Oil prices: what if it is caused by speculation?

[Renob]

@bordelond

Again … worldwide consumption has not increased over 25% in four months.

Yet price-at-the-pump in the U.S. has increased over 25% in four months. Why is the price-at-the-pump in the U.S. rising that much faster than worldwide consumption?

Your view seems to be that prices must rise only by the same percentage point that consumption rises. Please point to any credible economist (or even one who is not credible) that supports such a simplistic view of the market.

[bordelond]

@Gorsnak

I am unequivocally stating that the current price is fundamentally based on the current balance of supply and demand, yes.

I understand the prices being high, in general. I don’t understand the prices at the pump rising at the rate they have been rising since early in the year.

[ralph124c]

Regular gas fell 6 cents overnight-so my gasoline retailer responds to the price of crude changing very efficiently!
The “invisible hand” is working damn fast! Adam Smith had it right!

[bordelond]

@Renob

Your view seems to be that prices must rise only by the same percentage point that consumption rises. Please point to any credible economist (or even one who is not credible) that supports such a simplistic view of the market.

No – I acknowledge that my view is incomplete.

That said, I cannot derive logically, on my own, why the prices are moving as they are. The system should, at some level, be understandable once the facts are presented … indeed, with enough knowledge, the movement of the prices should become intuitive.

[XT]

@bordelond

That said, I cannot derive logically, on my own, why the prices are moving as they are. The system should, at some level, be understandable once the facts are presented … indeed, with enough knowledge, the movement of the prices should become intuitive.

It’s a fairly complex system though…it’s not really all that intuitive. For one thing, part of the reason prices are up is because oil is tied to the US dollar…which is dropping. That means oil is going to be more expensive. Another factor is that world wide demand is up while supply is constant (at this time…this could change), so atm demand is outstripping supply which means prices are up. Another factor is uncertainty…others have explained this better in this thread but when you buy oil you are attempting to predict the FUTURE price of that oil. IOW, you are making an educated guess as to both oil availability, price, delivery, etc. Right now the market is in a period of uncertainty…which is further driving up prices.

I’ve used this link in the past but thought I’d drop it in here…it’s How Oil Prices are Determined 101 and might be helpful. There are some other good links in there to on how the commodities market works if you want to look into it:

A. Commodity traders are responsible for oil prices by bidding on oil futures contracts. There are many factors they look at when developing the bids that create oil prices:

* Current supply in terms of output, especially the production quota set by OPEC.
* Oil reserves, including what is available in U.S. refineries and what is stored at the Strategic Petroleum Reserves.
* Oil demand, particularly from the U.S. (as estimated by the Energy Information Agency . During the summer, forecasts for travel from AAA are used to determine potential gasoline use.

-XT

[Renob]

@bordelond

No – I acknowledge that my view is incomplete.

That said, I cannot derive logically, on my own, why the prices are moving as they are. The system should, at some level, be understandable once the facts are presented … indeed, with enough knowledge, the movement of the prices should become intuitive.

Why? Do you intuitively understand why milk is priced at $4.00 a gallon or soda is $1.25 per a two-liter bottle?

Prices reflect a huge amount of information, boiled down to one number. They re the result of millions of economic transactions a day. Yes, people who are experts can have some idea on why they rise and fall. But they certainly cannot predict it. If they could there would be a lot more rich folks out there. The folks here have given a variety of good sources to give you some idea on what drives oil prices. If you are unable to wrap your mind around that, there’s no shame in that. I doubt that many of the “experts” really fully understand it. But to think that there is some kind of mysterious group of evil men manipulating prices (as gonzomax thinks) is pretty ridiculous.

[bordelond]

A Fortune article gonzo will enjoy.

One excerpt that makes me curious:

A big swath of the (global) market isn’t really paying that $125 a barrel number you hear about seemingly every hour. In China, India and the Middle East, governments are heavily subsidizing oil for their consumers and corporations, leading to rampant over-consumption - and driving up prices even more.

When do the Chinese and Indian economies reach the breaking point of these subsidies? How can these countries afford to make such subsidies?

[RTFirefly]

@bordelond

Again … worldwide consumption has not increased over 25% in four months.

Yet price-at-the-pump in the U.S. has increased over 25% in four months. Why is the price-at-the-pump in the U.S. rising that much faster than worldwide consumption?

It happens almost every year in the spring. It’s been discussed at some length in threads from previous years about gas prices. I vaguely remember it has something to do with demand for gasoline relative to other petroleum products, and something to do with seasonal adjustments to fuel that the refineries have to make.

Taking 17 weeks as a close proxy for 4 months in the spreadsheets available at the link, gas prices were 46% higher at this time in 2007 than four months earlier. For 2006, it was 22%; in 2005, only 10% (but early May had been over 20% higher than early January); in 2004, 23%; in 2003, they were down 5%, because prices had spiked earlier on the expectation of oil supply disruptions due to the war, and dropped when they didn’t materialize; in 2002, up 23%…you get the idea.

