How Fear, Greed Factor Into the Price of Gasoline

The price of oil is set not in Vienna at the headquarters of OPEC, but at the New York Mercantile Exchange.

Llewellyn King, PBS

Sunday, May 1, 2011

WASHINGTON — The fate of the Obama presidency hangs not on a birth certificate or the red ink on the federal budget but by the hose nozzle of your local gas station.

Electoral discontent is measured by the price of a gallon of gasoline. Heading past $4 toward $5, that is a lethal trajectory for President Obama.

Enter the demagogues, especially the clown-in-a-business-suit, Donald Trump. Unfettered by the gravity that goes with facts, Trump says that he would fix the oil price — now around $110 a barrel — by facing down the producers, particularly the Organization of the Petroleum Exporting Countries (OPEC). He told an interviewer on television that he would call OPEC and tell them to pump more or face the consequences. The latter, he did not specify. War? Against whom?

In a compelling book by Leah McGrath Goodman, The Asylum: The Renegades Who Hijacked the World’s Oil Market, the author lays out the ugly fact that often — in fact, more often as not — the price of oil is set not in Vienna at the headquarters of OPEC, but in downtown Manhattan at the New York Mercantile Exchange (NYMEX).

Tens of thousands of future contracts are traded in nanoseconds at the NYMEX, and the price of oil is set. This price affects not only the price that will be paid when these contracts expire and delivery takes place, but also, according to Goodman, the all-important over-the-counter market, where sellers trade more directly with buyers without government oversight.

Goodman contends that there is little oversight of the NYMEX because the agency charged with the role is the weak and ineffectual Commodities Futures Trading Commission (CFTC), where many staff and commissioners are busy burnishing their resumes so they can cash in later as market executives.

The over-the-counter market is not regulated at all because of a pernicious interference from Congress known as the “Enron Loophole.” How did it get into law? It is one of those pieces of special-interest protection that owes its existence to legislative immaculate conception. It was not in the committee version of the bill; it slipped in along the way without parenthood, but is largely believed to be the work of former Sen. Phil Graham, R-Texas, whose wife, Wendy, was chair of the CFTC.

In classic theory, a market is where a willing buyer and a willing seller strike a price. In the world of traders, it is something else: It is where volatility is rewarded and myths hold sway.

Today there is no actual shortage of crude oil. Supply and demand, according to those who monitor these things, is in balance. But fear stalks the trading floors because fear is good for traders; and fear is a critical part of the oil price.

Wars and rumors of wars are relished in trading pits. They raise the specter of coming shortage and introduce the instability the traders love. During the electricity shortage in California in 2001, traders, particularly at Enron, sought not only to capitalize on fears of shortage, but also to guarantee shortage by taking generating equipment off line.

Of course, reality must eventually catch up with speculation. The production of oil must meet demand and the price will briefly reach real world equilibrium. This happened in 1986, when the price collapsed because Saudi Arabia opened its spigots after the volatility of the 1970s. Many traders were wiped out and speculative billions were lost.

Some oil industry observers believe that the market is trading on a “fear premium” of about $1 per gallon of gasoline, spooked by the uncertainty in the Middle East and traders exploiting that fear.

Good for Obama. Time for the president to engage in a little market manipulation of his own.

The nation has about eight months of supply of crude oil saved in salt domes, in what is called the Strategic Petroleum Reserve. There is more oil available in the Naval Petroleum Reserve, a set-aside of oil in the ground. Obama needs to say that we are going to start using this oil as soon as it can reach the refineries.

He has to go the whole hog — to set the machinery of using our special reserves in motion. That will humble the traders.

However, any new wars in the Middle East, and all bets are off. Poltergeists would stalk lower Manhattan.

Llewellyn King is executive producer and host of “White House Chronicle” on PBS.