Probably all of us watched, fascinated, as the primary debates rolled out over the last year. It almost seems superfluous now with the two candidates all but selected and ratified by their respective party conventions. Now we are anticipating the greater debates between the two candidates. However, another debate has been accelerating that revolves around issue that has a more direct and far reaching impact on all of us. I refer to the debate over whether oil and other commodity prices in general, have risen so dramatically because of rising demand or has it been a result of investment speculation. The answer and possible solutions take on a sense of urgency that is as great an imperative as our generation has ever faced. To the extent that there are two sides of this debate, they both present equally compelling arguments. In the end, the answer is the proverbial "yes". It is due to both. But that is the simplest of answers.
Historically and as recently as the 1980s there were commodity speculation rules that tended to inhibit the potential for volatility. Then, as post cold war expansion began, deregulation, that great tool of free market aficionados began in earnest. Deregulation reached full tilt in the nineties. Companies grew, payrolls grew, emerging markets grew, and new waves of middle class consumers grew at enormous rates. Trade and development economists preached the wonders of open markets, unfettered production, and industrialization. The World Bank and International Monetary Fund conditioned loan policies on the elimination of government intervention in markets. Global commodity agreements, price supports, and other mechanisms which helped keep global supplies and prices stable were dismantled. The World Trade Organization's Agreement on Agriculture, together with multi-lateral and bilateral agreements including the North American Free Trade Agreement (NAFTA), slashed agricultural tariffs in the developing world, and opened up markets for a growing global agribusiness industry.
In many countries today, the price of gasoline and other petroleum products are controlled, and subsidies are provided, designed to cushion consumers and businesses from rapid swings in the market price. One can well imagine the importance of these subsidies in rapidly emerging markets such as are here in SE Asia and China. In China today drivers pay roughly half what the American consumer pays for gasoline.
However, as oil reached a recent pinnacle of $140 per barrel many of these subsidies have fallen under the sheer weight of it all. In addition, while some regulation on trading still exists in the United States, traders easily move across borders to unregulated markets to keep the bubble aloft, or so some would have us think. Those who believe that market speculation and even manipulation are the causal root for the painful price we are seeing at the pumps point to the growing gap between the wealthy and the not so wealthy. They argue, convincingly, that the speculation, now doing so much damage at America’s gas pumps, comes mostly out of hedge funds, those uber-funds open only to the deepest pocketed investors. Hedge funds, for the most part, are free to invest in anything they like. This special status largely frees them from any federal financial oversight and regulation. To be sure, some $260 billion is invested in commodity funds today, 20 times the level of 2003. But a recent Economist article shows that there is far more to this story.
"Surely all that hot money has supercharged the demand for oil? But that is plain wrong. Such speculators do not own real oil. Every barrel they buy in the futures markets they sell back again before the contract ends. That may raise the price of “paper barrels”, but not of the black stuff refiners turn into petrol. It is true that high futures prices could lead someone to hoard oil today in the hope of a higher price tomorrow. But inventories are not especially full just now and there are few signs of hoarding."
Big-Business-Conspiracy theorists have also singled out the oil companies, charging them with withholding supplies, in hopes of selling at a better price later. They point to the lack of increased output without acknowledging that the world's refineries are in similar shape to America's highways, bridges, and other key infrastructure. We missed our chance for investment in greater output from refineries during and immediately after the effects of the 1970 oil embargo. In that regard the oil companies have been remiss. Another factor is that notably, when prices are high, the more efficient Western firms are kicked out of countries newly asserting their sovereign rights. The result is often less efficient production as has been true in Russia and Venezuela for example.
But issues surrounding increased oil production and refinery output are not just limited to precipitous behavior on the part of sovereigns. Once oil prices went beyond $70.00 per barrel, the recovery of it from deep deposits embedded in sands and shale has kicked in. Notable, the Athabasca oil sands in Canada offer huge reserves. The problem is that in order to recover these deposits, vast quantities of steam must be injected deep in the earth to percolate the oil up. The resulting sludge then requires several more steps of processing before shipping to refineries. Separating petroleum from sand burns so much natural gas that the enterprise is becoming the largest source of greenhouse gas emissions growth in Canada. The oil sands lie within a major intact ecosystem, the boreal forest covering almost a third of Canada's land mass. The carbon footprint of operations such as described is enormous. More greenhouse gases, more impact on global warming, more cycles of floods and drought, more negative impact on food grain production. All this so we can drive an SUV?
Demand seems to be the one area where we, as individuals can have the greatest impact. Here in Malaysia, subsidies ended last weekend and the price of gasoline rose 40% overnight. Not surprisingly there has been a marked and noticeable decrease in traffic. One would hope that something similar will occur, or is occurring in the U.S. as prices rise to as much as $4.00 per gallon. While we may expect subsidies to begin to topple all over the world, we should be mindful that roughly half the world's population enjoys fuel consumption at subsidized prices today. Remove the pain of consumption and guess what... In this regard I expect that subsidies are the next shoe to fall on the already hard hit consumer, but no pain, no gain as they say.
