In the last ten years the price of oil has gone up tenfold but the price of gas is up from $1 a gallon to $4 and the cost of oil is the biggest part of the price of gas. Adjusted for inflation, the average price of unleaded gas had been relatively stable at around $2 a gallon for nearly twenty years and the price of oil adjusted for inflation also had been more or less stable at about $30 a barrel from 1986 to the run up during the last few years.
What is responsible for the present price; here is what makes up the price of gasoline at the pumps:
Oil - 75%
Refining - 10%, a necessary cost factor that can’t be eliminated
Distribution, etc. - 5%, to get the gas to the pumps
Taxes - 10%, about 40 cents of $4 gas is taxes
All businesses in the chain, refiners, distributors, convenience stores, etc. are being squeezed in the process of enabling consumers to buy gas (Exxon is actually getting out of the service station business!).
With oil prices skyrocketing Chevron and Exxon should be making outrageous profit margins, right? So Democrats want to tax those "windfall" profits. But lets look at the reality:
From March 2007 to March 2008, Exxon's profit margin was just 10%. Meanwhile, its income tax rate was about 43%.
But when compared with the profit Microsoft made, oil company profits are relatively modest – the Microsoft's profit margin was over 28% and Microsoft's tax rate was under 30%.
Microsoft makes a greater profit margin than Exxon and it's taxed considerably less. Perhaps if anyone deserves an "excess profits tax," it's Microsoft, not Exxon. Yet no one has suggested taxing the "windfall" profits of the software giant. Actually, considering the economic definition of "windfall profits" – that being reaping a profit with no participation in the business – it is the government that enjoys "windfall profits."
Unfortunately right now people just want to hear that the government is doing something to fix high gas prices. Many people naively believe the gas stations and Big Oil companies like Exxon are gouging them.
But as you can see, calling for a windfall tax on "Big Oil" is a pretty dumb idea.
Another villain in the oil story according to Democrats is the "speculator". But are speculators the reason oil prices go up?
When we bet on a sporting event we do it because we think one team will win over the other or at least beat the ‘spread’. When we buy stock on the market we do it because we think the stock price will go up. When people buy or sell short commodities on the futures market they are betting that the price will go up or down before they have to deliver the commodity. Do these people affect the price or are they simply trying to profit from their judgment of the outcome?
Why do we think it’s any different for oil speculators?
Politicians in government read the pulse of the public and right now the pulse is racing about gas prices. Can the Democrats say that they are responsible for higher fuel prices, of course not! So there has to be a boogeyman out there to be blamed. First they call the oil company executives to the carpet to justify their "windfall" profits, which by any definition are not "windfalls" anyway, and like spectators at gladiator matches the public is satisfied to know that big bad oil companies are to blame because their congressman and senators tell them so. It’s easy to agree because - "look at the huge profits they make."
As gas prices go up, and maybe some people start to believe oil companies may not be responsible (look at what makes up the price of gas at the pump), then attention must be turned to the mysterious "oil speculators", all the while knowing that it is really the Democrats who don’t want to increase our supply of oil who are the real villains in the story. But the reality is again that this is not the case anymore than those speculating that the price of wheat or corn will change in one direction or the other are responsible for the changing, i.e. increasing, the price of that commodity at the moment. If this were the case, then you would have to say that a while ago when Hillary Clinton made a 2,000% profit on futures trading, she was responsible for the price of beef or whatever it was she was speculating in.
If those representing us really did understand the oil markets, they would know that the true sign of a speculative influence is not increasing trading volumes but rising oil inventories. Speculators would be hoarding oil - building up inventories either in anticipation of higher prices or as part of a scheme to drive prices. Yet according to the Department of Energy, U.S. oil inventories are now at below-average levels. U.S. oil stocks stand at 309 million barrels, versus 330 million in June 2005. In reality it is the oil producer that affects the market more by increasing or decreasing the supply of oil available on the market.
Condemning futures traders is probably good politics, but it's an ignorant public policy. The only way to lower prices at the pump is by increasing the supply of oil; the law of supply and demand never fails if let alone.
Without speculators willing to take both sides of futures contracts, oil refiners and other end-users might be inclined to store more oil as a hedge against further price increases and this would further increase buying on the spot-market. Any increased demand when oil supplies are decreased by building inventories obviously leads to even higher oil and gasoline prices.
A basic misconception is that speculators are really buying. They're not buying oil, they're buying futures, and this is a very important distinction. A futures contract is an agreement between a buyer and a seller to deliver a certain amount of oil, usually 1,000 barrels, at a specific price on a specific date. The value of that contract rises and falls, depending upon market conditions, right up until the date of delivery.
Who buys these contracts - the pension funds, index funds, hedge funds and other so-called speculators who almost never take delivery of any oil? Energy markets expert Craig Pirrong says "For speculators to be propping up the price of oil, they somehow have to be taking physical oil off the market"; Pirrong is a finance professor at the University of Houston's Bauer College of Business.
An example Pirrong gives is when the federal government decided to support cheese prices in the 1970s, it did so by buying up warehouses full of cheese and keeping it off the market. "Well, where's the cheese now?" Pirrong asks. "Where's all the oil that the speculators have held off the market?"
If you really believe that speculators are affecting oil prices, remember that affect can go in two directions. If speculators are driving up spot oil prices every time they buy futures, then the converse must be true too. There must be an equal and opposite downward push on spot prices every time that future is sold. In other words, critics of the futures market can’t have it both ways.
We should remember that futures trading require buyers and sellers. For every investor who is betting oil prices will go up, there also needs to be an investor willing to take the opposite side of that bet.
As New York Mercantile Exchange Chairman James Newsome explained to a congressional committee, speculators are evenly split between shorts and longs and the percentage of futures contracts held by speculators (as opposed to commercial traders) "actually decreased over the last year, even at the same time that [oil] prices were increasing."
We need to place the blame for our present oil situation where it belongs; on the Democrat congress, not on the artificial boogeyman created by the Democrats and their accomplices in the news media.