High energy prices: coincidence?

Great Debates
1

In 1996, the energy markets in California were partially deregulated (badly, some say; the system could be gamed by various means to artificially limit supply or create imaginary demand).

In 2000, the prices went sky-high.

In 2000, the oil futures markets were deregulated with the help of legislation crafted by energy companies.

In 2008, prices are sky-high.

I’m not saying deregulation is a bad thing or a good thing: we have an ongoing thread about the Invisible Hand and the principles of the free market, so leave that discussion over there.

What I’m saying is that the energy policy seems to be in favor of allowing energy companies — one energy company in particular seems to have machinated both these schemes, Enron — to manipulate the market. (Republicans in Congress wrote the bill, and Clinton signed it, so there’s plenty of partisan blame to go around. It’s no wonder Congress hasn’t been analyzing it too closely until recently.)

Ten years ago I might have believed that it was the free market, supply and demand, causing oil prices to rise. I would have listened when the pundits said sagely, “Oh yes, it’s supply and demand, speculation has nothing to do with it, trust us.”

But there’s a history now, a complicity. Enron had its grubby paws in both markets; they were instrumental in the deregulation of oil futures. We’ve proved that there’s unscrupulous bastards out there willing to cheat the world of billions. Is it really a coincidence that this has happened twice in 10 years?

I don’t think so: not now. Oil prices just dropped $9/bbl in a single day, and everybody said “oh, it’s because some guy made a speech.” I don’t buy it — Congress is debating how to close the loopholes in the energy trading market, and I figure the savvy buyers are getting out. The artificial demand goes down, the price goes down.

Now, I’m not an expert on the economy*, but I’m willing to learn. Is all this really a coincidence? Am I misunderstanding some complexities somewhere?

*And I’m in good company, apparently.

2

I’m sure there will be plenty of people along to go into the details. In essence the demand (world wide) for oil is high (China and India and other emerging nations are buying the stuff like candy). Couple that with fears of potential wars in the ME, especially Iran (they sit astride one of the major logistics routes for getting oil out of the region) and there really isn’t any mystery as to why the price of oil went so high.

Regulation or the lack there of had really nothing to do with it.

-XT

3

California was going to be a mess because of the way they deregulated. I can’t recall all the specifics of the law, but they had a serious, serious problem with the half-in/half-out structure.

I vaguely think it was because the local energy companies were required to provide power but not supported properly. And Enron basically cornered the market and was squeezing them (some couldn’t pay, hence the “rolling blackouts”). But Enron’s ascendance was itself economically tottery, and when prices changed…

Anyway, I’m not necessarily in favor of deregulation, but there was a huge issue with what California did. It barely even qualifies to be called the word.

4

OTOH, let’s see what taking away the futures market for a commodity did:

http://money.cnn.com/2008/06/27/news/economy/The_onion_conundrum_Birger.fortune/?postversion=2008062713

Frankly, I don’t see how a futures market, properly done, could not increase supply and stabilize prices in the long term. If people are willing to purchase in advance, producers have more incentive to produce.

Of course, this doesn’t mean that law can’t be so poorly written as to have investors take advantage of it.

It’s amazing people look at declining oil production, fast-shrinking reserves for sweet crude, and skyrocketing global demand, and blame an US regulation rule. To paraphrase a recent columnist, the world’s no longer anti-America, it’s post-America; dirty investors can corner a state’s utilities, but the global oil market is far too big to corner like that.

5

Futures markets move to a significant degree based on the expected change in future prices, but they also move because of other forces. One big force is the lack of other investments - when other investments yield lower returns, investors will start looking for new markets to play in. More buyers means higher futures prices (and often, higher actual prices).

Another factor is that presidential elections always bring along a lot of uncertainty about what the new administration will do, which results in more volatility, and often higher futures prices. The end of an administration can also result in less willingness on the part of the president to make any signficant moves because they know their influence is on the decline. That can also result in greater uncertainty about future supplies and higher prices.

I have no idea whether there is actual market manipulation going on, but there are other factors that contribute to these sorts of increases.

6

This graph explains much. Demand up, supply more or less static. Economics 101, the price should go up.

And low and behold, the dismal science comes through.