[bordelond]

@Renob

Why? Do you intuitively understand why milk is priced at $4.00 a gallon or soda is $1.25 per a two-liter bottle?

:shrug:

I sure thought I did From what I understand, the demand for both milk and soda is much more elastic than that for gasoline. Therefore – from what I understand, mind you – I have a kind of “trust” in the price of those goods (though I realize that soda is very cheap to make in bulk, and much of the price to consumer is advertising and profit).

…

Thanks for the link, xtisme.

[XT]

@bordelond

When do the Chinese and Indian economies reach the breaking point of these subsidies? How can these countries afford to make such subsidies?

Well, the quote is a bit misleading in one part…overall the Chinese etc are still paying the same rates for oil as anyone else (though they may be paying less due to the ability to buy more or further in the future…I’m unsure how it works for countries to be honest. Like I said, it’s rather complex), it’s just that the governments are subsidizing the oil to their refining corporations, making the gas cheaper to their citizens (though of course this probably means they have to ration gas but I doubt their citizens are going to complain).

You ask a good question though…I wish I still had the article up, but I was reading that several nations that subsidize oil/gas are talking about stopping that practice as the costs are getting to great. As to China…well, China is a rich country and their citizens are already used to rationing so they could keep it up for a while I’m sure. No idea about India.

-XT

[bordelond]

@RTFirefly

Taking 17 weeks as a close proxy for 4 months in the spreadsheets available at the link, gas prices were 46% higher at this time in 2007 than four months earlier. For 2006, it was 22%; in 2005, only 10% (but early May had been over 20% higher than early January); in 2004, 23%; in 2003, they were down 5%, because prices had spiked earlier on the expectation of oil supply disruptions due to the war, and dropped when they didn’t materialize; in 2002, up 23%…you get the idea.

Good info … does that site have older data?

Maybe it’s the absolute change that’s so startling. I remember hearing about “driving season” and such in the late 80s and into the 90s … but it seemed those seasonal increases were maybe a dime to 15 cents (per gallon at the pump). Of course, that’s going from memory and not looking at hard data.

[RTFirefly]

This IHT article doesn’t give much of a clue of how various countries set gas prices, but it gives an indication of how widespread the practice is in South Asia. The article’s mostly about protests in the wake of fuel price hikes in India and Malaysia, but it also mentions Taiwan, Sri Lanka, and Indonesia as having recently raised fuel prices.

[RTFirefly]

@bordelond

Good info … does that site have older data?

I couldn’t find anything further back than fall 1990, but I wasn’t looking very hard.

[ultrafilter]

One more article that may be of interest: the oil price was The Economist’s cover story last week. There are links to a couple other articles in there that might be worth a look.

[bordelond]

RTFirefly, I found the historical information on your link going back to 1992. My memory was pretty much correct – 25% increases late in the spring weren’t the norm 10-15 years ago (I used the Gulf South regional data, not U.S.-wide).

[XT]

@RTFirefly

This IHT article doesn’t give much of a clue of how various countries set gas prices, but it gives an indication of how widespread the practice is in South Asia. The article’s mostly about protests in the wake of fuel price hikes in India and Malaysia, but it also mentions Taiwan, Sri Lanka, and Indonesia as having recently raised fuel prices.

Thanks! That’s very similar to the article I was reading earlier, but this one actually goes into a bit more detail.

-XT

[XT]

@ultrafilter

One more article that may be of interest: the oil price was The Economist’s cover story last week. There are links to a couple other articles in there that might be worth a look.

I hadn’t read this one (THANKS!), but thought I’d quote a few passages from your cite:

IN THE early 1970s a fourfold rise in the price of oil almost brought the world to a standstill. The shock of the Arab embargo left a deep mark in many countries: America subjected its cars to fuel-efficiency standards, France embraced nuclear power—though sadly shoene rukku, or “energy-conscious fashion”, the inspiration for Japan’s fetching short-sleeved business suit, was ahead of its time.

Thirty-five years on, oil prices have quadrupled again, briefly soaring to a peak of just over $135 a barrel. But, so far, this has been a slow-motion oil shock. If the Arab oil-weapon felt like a hammer-blow, this time stagnant oil output and growing emerging-market demand have squeezed the oil market like a vice. For almost five years a growing world shrugged it off. Only now is it recoiling in pain.

Action replay

It is clear that high oil prices are hurting many economies—especially in the rich world. Goldman Sachs reckons consumers are handing over $1.8 trillion a year to oil producers. The wage-price spiral of the 1970s has been avoided, but the income shock is painful. Beset by scarce credit, falling asset prices and costly food, developed-country households are hardly well-equipped to foot the oil bill. America’s emergency tax rebate, voted this year to help people cope with the credit crunch, has in effect been taken right away again.

