Federal Government Policy Issues
Discussion and information on selected policy issues concerning tax, foreign relations, energy and other significant policies. The intent is to provide data and analysis that will assist in determining the appropriateness of the policy. Any posts containing rants, personal attacks on officials or other posters or which do not concisely present a point of information will not be published.Saturday, May 06, 2006
Energy - Pricing and Supply
Prices of oil and products refined from oil such as gasoline are near all time highs in the US and there is concern that the high prices will negatively impact the US economy. The President states that the current high prices are caused by a global shortage due in part to strong economies globally especially in China. The President has proposed several policies that will increase supply, reduce demand and will moderate prices.
Will the proposed policies improve supply and reduce prices, what are the problems caused by the current prices and energy situation and what other policy alternatives might be considered?
Will the proposed policies improve supply and reduce prices, what are the problems caused by the current prices and energy situation and what other policy alternatives might be considered?
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Any plan to reduce energy prices & supply should have both short term and long term components. Two items that come to mind to provide short term relief are:
1) Eliminate the oil depletion tax break that allows oil companies to take a tax break for the oil they pump and replace it with a tax break for new oil supplies discovered. Currently, oil companies are increasing reserves by buying other oil companies rather than through exploration.
2) Import ethanol from Brazil. Brazil can deliver ethanol to the US for 85 cents per gallon while the cost of domestic ethanol production is $1.10 to $1.40. The cost of Brazilian ethanol increased from 65 cents per gallon 2 years ago due to the weak dollar. Additionally, producing ethanol from sugar cane takes 1 gallon of fossil fuel to produce 8 to 10 gallons of ethanol while producing ethanol from corn in the US takes 1 gallon of fossil fuel to produce 1.2 to 1.4 gallons of ethanol. Currently, there is a 2.5% plus 54 cents per gallon tariff on imported ethanol. I assume that tariffs and quotas are intended to protect the US corn growers.
Consequently, any short term policy which promotes US produced ethanol from corn will not significantly reduce oil imports due to the low conversion factor (1.2-1.4 gallons of ethanol from 1 galloon of oil), will increase fueld costs to the consumers compared to importing ethanol and will only add to the incomes of US corn growers and ethanol producers.
http://www.iowafarmbureau.com/programs/commodity/information/pdf/Trade%20Matters%20column%20050714%20Brazilian%20ethanol.pdf
www.iran-daily.com/1384/2495/html/energy.htm
1) Eliminate the oil depletion tax break that allows oil companies to take a tax break for the oil they pump and replace it with a tax break for new oil supplies discovered. Currently, oil companies are increasing reserves by buying other oil companies rather than through exploration.
2) Import ethanol from Brazil. Brazil can deliver ethanol to the US for 85 cents per gallon while the cost of domestic ethanol production is $1.10 to $1.40. The cost of Brazilian ethanol increased from 65 cents per gallon 2 years ago due to the weak dollar. Additionally, producing ethanol from sugar cane takes 1 gallon of fossil fuel to produce 8 to 10 gallons of ethanol while producing ethanol from corn in the US takes 1 gallon of fossil fuel to produce 1.2 to 1.4 gallons of ethanol. Currently, there is a 2.5% plus 54 cents per gallon tariff on imported ethanol. I assume that tariffs and quotas are intended to protect the US corn growers.
Consequently, any short term policy which promotes US produced ethanol from corn will not significantly reduce oil imports due to the low conversion factor (1.2-1.4 gallons of ethanol from 1 galloon of oil), will increase fueld costs to the consumers compared to importing ethanol and will only add to the incomes of US corn growers and ethanol producers.
http://www.iowafarmbureau.com/programs/commodity/information/pdf/Trade%20Matters%20column%20050714%20Brazilian%20ethanol.pdf
www.iran-daily.com/1384/2495/html/energy.htm
Oil Prices
Some analysts estimate that $30 to $40 of the current oil price is due to financial speculation. Although there are other influences that have contributed to the oil price increase including the weak US dollar, financial speculation is certainly responsible for a significant percentage of the increase in oil prices which increased 57% in 2007. In 2007, hedge funds and other speculative investors were responsible for one-third of all trades on the Intercontinental Exchange, a key market for setting oil prices, up from 0.2 per cent of trades in 2002. Commodities are seen as a safe play in declining markets and it is notable that when weak economic projections drive the equities market and bond yields down that oil prices increase which is counter-intuitive. Recall that when the liquidity crisis (more of a credit crisis than a liquidity crisis) became an issue with the markets in 8/2008, oil prices quickly dropped more than $10 bbl as hedge funds were forced to sell liquid assets such as oil futures to generate funds to cover financing shortfalls.
Most commodities have seen significant price increases over the last year and in many cases these price increases have been greater than the oil price increase. Copper prices, for instance, have increased by almost 500% over the last year.
