A Post Modern Look At Oil Prices

A Post-Modern Look At Oil Prices

What demand-supply imbalance can induce a surge of $10.75 or 8.4% in oil prices in just one trading session on the New York Mercantile Exchange (NYMEX)? Answer: none; unless the 85 million barrels per day global supply of crude oil, matched, almost exactly, by world demand, is inexplicably hit by a demand upsurge or supply failure that nobody has reported.

However, that is exactly what happened on Friday, June 6th 2008, accompanied, handily, by a Goldman Sachs pronouncement from Jeffrey Currie, Head of Global Commodities Research at New York. This near perpendicular up-tick represents the largest ever gain in US dollar terms and the biggest percentage increase in crude prices since June 1996. Currie said he expects oil prices to touch $150 by July 4th, America’s Independence Day.

This price surge came on top of 4.5% on June 5th, the day before; ostensibly because the European Central Bank’s Claude Trichet said that the bank might raise interest rates next month. This led to a sharp fall in the value of the US dollar against the Euro, and oil prices are counted in US dollars.

But just before, at the beginning of June, the US Federal Reserve Bank Chairman Ben Bernanke, indicated he wouldn’t lower US interest rates further, currently at 2%, even if he made no remarks about increasing them. Oil prices actually fell on this news, taken as an indicator of returning calm in the US economy. Equity prices on NASDAQ, Dow Jones and Standard & Poor (SP) 500 rose; accompanied by rallies in the European, Asian and Emerging markets. But the nabobs of Wall Street expected more bad news. And sure enough, on June 6th, it was announced that the US unemployment rate was at the highest in two decades.

The upshot of all this -- in two days oil prices rose fifteen dollars, even hitting a record high of $ 139.12, intra-session, on June 6th. Crude has become a safe harbour of high demand, a place to recoup losses, an inflation hedge. It seems surreal that on the 4th of June, oil prices were hovering at $123, down from an earlier all-time high of $135 a barrel. High oil prices may cause consternation, alarm and pain on high streets around the world; but in 2008, they look very reassuring to financial men gouged by massive losses in other fields.

The current price movements are incomparably sharp, several dollars a day, pursued by hundreds of billions of dollars, translating to an estimated 2.5 trillion dollars in “oil futures” alone, according to The Economist. This can be contrasted with earlier oil and other commodity “futures” and “spot” trading movements, being counted in seemingly quaint cents, that too over a week of trading sessions!
And in those times, only a year or two ago, the difference between “paper barrels” of the “futures” trades was much greater than the “real” prices on the “spot” markets. But, today, the prices are just cents apart on the futures and spot markets. Anticipation of future higher prices, quite often deliberately “talked-up” are upping real prices too. You might soon see spot prices outstripping futures quotes, at least in between the 15 minutes it takes to update rates on the Bloomberg site!

So, if this ruinous price inflation isn’t caused by a demand upsurge or a supply breakdown, what exactly is going on?

The answers lie in the ability of the global financial markets, led by those in New York, to lead the “real” demand-supply based ones by the nose and by several lengths. It is a virtual and post-modern phenomenon that has dwarfed the importance of producers of actual goods and services for all time. It is now possible to outstrip any reporting mechanism in real time and make the anticipation a reality before it is registered to be so. The power positions of the trade have shifted irrevocably from producers to traders.

All those who have lost a lot of money on Wall Street and its counterparts in the G-8 countries in recent times, have found, in commodities, and particularly oil, a place to not only recoup their losses but earn bumper profits to replenish depleted coffers. And to deflect attention, a curious element of public relations disinformation has been pressed into service. It speaks of India and China as the cause, of, amongst other things: global warming, food shortages and last, but not least, high oil prices. But the reality is that future projected demand growing at 15% p.a. in China and 6% p.a. in India do not constitute a present day fuel demand crisis. Nor does the doubling of the US strategic oil reserves from 350 million barrels to 700 million barrels. The current oil price rise merely marks a permanent shift from the real economy to the financial one.
Today, OPEC as the world’s largest oil producing block, accounting for 40% of the world’s oil, barely calls the shots even to the extent of its statistical strength. When Saudi Oil Minister Ali Al Naimi said that the surge in oil prices is “unjustified” and when the official Saudi Press Agency added that it is being driven by “non-fundamental factors”, they was not being hypocritical.

The power to decide oil prices today is on Wall Street, Broad Street and North End Avenue, making hay with an inevitable nod and a wink from Washington. In June 2006, a Senate Committee of the US probed the role of market speculation in oil and gas prices. The report pointed out that US energy futures were traded on regulated exchanges within the US and subjected to extensive oversight by the Commodities Future Trading Commission (CFTC), a government agency. But the number of trades on the unregulated over-the-counter (OTC) electronic markets is anybody’s guess, because no records are overseen.

Trading in energy and other commodities by large firms on OTC electronic exchanges is exempt from CFTC oversight by virtue of a provision inserted at the behest of the somewhat notorious and now defunct Enron Corporation into the Commodity Futures Modernisation Act of 2000.

So when will it stop? When the bad economic news stream in the US stops, and it is profitable for the money men to return to equities. Then, as suddenly as it began, it will be time up for commodities.

(1,050 words)

By Gautam Mukherjee
Monday, 9th June 2008

Published in print and online in The Pioneer www.dailypioneer.com on the EDIT page as "Greed fuelling price hike" on Saturday 14th June, 2008