"It should be obvious to you all that the [gasoline] demand is outstripping supply, which causes prices to go up." —President George W. Bush, Associated Press, Mar. 5, 2008
"I mean, I would suggest Americans understand how supply and demand works. And if you restrict supplies of crude, the price of oil is going to go up and it affects gasoline."—Bush, ABC interview, Apr. 27
One thing about the former President and oil man: He's consistent about oil. Even years after leaving office, he manages to stay remarkably on-message when it comes to justifying the price of oil, even though he was wrong—and knew it—in 2008 and is still wrong today. For the record, oil and fuel demand had already started falling seven months before he made his March 2008 comment.
It's not just Bush who continues to blame oil supply and demand for causing higher prices this year. Politicians, the media, and Wall Street continue to make the same argument. The problem is that they are all wrong.
How wrong are they? Let's take a look. On Apr. 27, when our former President made his remarks, our nation's crude inventories were 30 million barrels higher than at the first of the year. Today, those inventories have risen by a further 10.7 million barrels. Despite continuous reports that world oil demand is skyrocketing while production has been constrained, the supply realities do not validate Bush's excuses for the price of oil.
Today we know, thanks to official documents released through WikiLeaks and covered by the McClatchy Washington bureau, that while the price ran up to $147 a barrel in 2008, the Bush Administration was leaning hard on the Saudis to pump more crude. The Kingdom agreed, warning it might have problems finding buyers. One of the official dispatches quoted Saudi Oil Minister Ali al Naimi as saying: "Saudi Arabia can't just put crude out on the market … speculators bore significant responsibility for the sharp increases in oil prices in the last few years." That message was delivered to then-President Bush in at least one diplomatic meeting.
No Buyers for Additional Saudi Oil
More recently, Saudi Arabia offered plenty of oil to real crude buyers in March. No one wanted the additional production, so Saudi Aramco pumped 800,000 fewer barrels per day in March than it had in February. What does that tell you about worldwide demand?
In April a quite-credible executive, Exxon Mobil (XOM) Chief Executive Officer Rex Tillerson, spoke with the Financial Times on energy issues. About the Saudi decision, Tillerson noted: "The Saudis did make available additional crude; what they found … [is] nobody was buying it." Tillerson also told Congress on May 12 that, based on the laws of supply and demand, oil should be selling in the range of $60 to $70 a barrel.
O.K., if it's not supply, what's behind high gas prices? Could it be that there's not enough gas being refined? Maybe. Gasoline supplies have been falling during the course of this year. According to data from the U.S. Energy Information Administration, for the first 20 weeks of 2011, our average refinery utilization was only 83.03 percent. Compare that number to the first 20 weeks of 2005, when our refineries were running at 91.54 percent utilization. Even before BP's (BP) Texas City refinery explosion in March 2005, the utilization rate was 91.2 percent, compared to this year's 83 percent.
What about China, then? Aren't the Chinese hoovering up oil faster than it can be sucked out of the ground? True, the Wall Street Journal ran a column on Apr. 28 in which it pointed out that "China guzzled 874,000 more barrels of oil in March than it did a year earlier—a 10.6 percent increase, despite high oil prices, notes Barclays Capital." But what the Journal neglected to mention is that much of that oil came from China's own oil industry; China's importation of oil from world markets, year-to-date through April, is running just 5 percent higher than it was a year ago.
Nor is the demand coming from Japan, which lost 29 percent of its refinery capacity after the earthquake that rocked that country in March. This immediately reduced overall demand for oil from international markets. Not by an insignificant amount, either: Japan used to import 4.2 million barrels of crude daily. This should have put downward pressure on prices.
Wall Street Foresees Higher Oil Prices
Yet prices remain high and according to some Wall Street banks, could go even higher, regardless of what Exxon's CEO said. On May 24, Goldman Sachs (GS) forecast that Brent crude could rise through the end of 2012, possibly to $140 a barrel. Morgan Stanley (MS) raised its forecast on Brent to $120 a barrel, up from $100, and JPMorgan Chase (JPM) is suggesting Brent could hit $130 by the third quarter of this year.
It's also not the weak American dollar that's boosting the price of crude. Such weakness would make our refined products much cheaper for export, so U.S. refineries would be running full-out trying to keep up with world demand. So what's the cause?
The answer is no secret—at least, not to readers of my previous columns. Once again, if you lift up the rock of high gas prices, what do you find underneath? Speculators who make large bets with mostly borrowed money to game the oil futures market. Thanks to their efforts to make a profit, they have essentially unhinged the oil market from any basis in reality. No real surprise there. What is surprising is how Washington continues to abet them.
