What would be far better is a national conversation about energy policy that relies on analysis above sloganeering, and a general civil discourse about how to rein in financialist speculation without harming the producers and traders who rely on our futures markets.
*The other two are “deficit/debt,” and “unemployment.” [Examiner]