Oil Firms Earn Superprofits via Speculation

The current situation in the world oil market should be an argument for the strict regulation of the downstream oil industry. However, the Macapagal-Arroyo administration still insists on giving oil deregulation a chance, much to the detriment of Filipino consumers particularly the poor.

BY ARNOLD PADILLA
IBON Features
Posted by Bulatlat

With the unprecedented levels that world oil prices have reached in the last few months, it would seem that an actual shortage (i.e., unmet demand due to lack of supply) in oil now exists.

However, an analysis of the current oil market shows that there is more than enough crude oil to supply the global requirement of around 80 million barrels per day.

Nevertheless, the trends show that world oil prices will not stabilize until the end of the year or even beyond.

Consequently, pump prices at the local market will further increase in the coming months. According to Petron Corporation – one of the country’s three oil giants - gasoline prices may breach the P30 ($0.53, based on an exchange rate of P56.445 for every U.S. dollar) per liter mark if Dubai crude would climb to more than $40 per barrel.

As a result of oil deregulation, all the Department of Energy (DoE) can do is haggle with oil companies to implement price increases on a staggered basis.

Intense speculation

While there is no actual shortage in supply, intense speculation in the global market continues to push oil prices up. Political anxieties in major crude oil producing countries like Iraq, Nigeria, and Venezuela plus the supposed lack of spare capacity and seasonal increase in demand due to the coming winter season have raised the risk of tight supply and have attracted aggressive speculators.

The Reuters wire agency reported that the oil industry is now massively drawing hedge funds due to volatility. It cited an analyst’s forecast that U.S. crude oil futures prices could break the $60 per barrel mark by the end of 2004.

Under a deregulated environment, Filipino consumers are left without a 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 as prices continue to soar.

How do speculators push oil prices up? Some analysts say that oil prices are determined by the supply-demand balance. Thus, by speculating on future supply and demand situation, speculators are able to affect prices.

For transnational oil companies which can twist the supply-demand balance because of their commanding position in the market, speculation simply means more opportunities to make superprofits. How? Let us examine how global crude oil is priced.

Benchmarks

Crude oil traded around the world use three major benchmark prices: Brent, West Texas Intermediate (WTI), and Dubai.

Brent is produced in the North Sea within the territorial waters of the United Kingdom. It serves as a benchmark for about 40-50 million barrels of crude oil produced or sold daily in Europe, Africa, and Middle East.

Meanwhile, WTI is a blend of crude oil produced in Texas, New Mexico, Oklahoma and Kansas. It is the benchmark for around 12-15 million barrels of crude oil produced or sold each day in the Western Hemisphere.

Finally, Dubai is produced in Dubai and Oman. It is the benchmark for about 10-15 million barrels per day of crude oil. Generally, crude oil produced in the Middle East and purchased in Asia is priced off Dubai.

Comparing their monthly average in January and October (1-12 only), Brent has increased its spot price by 56 percent; WTI by 51 percent; and Dubai by 32 percent. (See Table)

Note that their actual production is small relative to global production. Brent, for instance, only accounts for less than 1 percent of world crude oil production yet it determines the price of more than 60 percent of internationally-traded crude oil.

This serves the interests of giant oil companies. They only need to manipulate a small market to fix the price of oil they sell in the global market.

Term contracts

Crude oil is traded through term contracts, spot markets, and futures markets. Actual trade (i.e., “physical” oil is bought and delivered) happens in term contracts and spot market transactions. Futures markets, on the other hand, involve “paper” oil (i.e., there is no actual delivery of oil) where participants speculate on future prices to profit.

At least 67 percent of physical crude oil is traded through term contracts which cover multiple transactions between a buyer and a supplier over a specified time. These contracts stipulate the volumes to be delivered for the duration of the agreement and fix the method for calculating the price of the oil.

Transactions among the different units of the same company (i.e., giant transnational oil corporations) fall under the term contracts.

