Why Oil Prices Are So High

At last, an answer that doesn't leave me asking more questions. From CounterPunch, conservative economist Paul Craig Roberts:

The dollar is weak because of large trade and budget deficits, the closing of which is beyond American political will. As abuse wears out the US dollar’s reserve currency role, sellers demand more dollars as a hedge against its declining exchange value and ultimate loss of reserve currency status.

In an effort to forestall a serious recession and further crises in derivative instruments, the Federal Reserve is pouring out liquidity that is financing speculation in oil futures contracts. Hedge funds and investment banks are restoring their impaired capital structures with profits made by speculating in highly leveraged oil future contracts, just as real estate speculators flipping contracts pushed up home prices. The oil futures bubble, too, will pop, hopefully before new derivatives are created on the basis of high oil prices.

And

Saudi Oil Minister Ali al-Naimi recently stated, “There is no justification for the current rise in prices.” What the minister means is that there are no shortages or supply disruptions. He means no real reasons as distinct from speculative or psychological reasons.

The run up in oil price coincides with a period of heightened US and Israeli military aggression in the Middle East. However, the biggest jump has been in the last 18 months.

When Bush invaded Iraq in 2003, the average price of oil that year was about $27 per barrel, or about $31 in inflation adjusted 2007 dollars. The price rose another $10 in 2004 to an average annual price of $42 (in 2007 dollars), another $12 in 2005, $7 in 2006, and $4 in 2007 to $65. But in the last few months the price has more than doubled to about $135. It is difficult to explain a $70 jump in price in terms other than speculation.

Click here for the rest.

So I've been avoiding this subject for a while now, even as the gas crunch starts to affect my own personal bottom line. Why? Because I've been extraordinarily dissatisfied with the explanations I've heard, explanations from NPR's All Things Considered, the New York Times, PBS's The News Hour, you know, well respected news sources that are supposed to sort this shit out. The most widespread and most unsatisfying explanation appears to be about supply and demand in a global economy where Asia continues to grow at a quick pace. But the Asian economy has been growing quickly since its late 90s meltdown: why are oil prices only now shooting rapidly into the stratosphere? Like I said, unsatisfying. Some economists being interviewed by the above mentioned news sources have, like Roberts, also talked about oil futures speculators, but, unlike Roberts, are very mysterious and even dubious about the role such speculation might play.

So far, Roberts, a conservative economist who has broken ranks with the faithful in recent years, is offering the only explanation with any internal logic and consistency.

If you don't grok economics well, here's what I get out of the above excerpt. Before I go any further, it is important to note that oil, by an American/Saudi arrangement made during the early 70s, is priced in dollars worldwide. And dollars appear to be a big part of the problem. That is, dollars just aren't worth as much as they used to be; consequently, one needs more of them to buy everything, oil in particular.

Our dual deficits, trade and budget, have apparently created intense pressures on the dollar's exchange rate, primarily because we must borrow heavily from foreign nations in order to finance our red ink spending: borrowing in this way, on such an enormous scale, essentially creates masses of new dollars which are poured into the economy like Niagara Falls, causing inflation. In short, the more dollars there are, the cheaper they are. That's what inflation is ultimately, the devaluing of the dollar.

(It's actually much more complicated than this when factoring the important concepts of petrodollars and reserve currency, but I'm just going to leave it with what I've said about dollar inflation affecting oil prices more significantly than prices for other commodities. Especially because I barely grasp this stuff myself.)

Compounding the inflationary pressures of the trade and budget deficits are the super low interest rates that the Federal Reserve Board has been setting in order to keep our entire finance system from collapsing in the face of the mortgage and lending crisis. This, too, by making it cheaper to borrow, creates new money, and causes more inflation, making the dollar lose still more purchasing power. But if I'm reading Roberts correctly, this particular issue is less about inflation than it is about where much of the new money created by these low interest rates is being spent: it's going into oil futures.

Futures, as an economic subject, makes my head hurt, but my understanding of the idea is like this. Investors will bet that a commodity price will either go up or down. If they're betting that the price is going down, they want to sell now while the price is high. But if they're betting that it's going up, they'll buy now while it's cheap, and sell later when it's high. If you get enough investors betting that the price will go up, the price will go up, just because so many investors think it will: investor perception becomes reality simply because all their purchases now create high demand, and high demand for a finite resource, in turn, makes the price go up.

Just go watch that movie Trading Places to get a better explanation of the commodities market.

At any rate, the irony here is that this entire dynamic turns the law of supply and demand on its head. Global oil demand, in the real economy, has remained relatively stable in recent years; supply, according to the Saudis, is plentiful at the moment for all the world's needs. There should be no oil crisis. But demand among investors, however, has skyrocketed because they need somewhere to put all this money being pumped out by the Federal Reserve Board.

If this is actually the case, what we're looking at is an oil bubble, which, like the tech bubble and housing bubble before it, ought to burst at sometime in the future--oil is not really worth as much as investors think it is at the moment, and at some point, the more cautious among the futures set will start to sell it all off, making billions, but leaving other futures investors holding the bag. In the meantime, we're in the midst of handing over those billions, out of our own pockets, to those first few who sell while prices are high. In other words, right now, we're holding the bag.

Now what I want to know is why this bullshit is being allowed to happen. Don't we have any laws or agencies that are supposed to keep this shit from happening?

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