Mar 17, 2012: Something tells me that maybe the Government, Republicans and Democrats alike just may not understand how commodities are priced. The idea that they can cause significant impact on gasoline prices by diverting oil from the National Energy Reserve or by having a conversations with the Saudis, or putting a rig in every pristine coastline and drill deep into the earth is pretty unrealistic. I don’t like paying $60-80 filling up our automobile but I know that if we practice conservative uses of the car we will not increase our driving expense too much above what they have been. The price of oil is determined by global demand and global supply but there are other factors. Looking at it from an old broker’s standpoint, one who was in the business of accommodating buyers and sellers of stocks and bonds along with handling futures contracts in commodities to help them hedge their business operating costs, I am flabbergasted why people, don’t understand why prices for commodities of all kinds are increasing faster than they normally would have given the level current inflation (devaluation of the dollar). When you see the Federal Reserve flushing the system with dollars every day in order to keep current interest rates relatively low, shouldn’t it occur to everyone that businesses who use a commodity like oil and that oil makes up a major percentage of their operating costs, would want to protect themselves from anticipated higher market prices for that commodity in the future? If you were running a company in that situation, particularly one that sold its product by term sales contracts with durations of 6 months or longer, wouldn’t you want to assure that your cost for that commodity was safely plugged into your marketing plan and contract price? Of course you would! So how do you do that? You buy a contract for delivery of your required needs of a commodity out in the future. This contract for future delivery provides the buyer a hedge against rising prices and every smart and successful businessman operates this way. So what does that mean regarding the price of a commodity like oil? It means that the current demand globally is above the current cash supply but the same transaction could affect the perceived supply in the same way. The price of the future contract is reflecting the anticipated use and need at some time in the future. It can be sort of like double counting in a way causing demand or supply of the commodity to be perceived to be greater than it really is. Transactions are increasingly priced based on the anticipated demand and supply further and further into the future. So if you can make money running a Trucking company at the rates you are now paying for fuel or extractive derivatives today and you want to build in the cost of fuel for the next 6 months (longer or sooner) you go out and buy a contract for future delivery of that fuel and if the price keeps rising, you don’t care as much because your costs are fixed. You are able to raise prices now against costs set in 6 months ago. Conversly if the futures are discounting low prices you are able to resist reducing prices as long as possible while enjoyin better margins. As a matter of fact that is why the current price of many products and services have not risen too much yet because the operating expenses at lower levels were hedged.
Since oil and other commodities are traded based on the dollar and devaluation of the dollar like Mr Bernanke is doing now will cause the dollar price of those commodities to rise many traders are trying to exploit what they see as extrordinary demand during a time when the world supply from Iran is being restricted. The dollar is strengthened by the FRB selling Treasuries in open market activities but the Fed’s strategy is to ease rates now not raise them, so it is adding to its balance sheet by buying treasuries securities on balance Now however with the dollar continually being devalued (not in terms of the Euro or Yen but in terms of the Yuan or its real purchasing power), some investors are going to wake up to the fact that holding them or lending them to the U.S. or to home buyers as low interest mortgages, etc. is not and will not provide a real return. Oh they may provide a relative degree of safety, but real returns? No. The demand for energy in the global economies is going to result in greater consumption of more extractive type products. This seems true no matter what Mr. Gingrich’ opines. Newt is wrong if he thinks developing our untapped oil reserves will result in $2.50 per gallon gasoline. Oh it could if everyone stopped driving their cars 50% of the time but I won’t see that in my lifetime. But what I will see, not this year, nor next possibly, but by 2016 certainly is interest rate levels that will be much higher than today as investors around the world decide they want more return on their dollar investments. You can bet that the price of any commodity that has high prospective use will continue to reflect the expectations of business managers who are hedging their future costs. Along with the devaluation of the currency in which it is priced ,we consumers will have to just ride that roller coaster until a new technology gives us a real alternative to travel using an extractive commodity like oil, natural gas or coal. Can we soften the effect? Sure, change our behavior. Use less and conserve more. But we are not going to put windmills on our automobiles or convert to battery powered cars.
The political argument is stated that the government is responsible for the rise in the price of oil. I think that is correct to some degree but with the developing of marginal fields and only by adding product that is extremely expensive to extract. The key point to remember is that markets work and given the opportunity to function in a free like manner, they will enable consumers who are productive to earn currency to barter for their basic and extended needs as they see them, not as based on a standard set by a government..
One Man’s Opinion- Bud Brewer