Odds are, if you've flipped on CNBC lately or listened to the predictions of our doomsaying politicians, you know the economy has hit a rough patch. But as college students, most of whom are more concerned with making our next rent payment than pruning our stock portfolios, what does this mean for us?
With barrels of light sweet crude for June delivery closing at $126.29, you can bet your gas money we're feeling squeezed at the pump. The last time I stared, incredulous, at the spinning reels on the gas pump I had to thank God I wasn't epileptic. Most of us would take a moment to shake our fists at Big Oil, at the record billions in profit of Exxon and its ilk, but in order to understand who is at fault in this mess we need to understand whose fault it isn't.
Exxon Mobil and other large oil corporations are merely the all-too-happy recipients of a windfall profit that is the invariable result of the combination of scarce supply with voracious demand. Oil corporations do not set the price per barrel of oil; they merely sell what barrels they have to the highest bidder.
The price of oil is determined by supply and demand as represented by futures contracts. Domestically, these contracts are traded via the New York Mercantile Exchange. Oil available for purchase is listed on the exchange at the price of the last sale, where players from major airlines to large financial firms trade oil in lots, or groups, of 1,000 barrels. At a given price point, if there are more buyers than sellers, the price of oil rises until a roughly equal number of people are willing to trade at the offered price (this could be due to a decrease in players willing to buy at the higher price as well as an increase in players willing to sell at the higher price). Conversely, if more oil is offered for sale than demanded at a given price, the cost will go down until equilibrium between buyers and sellers is reached.
At $70 or at $126.29, oil corporations are more than happy to part with the barrels they pull out of the ground, selling them to the person who is willing to pay them the most. If someone offered to buy your 1,000 barrels of oil for $70/barrel, and someone else offered to buy them for $126/barrel, who would you sell to? If you chose to sell at $126, does that make you a profiteering monster? So if Big Oil isn't to blame, why the sudden spike in gasoline prices?
We have the flagging economy to thank (in part) for this stratospheric rise. Generally, increases in the cost of energy usually spur economic contraction, rather than the other way around. While traditionally this has been (and yet remains) the case, in this age of online brokerage firms, with commodities trading just a few clicks away, what has historically been the territory of large institutional investors is now fair game for the average investor looking to fortify his portfolio against the uncertainty in the broader securities markets.Currently, there is a substantial premium built into the trading price of oil. Demand for oil has increased as a result of individual investors flocking to commod ity exchanges to hedge against the volatility in the stock market. Now, John Doe and Jane Roe have joined Delta Airlines and Goldman Sachs to compete over oil futures contracts.
Indeed, the New York Mercantile Exchange has adapted oil futures contracts (e.g., NYMEX miNY) to be traded in lots of as few as 500 barrels for the express purpose of making it easier to incorporate oil futures into individual investment portfolios. This influx of players who are willing and able to buy oil translates to higher prices, as investors seek refuge from the turbulence in the stock market. Voila, more misery at the pump.This shift to new markets by the average investor is part of the reason that the commodity prices of corn, wheat and soy have recently skyrocketed. During your last visit to Publix, you may have noticed the unusually high prices of soy and baked goods. This hike is due to the commodity prices of corn, wheat and soy roughly doubling from the year-ago period.
Granted, the dramatic rise in cost of oil and certain agricultural commodities is predominantly due to very serious supply constraints in the face of ever-growing demand. In the case of oil, the lack of readily available alternatives, coupled with public policy that not only blocks new exploration but also discourages the construction of more refineries (not to mention nuclear plants), is a recipe for disaster.
Indeed, monocropping for corn to produce ethanol is a futile endeavor (incapable of solving, or even meaningfully mitigating, our energy issues) that has served only to constrain the supply of corn, wheat, soy and other agricultural commodities crowded out by the planting of corn for ethanol.
However, rampant investor speculation on these basic necessities of life has compounded these already serious issues. Perhaps, once the economy gets rolling again and investors shift emphasis in their portfolios from commodities to stock, a small measure of relief will be in sight.
Do you love what you're hearing or do you think I'm a crackpot? Feel free to tear into my ignorance or laud my insight. Your opinions are the ones that matter, so leave a comment.
