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The official scapegoat (update)
Posted by: McQ on Thursday, July 24, 2008

Gas too high, bunky? Does it hurt the wallet to fill the tank?

Don't worry, Congress has identified the problem and is moving swiftly to take care of it:
The political class needed to blame somebody for the run-up in energy prices, and settled on "speculators" as the designated villains. The mob grew to include everyone from Barack Obama to John McCain, and Bill O'Reilly to Hugo Chávez. Congress held over 40 hearings this summer. It was cynical, sure, but serious people assumed that the politicians were in on the conceit.

Maybe not. While some kind of crackdown on the U.S. oil futures market is inevitable after so much political agitation, Congress has begun to believe its own demagoguery. The Senate may vote on a bill this week that will drive commodities trading overseas and decrease oversight and market transparency.

Meanwhile the facts just don't support the "hang the speculators" mentality. Here, in simple graphic terms, is an explanation of why it isn't speculators driving the price of oil:

Yup, it's something even those with little interest in economics can understand. People making more money (GDP) want to live a better life. And that means more demand for oil. But if Congress admitted that point, then they'd have to agree that it would be a good idea to increase supply as a remedy to the increased demand. That, of course, would mean drilling here and drilling now.

They'd much rather blame it on speculators, because if they admitted the supply shortage was a result of their 3 decades of a lack of a coherent energy policy, why you might vote them out of office.

But the chart, from a report from the Commodity Futures Trading Commission which pretty much demolishes their argument that today's high gas prices are the fault of speculators - not that anyone in Congress will care. A scapegoat was needed and one was found.

This calls for a new motto:

Congress - always spending your money to solve the problem that doesn't exist while willfully ignoring the one that does.

Next up? Draining the Strategic Oil Reserve.

[You can read the report here if you're so inclined.]

UPDATE: Kurt Brouwer at Fundmastry Blog takes an indepth look at the report and adds some excellent commentary of his own. Give it a read.
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Previous Comments to this Post 

Meanwhile, in other news, Southwest Airlines posts a profit while others are losing bigtime:
The Dallas-based airline’s sales rose 11 percent compared to the year-ago period, making the most recent quarter the company’s 69th consecutive quarter of profitability.

During a tumultuous time for airlines, Southwest (NYSE: LUV) has managed to maintain profitability, mostly due to fuel hedges established a few years back (-CR). The hedges lock passenger carriers into set fuel prices that are not as susceptible to rapidly changing market prices.
Fuel hedges are enabled by relatively liquid commodities futures trading. It has been said that Southwest is not an airline but a hedge fund with airplanes! Clampdowns on futures trading could mean bye-bye profitability in LUV-land.
Written By: CR
URL: http://
Yup, and Sens John Kerry and Olympia Snowe are moving to ease the plight felt by the poor.
"It might be summer outside, but as families sit down to sign heating
contracts for the winter, consumers and small businesses are feeling the chill
of skyrocketing heating oil prices," said Senator Kerry, Chairman of the
Committee on Small Business and Entrepreneurship. "We need to act now to make
sure that small businesses impacted by these rising energy prices have access
to capital so that they can weather this storm, and so the six million
families in the Northeast that rely on heating oil to stay warm in the winter
will be safeguarded from supply disruptions."
Not to be outdone to express concern for the poor is FISA prone Representative from Washington, Jim McDermott.
Rep. Jim McDermott (D-WA), chairman of the Ways and Means Subcommittee on Income Security and Family Support, introduced legislation today to provide financial assistance to vulnerable Americans struggling to survive under crushing gasoline prices.
The Emergency Gasoline Assistance Act (H.R. 6561) would create a program to provide $5 billion to states as a one-time grant with the money designated to provide assistance to families of modest means to purchase gasoline. This program could provide every family that is currently living below the federal poverty threshold with $500 in assistance. State governors would have the flexibility to use the money to create programs that target the specific needs of their communities.

From each according to his abilities, to each according to his needs.
Written By: tom scott
URL: http://
If it’s all so simple, then why the sudden spike? Let’s assume for the sake of argument that oil demand does move in lockstep with global GDP, even though no such thing has been demonstrated. How does a gradual increase in global GDP explain anything but a correspondingly gradual increase in oil prices? It doesn’t. GDP increases over periods of years do not explain oil-price increases over periods of days. To explain that, we need to look at what changed over that same short term. What sudden changes in either supply or demand caused the spike in prices? None.

Perhaps those who really want to figure this out instead of just pushing their own kind of demagoguery should at least consider the possibility that this isn’t a strict either/or situation. Maybe increases in global demand are part of the explanation, but maybe that’s only because those increases reached some sort of critical threshold that resulted in a behavioral change. Whose behavior? Well, producers don’t seem to have changed their behavior in any significant way, and if consumers have it has been to reduce demand. Have you been to a transit station lately, seen how crowded it is, how many bikes are chained everywhere? They’re calling it the "Summer of Splat" in Atlanta, because of all the accidents involving people who are riding again for the first time in decades. If neither producers nor consumers have changed habits in ways that would drive a price increase, *who has*? It has to be someone involved in the transaction who’s neither a producer nor a consumer. That could only mean someone either directly in the supply chain (refiners, wholesalers, retailers) or in the markets than connect the supply chain - brokers and speculators. Why is it inconceivable that *they* were the ones who reached a tipping point, responding to real supply/demand changes in ways that magnified or distorted the effect of those changes on price? It’s not like this would be the first time a market exhibited undesirable chaotic behavior.

I’m sure speculators aren’t solely to blame for the price of oil, but I’m equally sure they’re not 100% innocent either. What’s wrong with damping oscillations that threaten the integrity of a system?
Written By: Jeff Darcy
What sudden spike?