Much has been written about the rising demand coming from emerging markets such as China. To be sure, China today is second behind the United States in consumption, but it is a far second. Following is a list of the top ten oil consumer countries in the world today:
#1 United States: 20,730,000 bbl/day
#2 China: 6,534,000 bbl/day
#3 Japan: 5,578,000 bbl/day
#4 Germany: 2,650,000 bbl/day
#5 Russia: 2,500,000 bbl/day
#6 India: 2,450,000 bbl/day
#7 Canada: 2,294,000 bbl/day
#8 Korea, South: 2,149,000 bbl/day
#9 Brazil: 2,100,000 bbl/day
#10 France: 1,970,000 bbl/day
China consumes a third of the amount of oil that is consumed in the states. Nevertheless, those subsidies in China largely favor the wealthiest citizens who drive cars. In America, we are thrust into the "free market" white water, allowed to sink or swim on our own. Fair? Probably not. still, we are faced with a bill demanding piper that cannot be avoided.
As onerous as it is for Americans to bear $4-a-gallon gasoline, the earliest results are somewhat encouraging. Mass transit use is way up and oil demand is falling per the most recent figures. For the first time since 1979, the number of miles driven has dropped. And General Motors is weighing an end to production of the granddaddy of guzzlers, the Hummer, as buyers flee such vehicles. But we have far to go before we can celebrate the decline of the Hummer, no matter how iconic it is. The truth is we are already faced with a crisis of starvation and irreversible damage to the ecology of our planet.
There is another vital factor in the rise of oil prices. Oil is traded globally in dollar denominations. The dollar, as everyone knows, has fallen dramatically in value, the result of a misguided Fed policy to pump more liquidity into markets to keep the dream going as well as profligate spending on everything from large flat panel TVs to Bush's war machine. Remember, since the beginning of the new millennium, we've witnessed one bubble after another. First we watched the Internet/Tech implosion that dramatically removed billions in hyper inflated equity from markets all over the world. Next, as we have painfully seen, credit markets and housing became the darling of investors, and the air pumps cranked away 24/7. People took second and third re-fi loans at ridiculously easy start terms. Houses in hot markets saw valuations rise 2 and 3 fold. The world partied on. That is until the popping noises began. If you stop to listen, you'll still hear them. The mortgage crisis, has evolved into a full blown credit crisis, rattling the foundations of the world's largest financial institutions. Just yesterday a headline suggested that we still have billions of write downs to go before the dust will settle on this one.
Something that must be mentioned about higher commodity prices. Deregulation, a primary enabler of globalization, has not just been prevalent in the oil trade. In all sectors, cross border economic controls have been lifted. The result has been another gorging feast and all commodities have been the subject of the next wave of bubble blowing. Who benefits? Not you and I, as we face higher and higher costs with shriveling dollars. Everything from metals to cattle feed, to basic starches such as rice and wheat, are rising much faster then the average consumer can absorb.
The problem with booms is they're inevitably followed by busts. What we're seeing right now -- skyrocketing food prices and growing hunger -- are still the effects of the boom. If the weather turns bad, as it has in the Midwest and in Africa, in fact...everywhere (think global warming) commodity prices could still double over the next...who knows how long. But with the stability of the food and agriculture system left up to the whims of mother nature's next crop yield, or how Cargill, ADM and the venture capitalists spin the roulette wheel, the bust is well in the making.
While farmers in the U.S. may have seen the price for a bushel of corn go from $2 to $6 in the last couple of years, their inputs, everything from seeds to fertilizer to diesel for tractors, have also multiplied, significantly deflating any increase in income. The difference between a short windfall and long term profit shift is being able to pass on price increases to consumers, something only the big guys have the market power to do. Cargill's third-quarter profits have increased over 86%. General Mills' are up 61%, and Monsanto's are up 45%.
If the rural farm economy tanks, we'll see farm foreclosures, another banking crisis, and global hunger that will make the sub-prime mortgage effects look like a drop in the bucket. Keep in mind, when a housing bubble inflates till it pops, people lose their homes. But when a food bubble grows, people starve. At the recent
U.N. food summit in Rome, the statistics were given that 850 million people are already short of food and rapidly rising prices could push up to 130 million more into the hunger trap.
In my mind there is only one answer to the dilemma before us. We are squarely in a time when we all need to cinch our belts a notch or more. It has never been more vital. Regardless of how 'wealthy" you feel, reducing your personal carbon footprint, your personal consumption of natural resources has never been more of an imperative. It is also time for us to be more generous in our giving. And if you feel that a big car, and the latest in consumer gadgets, and consumption of champagne is important to your sense of self esteem, better quickly learn to get over it. We should be reminded that within six months after the attack on Pearl Harbor, Detroit had been retooled to the production of war machines. Three years later we had routed, along with our vital allies, both the German and Japanese war machines. Such resolve and self sacrifice should be easily directed to non military spending. Is it time to plant "victory" gardens as Americans did during WWII? Maybe so, but be careful of salmonella laced tomatoes and spinach. If it isn't one thing, its another.
