HardAssetsInvestor

Written by Brad Zigler  |

August 12, 2009

Do Lawmakers Really Understand The Energy Markets?

Details

Commodity market regulation is a hot topic in Congress right now, but do politicians really get how the crude oil market works?

• The impact of inflation
• Contango, backwardation and inventory levels
• Seasonal differences are normal

Last week, the U.S. Federal Trade Commission (FTC) issued new rules to prevent oil market manipulation, greatly boosting the agency's enforcement clout. The FTC will now coordinate its efforts with the Commodity Futures Trading Commission to police the physicals and futures markets.

Among other things, the FTC's new rules prohibit oil market participants from making misleading statements or intentionally omitting information that could affect prices.

In her advocacy for the tougher regulations, Sen. Maria Cantwell (D-Wash.), a member of the Senate's Energy and Natural Resources Committee, said this year's hike in oil prices raised questions about manipulation of the markets.

"Oil supplies are near 20-year highs," she said in a written statement, "and demand for oil is at a 10-year low -- so why have gasoline prices gone up a dollar a gallon since the beginning of the year?"

Why, indeed?

If we gauge the oil supply as the commercially available domestic stockpile outside the Strategic Petroleum Reserve, the senator's got a point. According to the U.S. Energy Information Administration, when Cantwell's statement was published, the U.S. oil supply stood at 349.5 million barrels. Twenty years before, 334.5 million barrels were available.

Gasoline prices, too, have risen this year, although when measured by unleaded gasoline futures, it's more like an 80-cent rise than a buck.

However, Cantwell has left behind a lot of context by pitting the crude oil supply against gasoline prices.

First, there's the trend in our domestic oil supply, represented by the dashed black line in the chart below. When you derive the trend line mathematically, smoothing out the choppiness, you see that our domestic supply is actually getting smaller.

The black solid line represents week-by-week oil inventories. The most recent peak was in May, when our domestic stocks topped 375.3 million barrels, the highest level since the summer of 1990, when we had 391.9 million on hand.

Spot crude averaged a price of just under $52/barrel in May. With oil supplies down some 26 million barrels by late July, though, the price of oil has risen nearly $20 a barrel.

Inventory Vs. Futures Spreads

Directly comparing today's oil price to supply over the longer term, however, ignores the effects of inflation. We've seen inflation's impact on oil prices in "A Picture's Worth A Thousand Word (Or Dollars)." When oil supplies peaked in summer 1990, crude was nearly $21 a barrel. Inflating the 1990 price by the Consumer Price Index makes the oil worth 34 simoleans in 2009 dollars. Inflation accounts for 42% of the apparent price rise since oil's last supply peak.