Above we cited former President Bush's attempts to defend high gas prices. He's not alone. Before he was elected President, one of the tent poles of Barack Obama's campaign was to close the "Enron loophole" by nullifying part of the Commodities Modernization Act of 2000. That loophole allowed unlimited contracts for oil without disclosing the intended buyer or speculator or the price a buyer was willing to pay for crude. It marked the beginning of oil trades on the "dark" (unregulated) futures markets. In the same period, speculators also managed to borrow ever-greater margin to put with actual cash on their bets.
Change You Can't Believe In
In fact, on June 22, 2008, three weeks before oil peaked at $147 a barrel, Obama said that if elected President, he would crack down on speculators in the energy markets to rein in runaway fuel costs. Furthermore, to prevent any misunderstanding of Obama's position on that day, his campaign released this unusually specific statement: "The [Enron] loophole is one example of the special-interests politics that put the interests of Big Oil and speculators ahead of the interests of working people."
Obama wasn't the only candidate promising to come down on speculators. Republican nominee Senator John McCain's (R-Ariz.) top economic advisor, Douglas Holtz-Eakin, told Reuters that McCain had been working hard, even breaking ranks with fellow Republicans, to close the Enron loophole. McCain spokesperson Tucker Bounds added: "The truth is Barack Obama is following John McCain's lead to close a Wall Street loophole that was signed into law by President Bill Clinton."
Both candidates for the Presidency of the U.S. were taking the exact same position on why oil had gone to $147 a barrel and gasoline prices to over $4 a gallon. Each blamed the speculators. You can't get any more bipartisan than that.
Speaking of bipartisan, Minnesota Republican Norm Coleman and Senator Carl Levin's (D-Mich.) Permanent Senate Subcommittee on Investigations, researching this issue in June 2006, first exposed how speculators were manipulating the oil markets. Indeed, the Commodities Futures Trading Commission has just filed civil charges against numerous individuals and trading firms for manipulating the price of oil for personal benefit in 2008.
BP Was Fined for Price Manipulation
It wasn't widely reported, but BP was twice fined for manipulating energy markets. The first fine, in 2003, covered oil inventories in Cushing, Okla., and the second, in 2004, was for manipulating the propane market. In the latter case, BP paid fines of $303 million. Knowing this, it is hardly surprising that two people named in the current CFTC civil lawsuit— James Dyer and Nicholas Wildgoose—are former BP energy traders.
In 2008, six columns I wrote for BusinessWeek detailed why oil was heading toward $147 a barrel. (Read the first one here.) The key issue was whether the stories we were being told that severe, and possibly permanent, oil shortages were the primary cause of the price spike were truth or fiction.
As readers may recall, Goldman even put out advisories that oil could exceed $200 a barrel in that period. Although the news stories about short oil supplies remained consistent, an investigation of oil usage showed not that oil supplies were getting tighter, but that demand destruction had been taking place for nearly a year. Backing up that investigation's results, in September of 2008—after the oil market started collapsing—the International Energy Agency published its oil charts and verified that oil-and-fuel demand destruction had started in August 2007.
That month, oil was selling for under $70; but even as demand for crude and fuels declined over the next 11 months, the price of a barrel of oil more than doubled, to $147. Amazingly, most analysts continued to predict oil would go even higher. At least one got it right: On Aug. 22, 2007, Fimat analyst Antoine Halff was quoted by AFP as saying: "It's not completely surprising, given the numbers—the rise in crude [inventories] and the fall in refinery runs show crude is not as much in demand."
Today hype is still driving the market. As in 2008, the chorus seems to be led by Goldman Sachs and other Wall Street banks. However, the head of Exxon Mobil said the exact opposite—that based on supply and demand, oil should be in the $60-to-$70 range.
The Real Shortage: Credibility
This bundle of contradictions is the problem for those in the media who are trying to make sense of it. It boils down to this: Whom are you going to believe? The head of one of the world's most-respected energy companies—or investment bankers trying to score profits from their trading desks? You already know the answer.
As in 2008, the oil executive's comments came and went with little notice, but the Goldman forecast gets repeated ad nauseam. As in 2008, Goldman again reversed its position while oil rose on world markets. Making things worse, at least according to the New York Post, Goldman has now called for gasoline to hit $5 a gallon this summer, despite the known fact that demand for gasoline continues to languish, compared with previous years.
Today we have 40.7 million more barrels of oil in inventory than we did at the first of the year. Our refineries are still running at the pitiful utilization rate of just 86 percent. The Saudis and the CEOs of major oil companies Total (TOT), Petronas, and Exxon all say there is no shortage of oil anywhere in the world.
That's right. Buyers are turning down oil, gasoline demand is down, and the price keeps climbing. The question is not so much who is behind the increases but why are we letting them get away with it?
Someone should send Obama and McCain their own 2008 campaign promises. They offered no magic bullets to fix the problems, but saw legitimate ways to put the commodities futures market back where it belongs—in the realm where discovery costs, supply, and demand dictate price.