Rex Tillerson, the boss of ExxonMobil admitted last week that the price of oil–based purely on supply and demand- should be in the $60 to $70 a barrel range. The reason it’s above $100 a barrel, Tillerson explained, is due to the oil majors using futures contracts to lock in current high prices, and speculation that is engineered by the high-frequency trading of quantitative hedge funds.
That was just one of the stunning revelations made during the Senate hearing on tax subsidies to the oil industry– which featured the 6 most powerful CEOs– BP, Shell, Chevron, Conoco-Phillips and Exxon-Mobil– all sitting like ducks in a row giving the stiff-arm to pressing unfriendly inquiries from a host of Democratic Senators.
The formal showdown between Big Oil and Big Politics was enormously revealing theater about just how selfish and narrow-minded cash-rich industry can be when called upon to do their patriotic duty in balancing the budget. Ouch!!!
Here are some other juicy disclosures from the hearing:
–The average cost of producing 1 barrel of oil was $11; the average price of the oil in the marketplace–$72– some 6.5 times the cost of getting the oil out of the ground.
–The profits for the big 6 oil companies was $36 billion in the year’s first quarter. A large part of the $36 billion was used to buyback shares or pay dividends to shareholders.
–These giant US companies have only 1.4% of global oil reserves; the national companies of OPEC have 68% of the reserves. Therefore, argue the CEOs best not to take away tax advantages, i.e. what the Senators call “subsidies.”
– If those nasty Senators take away the tax advantages, exploration for oil in the US will dry up– and move abroad where the tax advantages are splendid. This is called waving the red flag- and threatening to put the nation’s oil deficit in even more dollar-bashing trouble.
–If Obama doesn’t loosen restrictions on drilling in Alaska and offshore US– we will become even more horribly dependent on importing foreign oil.
–There is NO energy plan for the US– and warns Sen. Max Baucus of Montana- “we will require the good faith on everyone’s part– which is going to be enormously difficult.” This is an understatement when one sees the way the oil executives and the Senators agree on almost nothing. No CEO would admit the tax advantages were subsidies.
–The deduction for intangible drilling expenses was given to the oil industry in 1960 when a barrel was worth about $15-17. So, why do they need this favor when oil is $100 a barrel? Good bloody question , I thought. The oil execs looked horrified and warned that all exploration in the US would cease and desist.
Well, here we have the truth from the "horse's mouth." You don't have to believe ignorant old me. "$60 to $70 a barrel range." Lenzner continues by stating that, broadly speaking, the rest of the price is created by the "market forces" that I keep talking about.
I find it difficult to believe that the casino-like process of playing with the possibility of extracting profits from the manipulation of futures contributes to the production of petroleum.
This "game" contributes to the bank accounts of the players, but what does it do to the rest of us?
If the answer is nothing, then the "crap shoot" in New York and other places should be dealt with, probable through international treaties of regulation.
There are actually several different crude oil markets because of how oil is refined. Heavy crudes (high wax content, high API viscosity, high density) cannot be refined efficiently by refineries geared to refine light crudes and vice versa. A similar situation exists with “sweet” and “sour” crudes. Light, sweet crudes are cheaper to pump, transport, and distill and produce more gasoline per barrel than other types of crudes so it generally goes for more dollars per barrel than others. However, This distinction has a important impact on the balance of supply and demand because there is imbalance between production and refining capacity. Refineries designed to distill sour crudes cannot distill sweet and vice versa. The same is true for light vs. heavy crudes as well. The problem is that 75% of the world’s crude is sour but something like 40% of the world’s refineries are geared to sweet crude.
Further, world production of sweet light crudes has either peaked is close to peaking, which means the imbalance between production capacity and refining capacity will increase. The recent shut down in Libya’s production of sweet light crude has further thrown off the supply side of the equation. Other producers of sweet and light crudes like Nigeria simply cannot produce any more. While the Saudi’s production can increase to fill the gap, they have only sour and heavy crudes, which does nothing for the 40% of refineries geared toward sweet light. The remaining refineries geared toward heavier sour crudes are already operating near capacity. Increasing production of heavy, sour crudes cannot translate into more gasoline or fuel oil delivered to customers.
World production of sweet crudes has peaked and increasing prices will not impact production.
Speculators aren't particularly wedded to the long side of markets; they're equally happy to sell short if that's where the path of least resistance seems to lie. Let's not forget speculators were also blamed for trashing the shares of various financial institutions only a few years ago.
Sure, when there's too much money playing the momentum game they increase volatility, exaggerating both upmoves and downmoves. Still, only those few light-footed enough to get out of their positions in time can succeed at this particular game longer term. Most will eventually be chewed up by the fluctuations.
The real distorting factor isn't so much speculators as investors. Commodities are now widely viewed as an asset class and institutional (as well as other private) money has poured in over recent years with the total invested at the end of 2010 estimated at $376 billion. In 2009/2010 alone, net inflows to the sector were estimated at $134 billion.
There's no way that isn't going to have an impact on price. Commodity markets aren't geared for this kind of activity; they're not used to dealing with large long-term inventory accumulators (whether direct or via derivatives). There was an early run at this back in the late 70s but it was cut short by the subsequent commodity crash.
In part, it's just another reflection of the monetary/credit madness that's affecting everything (note the late 1970s were similarly confused and volatile, albeit at much lesser absolute and relative levels). In part too, the widespread readiness to buy the commodity story reflects deep-seated concerns about resources more generally: peak oil of course, population pressures, climate change, the "shortage" of agricultural land and potential losses of productivity, and so on. Maybe some are exaggerated, maybe some are just plain wrong, but the fact is they've entered into people's consciousness and necessarily affect all their actions.
What to do about it? Tough question: one thing I'm pretty sure of is that trying to squelch particular manifestations is a waste of time. The distortions are just going to pop out somewhere else.
In time (and probably not all that much time) we'll see the flip side of these soaring prices, much as we did in late 2008/2009. And, along the way, quite a bit of this newly enthusiastic investment money will retreat to the sidelines, licking its wounds. Perhaps even vowing "never again".
Then too, in the much bigger picture the longer exaggerated prices stay around the greater the impact will be on creating new supply and developing substitutes.