Who is to blame for the soaring oil price?

07.05.2008

With the oil price at near-record highs and Shell (RDSB) and BP (BP) declaring record profits last week, there are various truckloads of drivel about the oil majors being ruthless profiteers doing the rounds at the moment. But who’s really raking in the money?

Let’s start with a multiple-choice question.

With the oil price above $100 a barrel, who makes the most money out of a gallon of petrol at the pump? Is it:

A. Greedy oil companies.
B. Greedy Opec members.
C. Our glorious Government.

You don’t really need me to answer that do you?

Who makes all the money from petrol? Well, something like 75% of the price you pay at the pump makes its way to whichever hard drive our government currently keeps its coffers in. Then of course those record profits that BP and Shell declared will mean record levels of juicy corporate tax.

Then there are those nice, taxable dividends that are being paid out to shareholders. And those thousands - or is it millions? - of people that BP and Shell employ all pay lovely income tax and NI. Then there’s tax on all the money the refiners make, and the explorers, and the transporters, and the traders and the petrochemical companies …

Yet the government still runs record budget deficits.

Who sets the oil price anyway?

There is also the ridiculous, facile notion doing the rounds that the high oil price is somehow the fault of BP, Shell and the other major oil companies. Utter cock-a-doodle-do.

Yes, they make a lot of money, yes their management get paid a lot, but companies such as BP, Shell and Exxon are small fry compared to National Oil Companies (NOCs). National Oil Companies, such as Saudi Aramco, control approximately 90% of the world's oil reserves and 75% of production (similar numbers apply to gas).

In addition, about 60% of the yet-to-be discovered reserves are estimated to lie in countries where NOCs have privileged access to reserves. Thus, future production is likely to stay dominated by NOCs. Indeed, if global supplies were controlled by companies such as BP and Shell, production would likely be more efficient and prices lower.

But the price of oil is not set by NOCs either, nor is it set by Opec.

The price of crude oil is set by movements on the three major international petroleum exchanges: the New York Mercantile Exchange, the International Petroleum Exchange in London and the Singapore International Monetary Exchange. In other words, it is set by the market.

Just like any good exchange, they are no doubt full of gamblers, speculators, scoundrels, and wide boys – people like you and me - but, nevertheless, the price agreed for a barrel of crude is a price agreed in a market that is, for the most part, free. You can manipulate it, you can influence it, but the overriding rules of supply and demand dominate in the grand scheme of things. The free market price of oil is rising because demand is greater than supply.

So stop blaming BP and stop blaming Shell. They’re just businesses and business is there to make money.

We all know why demand is rising. China’s energy consumption is rampant. India’s is not far behind. Then there’s that ever-expanding middle class appearing the world over. Demand has not declined in this recent economic downturn, nor will it do so by anything significant should the downturn worsen, as I’ve shown before (see here: Will oil hit $160 a barrel next week?). A few Westerners tightening their belts is insignificant compared to this once-in-a-century expansion in the East.

Meanwhile, the downward trend in new oil supply shows no signs of decelerating.

One supply that is on the increase, however - a supply that shows no signs of peaking - is the supply of money in the West. This wonderful chart from Gary Dorsch demonstrates how the rising oil price has merely matched the growth in the supply of money.

Another wonderful chart – this one from James Turk of Goldmoney – shows that, measured in a less-easily-inflated currency such as gold, the oil price, though high, looks far less dramatic:

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We have a confluence of factors that have led to higher oil prices: increasing global energy demand, particularly from China; decreasing supply; and monetary debasement in the West. None of these trends looks remotely interested in changing.

That's not to say the price will rise without a blip. For the moment, measured in gold and by its distance from the long-term moving averages, oil is looking expensive. From a technical perspective, oil could easily do a double top at $120 and retrace. If it does, make sure you buy some, if you don’t already own any.

Finally, I keep reading that a good way to ‘play oil’ is to own Shell or BP. Not necessarily so. Yes, these stocks are undervalued - hugely so. And if the stock market rally continues over the coming months, as I think it will, commodities stocks should do well. But, like gold, oil stocks do not necessarily go the same way as oil, though logic says they should. Since 2007 BP, is up 7 or 8%, Shell almost 15%. Oil is up about 80%. Which would you rather have owned?

Turning to the wider markets…

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The FTSE 100 was flat on Tuesday, ending unchanged at 6,215. Higher oil prices hit airline stocks but buoyed commodity groups.

Across the Channel yesterday, the Paris CAC-40 fell 23 points to end the day at 5,040. And in Frankfurt, the DAX-30 fell 35 points to 7,017.

On Wall Street, US stocks rebounded. The Dow Jones rose 51 points to end at 13,020. The broader S&P 500 closed up 10 points, at 1,418, while the tech-heavy Nasdaq gained 19 points to close at 2,483.

In Asia this morning, Japanese stocks hit a four-month high, with the Nikkei 225 rising 53 points to close at 14,102.

Crude oil was trading at $122.20 in New York. Meanwhile Brent spot was trading at $120.31.

Spot gold was trading at around $876 an ounce this morning, while silver was trading at $16.81. Platinum traded around $1,933.

Turning to forex, sterling was trading at 1.9562 against the dollar, and at 1.2628 against the euro. The dollar was last trading at 0.6459 against the euro and 105.19 against the Japanese yen.

This morning, Nationwide reports that UK consumer confidence is at its lowest in at least four years (its survey began in May 2004). Chief economist Fionnuala Earley said “Food and fuel prices remain high and with house prices no longer rising, it is unlikely that consumer confidence will pick up very quickly.”

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