Thursday, July 3, 2008

Oil Prices Are Not Dependent on Oil Sources

A reader of my post “A Tax By Any Other Name” felt that I was naïve to suggest that supply and demand sets oil prices. The reader believes that oil pricing is driven more by speculation than anything else.

I agree with the reader that speculation is a large part of the reason we are paying $4 per gallon for gas at the moment. In my post I stated the supply and demand for oil is only a part of what sets the price for gas. I was mostly writing on how the increasing supply and decreasing demand for dollars is contributing to oil price increases. But in the last six months the falling dollar and increased oil consumption cannot account for the sudden 50% price rise for a barrel of oil. Speculation is clearly part of the problem.

It is no secret that the banks, investment houses, hedge funds, and oil companies now conduct most the trading in oil futures on all electronic foreign exchanges (such as the InterContinental Exchange or ICE) that are out of reach of U. S. regulators. A CBS news story quoted Michael Greenberger, a former top staffer at the Commodities Futures Trading Commission, as saying that 25% -50% of the price per barrel might be due to speculation. Greenberger believes that “If you can trade out of the sight of U.S. regulators, you can manipulate these markets."

What is especially disturbing about “foreign exchanges” like the ICE is that it is not actually foreign. Among its founding partners are Goldman Sachs and Morgan Stanley, its headquarters is in Atlanta, its primary data center is in Chicago, and it settles most trades in U. S. dollars. Despite all of its U. S. ties, the ICE claims that because its energy futures business is conducted in London—whatever that means—U. S. laws or regulations do not apply to it.

But all this supports the crux of my earlier argument that the energy independence that politicians speak of achieving is a myth because oil companies “will always sell their product to highest bidder, wherever the bidder resides.” The price of oil has no relationship to its origin.

In 2007 the U. S. imported about 10 million barrels of oil per day and produced about 5 million barrels per day. According to the Energy Information Administration, the top three countries of origin for imported oil in 2007 were Canada (1.85 million barrels per day), Mexico 1.47 million barrels per day) and Saudi Arabia (1.36 million barrels per day). Canada and Mexico actually supply more oil to the United States than Saudi Arabia.

If the U. S. decides to increase its domestic production of oil through offshore drilling or other means, it will contribute to the world supply of oil and that additional supply will be factored into the world price. Any politician who claims we can be more energy independent by drilling for more oil in the U. S. is being disingenuous. A far more relevant question to ask our political leadership is: Why are U. S. investment banks allowed to manipulate energy futures markets with no government oversight? I don’t think there is going to be a straight answer for that question.

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy

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