Putting on the price of oil, it doesn’t look like there’s been a "sudden spike." In fact, the price of gas has increased at a slower rate then the price of oil. And if trends continue, we may have reached the peak for the season.
Written By: Keith_Indy
What’s wrong with damping oscillations that threaten the integrity of a system?

Practically because this was tried with ONIONs, of all things, and it didn’t stamp out variability of prices...Also, you can ban speculation in the US, but you can’t ban it worldwide, so if speculators are your bogey man they’ll merely move offshore to Singapore, London, and the like, a barrel of oil will STILL be $140, only it’ll be a non-US citizen making the cash, and therefore paying his/her government the taxes on his/her wages. Bottom-Line: more unemployment, reduced taxes and STILL $4 gasoline.

Philospohically, because there is a futures MARKET, it’s the market at work where folks can make or LOSE money, why eliminate it?
Written By: Joe
URL: http://
Hmmm, with oil and gas prices seemingly reaching their peak for the year, the Congress could do nothing and claim that their hot air about regulation helped curb the prices.
Written By: Keith_Indy

You are right, speculators do dominate the short term price, but they don’t control the overall picture. Nor, just because they are speculating, does that mean they are wrong about their speculation. Prices are set somehow, why is someones speculation (which is what all markets are) about the future price of something a problem? If they are wrong about that speculation they will lose money (and many have in the last two weeks, huge amounts of money.) Their specualtion won’t set the eventual price, or the future futures price.

Finally, remember that in the futures markets you can make money, and lose it, regardless of the direction of prices (which is one reason my firm likes using managed futures, little correlation to overall market trends.) So speculators have no particular reason to favor prices going up, so acting as if they are "controlling" the price in any one direction is silly. So yes, they set the future price (for the moment) but they don’t (as individuals) determine what it actually will be over any significant time frame.

Dammit, I guess this means a post tonight.
Written By: Lance
Philospohically, because there is a futures MARKET, it’s the market at work where folks can make or LOSE money, why eliminate it?
But Joe, that kind of thinking doesn’t help the Democrats . . .
Written By: Don
URL: http://
Philospohically, because there is a futures MARKET, it’s the market at work where folks can make or LOSE money, why eliminate it?

But Joe, that kind of thinking doesn’t help the Democrats . . .
I’m sorry I don’t know WHAT was going thru my noggin’!
Written By: Joe
URL: http://
Hmmm, with oil and gas prices seemingly reaching their peak for the year, the Congress could do nothing and claim that their hot air about regulation helped curb the prices.
Great Success!!! Now watch how the frogs’ croaking starts the rain...
Written By: CR
URL: http://
Like many economic problems, there is not just one cause.
Demand it outstripping supply so that causes the price to go up. This is true for what is going on but it is not the only reason.
The other reason is the decline of the dollar. It effects the price of oil in two ways.
1) A weak dollar makes our exports cheaper but it makes our imports more expensive simply due to the exchange rate. We import a lot of oil. The weak dollar makes it more expensive.
2) The declining dollar represents an asset that is losing value. No one in their right mind would hang onto them. So you trade your dollars for something that will hold its value. Oil is obviously one of the answers for the simple reason that demand is outstripping supply. That said, oil is not the only commodity that is rising in price.

Politicians can blame speculators all they want but the reality is that the speculators are reacting to what the government is doing. Restricting supply and engaging in monetary inflation policies. If the politicians ban the speculators there could be a very horrific consquence. Not only will they simply go overseas and trade (damn them for outsourcing) they could say to hell with the greenback and start trading in Euros. Then you’ll see an economic meltdown.
Written By: tkc
URL: http://
tkc makes the point that I have been wondering about.

Given that:

#1. oil is a global marketplace; and
#2. US domestic production accounts for only a very small amount of the oil; and
#3. there are other futures markets; and
#4. there is at least the perception that there is a lot of money to be made;

then how could a US law that applies only to US futures markets make any kind of significant dent in the impact of oil futures trading on the price of oil?

Wouldn’t speculators just move to other markets that are beyond easy reach of the US laws?

What is it about futures trading that I don’t understand? What prevents this shift or how is this shift somehow irrelevent?
Written By: Terry
URL: http://

For one thing, we are trying to bully other markets, most importantly London, into accepting our rules.

Even if unsuccessful, in the short run it could be disruptive, and cause one of our fading areas of world dominance economically to suffer. London has been gaining, as have other financial centers. We don’t exactly need to be shedding jobs and economic activity at the moment.
Written By: Lance
Thanks, Lance. I suspected as much, but simply am not familiar enough with futures trading to trust any conclusions I draw from my scant knowledge.
Written By: Terry
URL: http://
McQ—thanks for the kind words about my blog and my post on oil production. Oil prices have been on the way up since 2002, so it really has not been a sudden change. It’s just that most folks did not notice it until gas prices went over $3/gal. Because gas is a necessity, it takes a huge price increase to induce people to change behavior as they are now doing—and voila, oil prices are heading south.

On the issue of speculation, Jeff commented that speculation has increased the price volatility. That’s possible, but unlikely. Speculation typically dampens volatility because speculators are willing to try and pick the bottom or the top while most normal market participants stand back at those points.

There’s nothing suspicious about speculators in any market—we all know they’re trying to make money. However, their trading adds liquidity and volume to the market at extremes when liquidity and volume are sorely needed.

tkc is right. The falling dollar has exacerbated the surging price of oil for Americans. The exact relationship is hard to define, but my guess is that roughly 20% of the price increase in the past few years is due to the declining dollar.

Written By: Kurt Brouwer
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