Category Archives: Energy

Is gas “price-gouging” to blame for high gas prices?

President Obama raised this question a couple of days ago during a “town hall” meeting in California. The MSNBC article entitled “Obama says new task force will examine gas prices” quotes him as saying, “”We are going to make sure that no one is taking advantage of the American people for their own short-term gain.” This article also quotes the President as saying that “The task force will focus some of its investigation on “the role of traders and speculators” in the oil-price surge”.

An article which appeared in the The Globe and Mail entitled “U.S. launches probe into energy prices”, notes that “U.S. Attorney-General Eric Holder made no allegation of wrongdoing against companies or speculators on Thursday. But the multi-agency Financial Fraud Enforcement Working Group will play a key role in identifying fraud in the energy market, he said” (italics added for emphasis).

While the notion that “high” gas prices result from “price gouging” by a cadre of unsavory and greedy oil companies, energy traders, and speculators makes for a provocative political narrative, it’s really bad economics. As canards go, this one is particularly favored by the political elites; indeed, as Tim Evans, energy analyst with Citi Futures Perspectives, told Reuters news service, “You can almost set your watch on these kinds of things.”

I can think of several reasons why gas prices are high compared with historical norms and likely to remain so for some time:

  1. Rising demand from emerging markets (particularly China and India)
  2. Risks of supply chain disruptions due to the ongoing political upheavals in Libya and the Middle East
  3. Domestic supply constraints due to the ongoing deepwater drilling moratorium in the Gulf of Mexico
  4. The ongoing depreciation of the value of the US dollar vis-a-vis foreign currencies. The Federal Reserve’s major currencies index (which measures the foreign exchange value of the U.S. dollar against a subset of currencies in the broad index that circulate widely outside the country of issue) currently stands at 20–year lows. Since this past January, the value of the US dollar compared with other major foreign currencies has fallen by nearly 5%. Since trading in the global oil markets is dollar denominated, some of the rise in gas prices can be attributed to this factor alone.

Therefore, in order for gas prices to become cheaper for Americans, this will require some combination of 1) a slowdown in the global economy, 2) a favorable resolution of political risks in the Middle East, 3) a credible commitment on the part of the US government to rescind its deepwater drilling moratorium, and/or 4) a recovery in the value of the US dollar vis-a-vis other currencies.

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Is gas "price-gouging" to blame for high gas prices?

President Obama raised this question a couple of days ago during a “town hall” meeting in California. The MSNBC article entitled “Obama says new task force will examine gas prices” quotes him as saying, “”We are going to make sure that no one is taking advantage of the American people for their own short-term gain.” This article also quotes the President as saying that “The task force will focus some of its investigation on “the role of traders and speculators” in the oil-price surge”.

An article which appeared in the The Globe and Mail entitled “U.S. launches probe into energy prices”, notes that “U.S. Attorney-General Eric Holder made no allegation of wrongdoing against companies or speculators on Thursday. But the multi-agency Financial Fraud Enforcement Working Group will play a key role in identifying fraud in the energy market, he said” (italics added for emphasis).

While the notion that “high” gas prices result from “price gouging” by a cadre of unsavory and greedy oil companies, energy traders, and speculators makes for a provocative political narrative, it’s really bad economics. As canards go, this one is particularly favored by the political elites; indeed, as Tim Evans, energy analyst with Citi Futures Perspectives, told Reuters news service, “You can almost set your watch on these kinds of things.”

I can think of several reasons why gas prices are high compared with historical norms and likely to remain so for some time:

  1. Rising demand from emerging markets (particularly China and India)
  2. Risks of supply chain disruptions due to the ongoing political upheavals in Libya and the Middle East
  3. Domestic supply constraints due to the ongoing deepwater drilling moratorium in the Gulf of Mexico
  4. The ongoing depreciation of the value of the US dollar vis-a-vis foreign currencies. The Federal Reserve’s major currencies index (which measures the foreign exchange value of the U.S. dollar against a subset of currencies in the broad index that circulate widely outside the country of issue) currently stands at 20–year lows. Since this past January, the value of the US dollar compared with other major foreign currencies has fallen by nearly 5%. Since trading in the global oil markets is dollar denominated, some of the rise in gas prices can be attributed to this factor alone.

Therefore, in order for gas prices to become cheaper for Americans, this will require some combination of 1) a slowdown in the global economy, 2) a favorable resolution of political risks in the Middle East, 3) a credible commitment on the part of the US government to rescind its deepwater drilling moratorium, and/or 4) a recovery in the value of the US dollar vis-a-vis other currencies.

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Observations concerning some of today’s events in the worlds of finance, insurance, and risk management

1. Lehman Brothers and AIG: As John Markman cleverly notes, “…the Federal Reserve stood up to the big Wall Street financial houses on Sunday and essentially told them, ‘thanks but no thanks’ on their request for a bridge loan to nowhere”. Consequently, Lehman Brothers (the 4th largest investment bank in the world) has filed for bankruptcy protection, and its shares are trading today for 23 cents per share. Bill Gross made an interesting comment concerning Lehman and American International Group (AIG) this morning on CNBC; he noted that while AIG is technically solvent, it is highly illiquid, whereas Lehman is technically insolvent but otherwise quite liquid. Just one year ago, AIG had a market capitalization of nearly $200 billion, making it one of America’s most valuable publicly traded corporations. Today, AIG’s market capitalization stands at $18 billion. The problem AIG faces is that if this company can’t resolve its liquidity problems really soon (like sometime within the next couple of days), then it risks being downgraded by the credit rating agencies. If AIG’s credit rating becomes impaired, it stands to lose a substantial share of its client base. AIG is particularly heavily exposed to commercial insurance lines of business, and their clients have no interest in doing business with credit-impaired insurers. If this scenario plays out, expect to see AIG follow up with its own bankruptcy filing.
 
