dihard:

The big blame game is really getting to be too much. 77% of Americans blame the government for high gas prices, 75% blame oil companies, and 70% blame foreign oil producers, per a recent Consumer Reports survey. But all of those culprits pin the blame on another party. So, really, who is to blame for high oil prices?

Oil companies? Many like to blame big oil companies with their “windfall” profits. But they only get 4% of the cost of gasoline at the pump. Big oil often passes the blame onto speculators, the government, or a dearth of supplies.

Speculators? They’re not to blame either, according to recent news. First of all, the percent of futures contracts held by speculators has declined over the past year, so they can’t be to blame. Secondly, in order for speculators to actually change the price of oil, they’d have to take the physical oil off the market. Which they don’t - traders buy a futures contract, or an agreement for the seller to deliver a certain amount of oil on a certain future date for a certain price. But they resell the contract just before the date of delivery, and it typically rolls over into the next month’s contract.Thus, speculators don’t affect the actual spot-price of oil.

In fact, futures trading actually encourages oil companies to make costly investments in new production, which keeps the gas prices down. And they may actually discourages hoarding and makes prices less volatile.

Oil producers? The US Energy Secretary blames insufficient oil production, which has not kept up with demand. But they, namely OPEC, have been blaming speculators and the decline in the dollar, indicating that we are gouging ourselves. OPEC Secretary General stated today there is “no shortage” in the oil market.

The news? Economist Martin Feldstein concludes in today’s WSJ that “news stories, rumors and industry reports can cause substantial fluctuations in current prices – all without anything happening to current demand or supply.”

Congress? While only 4% of the cost of gasoline goes to oil companies, 15% of the cost of gasoline goes for taxes. Plus, Congress prohibits the production of domestic oil and natural gas, so they’re certainly to blame, right? This op-ed argues that if Congress were even to announce it has opened the way for domestic production, prices would drop. There’s that “news stories, rumors, and industry reports” component again. Congress likes to also blame the speculators. But a recent Fortune article invites Congress to “demonstrate a basic understanding of the mechanics of futures trading… Even better, they should be required to explain in detail how it is that investors who never take delivery of a single barrel of crude - and thus never remove a drop of oil from the open market - are causing record high oil prices.”

Understanding what factors drive the rise in oil prices, much like understanding the subprime mortgage crisis, is critically important to not only those making the law, but also essential to the lives of everyday consumers. For me, comprehending such a complex development is beyond my training, but I think I understand it enough on some elementary level—at least enough to know that the above analysis isn’t nearly complete (or accurate). Chalk it up to my distrust of information generated by a think tank financed by ExxonMobil that denies the existence of climate change.

My first point would be that while it does a good job of explaining some of the players involved in driving up oil prices, it is incredibly one-sided. Obviously, if we ask the Wall Street Journal, oil companies, think tanks funded by oil companies, oil companies at summits in foreign countries, and Forbes magazine, we are undoubtedly going to arrive at the conclusion that firstly, no business interests are to blame, and secondly, it’s clearly Congress’s fault for preventing expansion of oil drilling (like in the Artic National Wildlife Refuge, for example).

Let’s also call the US Energy Secretary’s statement that insufficient supply thanks to OPEC is really to blame (even though Saudi Arabia will be increasing supply) what it really is, a punt of the football. If there was a way Congress could solve this problem other than regulating the loopholes in the speculation market, which is probably a good place to start, the Bush administration doesn’t want to do it. They’d rather meet with Saudi Arabia and avoid regulation altogether (or failing at opening up ANWR again) than even touch the legislative side of things. And besides, he’s got six months left and he wants to solve the Israeli-Palestinian conflict.

The second area where the I think the analysis comes up short is it’s swift dismissal of any blame on the speculation industry, using highly dubious evidence (from the ExxonMobil funded think tank). Bear with me, because here we have an area where my comprehension of the speculation industry will be put to the test. From what I can make of it, the speculation industry is not blameless, and a few key areas need looking at.

  • First, and this may contradict my economics learnin’ but I’m going with it anyway, the oil industry benefits from the high prices the speculation market generates for oil. If this weren’t the case, ExxonMobil would have silenced the report from the Institute for Energy Research. But the report accomplishes one if not more beneficial ends. It makes a case for not regulating the speculation industry. Through the eyes of Exxon, the report can roughly be interprated as this: The speculation industry, which may or may not be driving up oil prices, is (according to the report that was funded by Exxon) definitely not driving up oil prices, which is definitely in turn not responsible for increasing oil prices, so there’s no need to regulate ExxonMobil the speculation market, right? (Unless the speculation industry and oil companies are indeed to blame for increasing the price of oil and reaping huge profits at the expense of the American consumer.)
  • Secondly, the speculation market drives up oil prices. Speculators buy futures contracts that guarantee them a certain number of barrels of oil at a certain price at a certain date in the future. They make a profit when the price of oil per barrel goes above the set amount they are required pay per barrel according to their contract. (Of course, they do sell the contract at the last minute because a speculator does not personally want to actually buy the oil, but let’s ignore that for now.) When a speculator sells a oil futures contract, they sell it at the market price. When oil producers issue a futures contract, they issue it at the market price. So what happens when you have a situation like today where speculators have so much confidence in the market that they do not see the price of oil going down anytime soon?
    • Speculators keep buying futures contracts at higher and higher prices, with a pretty confident assumption that the price they pay today will be cheaper than the price of oil in the future, profiting when they are right.
    • Oil producers keep selling oil futures contracts at higher and higher prices, because speculators will keep paying higher prices for futures contracts. Oil producers reap higher profits from higher prices.
    • The increased prices from all of the futures contracts that oil producers and oil speculators profit from is passed down to consumers, because all the contracts represent barrels of oil that you and I pay for at the pump.

If my understanding is correct, what is going on in the oil speculation industry right now is much like what went on in the sub prime crisis, where everyone but the American consumer (and BearStearns + other unfortunate financial companies) profited from what ultimately ended up being a scheme for some smart financial guys to make a quick (and sizable) profit.

But hey, I could be wrong. If anybody actually wants to correct or clarify some of the things I tried to tackle then I am all ears. Hopefully I made sense, but I don’t have time enough to check. Back to school work. Yay.