Black Gold, Texas Tea, and a Leveraged Market

With oil jumping $11 in one day to close just above $138.40 a barrel, Americans are wondering "What the hell?" as gasoline surges well beyond the cost of a gallon of milk.  I have long believed that the cost of a gallon of milk was the bellweather for when gas would reach an unnacceptable price.

But what do we do about it?

First, we need to understand the problem. 

Unlike 1973 and 1979, when we were caught between an embargo and price controls, there is not a shortage of crude in the world.  Yes, we are near capacity in terms of refining AND we are competing against other nation-states with money to spend.  And this does drive the price up.  But there is not a shortage of crude oil in the world -- despite Roscoe Bartlett's goofy-ass claims about "peak oil".  There may well be a shortage of refined product soon, however, as the wholesale price of gasoline and diesel (and #2 fuel oil) reaches a point where retailers no longer have the ability to buy on credit.

No, the real problem here is the oil market is highly leveraged in a number of ways.  First, nearly 70% of the speculative investors in the futures market are not part of the production or supply chain.  They are investors who will never take delivery of one barrel of oil.  They are only interested in the maxim of drug kingpin Prop Joe from "The Wire":  buy for a dollar and sell for two.  What we can look forward to is the eventual collapse of the oil bubble -- when these same investors claim they didn't understand the futures market and were duped by vicious Wall Street traders.  You know, just like what happened in the sub-prime crisis.

Second, our largest competitors for the purchase of crude heavily subsidize the cost of the refined product to their own citizens.  That means China, India, etc.  That adds an unreasonable leverage to the market, as there is no market-equalization in terms of supply and demand.  Subsidizing the cost of fuel in those markets cuts the elasticity of price.  The result is that any demand decline in the United States has zero benefit in the world market.  The Dragon will continue sucking up all the Texas Tea it can get its claws on.

Third, there is a lot speculation that China is boosting its supplies of petroleum in advance of the Beijing Olympics to ward off any supply issues while it is on center stage.  Economists would refer to this as "hoarding", and would stress that it places undue strain on the supply chain.  In the 1970s, the government tried to convince people to only fill their cars when the tank was nearly empty, for the same reason. The "hoarding" of a reserve by market actors distorts the natural market signals to suppliers.  This creates a third point of leverage, as at some point -- maybe after the Olympics -- the "hoarders" will hold a sizeable inventory at a high price, that they will need to sell off.

Finally, all these actors benefit from a ridicously short-sighted and idiotic policy in the United States pushed by the left-wing fascist hordes in the Democrat Party which absolutely forbids using our own energy reserves to supply our needs.  The miserably stupid and pathetic leadership in our Government -- abetted by weak and feckless Republicans who resemble the "moron wing" at a state hospital more than their own voters -- is exacerbating the price situation by allowing other state consumers in the market to bid up the price of oil.

So that is the problem.  What do we do about it?

Unfortunately, until the government can cure its case of extreme craniorectal impaction, we are largely screwed.  There is not much that you and I can do.  Our nation and our economy runs on energy.  Emptying the Strategic Petroleum Reserve would only have a short-term (as in, about 5 days) impact on domestic supplies.  And something tells me that certain nation-state actors are waiting for us to do just that.  Drilling more -- which we should do NO MATTER WHAT -- would take a year or better to have a larger impact.

One thing the government could do -- but probably won't, because it makes sense -- is to take the leverage out of the market slowly, by increasing the margin requirements in the futures market.  By increasing the margin requirements, the government would slowly start to squeeze the non-industry actors out, and remove the rampant speculation that is driving the price oil beyond reason.