Notes at the Margin Philip K
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Notes at the Margin Philip K. Verleger, Jr. Volume XIV, No. 2 January 11, 2010 The Big Freeze: The Dog that Did Not Bark Whatever happened to global warming? Wait a minute. You mean to say The New It is cold across the globe. There is a short- York Times has not carried a story on the in- age of natural gas in China. Temperatures crease in home heating oil prices? You also have dropped to -23ºC (-8ºF) in the United claim you could not find the Washington Kingdom. Transportation services have been Post piece about children going hungry? disrupted across Europe, China, and the There was nothing about greedy oil compa- United States. nies, you say? Truckers have not complained The United States is suffering from the any more than they usually do? Clearly, you massive cold spell. Florida’s orange and have not done the research. strawberry crops have been ruined. The What do you mean prices did not in- streets of Atlanta have been turned into an crease? Prices always rise when it gets cold. ice rink. The wind chill in Bismarck, North This is how the world works. Every few Dakota hit -51ºF. years, it gets really frigid in December or The front pages of major newspapers January. Every few years, heating oil prices over the last week have been full of the tra- rise dramatically during the cold spell. ditional stories describing the trials and tri- Every few years, truckers complain about bulations of those keeping warm with heat- price spikes and highway departments cut ing oil in the Northeast. The New York Times plowing. Every few years, the press and pol- reported on the problems of Connecticut res- iticians have a field day beating up the oil idents who face 50 to 100 percent price in- industry about the higher prices. This rela- creases for their heating oil. The Washington tionship explains why politicians invented Post reported that in home after home child- price controls. ren are going hungry because families have It was very cold last week. Oil prices to spend everything on heat. The highway should have increased. On a historical basis, department in one northeastern state re- the spot price of distillate fuel oil in New ported it will have to stop plowing roads be- York should have jumped 60 percent from cause diesel fuel prices have spiked so high. prices before the cold hit. Spot supplies of The Los Angeles Times noted independent heating oil should be selling for $3.20 per truckers across the country are parking their gallon in New York Harbor. trucks for the same reason. Once again, oil You mean to tell me I can buy all the industry managers are being characterized as heating oil I want for $2.20 per gallon? rapacious price gougers who take every op- What has happened? Have the Communists portunity to squeeze consumers. taken over? Notes at the Margin is a e-mail service published by PKVerleger LLC (www.pkverlegerllc.com). Please direct all inquiries to Dr. Philip K. Verleger, Jr. at [email protected]. © 2010, PKVerleger LLC. All rights reserved. Reproduction of Notes at the Margin in any form (photostat- ically, electronically, or via facsimile), including via local- and wide-area networks, is strictly forbidden without direct licensed permission from PKVerleger LLC. Notes at the Margin Page 2 January 11, 2010 OK, enough fun. Michael Masters take strategy of encouraging passive investors note. The market has worked. I calculate has worked where the DOE and IEA bu- that U.S. consumers are enjoying a benefit reaucrats have failed. that may total $400 million per day because Last year, President Sarkozy of France oil prices did not rise. On a worldwide basis, and Prime Minister Brown of the United the benefit may add up to more than a bil- Kingdom wrote of the need to stabilize lion per day. There has, of course, been no energy prices.1 They called for an interna- publicity about this. tional effort to cooperate on the issue. I pre- This report’s title, “The Dog that Did sume they have recognized the value of Not Bark,” comes from the Sherlock what is happening now and written a thank Holmes story “Silver Blaze,” where the de- you letter to the CFTC. tective solves the theft of an expensive race The CFTC will hold a public meeting on horse based on a stable dog not barking passive commodity investment on January when it should have. Likewise, the failure of 14. For reasons I will explain in a moment, heating oil prices to rise is a silent dog that it should take place on January 16. However, no one except me appears to have noticed. let me note first that the meeting should cel- The economic