2. Hurricane Ike: The three major catastrophe risk modeling firms (Applied Insurance Research (AIR), EQECAT, and Risk Management Solutions (RMS)) project insured losses of between $6 – $18 billion, primarily in the Texas counties of Brazoria, Harris, Galveston, Chambers and Jefferson. Since the Texas Windstorm Insurance Association (TWIA) is heavily exposed to insured properties in these counties, I suspect that claims may very likely exceed TWIA’s capital base of $1.87 billion, which consists $370 million in a Catastrophe Reserve Trust Fund and $1.5 billion in reinsurance. Depending upon the magnitude of TWIA’s Ike-related losses, private insurers in Texas could face assessments which would have the potential for setting in motion a financially vicious cycle in which future earnings and capitalization are impaired, which in turn adversely affect insurer credit ratings. Matters can only get worse if the Texas gulf coast gets hit with any more hurricanes any time soon.
 
3. Oil Speculation: Apparently so-called “oil speculators” were not behind the large run-up in oil prices during the first half of 2008, any more than they were behind the subsequent retreat in oil prices during the past couple of months. Last week, the Commodity Futures Trading Commission (CFTC) issued a report which provides compelling empirical evidence to the effect that financial trading hasn’t been driving price moves in oil markets after all. For a synopsis of this study, see the article from today’s Wall Street Journal entitled “See You Later, Speculator”. As I noted in my July 10, 2008 blog entry entitled “Rebuttal of ‘An open letter to all airline customers‘”, this finding comes as no surprise. Thankfully American Airlines has finally gotten around to removing the link from its home page urging consumers to “stop oil speculators by sending Congress an S.O.S.”…
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Observations concerning some of today's events in the worlds of finance, insurance, and risk management

1. Lehman Brothers and AIG: As John Markman cleverly notes, “…the Federal Reserve stood up to the big Wall Street financial houses on Sunday and essentially told them, ‘thanks but no thanks’ on their request for a bridge loan to nowhere”. Consequently, Lehman Brothers (the 4th largest investment bank in the world) has filed for bankruptcy protection, and its shares are trading today for 23 cents per share. Bill Gross made an interesting comment concerning Lehman and American International Group (AIG) this morning on CNBC; he noted that while AIG is technically solvent, it is highly illiquid, whereas Lehman is technically insolvent but otherwise quite liquid. Just one year ago, AIG had a market capitalization of nearly $200 billion, making it one of America’s most valuable publicly traded corporations. Today, AIG’s market capitalization stands at $18 billion. The problem AIG faces is that if this company can’t resolve its liquidity problems really soon (like sometime within the next couple of days), then it risks being downgraded by the credit rating agencies. If AIG’s credit rating becomes impaired, it stands to lose a substantial share of its client base. AIG is particularly heavily exposed to commercial insurance lines of business, and their clients have no interest in doing business with credit-impaired insurers. If this scenario plays out, expect to see AIG follow up with its own bankruptcy filing.

 
2. Hurricane Ike: The three major catastrophe risk modeling firms (Applied Insurance Research (AIR), EQECAT, and Risk Management Solutions (RMS)) project insured losses of between $6 – $18 billion, primarily in the Texas counties of Brazoria, Harris, Galveston, Chambers and Jefferson. Since the Texas Windstorm Insurance Association (TWIA) is heavily exposed to insured properties in these counties, I suspect that claims may very likely exceed TWIA’s capital base of $1.87 billion, which consists $370 million in a Catastrophe Reserve Trust Fund and $1.5 billion in reinsurance. Depending upon the magnitude of TWIA’s Ike-related losses, private insurers in Texas could face assessments which would have the potential for setting in motion a financially vicious cycle in which future earnings and capitalization are impaired, which in turn adversely affect insurer credit ratings. Matters can only get worse if the Texas gulf coast gets hit with any more hurricanes any time soon.
 
3. Oil Speculation: Apparently so-called “oil speculators” were not behind the large run-up in oil prices during the first half of 2008, any more than they were behind the subsequent retreat in oil prices during the past couple of months. Last week, the Commodity Futures Trading Commission (CFTC) issued a report which provides compelling empirical evidence to the effect that financial trading hasn’t been driving price moves in oil markets after all. For a synopsis of this study, see the article from today’s Wall Street Journal entitled “See You Later, Speculator”. As I noted in my July 10, 2008 blog entry entitled “Rebuttal of ‘An open letter to all airline customers‘”, this finding comes as no surprise. Thankfully American Airlines has finally gotten around to removing the link from its home page urging consumers to “stop oil speculators by sending Congress an S.O.S.”…
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