Why is gas so high? Because it is being manipulated again.

Remember Fall 2007 and Spring 2008 when heating oil was above $4+ a gallon, gas the same, and in July the price of a barrel (bbl) of crude oil hit $147?

Well, unless you are a fact freak like I am, you might not remember the $147 number, but at that time we were projecting $8 gas, thinking about wind turbines on Munjoy hill, about clear cutting the Northern woods of Maine for firewood and pellets, everyone was buying wood and pellet stoves, and the Government worried about people actually freezing to death over the 2008/2009 Winter.

Then something strange happened: the price of crude oil plunged $20 over two weeks to $125, then to below $100 by September 15, and finally on December 21, crude was trading at $33 a bbl.

Why? Did we drill, baby, drill? Did we discover a cheap way to extract oil from shale rock? Did the idea of biodiesel cars running on french fry fat from McDonalds force the oil producing countries to lower the price of crude?

Nope.

Common wisdom is that the slide started when America and much of the world cut back on demand, largely by driving less. However, I contend that the documented 4% – 6% drop in demand experienced in the US could not have caused the spectacular collapse from $147 to $33.

Rather, I believer it is because the speculators were caught, or about to be caught with their feet on the accelerator pedal.

In late June and the first weeks of July, the Congress was laying the ground work for an investigation into speculation of commodities trading in crude futures.

Here is how commodities trading works.

Let’s say I win $50,000 in the Megabucks and want to spin the wheel.

I can buy a futures contract on just about any commodity: wheat, copper, pork bellies (bacon), and yes, crude oil, for a future delivery. Farmers like this trading because they obtain their money even before the seed goes in the ground. However, most traders do not get in at the beginning – buying a contract from the farmer – but at some time later.

As with any trading, I am buying the contract at a price at which I believe I can make a profit at some time down the line. I may hold this contract for a month or for a day based on changes in the weather, the economy, international politics, etc. Anything can drive up (or down) the price of the contract.

Or I might get together with friends who have billions of dollars, and buy so many contracts that supply and demand simply drives up the price. And institutions like pensions and cultural institution endowments might jump into the game with me when they see a chance of a big, easy profit.

During Fall 2007 and Spring 2008, speculators were wildly bidding up the price of crude oil, even though there was no shortage of oil, there had been no oil field failures, the pipelines were flowing on 3/1/2008 at the same rate they were flowing on 7/1/2007. Hedge funds, largely made up of overseas billionaires pooling their money to buy oil futures on margin (ie., with maybe only 30% down) were driving up the price of crude. There was talk that major American cultural institutions were in on the game.

There were no speculation in crude between March 2007 and the end of August 2007. Crude traded between $62 and $74. By November 2nd the price had jumped to $95, by April 11, $116, by May 23, $131, and July 11, $147.

And as I noted, then came the announcement of a planned inquiry, and the price dropped $114 within five months.

So what is happening right now?

On Tuesday, the price of a barrel of oil closed at $70.01 for July delivery.

According to the US government’s Energy Information Administration (EIA), the national average price of gas on June 9 was $2.62, almost 60 cents more than at the end of April, less than six weeks ago. The EIA projects that the average price of a barrel of crude in the second half of 2009 will average $67, up $16 from the first half.

In January, the EIA predicted crude would average $43 for 2009 and $54 for 2010; the average price of gas for 2009 would be $1.87. The EIA projection was accompanied by the statement: “The oil price path going forward will be driven mainly by the depth and duration of the global economic downturn, the pace and timing of the recovery, and actual OPEC production.”

In the first week of May, the EIA projected that gas would average $2.12 for the year. Coincidentally, that is the week that crude began its jump from $50 to $70.

The oil is still coming out of the ground, the American storage tanks are full; the economy is still struggling. From the economic law of the supply and demand we would expect the price of crude gas to go down, but the prices are still going ups.

Why?

