Tuesday, April 25, 2006

Re: The Price of Gasoline

April 25, 2006

Re: The Price of Gasoline.

From: Dean Lawrence R. Velvel VelvelOnNationalAffairs.com

Dear Colleagues:

Recently I taped a one hour television interview on the price of gasoline with Public Citizen’s Energy Director, Tyson Slocum. The interview will appear on the MSL Educational Forum in New England on Comcast’s Channel CN8 on Sunday, April 30th at 11 a.m., and in the mid-Atlantic states it will be on the same channel on Sunday, May 7th, at 9 a.m.

Slocum’s most fundamental point in the interview was that the high price of gasoline at the pump is not attributable to the costs of drilling and refining oil, costs that are far less than the price at the pump. The high price at the pump, he said, is almost entirely attributable to the prices of crude oil and gasoline being driven up by wealthy speculators in the crude oil and gasoline futures markets. The speculators, of course, are trying to make a financial killing (for which the rest of us suffer at the pump).

Slocum’s views are so important to the forthcoming national debate on gasoline prices that MSL has circulated a lengthy press release describing what he said. Though it is in the form of a press release, the document is in reality a brief essay about the reason for the high price of gas. I am therefore taking the unusual step of printing the press release below on this blog.*

*This posting represents the personal views of Lawrence R. Velvel. If you wish to respond to this email/blog, please email your response to me at velvel@mslaw.edu. Your response may be posted on the blog if you have no objection; please tell me if you do object.

MSLNEWSCONTACT: Kirby F. Smith at (978) 681-0800, x-25 (voice); (978) 681-6330 (fax); smith@mslaw.edu (e-mail); www.mslaw.edu (Website)


ANDOVER, MA --- The energy director of Public Citizen, Tyson Slocum, said on Thursday that the high price of gasoline at the pump has little relationship to the costs of drilling for or refining crude oil. Instead the high cost and amazing fluctuations in the price of gasoline are due to the cost of a barrel of crude oil being artificially driven up by extensive speculation in oil futures. This speculation is engaged in by wealthy financial institutions such as hedge funds, investment banks, and commercial banks. They hope to make a financial killing by trading in the oil futures market, said Slocum.

Slocum’s remarks were made both at a luncheon with faculty of the Massachusetts School of Law (MSL), and afterwards at the taping of a one hour MSL television program on the high price of gasoline. The program will be shown in New England on Comcast’s Channel CN8 at 11 a.m., on Sunday, April 30, and on the same channel in the Middle Atlantic States on Sunday, May 7, at 9 a.m.

“I urge all citizens, including government officials and print and electronic reporters, editors, and producers, who want to know why their gasoline costs are so high, to watch this program,” said Lawrence R. Velvel, dean of MSL, who interviewed Slocum. “It provides the clearest and most concise explanation of how gasoline prices are set, that one is likely to read, hear, or see.” As often occurs analogously in the stock market in regard to the price of company shares, the price of oil futures has no relationship to the underlying costs of drilling for crude oil, said Slocum. The price of oil futures is based instead on speculators’ assessments of what the price of gasoline may later be regardless of the costs of drilling and refining crude oil. The speculators’ assessments vary from day to day. Thus the market price for a barrel of crude oil on the futures market varies from day to day, and therefore so does the price paid by consumers at the gas pump.

Crude oil producers -- the companies that pump crude oil out of the ground -- do not use their costs of drilling as the basis of what they charge per barrel of oil, said Slocum. Rather, they use the price established in the futures market, which is much higher. In the case of Exxon/Mobil, said Slocum, its cost for getting crude oil out of the ground is about 20 dollars per barrel. But for that crude oil it charges not the amount needed to make only a reasonable profit on the cost of drilling, but the amount set in the fluctuating futures market, which is now over 70 dollars per barrel. By charging the fluctuating futures market price, Exxon/Mobil has been able to make a 46 percent return on investment on its U.S. drilling operations, said Slocum. It has also, he said, been able to make a 59 percent return on investment on its subsequent U.S. refinery operations, he said. Slocum also makes clear that the high return on investment in refinery operations was due to the operations of a gasoline futures market which operates in the same way as the crude oil futures market.

The spot market price for crude oil does not bring down the futures market price for oil, said Slocum, because the spot market price demanded by sellers reflects the futures market price. There are two reasons for this, Slocum said. One is that spot market sellers are able to make a bigger profit by charging an amount close to or equal to the futures market price. The other is that spot market sellers fear that, if they were to undercut the futures market price, large vertically integrated oil companies would punish them for this price cutting by, for example, undercutting the spot sellers’ price in order to destroy the spot sellers’ profits and perhaps drive them out of business.

The essence of Slocum’s comments, then, is that the high and fluctuating price of gasoline paid by consumers at the pump is not due to the costs of drilling for (i.e., producing) and refining crude oil, but is divorced from those costs. Rather than reflecting costs, it reflects the wholly speculative price established on the futures market by speculators -- usually large financial institutions -- who drive the futures price upwards in their quest to make a financial killing.
In a statement of another fact that Americans rarely hear, Slocum said that the actions of President Hugo Chavez of Venezuela, the world’s fifth largest producer of crude oil, demonstrate that there is a vast discrepancy between the costs per barrel of drilling crude oil and the price of crude oil that is established in the futures market. Chavez, said Slocum, sells crude oil to other South American countries at prices far below the price established on the futures market. Chavez does this to curry political favor with other South American countries, said Slocum, some of which might otherwise be more disposed to favor George Bush in the ongoing, vigorous dispute between Bush and Chavez. By selling crude oil to other South American countries at bargain prices to win their favor, said Slocum, Chavez uses a lower price for crude in the same way that the United States has used foreign aid.

Interviewed later about Slocum’s comments, Velvel said “If he is right in saying that the actual costs of drilling and refining are far below the high price of gasoline at the pump and are not the reason for its high price, if he is right in saying that it is speculative trading by wealthy financial and other institutions on the organized futures markets that is responsible for the high price, then it seems self evident that the way to curb the high price of gasoline is to outlaw organized trading in oil and gas futures. It would seem obvious that, if the organized futures market is in fact responsible for the high price of gas, then getting rid of that market is the necessary step to curbing that price. At the minimum, this is a step which must be discussed.”

“Outlawing the futures market,” added Velvel, “would be vigorously opposed by the wealthy interests that may be making up to billions of dollars by speculating in the market -- by hedge funds, investment banks, commercial banks and others. But it has to be remembered that, because the organized futures market did not even exist until the mid 1980s, this country got along very well without it for the first 80 years of the automobile age. It is therefore obvious that the organized futures market is not essential, and, if Slocum is right, is instead the cause of terrible economic hardship for scores of millions of ordinary people and is a major drag on our economic activity because oil is so important in so many ways throughout the economy. At minimum this should be a subject of inquiry and debate.”

Advance copies of the MSL television program on which Slocum made his comments can be obtained by contacting Kirby F. Smith at the Massachusetts School of Law, (978) 681-0800, smith@mslaw.edu. Videotapes of the luncheon at which Slocum spoke are also available. Tyson Slocum can be contacted at (202) 588-1000.