7

And note that lots of countries subsidize gasoline and diesel, China in particular. Which means that people there pay below-market prices for fuel. Now, guess what that does for demand? So while countries that pay market (like the US) or above market (like lots of European countries) are cutting back and consumption has fallen over the last year or two, how much conservation do you think happens in countries where the government literally pays you to consume more fuel?

8

I admit that supply and demand play a part in recent oil prices. I understand there’s a limited resource, and that the dollar is falling, and that China and India are driving more cars, etc.

On the other hand, I get suspicious when people tell me it’s 100% supply and demand and that there’s no effect whatsoever from speculation. Oil prices were $10/bbl in 1998, and they shot up to $120/bbl in 2008. Did supply and demand alone really send the prices up by a factor of 12 in only 10 years?

If something’s going up in the stock market, don’t people invest in it? Doesn’t that cause prices to rise? How is speculation not at least part of the equation?

9

Is anyone saying that though? Speculation is part of the market…and seemingly a part of the market that is little understand. Put simply it’s all about risk and prediction…so, there are other factors than simply what the supply and demand equation is today. You have to try and guess what it may be like a month from now…6 months…a year. You have to guess whether or not there will be a war involving Iran, and whether or not they will cut off the logistics routes in the PG choke points. What the dollar will be doing. What China’s demand will be. How changes in off shore oil drilling (or not) will effect the futures market. And a host of other factors.

Of course not. There were a host of other factors involved in why the price of gas shot up…and why it shot down during that period as well.

I doubt the stock market had much to do with it. I assume you meant the commodities market.

It is. AFAIK no one is saying that speculation has nothing to do with the oil equation. The thing is, people seem to think that speculation is somehow wrong or evil or something…instead of a natural part of the market. They also seem to think that speculation is rampantly out of control or something…all the while watching the news of tension between Israel and Iran as the wonderful leader in Iran ratchets up the tension (then lowers it only to ratchet it up again). And this is just one factor in attempting to speculate on the supply/demand equation for the next 6 months.

-XT

10

I speculate in the markets (not oil, at least not directly) for a living. It is quite frustrating, yet predictable, to see people turning to the evil speculators as a convenient scapegoat. What’s even more frustrating is the glaring lack of knowledge decision makers appear to have about even the most basic functions of markets - especially futures markets. Here’s a good read for those interested:

http://money.cnn.com/2008/06/27/news/economy/birger_oil_speculation.fortune/index.htm?postversion=2008062709

From the end of the article:

11

I was just looking this stuff up due to a conversation on a different forum and, interestingly, not a single financial/business publication I looked at it credited any speeches with the drop in prices. As in neither Bush’s executive order lifting (oil actually closed at a near record high that day) nor the current talk of opening exploration in Congress.

I won’t bore you with links that all say essentially the same thing but I looked at the Wall Street Journal, Forbes, CNN/Money, Bloomberg, Economist, Oil Marketer & iStockAnalyst and all said the same thing: Oil fell because of softened demand in the United States (numbers came in showing a 3.7% drop in miles driven in May '08 vs '07 and a 4.3% drop in demand for oil products) and a stronger dollar against the Euro compared to recent weeks. Also credited were decreased tensions in the Middle East and an unexpected surplus of natural gas reported which drove down the energy markets.

12

Oh but world demand as many board members continually state has just gone up,up and up. The little demand drop in the US is more than matched by increase in India and China. But then when you read magazines that are knee deep in speculation and market reporting ,you would not expect them to say that the speculation they report on and sell is responsible.

13

The Asian and Middle Eastern sources I’ve looked at say the same thing as the US/European sources.

Although, really, I’m not interested in debating whether every financial site is lying or not. I’m just pointing out that none of them credit any speeches with the drop in oil prices.

14

I can and have met every such article with those of the opposite opinion.,ranging from big time investors to the Arabs who decide how much they will produce.
The Latest News from the UK and Around the World | Sky News Heres one I saved.

15

Because you can’t comprehend their arguments doesn’t mean your strawman is valid. People have tried through thread after thread to beat it into your skull, but you are immune from logic and reason on this subject. I see no point in going through it again with you and will only say (for the benefit of those who may still be on the fence about this) that demand is only part of the overall equation…as is speculation.

Now, let’s see some drive by links that you don’t really understand but will produce anyway to make a point that you won’t bother discussing…

-XT

16

Eight years? That’s a rather… tenuous… claim of causality.