In response to my letter that speculators were not to blame for the high price of oil, a letter writer to our local weekly paper, the Independent Coast Observer, who I shall call Mr. McManus, observed that there are multiple factors driving the cost of oil, then blamed the Republican Congress of 1999 for enabling Enron to play games with energy costs (and I might add, go bankrupt). Apparently confusing spot prices with the futures market, Mr. McManus then noted that barrels of oil – I assume he is referring to futures contracts for oil – may be traded more than 20 times before the oil is delivered.
Indeed, futures contracts are traded numerous times before the commodity – not just oil - is finally delivered. In fact, that’s the way commodity market trading is designed to function.
As Robert J. Samuelson explains in Newsweek, July 7, 2008, commodity investing is different than stock trading or real estate. Unlike Mr. McManus’s Enron-like example of traders trading oil back and forth on paper, oil futures trading creates a gain and a loss on each trade.
The International Energy Agency predicts that demand for crude oil will rise strongly over the next five years (2007 through 2012), driven by global economic growth of 4.5 to 5.0 per cent a year.
Concominantly, world crude oil production declined about half a million barrels per day in the past three years (2005 through 2007), and the combination of rapidly increasing demand with supply stagnation has drawn down worldwide oil inventories.
The surplus oil buffer – the excess of production capacity over demand – is shrinking from 3 million barrels per day to 1.5 million.
In summary, demand for oil is strong and growing steadily, and supply is actually shrinking along with productive capacity.
For the United States, oil production has declined steadily since 1970: 9,640,000 barrels per day then, only 5,100,000 now, or a decline of 47%.
US oil consumption is 20,770,000 barrels per day, compared to approximately 14,500,000 in 1970, or an increase in consumption of 43% while our production was falling 47%.
In the past two decades US crude oil reserves have fallen 23% to 280 million barrels, or enough to last less than two weeks at our current consumption rate of almost 21 million barrels a day (an additional 706 million barrels, or 34 days’ worth, is held in the Strategic Petroleum Reserve).
While Democrats demagogue speculators, all signs are that the market is adhering to the laws of supply and demand. Light, sweet crude for September delivery has now fallen in six of the last nine sessions and has shaved 18 percent off its trading record of $147.27 reached July 11, curbing speculation by costing many speculators their shirts..
"People are looking for any excuse to sell oil right now," said Jim Ritterbusch, president of energy consultancy Ritterbusch and Associates in Galena, Ill., and are doing so, even when faced with possible strife with Iran and a hurricane in the Gulf.
Following Obama's remarks that he would support offshore drilling in the US, "the market is increasing the odds now that the drilling deal will get done and we will see more production coming out of the Gulf of Mexico," said Phil Flynn, analyst at Alaron Trading Corp. in Chicago. "There's nothing that cures high prices like high prices."
As Anthony deJasay cogently explains: Like oil, speculators too can burn.
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