What's Really Wrong with the Price Of
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What Price Oil? - Roger Lowenstein - NYTimes.com Page 1 of 8 October 19, 2008 What’s Really Wrong With the Price of Oil By ROGER LOWENSTEIN Back before the mortgage meltdown turned into the worst financial crisis since the Great Depression, the country’s big economic problem was energy. The presidential campaign was on fire over what to “do” about the price of oil. Gas cost more than $4 a gallon, it was slowing down the economy, people were driving fewer miles and they were flying less. Believe it or not, this was an economic crisis that affected people who didn’t happen to be pinstriped bankers, hedge-fund managers or cabinet officials. You didn’t have to read the stock- market columns to know it was happening. Ordinary people started walking to town or skipping errands — taking the compact and not the S.U.V. Actually, I did that. And then, the price of oil plummeted, first because of slowing demand and recently amid panic selling during the credit crisis. And as it plunged more than 40 percent from its record high of $147 a barrel, the issue has faded. Well, gas still costs $3.50 a gallon, and the price of a barrel of oil, last week close to $80, still is four times what it was all of six years ago. If that doesn’t sound like a big deal, consider that in the half-dozen years of the housing boom, residential home prices rose only 125 percent, whereas oil prices, even now, are 300 percent higher than they were six years ago. So the energy issue is still here. Remember the winter after Katrina, when home-heating-fuel prices caused an uproar? This winter they are likely to be much higher. When the new president takes office, high energy costs will be — as they are already — a drag on the economy, one that is becoming conflated with the credit crisis. Last month, the U.S. auto industry sold fewer than one million cars — its slowest sales rate in 15 years. Tight credit and high gas prices each contributed to that. There is no way to completely unravel the two, but here is one fact: In the early part of this decade, when oil was cheap, Americans spent only 2 percent of their income on gasoline. Recently they have been spending about 4.5 percent — more than twice as much. And you can bet that the percentage is higher among families with lower incomes. What we should do about all this varies greatly according to your view of why gas prices went up. Various people who know the oil industry have been worrying for several years that global supplies were running low. Emerging (and populous) nations like China and India have been consuming more, and in many countries and for reasons varying from geology to politics, production was peaking or actually declining. So the supply- demand equation was getting squeezed on both ends. Last winter — when the price was in the neighborhood of $100 per barrel — John Hess, the chairman of Hess Corporation, told a conference of energy specialists, “An oil crisis is coming — in the next 10 years.” Just in case the age of oil is truly ending, Hess, a medium-size oil company, is investing in fuel-cell technology, an alternative to gasoline. Richard Rainwater, the Texas investor who made billions buying oil stocks, shares the view that oil is scarce, and so does Warren Buffett, the investor whom Wall Street has been dialing for rescue capital. “It’s supply and demand,” Buffett told me. “The ability to produce 10 percent or 12 percent more than the world needed was there, and we got lulled into thinking — we just kept assuming — it would always be there. But there isn’t any tap to turn on http://www.nytimes.com/2008/10/19/magazine/19oil-t.html?tntemail0=y&emc=tnt&page... 10/19/2008 What Price Oil? - Roger Lowenstein - NYTimes.com Page 2 of 8 now.” (Disclosure: I own stock in Buffett’s company.) Buffett said this during the summer, before high oil prices (and before the full force of the credit hurricane) slowed the world’s thirst for oil. Under current conditions, the oil “tap” is not so dry, though presumably, economic activity will pick up someday and oil will become scarce again. Of course, this is if you believe that scarcity had anything to do with why the price rose in the first place. There is also another, highly publicized view of the oil market. According to skeptics like George Soros and Michael Masters, a hedge-fund operator, the only thing wrong with the oil market is the market itself. Speculators, they say, drove the price away from its “fundamental” value; worse, a new breed of institutional investor has been buying oil futures, hoarding the supply. Masters compares these investors to the Hunt brothers, the Texas billionaires