Crude oil purchased under a term contract is supposed to be tied to the spot price of the specified benchmark (i.e. Brent, WTI, or Dubai) at the time the seller loads the crude oil into a cargo ship for transport to the purchaser.

Spot markets

A crude oil spot market, meanwhile, is an informal network of buyers and suppliers. Spot market transactions involve agreements to buy or sell one shipment of crude oil at a price negotiated at the time of the agreement. These transactions are priced at the time the crude oil is loaded at the terminal for delivery.

The spot prices of Brent, WTI, and Dubai serve as indicators for all of the crude oil bought and sold on the spot market, which accounts for about 33 percent of global crude oil trade. Spot prices theoretically indicate current supply-demand balance.

However, since the world’s biggest oil companies are both the producers and buyers, thereby allowing them to distort the supply-demand balance, spot prices merely reflect the prices with which these powerful corporations want to sell their products.

Spot prices are way too high than actual production costs. IBON estimates show, for instance, that Dubai spot prices are more than $20 a barrel higher than exploration and production costs.

Furthermore, the production, transport, and storage infrastructure that affect benchmark spot prices are controlled by giant oil companies thus making spot prices a doubtful reflection of the supply-demand balance. For example, Royal Dutch Shell and British Petroleum control 80 percent of the tank storage capacity of an important crude oil storage hub in the US that influences the price of the WTI.

Futures markets

Spot prices are also guided by reference to futures prices quoted on the New York Mercantile Exchange (NYMEX) for WTI and International Petroleum Exchange (IPE) in London for Brent. Futures prices refer to the price of oil traded in the futures market, which involves the purchase and sale of contracts for the future delivery of oil. Players in the futures markets include the oil companies and other businesses like financial institutions and investment funds.

As stated earlier, transactions in these markets do not really intend to deliver physical volumes of crude oil. Giant securities firms like Morgan Stanley, Merrill Lynch, Goldman Sachs, and Lehman Brothers; transnational banks like Citigroup, HSBC, BNP Paribas, and Deutsche Bank; and other Fortune Global 500 firms that do not have anything to do directly with the oil industry engage in NYMEX and IPE futures markets not to deliver oil but to earn enormous profits through buying and selling oil contracts (i.e., speculation).

Current speculation in the oil futures market is characterized by a growing presence of hedge funds. This phenomenon has nothing to do with actual supply-demand balance in oil but due to external factors. Hedge funds now look for more profitable avenues due to heavy losses in the financial markets. The volatility in the oil market provides good opportunities for hedge funds to offset such losses.

For oil industry players, futures markets supposedly allow them to spread the risk of price volatility. A futures contract between an oil producer and an oil refiner resolves the concern of the former of low crude oil prices and the concern of the latter of high crude oil prices in the future. In other words, a futures contract somehow protects them from adverse price movements.

This assumes that the firm which produces and sells crude oil and the firm that buys crude oil to refine it are separate entities. This is not the case for giant oil companies, which control all the aspects of the industry – from extraction to retailing. In other words, they do not need a futures market to protect them from adverse price movements because they can control the price.

Major oil firms can manipulate the transaction cost of oil as it is transferred from their own exploration/production units to their own storage tanker units to their own refinery units and to their own retailing units. Thus, they benefit from high oil prices caused by a speculative futures market because it further artificially bloats their profits.

Protecting the Filipino consumers

It is true that the Philippine government could not control the activities of the speculators and the giant oil corporations. But government can intervene at least in the local oil industry to protect the Filipino consumers. Unfortunately, government waived its authority to regulate the activities of the oil companies when it deregulated the downstream oil industry in 1996.

The detrimental effects of speculation and the manipulation of big oil firms on global prices are arguments against government’s deregulation policy. Deregulation presupposes that world prices are competitively determined by independent market forces. It has overlooked the role of giant oil corporations in dictating the prices and the impact of speculation on prices. Bulatlat

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