Oil: Policy, Politics and Profiteering
By Bob Wong, Vice President - June 4
As crude oil soared over $130 in May, the U.S. Congress resorted to its usual PR antics by hauling oil executives in front of the Senate Judiciary Committee to answer questions of why, according to Senator Leahy, D-Vt., “there is an unexplained disconnect between prices, and legitimate supply and demand.” Well, Senator, perhaps an informed observer might suggest that the true disconnect is between economic reality and expedient politicians like yourself and your congressional colleagues.
Eye-popping quarterly profits from oil companies provide a convenient target for angry consumers, giving cover to lawmakers on Capitol Hill who consistently abdicate their collective responsibility to promote fuel economy standards, provide access to domestic energy supplies, develop alternative and renewable energy sources, increase oil refinery capacity, and encourage lower energy consumption.
In the past two decades, Europe and Asia have embraced mass transit solutions by pursuing urban planning objectives that reduce reliance on the automobile. However, Americans (and Canadians as well) have been indoctrinated to believe in their perpetual entitlement to cheap and boundless energy supplies. Urban sprawl continues unabated, SUV drivers remain defiant, and politicians maintain their ridiculous posture of pandering to voters and denigrating the need for conservation. Whipping up populist sentiment against oil executives and their multi-million dollar salaries is just another sideshow to avoid serious debate.
Economic insecurities stemming from a credit contagion, falling home prices, $4 a gallon gasoline and job losses are exploited to promote the narrow agenda of the paranoid and the xenophobic. Incumbent politicians obsessed with self-preservation offer only short-term, incoherent solutions to long term structural problems, aided and abetted by an ill-informed electorate too eager to be bribed by promises their children will eventually pay for.
There are many competing theories for the high price of oil. Peak oil is popular and sounds credible. Proven oil fields around the world are facing declining production. The weak supply situation is further exacerbated by burgeoning demand from China, India and other developing countries, who become convenient scapegoats accused of crowding out the American energy consumer. The current global crude oil supply/demand imbalance is a 2 million-barrel deficit per day. While this shortfall has persisted since Q1 of 2007, the steep 100% rise ($65 to $130) in the price of crude in the last 12 months has certainly fueled conspiracy theories.
Meanwhile, rising standards of living around the world lead to more mobile populations that travel further, and more frequently, by land and air. Decades of cheap oil have seduced drivers into bigger and thirstier vehicles loaded with options and horsepower, with the auto industry welcoming the higher profit margins from these gas-guzzlers. Throw a weak US Dollar and rising global inflation into the mix, and clueless politicians are left spinning their wheels assigning blame to anyone but themselves and their disastrous policies.
Of course, no crisis is ever complete without its cast of sinister characters. Little blame is laid at the feet of inept politicians, bungling bureaucrats, incompetent regulators and profligate consumers who directly contribute to this predicament. Instead, comments from government officials, the financial media and academia now feed into the public psyche the myth of super-predator funds, stalking commodity markets and driving up energy and food prices. These speculators allegedly include hedge funds, pension funds, commodity index funds, sovereign wealth funds, etc.
According to a report from the New York Times, the U.S. Commodity Futures and Trading Commission will announce a set of policy changes to address public and political concerns that market malfunctions may be contributing to rising food and energy prices. Financial demand for commodities has grown tremendously as evidenced by the growth of investment in commodity funds, from $13 billion in 2003 to about $250 billion this year. However, are these super funds solely responsible for the current price spikes in crude oil?
An important primary function of the futures market, at least in its original intent, is to allow producers and consumers of commodities to hedge their exposure to market volatility by transferring risks to speculators. Speculators are motivated by profit potential but they provide liquidity which is an essential ingredient for any smooth functioning market. Funds, institution money and, for that matter, even the retail investor will, for the accepted amount of risk, seek the highest returns possible. With the S&P 500 and the Nasdaq trading at 1999 levels, and economic fundamentals lending themselves to bullish sentiment in the commodity sector, it is no surprise that money will continue to chase after returns offered by crude oil.
No stock, commodity or tangible asset could rise in value without a compelling narrative to convince the buyers to step up, and the owners to hold on. Leaving aside the argument of whether crude oil market price action suggests a bubble or manipulation, the compelling narrative in the rise of oil is the increase in global demand coupled with the decline of production from proven reserves. However, failure to alleviate the shortage with sensible policies is compounding the situation by creating the economic conditions conducive to financial speculation. It is imperative for policy makers to recognize that rising oil prices reflect primarily the growing imbalance between supply and demand. All other reasons such as the Iraq war, terrorism premium, weather disruption, the weak US Dollar and now, speculation are only temporary factors with marginal bearing on the long term structural price of oil.
U.S. oil demand is currently 25% of total world demand although its population is less than 5%. With projections of oil price to hit $200 a barrel, it is critical that this crisis be dealt with on both the supply and demand sides of the current imbalance. Congress must immediately lift the moratorium on domestic oil exploration, and impose minimum fuel standards on new vehicles produced. Efforts must be redoubled to increase production of fuel-efficient and hybrid vehicles, develop alternate fuel sources including wind and solar power, and expand the nation’s refinery capacity.
In the absence of a clear and coherent U.S. energy policy, the free market will continue to set higher prices until there is a full blown recession, or until there is the political will to address these issues in a responsible manner. Ill-conceived suggestions to raise margins on oil futures trading will simply encourage oil trading to migrate to foreign bourses, or to the unregulated OTC markets. Sovereign wealth funds that feel disadvantaged by U.S. regulations may be less willing to come to the rescue of the next Citicorp in trouble.
The U.S. presidential election in November will hopefully provide the impetus for changing the way business is done in Washington D.C. There can be no credible and serious policy enacted if the American public is to be misled by Congress that their energy problem results from the action of speculators, rather than the inaction of those they have elected. Common sense must once again prevail over diversionary tactics, and it should not have to take $200 oil to achieve that.
If you would like to learn more about investment strategies using oil futures please contact Bob Wong at 905-771-5854.
The data and comments provided above are for information purposes only and must not be construed as an indication or guarantee of any kind of what the future performance of the concerned markets will be. While the information in this publication cannot be guaranteed, it was obtained from sources believed to be reliable. Futures and Forex trading involves a substantial risk of loss and is not suitable for all investors. Please carefully consider your financial condition prior to making any investments.
