Runaway Energy Costs – causing inflation and panic

Runaway Energy Costs – causing inflation and panic

Spurred by soaring energy costs, food prices and other goods and services have risen nearly 20 percent or more in the past 20 months — more than double the usual increase.

Commodity prices for corn, wheat, soybeans and other staples have been skyrocketing over the past year to more than double their prices from 2006.

Economists have also pointed toward the growing demand for grains for ethanol and other biofuels, tying the price of corn to the price of oil and increasing the pressure and demand for land use.
“It is important to note the contribution of runaway energy prices to the retail cost of food goods and services. “Transportation, processing and packaging all cost significantly more now than in prior years.”
The snowball effect of soaring energy prices is causing increased prices for all goods and services, from food, medical, construction and other material.
Speculation is often criticized as the cause of surging grain prices. But the current abnormal price increases could not have occurred without firm demand. Indeed, farmers are cultivating cash plants while buyers are seeking cheaper alternatives, forming a chain of price surges.
World food production must rise by 50 percent by 2030 to meet increasing demand.

Biofuels to blame?
The increasing diversion of food and animal feed to produce biofuel, and sharply higher fuel costs have also helped to shoot prices upward, experts say.

The senate and the House should call for expanded funding for weatherization and tax credits for other energy-saving programs, $100 billion for expansion of mass transit systems, $100 billion for renewable energy development and renewable energy projects and $50 billion in bonds for roads, bridges and other transportation projects.
Traders are also at fault

A boom in speculation and trading by investment banks and hedge funds has put our energy markets on steroids. Contract volume in the futures markets has risen by a third in just the last year. Oil closed at a record high of $125.96 a barrel (USO: , , ) on the New York Mercantile Exchange on Friday. That's double the price two years ago, a difference clearly caused by market manipulation.

This isn't complicated finance. The way traders push up prices is surprisingly simple. They buy in European futures markets, which don't have the limits that U.S. markets do. That drives up U.S. prices where they may already have positions. It's a move to think about next time one of these exchange chiefs talks about all of the benefits of "market globalization."

None of it would matter except that these markets are supposed to be driven by supply and demand. China and other rapidly growing countries may be using more, or will use more resources, but the reality is that demand and supply haven't changed enough to warrant the price of oil doubling in less than three years.

Hedge Funds and Banks driving oil prices
In the most recent sustained run-up in energy prices, large financial institutions, hedge funds, pension funds, and other investors have been pouring billions of dollars into the energy commodities markets to try to take advantage of price changes or hedge against them. Most of this additional investment has not come from producers or consumers of these commodities, but from speculators seeking to take advantage of these price changes. The CFTC defines a speculator as a person who “does not produce or use the commodity, but risks his or her own capital trading futures in that commodity in hopes of making a profit on price changes.”

The large purchases of crude oil futures contracts by speculators have, in effect, created an additional demand for oil, driving up the price of oil for future delivery in the same manner that additional demand for contracts for the delivery of a physical barrel today drives up the price for oil on the spot market. As far as the market is concerned, the demand for a barrel of oil that results from the purchase of a futures contract by a speculator is just as real as the demand for a barrel that results from the purchase of a futures contract by a refiner or other user of petroleum.

Perhaps 60% of oil prices today pure speculation

Goldman Sachs and Morgan Stanley today are the two leading energy trading firms in the United States. Citigroup and JP Morgan Chase are major players and fund numerous hedge funds as well who speculate.

In June 2006, oil traded in futures markets at some $60 a barrel and the Senate investigation estimated that some $25 of that was due to pure financial speculation. One analyst estimated in August 2005 that US oil inventory levels suggested WTI crude prices should be around $25 a barrel, and not $60.

That would mean today that at least $50 to $60 or more of today’s $115 a barrel price is due to pure hedge fund and financial institution speculation. However, given the unchanged equilibrium in global oil supply and demand over recent months amid the explosive rise in oil futures prices traded on Nymex and ICE exchanges in New York and London it is more likely that as much as 60% of the today oil price is pure speculation. No one knows officially except the tiny handful of energy trading banks in New York and London and they certainly aren’t talking.

By purchasing large numbers of futures contracts, and thereby pushing up futures prices to even higher levels than current prices, speculators have provided a financial incentive for oil companies to buy even more oil and place it in storage. A refiner will purchase extra oil today, even if it costs $135 per barrel, if the futures price is even higher.

As a result, over the past two years crude oil inventories have been steadily growing,

resulting in US crude oil inventories that are now higher than at any time in the previous eight years. The large influx of speculative investment into oil futures has led to a situation where we have both high supplies of crude oil and high crude oil prices.

Compelling evidence also suggests that the oft-cited geopolitical, economic, and natural factors do not explain the recent rise in energy prices can be seen in the actual data on crude oil supply and demand. Although demand has significantly increased over the past few years, so have supplies.

Over the past couple of years global crude oil production has increased along with the increases in demand; in fact, during this period global supplies have exceeded demand, according to the US Department of Energy. The US Department of Energy’s Energy Information Administration (EIA) recently forecast that in the next few years global surplus production capacity will continue to grow to between 3 and 5 million barrels per day by 2010, thereby “substantially thickening the surplus capacity cushion.”

Compiled by:  YJ Draiman