More oil and gasoline discussion

A few days ago, I posted on these pages a note I sent to a friend who asked about oil and gasoline prices. He passed it on to a couple of his friends, one of whom commented back. Following is my reply to his comments. (His comments are in italics, with my responses interspersed between paragraphs.)
As a disclaimer, my income comes from oil as a producer so I too would like to think like Ross that "oil is just another commodity." However, I think Oil and Gas and the things made from them are special cases largely because of the infrastructure that has been created and paid for by government policy incentives and the monopolistic characteristics inherent in the business. (Example, if you have a gas burning car, you can't burn diesel, the refinery must blend the mix for our local area and can't transport it any more to various markets so economy of scale is limited. There are many ways producers can create a false local scarcity even before the cost of oil went up dramatically.
Policy "incentives" are not the same as government actually paying for something. There's hardly an industry that one could point to that doesn't get special consideration from government, because powerful Senators ensure such things for their districts. I object to such preferences, but they're not a reason to argue that oil is not just another commodity. I simply don't see "monopolistic characteristics inherent in the business", or at least not more than any other major industry, like steel, autos, even food production. Refineries can supply markets quite distant from the refineries themselves, so I don't understand that argument. Basically, xxxx, I don't think any of your claims in this paragraph apply to oil any more than to many other industries, and are therefore not a good reason to try to regulate or attack the oil industry.
It is nice to talk about the "free market" with O&G but the oil companies are some of the most heavily subsidized and tax incentives for industries. Many industries are, but if you took away their special treatment they would holler like crazy. Do those incentives come back to the consumer, you'd have to ask an economist, but I don't think we get the benefit that we pay for.
Again, I agree that O&G do get some subsidies...and I object to them...but they're much smaller on a per-unit basis than the subsidies for things like grains, sugar, and the worst offenders...alternative energy sources. Tax incentives are much less of a problem in my view. Some of the incentives come back to the consumer and some end up in the companies' bottom lines. Bottom line is that we pay much less per gallon of gas in "incentives" than we pay for some equivalent measure of wheat and much much less than we pay for ethanol or wind energy.
Internationally, the US Dollar has commanded the market until recently with the introduction of the Euro. Like many things it is a matter of fashion. The Arab countries don't like that the Fed and the US Government try to control things by freezing accounts and restricting transfers. They stopped buying US Treasuries when we went into Iraq and the European banks have always been the marketplace for "repackaging" US paper and selling it to OPEC, now they push their own paper and swap dollars for euros. The dollar is still dominant as the petro currency but it is not the only game in town any more. The Euro is a bit less restrictive about enforcing policy through currency.
Some of this is true, although the "freezing accounts" thing basically applied to the "war on terror" and did not apply to most of the oil exporting world. Generally, I'm not sure what the relevance of that paragraph was.
Another important consideration is the policy of our government for the last decade. We've run up huge deficits with trade and the Iraq war. Eventually the dollar has to go down to make up for this, when it goes down it goes down not only against the euro but also commodities.
It's definitely true that a weak dollar has been a big factor in the oil price going up. Don't confuse the budget deficit with the trade deficit. The budget deficit is a real deficit and a real problem. The "trade deficit" is neither, and its discussion in the mass media is causing the public to believe things which are simply wrong, such as that free trade might not be a big net economic winner for the nation and the world.
Hedge fund traders are a pet peeve of mine. A few innovators deserved to get a huge reward, then came the imitators who also wanted the billion dollar salaries, now we have the greedy numbskulls who got us into the financial mess we're all going to pay for. They also got the big money, but don't deserve the return. The hedge fund payment system just concentrates large payments to a few individuals that use to be spread out to many others. They no longer show returns that justify their high salaries, neither does US industry, I'm afraid.
How people get compensated is up to the market to decide. It's not up to us to attach moral judgments to. If they're worth it, they'll get paid. If they're not worth it, they won't get least not for long. The whole concept of what salary someone "deserves" is foreign to me. A person deserves whatever he can get without cheating.
Exxon paid their retiring CEO $500 million in 2004 when oil started to take off. Prior to that it was $10 per barrel for over a decade. Why should those guys get half a billion dollars when they had nothing to do with the profits or the price? At some point saying it is the "market at work" doesn't fly.
