This year is an instant replay of 2008 with the average price of regular gasoline in the US expected to reach $4 per gallon in the next month. Californians have already surpassed that mark and are heading for $4.50 per gallon by Memorial Day.
On Monday, April 11, Jeffrey Currie, the global head of commodities at Goldman Sachs (GS), told his clients that rising demand from emerging market players earlier this year had been overtaken by a supply shock driven by the MENA (Middle East and North Africa) unrest.
“That has had the effect of introducing more downside risk into the trade, particularly given record levels of speculative longs (trading) in crude,” In other words, he advised them to sell – sell – sell WTI (West Texas Intermediate) crude oil and investors, like lemmings, followed him off the cliff. The WTI crude oil price reacted by immediately dropping almost $6 a barrel, or 5.8%, in two days.
However, the price of crude oil is not based purely on supply and demand and has a speculative element built into it, which is once again being heavily influenced by money flows from the big hedge funds such as Goldman Sachs (GS) and Morgan Stanley (MS). In other words, Jeffrey Currie pulled a head fake and his investors have been willing to go along with him.
Lloyd Blankfein, the CEO of GS, made his now infamous remark to the Sunday Times of London on November 8, 2009, saying: “Investment bankers are just doing God’s work”.
Today the MENA unrest has caused increases in crude oil prices and investment banks are taking advantage of the opportunity to make huge profits. In any other times, this would have been called war profiteering, but now it is considered business as usual with Gordon Gekko’s motto “greed is good” back in vogue.
WTI is being used as the short leg of a spread involving funds playing off the MENA unrest. Investors are going long on Brent and shorting WTI then moving in and out of that spread whenever economic data is released in the US.
The chart below indicates we now have a significant disconnect between WTI and Brent futures in recent months. The black line shows the New York Mercantile Exchange (NYMEX) WTI and the red line shows the ICE Brent front month futures with the green line showing the basis (difference) between the two:
The following chart produced by Doug Short shows the differential between WTI crude oil and the average price of gasoline for the last 10 years:
There are good reasons for the WTI prices to take a big plunge in the next few weeks with crude oil inventories at Cushing at an all time high. The direct connection to supply and demand was lost after paper traders took over managing those inventories at the Cushing, Oklahoma hub.
On Wednesday, April 13, the benchmark WTI crude oil price closed up 86 cents at $107.11 a barrel on the NYMEX after dropping 3.3% on Tuesday. The Brent crude oil for May delivery also went up to near $123 a barrel on Intercontinental Exchange (ICE) in London.
Goldman Sachs (GS) has enough investors following their advice to be able to control the ups and down of crude oil. Meanwhile, the organisation of Petroleum Exporting Countries (OPEC) said higher prices have begun to chip away at fuel consumption, but did not call for an emergency meeting to address the situation.
President Obama could soon make another call for a windfall profits tax on major oil companies, which could bring in nearly a billion dollars a day for the US Treasury. He called for just such a tax during his campaign in 2008 at the height of the last speculative run up in gasoline prices.
In the end, the additional cost of crude oil comes out of the consumers pockets. The high gasoline prices are costing the U.S. consumers $360 million per day more versus the price paid last year at the pump.
About The Author – Bob van der Valk lives in Terry, Montana and is a Petroleum Industry Analyst with over 50 years of experience in the petroleum, gasoline and lubricants industry. He has often been quoted by news media and his opinions are also solicited by government entities in addition to his daily business of managing large scale supply and marketing operations.
The views and opinions expressed herein are the author’s own and do not necessarily reflect those of EconMatters.