Commentary
Economics 101 remedial
By William Blum
Online Journal Guest Writer


Jul 9, 2008, 00:16

The economists who defend the perpetual crises of the capitalist system -- the sundry speculative bubbles followed by bursting bubbles followed by a trail of tears -- most often turn to “supply and demand” as the ultimate explanation and justification for the system. This provides an impersonal, neutral-sounding, and respectable, almost scientific, cover for the vagaries of free enterprise.

They would have us believe that we shouldn’t blame the crises on greed or speculation or manipulation or criminal activity because such flawed human behavior is overridden by “supply and demand.” It’s a law, remember, “the law of supply and demand” is its full name. And where does this “law” come from? Congress? Our ancestral British Parliament? No, nothing so commonplace, so man-made. No, they would have us believe that it must come from nature. It works virtually like a natural law, does it not? And we violate it or ignore it at our peril.

Thus have we all been raised. But great cracks in the levee have been appearing in recent years, in unlikely places, such as the Senate of the United States, which issued a lengthy report in 2006 (when a gallon of gasoline had already passed the three dollar mark) entitled: “The role of market speculation in rising oil and gas prices.” Here are some excerpts:

“The traditional forces of supply and demand cannot fully account for these increases [in crude oil, gasoline, etc.]. While global demand for oil has been increasing . . . global oil supplies have increased by an even greater amount. As a result, global inventories have increased as well. Today, U.S. oil inventories are at an 8-year high, and OECD [mainly European] oil inventories are at a 20-year high. Accordingly, factors other than basic supply and demand must be examined.”

“Over the past few years, large financial institutions, hedge funds, pension funds, and other investment funds have been pouring billions of dollars into the energy commodities markets . . . to try to take advantage of price changes or to hedge against them. Because much of this additional investment has come from financial institutions and investment funds that do not use the commodity as part of their business, it is defined as ‘speculation’ by the Commodity Futures Trading Commission (CFTC). According to the CFTC, a speculator ‘does not produce or use the commodity, but risks his or her own capital trading futures in that commodity in hopes of making a profit on price changes.’ [Futures contracts gamble on the price goods will fetch on a particular date in the future; the contracts are traded like stocks.] The large purchases of crude oil futures contracts by speculators have, in effect, created an additional demand for oil, driving up the price of oil to be delivered in the future in the same manner that additional demand for the immediate delivery of a physical barrel of oil drives up the price on the spot market. . . . Although it is difficult to quantify the effect of speculation on prices, there is substantial evidence that the large amount of speculation in the current market has significantly increased prices.”

The prices arrived at daily on the commodity exchanges (primarily the New York Mercantile Exchange -- NYMEX), for the various kinds of oil are used as principal international pricing benchmarks, and play an important role in setting the price of gasoline at the pump.

A good part of the Senate report deals with how the CFTC is no longer able to properly regulate commodity trading to prevent speculation, manipulation, or fraud because much of the trading takes place on commodity exchanges, in the US and abroad, that are not within the CFTC’s purview. “Persons within the United States seeking to trade key U.S. energy commodities -- U.S. crude oil, gasoline, and heating oil futures -- now can avoid all U.S. market oversight or reporting requirements by routing their trades through the ICE Futures exchange in London instead of the NYMEX in New York. . . . To the extent that energy prices are the result of market manipulation or excessive speculation, only a cop on the beat with both oversight and enforcement authority will be effective. . . . The trading of energy commodities by large firms on OTC [over-the-counter] electronic exchanges, was exempted from CFTC oversight by a provision inserted at the behest of Enron and other large energy traders into the Commodity Futures Modernization Act of 2000.” [1]

A tale told many times. While you and I go about our daily lives trying to be good citizens, the Big Boys, the Enron Boys, are busy lobbying the Congress Boys. They call it “modernization,” or some other eye-rolling euphemism, and we get screwed.

The Washington Post recently had this to report on the Enron and Congress Boys: “Wall Street banks and other large financial institutions have begun putting intense pressure on Congress to hold off on legislation that would curtail their highly profitable trading in oil contracts -- an activity increasingly blamed by lawmakers for driving up prices to record levels. . . . But the executives were met with skepticism and occasional hostility. ‘Spare us your lecture about supply and demand,’ one of the Democratic aides said, abruptly cutting off one of the executives. . . . A growing number of members of Congress have reacted to public outrage over skyrocketing gasoline prices by introducing at least eight bills that restrict the ability of financial companies to buy futures contracts, [require companies to] disclose more about those investments or stiffen federal oversight of energy trades.” [2]

Some further testimony from the 2006 Senate hearing:

“There has been no shortage, and inventories of crude oil and products have continued to rise. The increase in prices has not been driven by supply and demand.” -- Lord Browne, Group Chief Executive of BP (formerly British Petroleum)

“Senator . . . I think I have been very clear in saying that I don’t think that the fundamentals of supply and demand -- at least as we have traditionally looked at it -- have supported the price structure that’s there.” -- Lee Raymond, Chairman and CEO, ExxonMobil

“What’s been happening since 2004 is very high prices without record-low stocks. The relationship between U.S. [oil] inventory levels and prices has been shredded, has become irrelevant.” --Jan Stuart, Global Oil Economist, UBS Securities (which calls itself “the leading global wealth manager”)

In 2008, when a gallon of gasoline had passed the four dollar mark, OPEC Secretary General Abdalla Salem el-Badri stated: “There is clearly no shortage of oil in the market.” El-Badri “blamed high oil prices on investors seeking ‘better returns’ in commodities after a drop in equity prices and the value of the dollar.” [3]

Finally, defenders of the way the system works insist that the oil companies have been experiencing great increases in their costs, due particularly to oil running out, so-called “peak oil.” It costs much more to find and extricate the remaining oil and the companies have to pass these costs to the consumer. Well, class, if that is so, then the companies should be making about the same net profit as before peak oil -- X-dollars more in expenses, X-dollars added to the price, same amount of profit, albeit a lower percentage of profit to sales, something of interest primarily to Wall Street, not to ordinary human beings. But the oil companies have not done that. Their increases in price and profit defy gravity and are not on the same planet as any increases in costs. Moreover, as economist Robert Weissman of the Multinational Monitor has observed: “While the price of oil is going up, these companies’ drilling expenses are not. Oil can trade at $40 a barrel, $90 a barrel, or $130 a barrel. It still costs ExxonMobil and the rest of Big Oil only about $20 to get a barrel of oil out of the ground.” [4]

The above is not meant to be the last word on the subject of why our gasoline is so expensive. Too much information is hidden, by speculators, oil companies, refiners, and others; too much activity is unregulated; too much is moved by psychology more than economics. The best solution would be to get rid of all the speculative markets -- unless they can demonstrate that they serve a human purpose -- and nationalize the oil companies. (Oh my god, he used the “N” word!)

Notes

[1] “The role of market speculation in rising oil and gas prices,” published by the Permanent Subcommittee on Investigations -- Committee on Homeland Security and Governmental Affairs, United States Senate, June 27, 2006.

[2] Washington Post, June 19, 2008, p.D1, “Wall Street Lobbies to Protect Speculative Oil Trades”

[3] Washington Post, May 10, 2008, p.D3

[4] “What To Do About the Price of Oil,” Multinational Monitor, May 28, 2008