Big Oil Blues 2008

I have had a running argument with a friend regarding the oil industry.  It first needs to be stated that we are both conservatives that believe that economies operate well, for the most part, in a free market system.  I, however, also believing in the ‘depravity of man,’ know that anything involving humans without any regulation will eventually be abused by man often to his own detriment.

In the last year, as the price of oil was rising out of control, I chose to place the blame on several groups that I felt were not playing fairly.  Each had its own interests in mind at the time.  First, there were the speculators.  These included retirement account investors who had decided to drive up the price of oil in order to increase the return on these accounts.  The problem with this type of move is that in the end, it amounts to a tax on the entire country, and as a percentage of income it results in a much larger burden for the poor.  Rampant speculation is always bad for the economy.  There is always a ceiling, and when it is reached, a big fall will always occur.  You can look back through history as it has happened again and again.  And, you do not have to look far.  The stock market is still suffering the effects of recent speculation.  In the housing industry, over the past few years, America was treated to stories ad nauseum about housing prices that were skyrocketing out of control on the east and west coasts.  It was referred to as a ‘bubble,’ and the ramifications of the burst are still being experienced throughout the industry (however, in Dallas, Denver and Houston, cities that for the most part did not did take part in the rampant speculation, housing prices have continued to rise at a reasonable rate).   Before that, we had the S&L scandal in the 1980s.  In all of these instances the economy was negatively impacted by rampant speculation in a particular industry.

The second group that obvious benefitted from the aberrant rise in the price of oil last year was the oil companies themselves.  They cried crocodile tears about how awful it was that ‘demand’ had driven oil to such high prices.  At the same time, because their profit on a barrel of oil was based on a percentage of the price, their actual profits went through the roof.  During this time, my friend and I had argument after argument.  I could not get over the percentage of profit built into the oil companies’ prices.  To me this showed that the oil companies were not attempting to exist in a competitive market.  As the price of a barrel of oil was driven up, and the oil companies’ profit went along for the ride, they simply got filthy rich.  I used the Wal-Mart as an example.  If the cost of a particular item went up for Wal-Mart, they would do their best to keep their costs low, and the affect on the consumer end would only be seen up to the amount of the increase in the cost to Wal-Mart.  Wal-Mart does not have a percentage of profit built in to its system.  It works on the concept of economies of scale.  No industry could employ the idea of economies of scale better than the oil industry, but there is simply no incentive to do so.  They exist in a perpetual state of mute collusion in which everyone benefits when the price goes up because people are still going to buy gas, and the entire oil industry can reap the profits.

They claim the price was demand driven, but that is a lie that has been proven at this point.  The price was driven by speculation, and as an industry, big oil had no incentive to keep this from happening, quite the opposite.

Until recently they were still blaming demand for the rise in oil prices.  I called B.S. on this.  The price of oil was about a quarter of what it had been six months ago.  So, if the price of oil were actually driven by demand, this would mean that America (and the world) would be using about 25% of the oil that it was 6 months ago.  This idea is just ridiculous.  This was all underscored even more today as news that OPEC’s largest cuts in production in its history were met with…, the price of oil going down again.  This proves that the price was not being driven by demand, but rather by speculation.  Demand and price have a positive correlation (when demand goes up, prices goes up), and supply and price have an inverse correlation (when supply goes down, prices go up).  Today’s announcement simply underscores how much out-of-whack the oil industry was this summer, because now, prices are continuing to fall regardless of the restriction of the supply.

Finally, the suppliers in the Middle East benefitted from the unrestrained speculation in the oil market.  Again, as with the oil companies, they had only to gain.  The negative impact to the economy here was huge.  It is never good to send large amounts of your wealth to another country, but as the price of oil went up, that is exactly what we did, and the dollar took a pounding as a result.  Today, the dollar is actually stronger than it was six months ago.  Interesting.

Check out this story.  I found the graph especially interesting.

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