benefits of the lower heat- ebrate the success of the agency’s program. ing oil prices are the direct result of passive Consumer advocates should bring cham- investment in commodities. Investors pur- pagne to toast the CFTC. The awful coffee chased commodity futures, bidding prices normally available should be replaced by into contango. The contango provided an bubbly, preferably a vintage French variety. incentive to build inventories. The low in- The meeting should, however, be re- terest rate environment created by the Fed- scheduled to January 16 to commemorate eral Reserve further reduced the cost of another hearing held on that date in 1990. holding inventories. As a consequence, the The 1990 hearing was held by the Govern- world entered this cold spell with record ment Affairs Committee chaired by Senator crude and product stocks. As cash prices John Glenn. The senators sought an explana- rose, the inventories were liquidated. tion for the 60- percent increase in heating Credit for the market’s success should be oil prices that occurred the prior December. I given to the agencies that regulate commodi- was one of the witnesses, along with Leon ty futures, particularly the Commodity Fu- Hess, founder of the Hess Corporation; tures Trading Commission. These agencies Charles DiBona, then president of the Amer- allowed passive investors to participate in ican Petroleum Institute; and Glenn Tilton, commodity markets. In doing so, they rec- then CEO of Texaco. Hess regaled the sena- orded the first success for energy policy in tors with stories of traders in the futures 40 years. As readers will note, governments market buying and selling oil and increasing have maintained strategic crude and product price volatility. He was hilarious and of ut- stocks for the last 40 years. These strategic terly no use. reserves have never been used effectively to moderate a price spike. Even the United 1 Gordon Brown and Nicolas Sarkozy, “We Must States’ vaunted “heating oil reserve” has Address Oil-Market Stability,” The Wall Street Jour- been useless. However, the CFTC’s brilliant nal, July 8, 2009. Notes at the Margin Page 3 January 11, 2010 DiBona presented the standard industry the cold spell hit. Note also that inventories line: in 2009 have declined at essentially the The petroleum industry has been making ex- same rate as in 1989, that is, 1989 and 2009 traordinary efforts to provide more heating were very similar but for stocks declining to oil to the Northeast and other areas of the a much lower level in 1989. country that have suffered during the record Heating oil inventories in PADD I, the 2 cold weather of late fall and early winter. key market for heating oil, dropped to 37 His explanation fell on deaf ears. The sena- million barrels at the end of 1989. PADD I tors were ready to authorize a lynching had heating oil stocks dropped to 67 million bar- it been legal. rels in 2009 as the recent cold spell pushed My testimony was more mundane. I ex- up demand. plained that the cold spell took place when inventories were very low. I added that backwardation had increased as stocks had Figure 1 declined. I also noted that PADD I Heating Oil Stocks, Weekly Data — markets had been “commo- 1989, 2009, and Normal Range ditized,” a new word at the Million Barrels 80 time. I went on to add that 1989 2009 refiners and dealers respond- 70 ed to the forces of commodi- 60 tization by minimizing in- 50 ventories in the absence of financial incentive to hold 40 them. The low stocks made 30 Normal Range the market more vulnerable 20 3 Jan Mar May Jul Sep Nov to price spikes. Note: Normal range computed from DOE data for years 1990 to 2009. The story remains the Source: PKVerleger LLC. same today. Figure 1 com- pares the distillate fuel oil inventories held in PADD I in 1989 with The price impacts were very different, PADD I stocks in 2009. The graph also however. Figure 2 (page 3) compares spot shows the normal range computed from 20 prices for New York Harbor distillate fuel oil years of data. Note that stocks in 1989 were in 1989 to spot prices in 2009. To make the low and plunged below the normal range as comparison easy, the weekly prices are ex- pressed as a percentage of the average price during the year. In 1989, prices for the last 2 Prepared testimony submitted by Charles DiBona to week of the year were 194 percent of the the Senate Committee on Government Affairs, Janu- average for the year. In 2009, prices for the ary 16, 1990. 3 Prepared testimony of Philip K. Verleger, Jr., to the last week of the year were 123 percent of the Senate Committee on Government Affairs, January yearly average.