Oil at $111 a Barrel: We Are Being "Sovereignly Screwed"!

The price of oil has diverged from fundamentals in such a dramatic way that it is placing our economy at grave and immediate risk, not to speak of the consequences of the enormous, unprecedented transfer of wealth that is taking place.

There are no crude oil shortages. Commercial inventories of crude oil, even excluding our Strategic Petroleum Reserve are 9% higher than they were at the end of last year. Crude inventories increased in seven of the last eight weeks. This past week crude oil inventories jumped by 6.2 million barrels far more than the 1.7 million barrels forecast. Yet prices barely budged below their all time highs of $111/bbl. Gasoline inventories are at their highest levels in the past 18 months.

Geopolitical concerns, though always present and forever overplayed are no more problematic presently than they have been in years past. Supply and demand? Largely adequate supply and diminishing demand. Yet, the price for crude oil continues to escalate to ever higher highs.

Turn on the television or read the papers and the reasons are always the same. The falling dollar (rarely a mention that the price of oil has increased by over 120% over the past 15 months, far more than the dollars the 18% fall over the same period (see "A Short Tutorial on the High Price of Oil and the Falling Dollar," 10/19/07). The dollar weakness can be blamed for much, but hardly the massive and disproportionate increase in oil prices. In addition the economy is slowing markedly and gasoline consumption is being impacted appreciably by higher prices as well as the weakening economy -- Economics 101 prescription for lower oil prices which just isn't happening (today's overall turbulence excepted but still to levels that are historically steep highs).

To better understand what is happening we need a time warp moment. With a tongue in cheek heading -- "Oil Baron Longs for Past, Not Futures" -- Newsday reported on November 2, 1990 -- (yes, 1990. Leon Hess, erstwhile owner of the New York Jets, was Chairman and Founder of Hess Oil & Chemical now known as the Hess Corporation -HES-):

"Leon Hess, whose oil company made more than $200 million by trading oil futures during the Persian Gulf crises..."I'm an old man, but I'd bet my life that if the Merc (the NY Mercantile Exchange) was not in operation there would be ample oil and reasonable prices all over the world, without this volatility" Hess said at a hearing the Senate Committee on Government Affairs held on the role of futures markets in oil pricing."

Ah, but, we are told, hedge funds, speculators, individual investors and even conservative institutional investors such as the CalPERS (the California Public Employees Retirement System) given the risks of the stock market and the disastrous bond markdowns are pouring significant funds into commodities as an asset class. As quoted by Reuters, "the financial flows have been overwhelming the fundamentals of the oil market." The inflows are large and the aforementioned groups are forever cited as the source of liquidity flooding the commodity pits. Yes, but oil continues to go up, up, up while other commodities such as grains have occasional and significant retracements.

But wait, there is a conspicuous absence in virtually all these analyses. Let me explain. In an eye-opening article that surprisingly received little or no attention by our forever somnolent press on issues of oil pricing, London's Financial Times headlined "Brazil Sovereign fund to target currency" 12.10.07. According to the FT Brazil's finance minister Guido Mantega Brazil is to create a sovereign wealth fund with the primary aim of intervening in foreign exchange markets to counter the appreciation of the country's currency.

Now consider the following. The vast transfer of wealth to oil exporters, most especially members of the OPEC cartel are accumulating enormous currency surpluses, permitting them in their own manner, to create sovereign wealth funds, deep reservoirs of cash without oversight, without transparency, without regulatory constraints, without operational standards, without disclosure requirements including conflicts of interest, without being subject to due diligence. This staggering accumulation of wealth has resulted in the formation of such behemoths as the United Arab Emirates with its $875 billion fund, Kuwait $250 billion, Qatar, Libya, Algeria, (coincidentally or not, all members of OPEC) among others and then of course Saudi Arabia whose sovereign fund according to the FT is expected to dwarf that of the UAEs.

Now given the lesson learned from the candid Brazilians, it doesn't take an advanced degree in Rocket Science to begin to discern a relationship between these opaque pools of capital and the otherwise inexplicable price moves in the energy trading pits. Are there valid reasons that underlie high oil prices? One could certainly put forward reasons supportive of strong pricing. But nothing either in demand nor supply nor market dislocation that in any way could reasonably substantiate the exacerbated degree of current price increases other than concerted manipulation toward ever higher prices, pure and simple. If Brazil presumes they can control the value to the Real on world currency markets through their sovereign wealth fund, influencing the price of a commodity, even one as widely traded as oil, would be equally plausible.

