Speculation: A Closer Look at Oil Price Hikes

Skyrocketing oil prices have become a global concern and a source of much debate as to what really lies behind them

By Ibon Features

(First of a series)

MANILA — The market price of crude oil has more than doubled over the past year to reach record-high levels of over US$147 per barrel last July. And oil prices continue to fluctuate, with industry players blaming a number of factors, including jitters caused by the current financial crisis in the US. Skyrocketing oil prices have thus become a global concern and a source of much debate as to what really lies behind them.

Executives from the major oil companies who were recently grilled before the US Senate Judiciary Committee once again attributed record-high oil prices to “the fundamental laws of supply and demand.” But while such market factors are responsible to a certain extent for high prices, they do not take into account other factors, such as speculation. Crude oil, also known as petroleum, is the most actively traded commodity in the world, with the largest markets in New York, London and Singapore Exchanges. Prices commonly quoted are those in spot markets (Dubai for crude and MOPS for refined petroleum products).

In an article that appeared in BusinessWeek in May, Larry Chom, chief economist for Platts (the world’s leading provider of energy information), said that the actual costs in producing the most expensive barrel of oil is only around $70 or $80 a barrel, with the remainder the “market’s risk premium plus speculation”. This implies that the current price of US$147 a barrel is inflated by some $67 to $77 a barrel due to speculation.

Speculation artificially increases oil prices because most oil is not traded in spot or futures markets but through long-term supply contracts. Because of vertical integration, most oil traded is between TNCs divisions (intra-TNC transactions) and do not need a spot market, yet the amount or the volume of trading in the commodity markets has substantially influenced pricing.

It should be noted, however, that oil transnational corporations, while they may not be directly engaged in speculation, do benefit from it. At the Senate hearing, John Hofmeister, president of Shell Oil, the US arm of Royal Dutch Shell, admitted that his company could be successful with oil prices at $35 to $65 a barrel. A mid-2006 report released by the Bank of Kuwait said that in Saudi Arabia, the break-even point on a barrel of crude is US$33, while in Kuwait it is only US$17.

Thus, the current US crude-oil futures price represents record windfall profits for the oil companies. Exxon Mobil, the largest oil company, reported record 2007 profit of US$40.6 billion while Royal Dutch Shell reported the largest earnings of any company in Britain of some US$31 billion.

But speculation itself is not enough to explain high oil prices. For that, the structure of the global oil industry itself must be scrutinized. Historically, the global oil market has never enjoyed genuine free competition since it has constantly been dominated by a handful of American and European oil giants. The current term for these oil giants is
“supermajors,” meaning vertically-integrated private-sector oil and gas companies engaged in all stages of the oil industry– exploration, production, refining, trading, marketing, and, sometimes, transportation.

The six “supermajors” are: ExxonMobil (US), Royal Dutch Shell (UK-Netherlands), British Petroleum (UK), Total (France), Chevron Texaco (US) and Conoco Philips (US). These six firms jointly account for US$1,482 billion in revenues and US$134 billion in profits as of 2006 according to Fortune magazine. They can also produce more than 80 million barrels per day of crude and refine more than 112 million barrels per day of various petroleum products.

The monopoly control the oil firms exert over the market allows them to manipulate prices. In 2006, for example, the US Commodity Futures Trading Commission filed a civil lawsuit against British Petroleum (BP) North America, alleging that BP traders– with the consent of senior management– “purchased enormous quantities of propane” to establish a dominant position in the market and then withhold fuel in order to drive prices higher.

It is also a myth that the Organization of Petroleum Exporting Countries (OPEC) dictates world oil prices. Although the OPEC member-countries account for two-thirds of the world’s oil reserves, and, as of March 2008, 35.6% of global oil production, the supermajors still control the infrastructure needed to transport and refine crude oil, and market and retail refined oil products. The supermajors in fact currently account for one-third of global refining capacity.

Meanwhile, Big Oil has also been blaming state-owned oil firms such as Gazprom (Russia) and the National Iranian Oil Company (Iran) for high prices by claiming these firms deliberately maintain low production in the same way OPEC does. In fact, the largest state owned oil firms have been lumped together by analysts as the “New Seven Sisters,” a reference to the seven largest oil firms that controlled the industry in the mid-20th Century. State-owned oil monopolies reportedly account for more than 90% of the world’s oil reserves.

But these claims may only be a ploy to pressure these oil monopolies to allow more investments by the supermajors. Mexico’s constitution since the 1930s has prohibited any foreign investment in the local oil sector. Venezuela, Russia and Ecuador closely collaborated with Western firms in the 1990s but recently started seizing their assets through a series of privatizations. Peter Robertson, vice chairman of Chevron Corp., has said if major oil companies had access to the vast resources of these countries, they would be using their ample profits to pump more oil at cheaper prices.

Locally, the Big Oil TNCs use their monopoly position to manipulate prices. Since oil firms’ purchases are actually under contract arrangements, this provides room for the local subsidiaries of Big Oil to generate more profits by jacking up pump prices whenever the spot market prices goes up, even if their oil prices have been negotiated long before with lower prices. This explains the weekly oil price hikes that have followed in the wake of upward movements in the oil spot market.

Locally under a deregulated environment, consumers are left with no choice but to bear the brunt of the increases in domestic pump prices caused by speculation and wild price hikes in the global oil market. Meanwhile, speculators and the giant oil companies rake in billion of dollars in profits.

While it is true that the Philippine government cannot control the activities of the speculators and the giant oil corporations, it can intervene at least in the local oil industry to protect the Filipino consumers. Unfortunately, amid the hardship that Filipinos face because of high oil prices, government continues to waive its authority to regulate the local oil industry. (IBON Features/Pinoypress)

(Next week: The failure of deregulation)