A friend of mine and I were discussing the recent spike in oil prices. Essentially, he blamed Obama. I pointed out that polity may play into it (the U.S.’s posturing toward Iran, etc.) and to a host of other international issues as well as Wall-Street speculation. When I concluded that market forces and speculation were ultimately more to blame than the president, he replied by saying the president could stop allowing the expansion and devaluation of the dollar and drill domestically. Thoughts?
My first impression is that this is another example of someone blaming the president for something that he has less control and influence over than he deserves to be blamed and/or credited for. But really there’s a lot more to your friend’s opinion than simple misattribution.
When one discusses the price of oil, it is important to recognize up front that there are multiple “causes” for the price of oil. Inflation, gas taxes, foreign demand, supply rates, speculation, and political unrest all contribute to the price of oil in some way. If someone wants to blame this, that, or the other thing for an increase in oil prices, the voracity of that claim must be measured by looking at the breakdown of all contributing factors, and figuring out which of those factors is actually demonstrably volatile; in other words, if some of the price factors are remaining constant, you can safely eliminate those factors as the cause of the increase. If other factors appear to be in flux, that’s strong evidence that those factors are causing the increase. That’s somewhat simplistic, but it’s essentially the only honest way to assess the issue.
When I wrote about this in May of last year, I argued for the “speculation” theory of oil price volatility. My argument was based on the methodology above; and while my link to an excellent pie chart I referenced at the time seems to have gone dead since then, I made the following points:
The decision to launch QE2 was made in November 2010. Available data suggests that as recently as March, inflation was only at 2.68% per annum. The price of gas, however, has increased by almost 30% Since December. Given that inflation only recently [starting moving towards an] estimated 5% marker, it just doesn’t make sense that inflation is responsible for very much of the recent increase in oil prices.
Inflation was only 2.93% in the month of January, 2012. So the “weak dollar” argument again fails to account for the recent spike in gas prices, as it did last May. Gasoline taxes did not increase either. There were, however, other objective factors that helped explain the increase:
There is one primary reason, in my eyes, that the cost of gas is rising so sharply right now: unrest and violence in the Middle East has led many investors to make massive commodity purchases hoping to take advantage of the fear of disruptions in supply caused by the Middle East revolutions.
Back in the year 2000 the investing community as a whole made up about 10 percent of long positions in the oil market and now they are up to 40 percent,” said Zeihan. “So you add that many new players and that much new money, but you do not add any more than a 10 percent increase in oil supply and, of course, you are going to have higher prices.
So back in May of 2011, you had ordinary inflation levels and tax levels remained the same. On the other hand, there was huge civil unrest in the Middle East, and shortly thereafter, a massive influx of new long positions on oil futures. Demand in China couldn’t be blamed because it remained relatively constant during that period. The only thing that changed was civil unrest in the Middle East, followed by a huge influx of long positions on the oil market, which suggested that investors were expecting a disruption in oil supply, driving up the price of oil and make oil futures profitable. What followed the May 2011 spike confirmed that thesis:
[T]he fact that the aforementioned disruptions [to supply] didn’t actually materialize the way we thought they would has led to a recent commodity dump, resulting in a 15% decrease in the price of crude over last weekend alone(!), as investors unload their long positions back onto the market.
This chart by John Kemp of Reuters demonstrates the shift:
So back in May of 2011, it was virtually unquestionable that the spike in oil prices was due primarily to speculation fueled by unrest in the middle east. So what about now?
All the same factors that were in place during May of 2011 hold true now: demand for oil in China is actually slowing down. Inflation has actually decreased between last May and January of 2012, so the weak dollar still cannot explain the increase in prices. Gasoline taxes still remainconstant compared to two years ago across the states.
Yet once again, we are seeing massive unrest in the middle east, and speculators are once again increasing their exposure to oil futures. So the idea that a devalued dollar is what’s driving up the price of oil is simply not borne out by the evidence. Chinese demand is waning, taxes are static, and inflation has actually decreased relative to the last major spike in oil prices. The only explanation that makes sense is speculation driven by unrest in the Middle East.
As for The “drill, baby drill” approach: drilling our way to energy independence is problematic, if for no other reason than it’s just another way of kicking the can down the road. But more importantly, much of the enthusiasm over America’s natural energy reserves is based on speculation of another kind:
The claim of a 100-year supply [of American natural gas] originated with a report released in April 2011 by the Potential Gas Committee, an organization of petroleum engineers and geoscientists. President and Chairman Larry Gring works with Third Way Energy LLC, a company based in Austin, Texas, that is engaged in acquiring and exploiting oil and gas properties along the Texas Gulf Coast. Chairman of the Board Darrell Pierce is a vice president of DCP Midstream LLC, a natural-gas production, processing, and marketing company based in Denver. The report’s contributors are from the industry-supported Colorado School of Mines. In short, the Potential Gas Committee report is not an impartial assessment of resources.
Turns out those estimates are essentially Bull$%^& for the most part:
Those details haven’t been made freely available to the public, but their summary breaks it down as follows here and in the graph below: 273 tcf are “proved reserves,” meaning that it is believed to exist, and to be commercially producible at a 10 percent discount rate. That conforms with the data of the U.S. Energy Information Administration. An additional 536.6 tcf are classified as “probable” from existing fields, meaning that they have some expectation that the gas exists in known formations, but it has not been proven to exist and is not certain to be technically recoverable. An additional 687.7 tcf is “possible” from new fields, meaning that the gas might exist in new fields that have not yet been discovered. A further 518.3 tcf are “speculative,” which means exactly that. A final 176 tcf are claimed for coalbed gas, which is gas trapped in coal formations. (Note: The PGC reports the total for probable, possible, and speculative coalbed gas as 158.6 tcf, but adding up their numbers for each category, we find the correct total is 157.7 tcf. We haven’t been able to reach the PGC to discuss the discrepancy. Adding the 18.6 tcf of proved coalbed gas reserves reported by the EIA in 2009—the most recent data it offers—to the 157.7 gives a total of 176.3 tcf for all categories of coalbed gas.
So the idea that we’re going to tap America’s natural energy reserves and suddenly start paying .99 cents a gallon for gas doesn’t really make a whole lot of sense. The advocates for drilling are relying on extremely dubious estimates of the “hidden reserves” of energy that are sitting beneath America’s soil. And the evidence currently shows that the X-factor driving up prices right now is speculation fueled by civil unrest in the Middle East. Neither Ben Bernanke nor Barack Obama are the reason why gas prices are going up again.