Can one reasonably suggest that these massive holdings of capital would not seek to support the price of the primary resource which is the mainstay of their economies by underpinning the price of oil on commodity exchanges around the world? Remember, trading on these exchanges is largely opaque and barely regulated. Anonymity of buyer and seller is easily achieved, especially so in the commodity exchanges outside the U.S. and over electronic traded markets. The way the price of oil is now traded provides it perfect cover to those who have the means and the objective of gaming the system.

Circumstantial evidence, circumstantial presumption? Perhaps. But certainly the logic is inescapable and cries out for congressional hearings on the role of the futures markets and the sovereign wealth funds and their offshoots in determining oil pricing.

Of course, there are many in this oil addled administration who are content with oil prices as they are, given the riches being visited on colleagues, friends and supporters in the oil industry no matter the crocodile tears now, at long last, being shed at the current level of prices. The same is true for too many in Congress especially those from states closely related to the oil and energy industry.

To expect much from this administration and the Congress given its craven obeisance to the oil industry these past years is wishful thinking at best. What is needed is an entirely new approach that needs be defined, ideally in the upcoming presidential debates whereby each candidate defines clearly his policies toward energy, and its consumption.

Certainly a way needs be found to divorce oil pricing from the commodities futures pits or at the very least, that trading on those exchanges become transparent and represent freely functioning markets that are not riddled with conflicts of interest or purposeful manipulation.

Some further thoughts of what might be done in future posts.

Comments

[Clinton]

Good luck trying to work around sovereign wealth funds. Too many people with too much power want to maintain the opacity. Our government is being run by these funds and we can't do anything to change this.
Too late!

[springsm]

"WE ARE BEING"???? Shouldn't that be "we have been". And forget "sovreign"­...it was local stuff..lik­e bush/chene­y/rummy/wo­lfie and all those wonderkins­....my take anyway..

[Metacortex]

The Iraq war was plainly wrong. Why it was wrong depends on whether a hawk or dove: If you're a hawk, it was wrong because Iraq was the 5th, not the #1 oil producer. If you're a dove, deception is always wrong. Unfortunately, we got what we asked for and may find ourselves, committees, sanctions and truth notwithstanding, on course to WWIII. A little knowledge and a lot of arrogance is a dangerous thing and McBush and the Neocons have proved it. The GOP has proven that they will do anything to win, because blind self-rightiousness is all they have. Their motto has been to sell the war to the public at ALL costs. The very threat that they may now lose the presidency and both houses of congress will force them to play the only card they have - fear. This President will likely have us in Iran before November. The Repubs are sooooo patriotic that they would sooner see this country fall while in their hands than to stand proud in anyone elses.

[Craig]

Start paying down the national debt and funding social security (instead of spending it for daily operations) and oil will start moving down.

Conservation can reduce our dependence on oil by 100% by improving mileage and replacing with alternative sources.

In the meantime we could focus on increasing our supplies from Canada, Mexico, and Venezuela (the hatred is limited between two crazy people, Bush and Chavez). that way will limit our national security concerns (and military expenditures) to the western Hemisphere.

[TexasDem0]

We need a reciprocal policy that charges the Saudis fee tied to oil prices for the military protection it gets from the U.S.

If we had an energy policy that had weaned us off of foreign oil, we could withdraw the U.S. Nave from the Persian Gulf and let the Saudis provide their own protection.

[retarius]

Why shouldn't they use their wealth to protect their assets? The US uses its military and its wealth to coerce sovereign nations to do its bidding, why shouldn't these prudent nations, that run surpluses, use the leverage that has been given to them...at least they are not Abu Graib-ing, Guantanamo-ing, and bombing innocents.
And think, who gave them the whip to beat the US with? Why those profligate consumers and legislators in America of course....­no thought to saving energy (might slow economic growth...B­ush 2001); no thought to living within their means....n­o, in America's eyes, the world owes America a living.

[fact finder]

This country survived for almost two hundred years with out a stock market. Get rid of the stock market let supply and demand rule the price and the troubles will go away. I may be wrong on the number of years that there was no stock market , but it was a long time. Leon Hess is 100% correct.

[Henry]

Ray:
I've a degree in economics. I've always thought, unless you were pro baseball or Bill Gates, that restraint of trade was frowned upon. Indeed, it was devious George who advised slick-Willie (when slick Wille was pres) that he, slick-Willie should have "jaw-boned" the Saudis to lower the price of oil, since they, the Saudis had influence upon the earstwhile "market" prices of oil.
Isn't it all true that we Ameicans have been screwed and abused by OPEC and that our republican government and now also the dems have "bent over". Is this the America we are supposed to be proud of? If Norman Rockwell were around to paint this "still" of America would it look like pornography? (I think it would)

[joebaggadonuts]

Henry,

If Norman Rockwell were around today he would be painting Guernica. http://en.wikipedia.org/wiki/Guernica_(painting)

Thanks.

Joeb.