So, what can be done? One option would be for the US to impose an excess profits tax on gains from speculating in commodities by investors who do not take delivery of and use the commodity on which the future was purchased. Airlines, trucking companies, etc. frequently purchase futures to hedge their exposure to rapid price rises and this is a reasonable business decision similar to the purchase of insurance and is not strictly speaking speculation. I would bet that if a 50% excess profit tax was imposed on profits from commodity futures speculation that many of these financial funds would unwind their positions and the price of the commodities would quickly drop to a price that represents the true price based on the real demand of the commodity.
Ideally, the excess profit tax would be coordinated with countries which have significant commodity futures markets. Even if this coordination did not take place, the sale of futures by US hedge funds, pension funds, index funds, etc. would cause a drop in the futures prices and commodity speculators in other countries would be forced to unwind their positions to avoid further losses.
Some analysts estimate that $30 to $40 of the current oil price is due to financial speculation. Although there are other influences that have contributed to the oil price increase including the weak US dollar, financial speculation is certainly responsible for a significant percentage of the increase in oil prices which increased 57% in 2007. In 2007, hedge funds and other speculative investors were responsible for one-third of all trades on the Intercontinental Exchange, a key market for setting oil prices, up from 0.2 per cent of trades in 2002. Commodities are seen as a safe play in declining markets and it is notable that when weak economic projections drive the equities market and bond yields down that oil prices increase which is counter-intuitive. Recall that when the liquidity crisis (more of a credit crisis than a liquidity crisis) became an issue with the markets in 8/2008, oil prices quickly dropped more than $10 bbl as hedge funds were forced to sell liquid assets such as oil futures to generate funds to cover financing shortfalls.
Most commodities have seen significant price increases over the last year and in many cases these price increases have been greater than the oil price increase. Copper prices, for instance, have increased by almost 500% over the last year.
So, what can be done? One option would be for the US to impose an excess profits tax on gains from speculating in commodities by investors who do not take delivery of and use the commodity on which the future was purchased. Airlines, trucking companies, etc. frequently purchase futures to hedge their exposure to rapid price rises and this is a reasonable business decision similar to the purchase of insurance and is not strictly speaking speculation. I would bet that if a 50% excess profit tax was imposed on profits from commodity futures speculation that many of these financial funds would unwind their positions and the price of the commodities would quickly drop to a price that represents the true price based on the real demand of the commodity.
Ideally, the excess profit tax would be coordinated with countries which have significant commodity futures markets. Even if this coordination did not take place, the sale of futures by US hedge funds, pension funds, index funds, etc. would cause a drop in the futures prices and commodity speculators in other countries would be forced to unwind their positions to avoid further losses.
Effect of $ Exchange Rate on Oil Price
Some analysts have attributed rising prices of crude oil in the US to the declining value of the dollar. The analysts note that oil sold is priced in US dollars so a declining dollar makes oil cheaper to countries with stronger currencies. This argument would only explain rising prices in US dollars if the cheaper cost of oil caused a country with a stronger currency to purchase more oil which would lead to a higher price as a result of higher demand.
However, in the case of Europe, annual oil consumption increased less than 1% (0.62%) in 2007 from 2006. In 2007, European oil consumption was 14.68 million bbls per day, up only 70,000 bbls per day from the 2006 average which is a small amount. Again, it would appear that the analysts are using spurious logic to drive the price of oil up.
Some analysts have attributed rising prices of crude oil in the US to the declining value of the dollar. The analysts note that oil sold is priced in US dollars so a declining dollar makes oil cheaper to countries with stronger currencies. This argument would only explain rising prices in US dollars if the cheaper cost of oil caused a country with a stronger currency to purchase more oil which would lead to a higher price as a result of higher demand.
However, in the case of Europe, annual oil consumption increased less than 1% (0.62%) in 2007 from 2006. In 2007, European oil consumption was 14.68 million bbls per day, up only 70,000 bbls per day from the 2006 average which is a small amount. Again, it would appear that the analysts are using spurious logic to drive the price of oil up.
Energy Speculation and Oil Prices
The following was copied from:
http://seekingalpha.com/article/78264-commodities-prices-speculation-exposed
When Congress passed the Commodity Exchange Act in 1936, they did so with the understanding that speculators should not be allowed to dominate the commodities futures markets. Unfortunately, the CFTC has taken deliberate steps to allow certain speculators virtually unlimited access to the commodities futures markets.
Masters closes with the key issue, that:
The CFTC has granted Wall Street banks an exemption from speculative position limits when these banks hedge over-the-counter swaps transactions. This has effectively opened a loophole for unlimited speculation. When Index Speculators enter into commodity index swaps, which 85-90% of them do, they face no speculative position limits.
