Who murdered Cheap Oil (the Fed Explanation)?

[HarrySchell]

another view of the problem:

Figuring out the who, why, and how of rising oil prices is a lot like playing the board game Clue — though it's anything but fun for the whole family.


May 27, 2008 - by Jane Whitson
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Reading endlessly about the “crime” of today’s sky-high oil and gas prices while talking heads, politicians, and economic experts assess blame and point fingers reminds me of an old board game I loved to play as a girl.

Remember the mystery game Clue? The object is to become a detective and solve a murder mystery by correctly deducing the murderer, the weapon, and scene of the crime. Through a process of elimination, a player correctly discovers the winning combination and wins the game. Action unfolds in a creaky English manor with intriguing names for suspects and rooms.

“Miss Scarlett did it in the Billiard Room with the lead pipe!”

“No, No! It was Colonel Mustard in the Conservatory with the revolver!”

Fast forward more than a few decades and there’s a new game in town — I’ll euphemistically call it Clue 2 — which involves solving the “energy mystery” of skyrocketing gas prices at the pump. Like Clue, it involves finding the culprit, the “murder” weapon, and scene of the crime. Unlike Clue, there seems to be no end to the possible suspects implicated in the hunt for the guilty perpetrator.

“OPEC did it in the Middle East with the wrench that tightened supplies even as Little Miss Western Demand begged for mercy while groveling at the feet of the Saudis!”

“No, it was India and China with the rope of increased neediness and outlandish carbon emissions in the Asia Room!”

“I think it’s murderous Big Oil with their obscene profits and price-gouging, doing it in the clandestine, mahogany Board Room.”

“Congress and radical environmentalists are doing it in the Lobby with a lethal ban on drilling in ANWR and the continental shelves starting back in 1995 when Clinton ran the show!”

Our eyes glaze over with talk of supply and demand, peak oil, and end of the Oil Age — and with it the rise of King Corn, biofuels, and endless scapegoating. Upon closer examination, however, we see there are many reasons why the price of oil should actually be going down rather than up.

U.S. demand for oil (12,000,000 barrels/day) dropped 1.4% in the first quarter of 2008 from the same quarter last year — the third quarter in a row to see a drop. Big Oil’s so-called “obscene” profits since 2002 are only about 8.1 cents on the dollar in sales — in line with every other U.S. manufacturer except the auto industry. And those profits come before Big Oil paid approximately $138 billion in taxes to the IRS at an effective rate (when additional severance, sales, and user taxes are factored in) of 40%, higher than any other U.S. corporations, which pay on average 35% in federal taxes.

Then there’s the fact of increasing supply: According to recent estimates from the API, “an estimated 4,577 new U.S. oil wells have been completed in the first quarter of 2008, up 12% from 2007, the largest increase since 1986.” In addition, huge new supplies of oil are being discovered off the coast of Brazil, elsewhere in the United States, the Caribbean, and Asia that will greatly contribute to increasing world and U.S. supplies. And finally, world surplus oil production capacity has gone from a very tight 1.5 million barrels per day a couple of years ago to more than 3 million barrels today, said petroleum economist Michael Lynch in March 2008.

All of these realities should be lowering the price of oil today instead of raising it.

With all this in mind, I’d like to propose what I believe is the correct answer — the real culprit lurking in the shadows — of today’s high and rising energy prices:

The Bush White House did it, in the Cabinet Room with 1) the printing press from the Treasury Department that printed far too much money to cover out-of-control government spending after 9/11 and 2) a pair of Federal Reserve scissors that started cutting interest rates from 6% down to 1% in a little less than a year back in 2002, under the tutelage of Alan Greenspan.

Together these two weapons — a printing press and pair of scissors — acted like a double-barrel sawed-off shotgun in annihilating the value of our dollar in short order. The effect was to shrink the buying power of our money while at the same time to increase the value of all hard assets like houses, commodities, gold, and now oil and gas (a commodity traded only in U.S. dollars on the world market) to near unaffordable levels today.

The Bush administration’s motive for this currency crime? To shore up our balance of payments with the rest of the world by helping our exporters in global markets and subtly making it harder for us to buy imported goods from abroad since our money bought less!

Yes, the devalued dollar is the real cause of today’s skyrocketing gas prices and panicked talk of oil scarcity. The devalued dollar started all the commodities bubbles of the 2000s, and investor speculation — futures traders and options contracts — are going to explode it.

Do I hear a second?

It’s a great fundamental truth of free markets that when the value of any currency falls, the value of tangible assets goes up. People start dumping the depreciating currency asset for something they perceive will better hold its value in times of uncertainty. Then the bubbles get formed by investors wanting to make a killing on all kinds of sophisticated trading. It’s what’s happening today.