Here is what many in this thread have been saying that I thought was interesting:

Stuck for answers, politicians have been looking for scapegoats. Top of the list are the speculators profiting from other people’s hardship. Some $260 billion is invested in commodity funds, 20 times the level of 2003. Surely all that hot money has supercharged the demand for oil? But that is plain wrong. Such speculators do not own real oil. Every barrel they buy in the futures markets they sell back again before the contract ends. That may raise the price of “paper barrels”, but not of the black stuff refiners turn into petrol. It is true that high futures prices could lead someone to hoard oil today in the hope of a higher price tomorrow. But inventories are not especially full just now and there are few signs of hoarding.

If the speculators are not to blame, what about the oil companies, which have failed to increase output in spite of record profits? Profiteering, say some. However, that accusation doesn’t stand up to much scrutiny either. The oil price is set in a market. For Shell, Exxon et al to hoard oil underground would be to leave billions of dollars of investment languishing unused. Others fear that oil is pricey because it is running out. But there is little evidence to support the doctrine of “peak oil” in its extreme form. The Middle East still seems to contain a sea of the stuff. Even if new finds elsewhere have been rarer and less accessible than in the past, vast quantities of oil could now be profitably stripped from tar sands and shale.

And so what is the real cause (well, a couple of them)?

The truth is more prosaic. Finding and developing new oil fields is an expensive and time-consuming business. The giant new fields in the deep water off Brazil are unlikely to produce oil for a decade or more. Furthermore, oil is perverse. When prices are low, oil-rich countries welcome the low-cost, high-tech and well-capitalised oil firms. When prices are high, countries like Russia and Venezuela kick them out again. Likewise the engineers, survey ships and seismic rigs that oil firms need to find and produce new deposits are expensive right now. The costs of finding oil have, temporarily, doubled precisely because everybody wants to give them work.

So…demand is up, while supply is pretty static atm and likely to stay that way in the near future.

Great article btw ultrafilter…really explains a complex system in easy to understand terms.

-XT

[bordelond]

From the site xtisme linked to in post #85, I found this article, which states:

**What Has Caused Recent High Oil Prices?: **
According to most news sources, high oil prices are a result of surging demand from China and India, and a curtailment of oil supply from Nigeria and Iraq. Since oil is denominated in dollars, the 40% decline in the dollar in the last six years has also put upward pressure on oil prices. (Source: BBC, Oil Price May Hit $200 a Barrel, May 7, 2008)

**What Is the Biggest Factor in High OIl Prices?: **
Like most of the things you buy, oil prices are affected by supply and demand. However, oil prices are also affected by oil price futures, which are traded on the commodities futures exchange. These prices fluctuate daily, depending on what investors think the price of oil will be in the future.

Lately, commodities traders have been driving up the price of oil, even though supply has increased and demand has fallen. The EIA pins part of the blame on volatility in Venezuela and Nigeria. It also cites an increased flow of investment money into commodities markets. In other words, money that used to be invested in real estate or the global stock markets is now being invested in oil futures. (Source: EIA Short-Term Energy Outlook)

Aren’t some of you all telling gonzo that the part in red is not actually happening?

[bordelond]

@xtisme

So…demand is up, while supply is pretty static atm and likely to stay that way in the near future.

And yet the article I just quoted says exactly the opposite – that supply has increased while demand has fallen.

Unless the two articles are talking about different time frames, I am at a loss as to how to reconcile such statments.

[XT]

@bordelond

Aren’t some of you all telling gonzo that the part in red is not actually happening?

AFAIK, no one in this thread is telling gonzo that the rise in prices has nothing to do with speculators, so I guess the answer to that is no. What people have been trying to convey to gonzo is that it’s a complex system, and that speculation is only part of it. Also, that speculators aren’t manipulating the market to attempt to further drive up the prices, since you can’t horde oil the way you do, say, gold (in the gold commodities market). The reasons the market is volatile has less to do with some mustache twirling capitalist out to stick it to the little man than a series of complex issues that have already been discussed.

@bordelond

And yet the article I just quoted says exactly the opposite – that supply has increased while demand has fallen.

I’m unsure what they mean by increasing supply there…afaik, supply is fairly static, though I suppose it may have risen a bit lately when I wasn’t looking. Demand has also fallen lately (as noted by someone in this thread in an earlier post). But here is the thing…demand has fallen, but it’s still outstripping supply. If, for example (this is only an example mind), supply was -3% of demand, and supply goes up .5% and demand goes down .5%…well, you are STILL at -2% correct? Yet supply has risen and demand has fallen. See?

-XT