October 24, 2008
What is happening to Oil Prices?
It used to be that the prices Virginians paid at the pump were determined by supply and demand. That all changed in 2001 when Congress passed the Commodities Futures Modernization Act. This legislation allowed energy futures to be traded electronically which effectively emasculated the oversight of the Commodities Futures Trading Commission (CFTC).
As a result, investment banks, hedge funds, sovereign wealth funds, and pension funds plowed cash into oil futures contracts. Crude oil, which stood at $24 a barrel in 2001, ultimately increased to $147.27 this past July 11th. This increase was not due to short supply, but a demand on the part of traders for higher futures. Their talking heads were on the cable business shows predicting $200/barrel crude by summer’s end. For a long time they were laughing all the way to the bank – or their seaside retreats in the Hamptons.
During this time we were telling anyone who would listen that the actual value of a barrel of crude was somewhere in the $55 to $70 range. However, the greed of the investment banks and others resulted in one of the largest transfers of wealth in American history and led us into the greatest financial crisis of our lifetimes. Where did all of our money go? Whoever answers that question will be the next winner of the Pulitzer Prize.
It was all a house of cards.
Every bubble bursts and so it was in the case of crude oil. The collapse of several of the giants of Wall Street saw those remaining running for the exits – bailing out of their long positions on crude oil. In a matter of weeks crude oil fell from $147/barrel to $63(today).
It used to be that when OPEC acted, the markets reacted. No more. This week the ministers of OPEC moved to significantly decrease production in an attempt to stabilize crude oil prices. The market’s reaction? Crude WENT DOWN another four percent. Never before, even in times of war and weather emergencies have we seen this phenomenon occur. Today the law of supply and demand has been replaced by the law of demand in the petroleum marketplace.
Despite all this uncertainty there is some good news. Because of it we are hopeful that the turnaround in petroleum prices - which no doubt contributed to the current recession - may help lead us out of it.
Consider this: A Virginia driver has a vehicle with a 22 gallon tank he/she fills once a week--
Summer Price @ 3.99/gallon = annual fuel bill $4,564
Today’s Price @ 2.40/gallon = annual fuel bill $2,745
Maybe there is a light at the end of the tunnel.
-Mike O'Connor
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