Thursday, June 19, 2008

About Oil, Futures, Governmental Mandates & Speculation

It's a strange month when Fox News' Bill O'Reilly and uber-liberal Illinois Democratic Senator Dick Durbin agree on something- anything.

This month, both of them have called for the severe restraint of, if not total prohibition against, investor trading in oil commodity futures.

Durbin wants trading in oil futures curtailed so that if you buy oil on the open market, you must take physical delivery. O'Reilly calls for substantially higher margins to be put down on oil future trading.

Both accuse 'speculators' of driving the price of oil up to the $130 neighborhood. I don't know what Durbin's estimate is, but O'Reilly makes a big deal out of the cost of oil when pumped out of the Arabian peninsular sands, and alleges that most of the rest of the price of a barrel of oil is what 'OPEC charges.' Further, he calls for governmental mandates to force American automakers to produce a certain amount of flex-fuel vehicles.

I like a lot about O'Reilly, but I don't agree with him on this issue.

First, I don't think the current price of oil is being manipulated by a group of speculating investors. Rather, it's the natural result of oil refiners gradually tightening capacity to match demand, after decades of losing money on the downstream business due to grossly excess capacity.

Second, OPEC does not 'charge' a price. Oil is bought and sold in competitive financial markets. It's the right of the owner of a non-renewable commodity to decide how much of it they will sell at what price they take. O'Reilly is wrong to castigate those owners of petroleum for exercising their right to decide how much to sell.

Third, if oil prices were being manipulated artificially by speculators, I would expect to see a lot of selling of oil futures by large hedge funds. Contrary to what a friend in institutional money management alleges about banks not extending credit to short sellers, those shorting equities don't need loans. And derivatives aren't equities. They dwarf the equity markets in terms of commodities.

It bothers me that both Durbin and O'Reilly demonize American oil companies as if they should be punished for doing well for their shareholders in a world in which they are slowly being squeezed out of ownership of the resource they refine.

As to governmental mandates for building flex-fuel vehicles, that's nonsense. Washington's artificial 'fuel economy standards' have put the American automakers in the poor house by forcing them to pump out cheap, unprofitable, largely-unwanted small cars to offset sales of the SUVs and pickups that Americans actually bought. Requiring flex-fuel cars will just do more of the same.

If Americans want flex-fuel cars at prices that Detroit can build them, they'll sell. As Dick Armey notes, whenever government mandates something, it means the public won't buy it any other way.

Both Durbin and O'Reilly are mistaken, in my opinion, in their rush to legislate large-scale governmental mandates to what is a passing economic situation. Do they both really believe some governmental functionaries will do a better job than American entrepreneurs and businessmen motivated by profit?

I can believe that Durbin really believes they will, but I think O'Reilly has just temporarily let his anger overrule his common sense.

All we will get out of governmental interference will be predictable graft, corruption, and favoritism of selected businesses by civil servants, instead of truly market-tested solutions to energy challenges.

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