• E-mail
• Print
• Comment
• Font Size
• Digg
• del.icio.us
• Discuss article

Speculators Will Drive Crude Oil Prices Higher Until Demand Collapses

Posted on: Friday, 30 May 2008, 00:00 CDT

By Rick Stouffer

The crude oil price bubble will burst, experts say. The question is when.

That's because the pricing of crude oil and gasoline mixes human psychology, bluffing and the actions of commodities traders who only see good times and higher prices ahead, industry experts agree.

The problem with permanent optimism at commodities trading markets like the New York Mercantile Exchange and others worldwide is that, eventually, good times and ever-higher prices will end, say the experts.

In the last year, crude oil prices have doubled, climbing 36 percent since Jan. 1 and 15 percent since May 1. Crude oil closed at $130.03 a barrel on Wednesday.

"We don't see any price relief until 2009," said Mary Novak, managing director for energy at consulting firm Global Insight in Lexington, Mass. "Global demand for crude oil continues to increase. Demand has to slow, to respond to price."

Traditionally, the cost of crude oil generally accounted for about 48 percent of the cost of a gallon of gasoline. Another 16 percent was the price to refine crude into gasoline plus profits, another 12 percent was the cost to transport and market gasoline at the retail level. The remaining 24 percent was federal and state taxes -- about 18 cents a gallon and 32.3 cents a gallon in Pennsylvania, respectively.

"In April, 73 percent of the price of gasoline was the cost of crude oil," said Jim Williams, president of WTRG Economics, London, Ark. "In May, the percent of gasoline's price tied to crude was even higher."

Surging crude prices translate into higher costs for refiners and skyrocketing prices at the retail pump. Williams said that when the price of crude increases by $1, the retail price of gasoline rises about 2.5 cents a gallon. That means a $10 jump in crude translates into a 25-cent increase at the pump. A crude oil barrel contains 42 gallons.

This week, the average gasoline price in Western Pennsylvania jumped 11.6 cents a gallon, according to AAA East Central's weekly Fuel Gauge survey. The average price of regular gas from a self- service pump was $3.946 a gallon, up from $3.83 one week ago, and 86.2 cents a gallon higher than the average $3.084 charged one year ago.

Hugh Campbell owns three Sunoco gasoline stations, including one in North Huntingdon that still does repair work, and two gasoline/ convenience stores in New Stanton and Monroeville. He's also president of the Western Pennsylvania trade group Petroleum Retailers & Auto Repair Association Inc.

"There's little profit on gasoline -- five or 10 cents a gallon," Campbell said. And "if you accept a credit card" it wipes out even that profit.

At $4 a gallon, Campbell says he makes about 63 cents profit on a $50 fill-up of about 12.5 gallons. But he must pay a 3 percent bank fee when a customer uses a credit card. On a $50 sale, that $1.50 fee means Campbell, in effect, lost 87 cents on the sale.

"We prefer cash," Campbell said. "You don't make money on gasoline, you make money inside the store or on repairs."

Crude prices are determined by what's known as the futures spot market price determined on major commodities exchanges like the Nymex. Prices quoted daily are month-ahead, spot market prices. Contracts between crude suppliers and refiners guarantee delivery -- not price.

"Crude oil trades globally on a daily basis, and there are no long-term contracts," Global Insight's Novak said. "When a refiner signs a contract, it's signing for volume and delivery, with the price based on the Nymex price."

Today's soaring Nymex crude prices are driven by speculative trading, the experts say. Speculation has grown in all commodities because hedge funds, pension funds and other large investors have moved out of the declining markets such as housing and finance in their search for profitable investments, Novak said.

"The $130 a barrel oil is due to speculation," Novak said. If speculation were eliminated, she estimates the price of crude could plummet to $75 or $80 a barrel.

"Let's say I'm an oil producer and a refiner comes to me and says, 'Last week I paid $110 a barrel for crude, I'll pay you $110 a barrel today,'" WTRG's Williams said. "I tell the refiner, 'I'll get $130 a barrel if I just sit on the crude for a month.' What's the refiner going to do? He has to pay."

Each day about 88.5 million barrels of crude trade on the Nymex, Novak said. Because of speculators, the total trading volume can be three times the physical amount of crude available. Most are paper trades, with speculators betting the real crude will be available when contracts are settled.

"The 20th (of each month) is when parties contract to take delivery," Novak said. "If the amount of crude available is short of what's needed, the crude price rises. You as a refiner have to have the crude, and it has to be delivered." So the going price is paid.

"A large number of contracts bought and sold are paper contracts, and so when it's time to match up contracts to physical product, many contracts are liquidated because speculators want nothing to do with product," said Tom Skarada, vice president-refining at Warren, Warren County-based United Refining Co., a privately held, small refiner (70,000 gallons of crude oil per day), who also is a wholesale and retail gasoline supplier.

"One would like to think that supply and demand has a lot to do with pricing, but there's a lot of psychology involved in the commodities market," said Amy Myers Jaffe, the Wallace S. Wilson Fellow in Energy Studies at Rice University's Baker Energy Forum, in Houston. "It's like the stock market."

Jaffe said some people trading in oil have the mindset that prices only can go up; others get involved because demand keeps growing as developing countries like China and India keep buying oil, driving up the price.

"People who didn't want to buy oil because the price was too high, look around, see what's happening, and now they will buy," Jaffe said.

Unlike years past, the world's largest oil producers aren't Exxon Mobil, Chevron or Conoco Phillips, but rather the National Iranian Oil Co., the Saudi Arabia Oil Co. and the Iraq National Oil Co. Even two years ago, America's largest oil company, Exxon Mobil, was only the world's 17th-largest player. The top 16 all were national oil companies.

"Today, the countries that own the oil are making the really big money," Williams said. "They're getting more and more money from the oil companies."

Source: Tribune-Review/Pittsburgh Tribune-Review

More News in this Category