By Mike Whitney
Is the Fed’s “Easy Money” policy pushing up the price of gas? The editors of the Wall Street Journal seem to think so. Here’s how they summed it up in an article last week:
“Oil is traded in dollars, and its price therefore rises when the value of the dollar falls, all else being equal. The Federal Reserve throughout Mr. Obama’s term has pursued the easiest monetary policy in modern times, expressly to revive the housing market…..
“Oil staged its last price surge along with other commodity prices when the Fed revved up its second burst of “quantitative easing” in 2010-2011. Prices stabilized when QE2 ended. But in recent months the Fed has again signaled its commitment to near-zero interest rates first through 2013, and recently through 2014. Commodity prices, including oil, have since begun another surge, and hedge funds have begun to bet on commodity plays again….(“‘Stupid’ and Oil Prices”, Wall Street Journal)
“Another surge” for commodity prices?
Not exactly. As a whole, commodity prices have remained relatively flat. (Copper, nickel, zinc etc are all up a bit, but not much. No more than 4 per cent for any of them.) It’s only oil that’s skyrocketing. Oil soared to a 10-month high on Friday hitting $109-plus per barrel, up 14 percent in the last month. Prices at the pump have also jumped to nearly $4 per gallon across the country putting more pressure on consumers’ budgets and, once again, raising the prospect of a double dip recession.
The WSJ is correct in saying that quantitative easing (QE2) did push up food and energy prices, but is that really what’s driving oil prices higher today?
Probably not. There are other factors that are likely having a greater impact, like the escalating tension in the Middle East – particularly the supposed threat of a war with Iran. Buyers are rushing to build up their stockpiles before the conflict might begin. Here’s an excerpt from a post at Econbrowser that explains:
“Phil Flynn, a senior market analyst at PFGBest Research in Chicago, offered this interpretation:
“We’re seeing panic buying in Europe and Asia because they’re absolutely convinced that they’re not going to be able to buy Iranian oil or there’s going to be some kind of conflict that disrupts the transport of oil through the Strait of Hormuz…. there is a lot of hoarding in case the worst-case scenario happens. Asian buyers have been buying up West African crude like it’s going out of style.” (“Crude oil and gasoline prices”, James Hamilton, econbrowser)
So, is panic buying driving up the price of gas or does it have more to do with a gradually improving economic picture that’s increasing demand around the world? That seems to be the gist of a report by NPR’s John Ydstie on Thursday’s All Things Considered. Ydstie notes that “for the first time in six decades” the US “has become a net exporter of gasoline. We’re sending more gasoline out than we’re bringing in.” (“What’s Behind The Rise In Gas Prices?”, NPR) And that’s because it’s now cheaper to produce gas in the US than it is in the rest of the world (mainly due to fracking). Unfortunately, cheaper production costs don’t translate into cheaper prices at the pump. Why? Because gas is traded in a global market where prices are set by supply-demand dynamics.
Still, whether China is purchasing more oil or not doesn’t explain the sharp uptick in prices, because there’s no apparent shortage of supply. In fact, according to the EIA, the statistical arm of the Energy Department, inventories are unusually high.
Here’s a clip from their statement: “At 339.1 million barrels, U.S. crude oil inventories are in the upper limit of the average range for this time of year….Total motor gasoline inventories increased by 0.4 million barrels last week and are in the upper limit of the average range.”
So, if there’s no shortage of supply, then Ydstie’s “global market” theory doesn’t make much sense because there’s no pressure on prices. And there’s something else to consider, too, which is that gas consumption in the US has dropped sharply in recent months. In fact, “demand for refined oil products is close to its lowest level in nearly 15 years”. (CNBC) Here’s a clip from a post by Charles Hugh Smith’s titled “Why Is Gasoline Consumption Tanking?” that explains what’s going on:
“Retail gasoline deliveries, already well below 1980 levels, have absolutely fallen off a cliff….the declines in retail gasoline deliveries are mind-boggling….”
“There are no data-supported broad-based drivers for dramatically lower gasoline consumption other than austerity and lower economic activity……What other plausible explanation is there for the decline from 42.4 MGD in July 2011 to 30.9 MGD in November 2011 other than a dramatic decline in discretionary driving? (“Why Is Gasoline Consumption Tanking?”, Charles Hugh Smith, Of Two Minds)
Whatever the reason may be, US drivers have cut back on their gas consumption dramatically which should have a material effect on prices, but it hasn’t. Prices continue to soar, and the soaring prices cannot be explained in terms of the Fed’s easing policy, constriction of supply, refinery closings, or fear of another Middle East war. (The so called “fear premium” should be no more than $10 to $15 per barrel) Investigative journalist Kevin G. Hall explains what is really driving prices in an article for McClatchy titled “Once again, speculators behind sharply rising oil and gasoline prices.” Here’s an excerpt:
“….oil’s price shot up because it trades in financial markets, where Wall Street firms and other big financial players dominate the trading of oil, even though they have no intention of ever taking possession of the oil whose contracts they are trading….
Historically, financial speculators accounted for about 30 percent of oil trading in commodity markets, while producers and end users made up about 70 percent. Today it’s almost the reverse.
A McClatchy review of the latest Commitment of Traders report from the Commodity Futures Trading Commission, which regulates oil trading, shows that producers and merchants made up just 36 per cent of all contracts traded in the week ending Feb. 14.
That same week, open interest, or the total outstanding oil contracts for next-month delivery of 1,000 barrels of oil (about 42,000 gallons), stood near an all-time high above 1.486 million. Speculators who’ll never take delivery of oil made up 64 per cent of the market…..
Not surprisingly, big Wall Street traders on Tuesday projected oil will rise above $112 a barrel; some such as Swiss giant Vitol even suggested $150-a-barrel oil is coming soon. When they dominate the market, as they do, speculators’ bids can make their prophecies self-fulfilling.
“These people are not there to be heroes. They are there to make money. It’s our fault because we are allowing them to do that,” said Gheit. “Obviously these people are very strong, and the financial lobby is the strongest of any single lobby. I’ve been in this business 30 years, and I can tell you I think this is smoke and mirrors.” (“Once again, speculators behind sharply rising oil and gasoline prices”, Kevin G. Hall, McClatchy News)
Repeat: “Speculators who’ll never take delivery of oil made up 64 percent of the market.” That explains why prices are going up, up, up.