The best answer to this sort of comment, one which we hear frequently at times like this, is "the market doesn't work compared to what?" In other words, any proposed alternative will without doubt give worse results. There may be changes to be made within the system, but they must be made by free markets. An attempt to limit the power of Exxon's CEO just failed:{BCFFC481-F3CC-462B-908F-5FB04F70AB39}&siteid=bnb
It is greed at work, oligopolies at work, but markets bring prices down and benefit the consumer our system no longer does that. We allow corporations to use government regulation to keep their profits and prices up relative to the historical average. We reward CEO's who have expertise in manipulating congress to give them favors and rewards for their stock holders not the public. Congress is suppose to work for the public first, not last. Given the system, Ross is right, but the system needs retooling.
I agree with much of this. We have to get the government out of the business of picking winners and losers. Greed, however, is a net positive for society, not a net negative.
"Given the system" the mortgage companies were right and it's OK to blame the Fed for keeping interest rates low. But if that argument was correct, Japan would still be in the tank because they've run 1 to 2% for decades. Spain is the only country that avoided the sub-prime disaster: Why? They had intelligent regulation that clipped the highs and lows of the market. We've been operating in the "wild west" without applying reasonable policy and intelligent regulation to any market for ten to twelve years.
I don't see an obvious case to be made for more government involvement just because of the sub-prime mess. Don't forget that a lot of the mess was caused by do-gooder liberal politicians who insisted on preventing banks from "discriminating", i.e. from not giving loans to people who shouldn't get them. A lot of this mess is the government's fault. What we need is to get rid of the moral hazard of letting people think they won't have any financial risk from making bad financial decisions. (I'm not talking about Bear, Stearns, by the way, which most people don't understand.)
The saying goes that "inflation is easy to start and hard to put out," I fear that George is going to leave with the house ablaze and it will take four years for another enlightened "Greenspan" type to get it under control. It is interesting how all the Republican pundits are now blaming Greenspan for the policies that caused the bubbles. Low inflation and low cost money wasn't the problem, it was the crazy idea that we don't have to pay for what we borrow.
There's no rational way to blame the President for inflation and commodity prices. Greenspan made a huge mistake and now admits underestimating the risk of the housing bubble. Cheap money was indeed the main problem.
It's like "new math" or "new economics." There is no "new math." And in that same vain, society and markets do better in the long run when the widest range of people and industries benefit from prosperity. When prosperity is concentrated, markets can't survive if there is political upheaval. What to you see the real impact of this high price of fuel and food on political unrest. OPEC may have won a tactical benefit but not a strategic one, that logic can be applied to the full range of energy related issues; fertilizer made from gas, fuel to transport, corn and soy dominated crops, etc. etc. All those rich guys want to live in Switzerland or Malibu or on an island in Dubai, but they can't survive we can't survive if societies around the world burn and are destroyed. Poor people have feet, they want a life too!
You're right...there is no "new math". And you're right that political upheaval can be economically devastating. That said, given how little the demand for oil has dropped, it seems to me that OPEC has done better than you believe. The question is how fast the high oil prices will drive development of new oil or alternative energy supplies. As far as concentrated prosperity, that certainly happens in many OPEC countries, but as much as the left likes to cry about disparities, it's simply not a factor in the US.
In short, oil has become the drug of choice for the world economy and our own economy. Like a giant drug cartel, all the players are hoked on making money from the consumer. Her consumer can only take so much, each dollar of increase marginalizes more people into the margins and they can't contribute to the economy or the system any longer. A system that needs to grow to create increasing profits and trends should create more happy "solders" to pay the expansion, O&G is not doing that. Systems don't run out of balance for ever. Fuel and food will find natural equilibrium again, too.
If the economy slows down because energy gets too expensive, the reduced demand for energy and the increased supply caused by people chasing the higher prices will cause prices to come down. That's the beauty of the market. As far as food, the main thing we need to do is to eliminate subsidies for ethanol and requirements for ethanol to be in the fuel mix. There is NO benefit to ethanol, including in environmental considerations, and it's causing huge food inflation. Again, the government is the cause, not the solution!
However, I have a different reason for liking the energy prices high. For every week that the price is above $100 there are more and more of us working on the technological substitutes for oil. It will happen sooner than people think. (The real price is about half, by the way. China pays about $30-$40/barrel for government backed long term contracts on oil.)
I agree...high prices will cause faster development of oil and alternative energy than people expect. Again, it's the market at work. This is not to say that I agree that I like energy prices high...just that it's not without some positive repercussions. I'd repeat, as I said before, when people say that a system isn't good, one must always as "compared to what?". The critics of free markets, of capitalism, of traders, and of rich people have never been able to answer that question, and history is littered with the devastating effects of their attempts to force "shared prosperity". There's no such thing...only shared poverty.
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