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underinvestment in the oil industry, as well as in just about
everything worthy of investment.  And yet peak oil theorists want to
blame Mother Earth rather than capitalists. . . .  -- Yoshie

<http://www.atimes.com/atimes/Global_Economy/JF18Dj07.html>
Myth-makers caught short in oil speculation
By R M Cutler

BRUSSELS - As in military science there is the danger of "fighting the
last war", so in economic science there is the danger of puncturing
the last bubble. This is especially hazardous when what one has is
not, in fact, a bubble. Then, the myths of such a bubble are what need
puncturing. So it is today with oil prices, which this week hit a
record US$139.89 a barrel.

Is demand actually decreasing in India and China? No, demand is still
rising; it is the rate of increase of demand that is declining, and
also not by much. Or, perhaps, is oil a hedge against dollar weakness?
"The dollar," said Canadian Finance Minister Jim Flaherty at the Group
of Eight (G-8) meeting of his colleagues last weekend in Osaka, "is a
market currency." And "one does not interfere with a market currency".

The G-8 finance ministers basically admitted there was not much they
could do about the recent worldwide increases in the price of oil,
which has more than doubled from a year ago, or, for that matter,
other commodities. All that they could bring themselves to do was to
commission a study from the International Monetary Fund to determine
what effect speculators may be having on oil supplies.

So are oil prices in a "bubble" manipulated by speculators, as
American financier George Soros told a US Senate committee earlier
this month? Soros is not hands-on enough today to be accused of
venting frustration at having to cover massive shorts as the price of
a barrel shot close to $140 towards the end of the first week of the
month. (He retired from day-to-day fund management some time after his
September 1982 coup against the British pound.) Indeed, he warned in
that same testimony that he does not consider himself an expert on the
oil market and stays away from it. Clearly, his finesse at hedging
remains unimpaired.

In fact, hedging is not so far from the heart of the matter. The US
futures exchanges may alter their reporting format in the foreseeable
future so as to separate futures contracts for delivery from those
typically canceled and renewed for the following month, which practice
creates statistics that some think inflates reported oil demand. This
matter is at the center of the successful negotiations last week by
the US Commodity Futures Trading Commission (CFTC) to close the
"London loophole".

The "London loophole" consisted of trading on the Intercontinental
Exchange (ICE), the leading electronic exchange for futures and energy
contracts, that did not have to be reported to the CFTC.

The CFTC has also set up an interagency task force to study
developments in commodity markets, including the role of speculators.
In the US, members of Congress, who have held a series of hearings
looking into what is driving energy prices to record levels, are
pressing the CFTC to increase oversight of the fuel market.

ICE chief executive Jeff Sprecher told Bloomberg News that his figures
reveal not speculators but rather hedgers - "this rapid influx of
commercial users" buying contracts now for real future deliveries in
order to avoid future price increases - as the driving force in oil
pricing today.

Nor did Soros fail to mention that fact in elliptical fashion,
although media reports did fail adequately to stress the second half
of his pull-quote: the bubble that he saw, he said, "is superimposed
on an upward trend in oil prices that has a strong foundation in
reality" (emphasis added). Last week, the Financial Times of London
noted one indicator of this "strong foundation in reality" when it
reported that refiners are paying record premiums for high-quality
crude oil to produce diesel and gasoline, something that they would
hardly be doing in the absence of strong demand in the physical oil
market.

Any discussion of oil prices and the complex chain that links
unrefined oil to products bought by consumers must also include
reference to the large worldwide complex of middlemen who follow the
instant-to-instant demand for the dozens of refined petroleum products
available. Refiners tweak their valves to produce whatever gives them
the greatest margin at the moment, based on orders from those
middlemen who are in direct and indirect contact with end buyers. The
people who do this operate on the basis of contract prices for
delivery of physical goods, not oil that exists only in paper
contracts.

In the aftermath of Hurricane Katrina, in late August 2005, which
struck a vital oil production and refining region of the US, the press
was rife with true and correct reports about shortages of refinery
capacity. US Gulf Coast region refinery capacity before the hurricane
was just over 8 million barrels per day, representing no less than
47.4% of total US capacity (not to mention being home to over a
quarter of federal offshore crude oil production), and 9.9% of world
refinery capacity at the time. This continuing shortage has not been
recently emphasized.

The post-Katrina reports on refinery shortages appeared mostly in the
North American media market and dealt mainly with US retail products.
The specialized global financial press noted that this phenomenon of
refinery shortages was worldwide. World refining capacity as a
multiple of world oil demand had dropped from 111% in 1990 to 103% in
2004. As it takes an absolute minimum of three years to get a new
refinery up and running, and the US Congress did not get around to
passing a bill giving greater incentives to refinery construction
until 2007, this American situation has not changed much.

On a worldwide scale, of course, available statistical series compiled
variously by governments, industry and international agencies differ
slightly among themselves, and estimates are continually being
fine-tuned. But the overall consensus appears to be that, even if
global demand grows less quickly because of an economic downturn,
still by 2010 the key capacity/demand ratio is very unlikely to exceed
104% by much, if any. This is not really enough slack to make up for
natural disaster outages, maintenance downtime and the like.

The Financial Times suggests, probably correctly, that a fixation on
oil futures prices in New York and London is responsible for relative
inattention in the continuing shortage in refinery capacity. That
refining shortage is surely one reason why the oil markets basically
shrugged off Saudi Arabia's announcement, a few days ago, that it
would increase production by 200,000 barrels per day after having
increased it by 300,000 a few months ago.

Another reason for lack of response to the Saudi move was skepticism
that the announcement would (or even could) be matched by deeds. The
Paris-based International Energy Agency expects to publish towards the
end of this year its first survey of reserves based on field-by-field
estimates for the 400 largest fields worldwide, which are together
responsible for about two-thirds of world production and, of course, a
number of the largest of which are in Saudi Arabia. Prominent press
leaks over the past few weeks foretell a conclusion that these
reserves are significantly lower than once thought.

The view that high oil prices are due to a shortage of refining
capacity in industrialized nations was supported this week by the
United Arab Emirates Oil Minister Mohammed al-Hamli.

"There are not enough refineries to meet growing demand," Hamli told
the Gulf News daily, according to a Reuters report on Tuesday. "A
shortage of refineries is one of the main reasons behind the
increasing prices as a result of the policies adopted by
industrialized nations not to invest in new refineries due to
environmental concerns, while the sector needs substantial new
investments."

None of this is to say that oil prices may not fall in the future, and
even fall importantly. Possibly prices will spike still higher, and
then appear to crash, relatively speaking. But it is hard to keep an
unsubstitutable commodity down for long.

R M Cutler (rmc at alum.mit.edu and http://www.robertcutler.org) is a
Canadian international affairs specialist.