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Oil Prices Are High Because . . . ??

Usually when governments representing the world’s largest oil producers and largest oil consumers meet to discuss why oil prices are so high, they don’t agree on the causes. It is curious, however, that the parties meeting in Saudi Arabia sometimes argued the opposite conclusions from what you’d expect.

The usual pattern is that during periods of very high prices, consumer advocates (buyers) blame the suppliers for manipulating the markets and exercising market power to keep prices artificially high, while suppliers claim the market is simply reflecting supply and demand fundamentals, and the problem is excessive demand driving up prices.

But note how these positions got switched:

But [Saudi] King Abdullah and the British prime minister, Gordon Brown, . . . soon offered totally different perspectives on the problem and how to approach it.

The king spoke of the “selfish interests” of speculators as a main reason oil prices have risen 40 percent this year, urging the gathered ministers to “rule out biased rumors and to reach the real causes for the increase in price.”

But Mr. Brown squarely pointed to fundamental economics and “oil demand rising faster than supply.” The U.S. Energy secretary, Samuel W. Bodman, put it more bluntly in a meeting with reporters, saying “there is no evidence we can find that speculators are driving futures prices.”

So we have one of the world’s largest suppliers suggesting prices are artificially high because of market manipulation, while two large net importers/buyers said it’s just market fundamentals, including too much demand, not market manipulation.

Of course Secretary Bodman is not representing the normal consumer viewpoint but is instead fronting for Bush/McCain supply side solutions. That’s in line with the Bush/McCain view that all will be well if we just allow more off-shore drilling. The Saudis were happy to oblige, promising to raise production if their customers asked.

Yesterday, McCain/Bush sent Lindsey Graham on Meet the Press to sell the dubious line that granting more drilling permits would immediately dampen the speculation that is raising the forward price of oil, thus contradicting their (Bodman’s) simultaneous claim that speculators are not driving up the current price. NBC’s Brian Williams missed the contradiction, but Joe Biden didn’t, noting that the oil companies already have millions of acres of off shore leases they have yet to explore. [More here] Since that’s true, giving oil companies even more leases they wouldn’t explore could have no immediate effect on current prices. C&L’s Amato caught more of Biden’s take down of Graham.

What remains unexplained is exactly how artificially high prices in a forward financial market (e.g., oil futures) could be sustained, even though no one — so far — is alleging that market power is being exercised in the "spot" or near-term physical market. One way to think about this is that if you’re a buyer and you think suppliers (or speculators) are asking artificially high prices in the forward markets, you just don’t buy forward; you wait. If there’s no market power being exercised in the near-term spot market, then you can meet your needs at a lower price by just waiting.

In other words, to successfully sustain an exercise of market power in the forward market, suppliers must be able to exercise market power in the spot market. They can either physically withhold product from the physical market or financially "withhold" it by refusing to sell it except at artificially higher prices. For example, oil companies could refuse to ship crude to refineries or refuse to truck refined gasoline to stations. But no one has accused the suppliers of taking these near-term actions. So what gives?

If suppliers aren’t withholding product in the spot physical market, then it’s not clear how speculators can sustain artificially higher prices in the forward markets, if that’s the cause. Perhaps there’s something unusual in the oil markets that changes the basic dynamics, but I haven’t seen a good explanation of it.

The Republicans are selling us snake oil with their "lease more and the price will fall" theories. But it’s not clear that "Enron-type manipulation" in forward markets is the core problem. Forward markets may well need to be better regulated — transparency is usually good for markets — but even if that’s true, I haven’t seen a credible explanation for how the current lack of regulation is causing prices to be higher than they should be. Perhaps our economists and/or oil market experts can explain it.

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John has been writing for Firedoglake since 2006 or so, on whatever interests him. He has a law degree, worked as legal counsel and energy policy adviser for a state energy agency for 20 years and then as a consultant on electricity systems and markets. He's now retired, living in Massachusetts.

You can follow John on twitter: @JohnChandley