The Oil Market Fix

Photo by Jakob Rosen on Unsplash

Hate high gas prices? Most people do. Naturally, we assume that producers and sellers rely on the market forces of supply and demand to set gas prices. This is only partly true. We are also paying a hefty “middleman tax” to Wall Street speculators as part of our $4.50 a gallon.

There’s a disconnect between crude oil prices and the actual supply and demand for oil. If Russia’s criminal attack on Ukraine had actually stopped the flow of Russian oil, then we would have had a shortfall, causing prices to rise. The flow of Russian oil has NOT stopped however, the supply has remained fairly steady. Still, our pump prices have exploded. What’s going on?

A form of price fixing is going on.

My city provides the perfect example to demonstrate how this fix works. Our gas mostly comes from locally sourced crude and is refined locally; you can’t miss the refineries as you drive north out of town. Much of this oil has a high wax content and is not easy to transport or refine. Our local oil and refinery industries have invested in the necessary heated trucks to move the product and the refinery equipment needed to “crack” it into gas and other products. They can’t just ship it easily to another market; transport costs are prohibitive and few refineries want to invest in the necessary refining equipment. On the other hand, the local demand is steady and predictable and events in Russia don’t affect it. Nevertheless, local gas prices have rocketed in lockstep with everyone else’s.

Analysts blame the “global market” for these kinds of departures from market dynamics, claiming oil is a “fungible” product, transportable anywhere on the globe to be sold for the highest going price, regardless of transport costs, existing contracts, or the relative ease of refining. Crude oil prices in this supposed global market are set in the futures markets, like the often-quoted Brent Crude numbers. That quoted price is NOT the price of oil however, it’s the price for contracts to take possession of oil in the future.

Photo by Ahmer Kalam on Unsplash

These contract prices are heavily influenced by investment sector players in the futures markets, who buy around 50% of all futures contracts. The hedge fund and money managers working the futures markets buy large blocks of contracts in hopes of profiting on their resale to actual users, and they salivate when they see possible shortfalls in future supply. They have no intention of taking delivery on oil, they have no use for oil. But they do want to be holding futures contracts when war or storm or political revolt interrupts the flow of oil into global markets.

When they see possible or probable future interruptions they scoop up futures contracts. Like scalpers when the Rolling Stones come to town, they bid among each other for the limited “tickets” and then turn around and scalp those tickets to the actual desperate Stones fans, in the case of crude oil, the refiners who crack the oil for gas.

Photo by Nils Schirmer on Unsplash

Sellers of crude oil to actual users of crude oil like refineries use these “global market” prices, set in the futures markets as buyers bid for contracts, to determine their current sales prices to the refineries, and those prices get passed on to us. In our local market, the folks drilling, pumping and trucking companies have been charging the local refineries that “global market” price and then, of course, the refiners and the gas stations have to pass the price increase on to drivers.

Futures markets do have legitimate purposes. When pork producers farrow a new generation of piglets, they consider locking in a pork belly price in a futures contract to guarantee a profit as those piglets come ready for slaughter. When however, enormous sums of money are spent in a particular futures market like crude oil futures, futures speculators are hovering near by to exploit market instabilities.

The global market for crude had been relatively stable, in the range of $45-$65 dollars a barrel in the 6 years before the pandemic, not fertile ground for profitable speculation. The pandemic disrupted this stability and futures speculators woke up, smelling the profits. Lockdowns and deep cutbacks in driving crushed demand for gas so starkly that the price of oil actually went negative for a while. Holders of crude had to pay somebody to take it off their hands. Producers cut production drastically; what sane person pumps oil that nobody wants to buy?

Photo by Bibhash Banerjee on Unsplash

When economies roared back to life however, speculators pounced. Knowing it would take months, if not years to ramp up global production, they went all in, bidding up prices on the limited supply of futures contracts. When the price of those contracts soared, oil producers held out for the inflated prices, not in the future, but right away. And so, though there was little local change in supply and demand, my city’s price of gas took off. Currently, the possible sanctions on Russian oil have put another global shortfall in play, and the speculators are having another field day.

There’s little that normal people can do in the short term to stem the flood of their money into these wealthy portfolios. The crude oil markets are global, the market players are unimaginably wealthy, with outsized political influence, and are largely immune to presidents or politicians. There is one possible course of long-term action for the family scraping to fill the tank however…figure out how to buy a lot less gas. Long term supply and demand will eventually win out in this market; if demand steadily falls then prices will eventually follow. Even if you don’t mind $5 a gallon gas, your gas dollar currently pays to heat up the atmosphere and foul the air, which is bad enough, but it also helps pay Putin to bomb hospitals and children. Something to think about.

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John Griswold

John Griswold

Master carpenter, watercolor artist and beat up old jock…owned by Black Lab Bo who considers two tennis balls a minimum mouthful