The speculators are back in the market, and the Congress has other things to worry about than a 60 cent increase in the cost of gas in less than six weeks.

The speculators are playing because the value of the dollar is falling on the world market as a result of President Obama’s borrowing to fund his spending, and a lower dollar makes futures trading on crude even more attractive. As more come to play and the price up, the speculators make a paper profit on every uptick of the contract. And remember, these the $70/bbl amount quoted before was for July delivery; the wheels are only beginning to turn for contracts with September, October, etc, delivery.

Speculators are also playing because they are anticipating a global economic recovery with increases in oil consumption very, very soon. Why do I say very soon. Because of where the oil is located.

So where is the oil?

It is in tankers, lots of tankers off the coasts in calm waters. That way, it can’t be counted as inventory by any country. On May 10 it was reported that 100 million bbls of crude and 25 million bbls of refined products such as gas were in tankers off Europe, West Africa, the U.S. Gulf and Asian ports.

In that report, the 125 million bbls would represent nearly 3 days of oil demand for the OECD (the 30 major developed nations of the world). On June 4, Reuters reported that the world-wide energy conglomerate, Total, was storing 100 million bbls in land and sea storage. It is highly probable that the oil in floating storage was purchased at late winter contract prices about $40+ bbl.

On Wednesday, the EIA released its weekly report on crude, gas and other petroleum inventories, and largely on the basis of this report, crude jumped $1.32 from Tuesday to close at $72.33. The EIA reported that crude inventory dropped nearly 4.4 million bbls during the week, but noted that the crude inventories are still “above the upper boundaries of the average range for this time of year.” Gas inventories dropped by 1.6 million bbls and and are below the average range.

I paid $2.67/gallon for gas Tuesday before the market closed; it should not be at this level. As I wrote this Tuesday evening, it had already been increased because of crude closed higher. As I update this Wednesday afternoon, it is higher again..

The world is awash in crude. And when the price of crude jumps by a dollar on the commodities market in Chicago, that should not instantly make the gas in the tanks in the gas station across the street be worth more — the crude that made that gas was probably bought in January, but the price still went up this evening.

Last year, we were able to have an impact on the price of gas and oil and the speculators.

1) Congress called for an investigation into the incredible run up in the commodities market.

2) With gas at $4+ a gallon, we drove much much less and our reduced demand resulted in a slow down in consumption and an increase in inventories.

This summer, the inventories are neither in the ground nor in the refinery holding tanks, they are literally at sea. I am told the situation is so bad navigating the Strait of Malacca between Indonesia and Thailand (through which 25% of the world’s oil is moved) that some supertankers that normally use that passage to Japan or China have to take the more dangerous southern route.

To mix metaphors, we at at sea and over a barrel on this one. I do not believe we will see $4 a gallon gas or oil this winter, but unlike the EIA, I think $3.10 is a very real possibility by December 15.

Update: July 6

Yesterday The New York Times, always slow to the mark, ran a article on the volatility and its impact on the recovery, To its credit the NYT accompanied the article with an excellent IMF/Bloomberg chart of the price of crude adjusted for inflation since 1983. Note the price hovering at or below $30 a bbl from 1986 to 2003 until the commodities market manipulation and then the fall back to that level last December.

The chart implies a fact that I poorly referenced in the blog; as the crude market has climbed rapidly since 2000, the crude market was already being manipulated with no really significant demand/supply imbalance to justify the rapid growth in the price.

Peter B. Hayward

Social Justice – We need to strive to change what we cannot accept for our all fellow human beings. We do not have the option of silence.

Copyright © 2009 Peter B. Hayward. All Rights Reserved

email me

Follow me for daily tweets at twitter.com/pbh444 .

To be notified immediately of new tweets from those you follow, you can use a PC program such as Mad Twitter, a Mac program such as Twitterrific, or for the iPhone/iTouch, many apps like Twitterific or a web based client such as Hahlo.