who cornered the silver market in the late ’70s — until silver crashed and the Hunts landed in bankruptcy. Essentially, he says, the oil price is, or was, seriously “wrong” — a distortion caused by traders that has little to do with the amount of oil being produced and consumed. According to this view, oil traders are the culprits, as are the futures market and the Commodity Futures Trading Commission, the federal agency that regulates it. (The agency has also begun its own probe of the oil market.) Masters has fired off scores of e-mail messages to journalists and Wall Streeters, urging limits on speculators. (One message found its way to Senator Joe Lieberman.) Masters is not a disinterested party; his hedge fund has bet heavily on companies, like Delta Airlines, that have been punished by soaring oil prices. But his argument struck a populist chord. “Speculators are driving up the price of food and energy for everyone else,” he told me. Shad Rowe, a Dallas money manager, says the situation raises the bigger question of “whether people in a complex society ought to be allowed to make bets that affect other people and that have nothing to do with them.” Of course, capitalism demands that people, or at least investors, make bets. That is how resources are allocated and money is invested where it is needed; high prices communicate scarcity. You could even say the oil market has performed a vital service to the country by telegraphing the need to conserve and to develop alternative supplies. The number of miles driven by Americans has declined, in recent months, by close to 5 percent. Consumers have abandoned S.U.V.’s, forcing Ford to speed up its plans to close truck factories and emphasize small cars. For similar reasons, General Motors and Chrysler are rushing to introduce electric cars. All of this is healthy, and none of it would have occurred in an environment of $20 oil. “Should speculators go to jail,” notes Robert Barbera, chief economist with the Wall Street firm ITG, “or should they get the Congressional Medal of Honor?” In a sense, the question is whether we want to return to an era of plentiful oil and low prices — assuming it is possible — or to accept that political, geological and possibly environmental limitations will force us to diversify. The candidates, while talking tough about cutting our dependence on foreign oil, have supported some policies that seem inconsistent with that aim. Barack Obama has called for investment in alternative energy sources like wind and solar, and for ramping up production of cars that don’t rely on gasoline. John McCain has supported offshore drilling and nuclear power. Such policies are responsive to the idea that energy, oil in particular, is a scarce resource. And a higher oil price is the most persuasive lobby for all of them. But on the stump, each candidate has inveighed against high gasoline prices — as if prices were the problem, rather than a useful, albeit painful, signal that conventional supplies are running low. Obama http://www.nytimes.com/2008/10/19/magazine/19oil-t.html?tntemail0=y&emc=tnt&page... 10/19/2008 What Price Oil? - Roger Lowenstein - NYTimes.com Page 3 of 8 supports a windfall tax on oil-company profits, a nonsolution that would discourage drilling and potentially worsen future shortages. (An Obama campaign flier asserts, “While you’re running on empty, Exxon made $4 billion in one month.”) McCain advocated a temporary repeal of the gas tax — a measure that would do the most to revive Americans’ love affair with big cars. Congress took a positive step toward energy conservation last year, raising mileage requirements to 35 miles per gallon, but the new standard will not take effect until 2020 and will not, even then, make cars in the U.S. as efficient as those now on the road in Europe, where the average is about 45 miles per gallon. Wind and solar credits were also extended as part of the financial-bailout bill. Congress also held hearings (with Michael Masters as a prime witness) probing the supposed harm done by oil speculators. Blaming speculators is good politics. In 1958, the government shut down the market for onion futures after a price spike, and recently the Securities and Exchange Commission has seemed to blame speculators for the havoc in bank stocks. The S.E.C. may not be all wrong, but oil trading and stock trading differ in an important respect. The stock market is a secondary market, in which investors merely exchange shares with one another. Except for the relatively rare occasions on which companies raise capital by selling new stock, changes in stock prices have little effect on nontraders, which means that mispricings (or bubbles) can persist for a long time.