The dollar started weakening in the early 2000s as the Treasury Department minted new money like there was no tomorrow to cover the burgeoning budget debts of the War on Terror. At nearly the same time Alan Greenspan starting cutting interest rates down to nothing.

Cheap, plentiful, devalued money was everywhere. In addition to printing too much money at Treasury to pay for historically high federal spending in wartime, and continuing to cut interest rates at the Fed, the Federal Reserve also started buying up all our dollar debt, which had the effect of lowering interest rates even more!

Our cash went from being king to pauper, as the Bush White House continued its policy of prosperity through devaluation.

With cheap credit and dwindling dollars, investors large and especially small piled first into housing and started blowing up the now-famous housing bubble. The larger and more sophisticated investors also started buying commodities like steel, copper, and iron ore, taking prices up dramatically over the past three years. Smart money additionally headed for gold, which recently went to record highs of over $1,000/ounce in March 2008 (from $300/ounce three years ago) and is predicted to go to $1,500-$2,000 if the dollar continues to languish at historic lows or fall further.

In this context, is it any wonder that we’re in the middle of a huge spike in oil and gas prices due to the puny dollar? To make things worse, the Big Boys in the world of finance are pushing futures trading in oil and gas to historic highs with no end in sight.

The gas and oil bubble has officially arrived. It’s one of the few things George Soros and I agree on. And there’s nothing we can do about it. Nothing, that is, until the bubble explodes, which it surely will. The only question is when and how much bigger will the bubble get before it blows up in our faces? (And when that happens we’ll see gas prices dropping like a rock and gas supplies and inventory being discovered everywhere, like in the housing market. Overnight the talking heads will no longer be moaning over the scarcity of oil but rather how plentiful it is with its scandalously cheap price per gallon.)

In the process of this dollar devaluation and various commodities bubbles growing and bursting over the past few years, Bush has become one of the most unpopular presidents in modern history, with the exception of two other U.S. presidents who also presided over a falling dollar: Richard Nixon and Jimmy Carter, according to John Tamney of RealClearMarkets. Remember the first oil crisis, long lines, and commodity bubbles of the 70s?

It is safe to say that all other things being equal, a devalued dollar will always lead to an unpopular presidency. And so it is with that of George W. Bush. In the simplest of terms, our money just doesn’t buy what it used to. And we’re not happy campers right now like we were in Ronald Reagan’s and Bill Clinton’s terms, both of whom presided over relatively stable to slightly rising dollar valuations and robust economies.

Any solutions to this now-solved mystery? Is the dollar dead or is there hope of reviving it? Stay tuned, and we’ll play another game of Clue 2.

I only hope because of this dollar mess we won’t be playing pin the tail on the donkey in November.

Jane Whitson blogs at Webutante.

[benign.neglect]

Oil is still very cheap, I don't know where people are coming from who say it isn't. It used to be cheaper than now, but it is still very undervalued. If oil was priced too high, we would see a serious decrease in demand. People would limit driving. The decreases we have seen so far are very modest, and demand remains strong.

I think there is still room to increase the price of oil and gas before we will see any decrease in demand.

Your article does explain why oil went from extremely cheap to just cheap.

[MedicineBow]

I wonder how the "federal government" and Alan Greenspan made the price of oil rise for all 6 billion people on the planet?

[ShootingNut]

Oil prices are very high, thanks to Wall Street greed. Playing the Futures Long, and Short has traders covering their hind ends running prices out of sight. Normal price range would still be 65-90 bucks a barrel, if it were not for the commodity traders. Fat cats trying to make more money throwing the dice, while the average Joe Family get's it in the rear.
Sure, demand plays a part but would not have run oil up where it is now.
Opinion only of course! Interesting read http://www.bloomberg.com/apps/news?p...d=aNpbEqWbUwok
Regards,
SN
PS: By the way, what are the Iraqi's doing with their oil revenues? Hoarding it while we pay for rebuilding?

[Waitone]

Major institutional investors including sovereign wealth funds and retirement funds are dumping money into futures contracts. Instead of buying and selling, these new investors buy contracts and hold. Just before the contracts expire they will purchase new contracts at the new price. Contract pricing is somewhat based on a percentage of available funds regardless of what the current market conditions are. In effect the new institutional buyers are creating a futures price ratchet in which the price is free to go one direction only.

We are looking at the latest financial bubble created and sustained by the financial system and like all bubble, this one will deflate. I am expecting a sudden and severe price correction.

[benign.neglect]

I am expecting a sudden and severe price correction.

Why should price correct, even if the bubble bursts?

Oil Companies know we will gladly pay $4 per gallon.

If the price of crude suddenly dropped, I see no reason why they should lower their prices, as long as they all stick together.

[ShootingNut]

Amen to the Bubble, and I do agree with your perception, she can pop anytime and it won't be too soon for me!