The really shocking thing about the Swaps Loophole is that Speculators of all stripes can use it to access the futures markets. So if a hedge fund wants a $500 million position in Wheat, which is way beyond position limits, they can enter into swap with aWall Street bank and then the bank buys $500 million worth of Wheat futures. In the CFTC's classification scheme all Speculators accessing the futures markets through the Swaps Loophole are categorized as "Commercial" rather than "Non-Commercial." The result is a gross distortion in data that effectively hides the full impact of Index Speculation.
Additionally, the CFTC has recently proposed that Index Speculators be exempt from all position limits, thereby throwing the door open for unlimited Index Speculator "investment." The CFTC has even gone so far as to issue press releases on their website touting studies they commissioned showing that commodities futures make good additions to Institutional Investors' portfolios.
The following was copied from:
http://seekingalpha.com/article/78264-commodities-prices-speculation-exposed
When Congress passed the Commodity Exchange Act in 1936, they did so with the understanding that speculators should not be allowed to dominate the commodities futures markets. Unfortunately, the CFTC has taken deliberate steps to allow certain speculators virtually unlimited access to the commodities futures markets.
Masters closes with the key issue, that:
The CFTC has granted Wall Street banks an exemption from speculative position limits when these banks hedge over-the-counter swaps transactions. This has effectively opened a loophole for unlimited speculation. When Index Speculators enter into commodity index swaps, which 85-90% of them do, they face no speculative position limits.
The really shocking thing about the Swaps Loophole is that Speculators of all stripes can use it to access the futures markets. So if a hedge fund wants a $500 million position in Wheat, which is way beyond position limits, they can enter into swap with aWall Street bank and then the bank buys $500 million worth of Wheat futures. In the CFTC's classification scheme all Speculators accessing the futures markets through the Swaps Loophole are categorized as "Commercial" rather than "Non-Commercial." The result is a gross distortion in data that effectively hides the full impact of Index Speculation.
Additionally, the CFTC has recently proposed that Index Speculators be exempt from all position limits, thereby throwing the door open for unlimited Index Speculator "investment." The CFTC has even gone so far as to issue press releases on their website touting studies they commissioned showing that commodities futures make good additions to Institutional Investors' portfolios.
ASLEEP AT THE WHEEL
I am amazed at the spirited defense of the legitimacy of speculators in the commodities markets. The Ecnomist, in a recent issue, stated that speculators are not responsible for the rise in oil prices because oil speculators only purchase "paper barrels" and do not take delivery of the oil. Hedge funds state that that there is always a buyer and seller of oil futures and, since the speculators sell to users of oil, the speculators do not impact prices. This logic is specious.
Congress has a bill in the works which would impose an excess profits tax on oil companies (only worth $17b over 5 years), increase margin requirements on oil speculators (they should bar them from trading) and allow the US government to charge OPEC with price fixing (OPEC could just stop selling to the US or charge higher prices).
As I have stated before, the short term solution to high energy prices is relatively simple and could be done very quickly. The steps to be taken would be to remove all tariff and quotas on Brazilian ethanol imports to the US and close the swaps loop hole in the Commodities and Exchange Act.
Beyond the impact on energy prices caused by speculators, I have a significant concern that the highly leveraged speculation in energy markets has created another liquidity bubble which may require Fed intervention when the bubble bursts. Given that pension funds have been large investors in commodity futures, a deflation of the commodities bubble will negatively and significantly impact corporate earnings. Many pension funds have realized such significant invesment returns that they have significantly reduced their annual contributions to the funds. The pension fund for one arm of Philip Morris in 2007 had such high returns that they were able to reduce their 2007 contribution required to fully fund future retiree benefits by $150 million.
I am amazed at the spirited defense of the legitimacy of speculators in the commodities markets. The Ecnomist, in a recent issue, stated that speculators are not responsible for the rise in oil prices because oil speculators only purchase "paper barrels" and do not take delivery of the oil. Hedge funds state that that there is always a buyer and seller of oil futures and, since the speculators sell to users of oil, the speculators do not impact prices. This logic is specious.
Congress has a bill in the works which would impose an excess profits tax on oil companies (only worth $17b over 5 years), increase margin requirements on oil speculators (they should bar them from trading) and allow the US government to charge OPEC with price fixing (OPEC could just stop selling to the US or charge higher prices).
As I have stated before, the short term solution to high energy prices is relatively simple and could be done very quickly. The steps to be taken would be to remove all tariff and quotas on Brazilian ethanol imports to the US and close the swaps loop hole in the Commodities and Exchange Act.
Beyond the impact on energy prices caused by speculators, I have a significant concern that the highly leveraged speculation in energy markets has created another liquidity bubble which may require Fed intervention when the bubble bursts. Given that pension funds have been large investors in commodity futures, a deflation of the commodities bubble will negatively and significantly impact corporate earnings. Many pension funds have realized such significant invesment returns that they have significantly reduced their annual contributions to the funds. The pension fund for one arm of Philip Morris in 2007 had such high returns that they were able to reduce their 2007 contribution required to fully fund future retiree benefits by $150 million.
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