30 July 2008

Continuing the Argument on Oil Prices: Fisking Public Citizen's Tyson Slocum

I've been meaning to try to keep my posts shorter, but this one isn't going to promote that trend. This post is an outgrowth of a long argument between yours truly and Gingerbaker, another regular at Ed Brayton's Dispatches blog. In a nutshell, Gingerbaker thinks I'm either naive or a "corporofascist" because I think increased demand is the primary cause of the last few year's increase in oil prices, and I think he's a silly conspiracy theorist because he believes its primarily caused by oil companies manipulating the market. It would take far too much space here to recount all the points of disagreement, but Ginger thinks I should read congressional testimony of Public Citizen's Tyson Slocum ( that gives evidence for oil company manipulation. As I noted in our argument, I don't doubt oil companies try to manipulate, so I'm sure it's not hard to find evidence of wrongdoing; I just doubt that the nefarious schemes of oil company execs could double the price of oil in two years. The odds of me being convinced by a report from Public Citizen--an organization that is reflexively anti-free markets because they think markets benefit corporations and harm consumers, exactly the opposite of what Adam Smith believed--is about the same as Richard Dawkin being led to an altar call by a Jack Chick tract. But I demanded that Ginger actually give me a source, rather than continue to make unsupported assertions, so it's only right that I actually look at it, rather than continue to bash it without reading it first.

First eyebrow raising claim:
At least $30 of the current $115 of a barrel of oil (or about 70 cents of a gallon of gasoline) is pure speculation, unrelated to supply and demand fundamentals.
Hooollly Cow! And what's his evidence for this? Well, I struggled to find it it. I did find this:
A recent bipartisan U.S. Senate investigation summed up the negative impacts on oil prices with this shift towards unregulated energy trading speculation:
.Several analysts have estimated that speculative purchases of oil futures have added as much as $20–$25 per barrel to the current price of crude oil...
Sooo....which analysts? Who? I have a deep fear that there is a bit of circularity going on here. Slocum--an analyst--claims speculation is causing the price increases, a Senate comittee mentions that in its report, then Slocum uses their report as evidence of his initial claim. OK, honestly I can't say that's going on, and I'll admit that it's not exactly fair to suggest it. But doesn't Slocum have some reponsiblity to give us real sources? I mean, he is giving congressional testimony and citing congressional testimony--even if he's not citing himself it's circular and doesn't get the reader back to any actual evidence or cite a reliable report.

Maybe it's not appropriate to ask that all this appear in congressional testimony (I think it is appropriate to so ask, but I'll play devil's advocate here); the fact remains that Gingerbaker wanted me to be convinced by this. He cited it as evidence, but it isn't evidence, doesn't have any evidence, so it's at least fair for me to critique it on that level.

Second, there's lots of worry about mergers.
In just the last few years, mergers between giant oil companies—such as Exxon and Mobil, Chevron and Texaco, Conoco and Phillips—have resulted in just a few companies controlling a significant amount of America’s gasoline, squelching competition. And the mergers continue unabated as the big just keep getting bigger.
Slocum appears to have been raised on Galbraith: "Big is bad!" "Firms can get so large they're no longer subject to market forces." Of course no economist I've read or met believes this anymore. If the struggles of GM, Ford, and Chrysler aren't proof that being big doesn't make you bulletproof, then nothing is.

But now I'm puzzled. Is the problem of high prices caused by mergers or by speculation? There's a Carnival Cruise Lines boat full of people doing "speculation" (what the less ideologically inclined call the futures market) who don't work for any of the oil firms. In fact one of the complaints in here is that investment firms are getting in on the act. I'll just leave aside the fact that Slocum obviously doesn't understand the purpose and value of futures markets, and leave it at the complaint that at the very beginning he's made two different claims. While they're not mutually exclusive, he doesn't tie them together for his audience.

Then there's:
five oil companies are reaping the largest profits in history.
Record profits, record profits, record profit. The mere fact of making record profits when prices are high is proof beyond a reasonable doubt of guilt, right? But Slocum completely misses the obvious--if you merge two profitable firms, they ought to make record profits! If they don't the merger was probably a damn mistake. Sure, higher prices played a big role in the record profits, but assuming the merger doesn't increase costs, they would have had record profits even if the price of gas had stayed the same. That's real simple math, but Slocum misses it.

And the charging of higher prices is not in itself evidence of wrongdoing. If demand for oil increases, what should an oil company do, raise prices or pump more oil? In fact they will raise prices first, an appropriate response because it signals to what would otherwise be oblivious oil consumers that demand has risen, so they can decide how to respond. This is a key point made by Hayek in his classic, "The Use of Knowledge in Society," but the role of prices as signals to consumers is still little understood. As prices rise, the return to oil companies increases, so more is pumped. I went to school in Bakersfield, California, and folks there were happy when the price of gas went up because people got called back to work to turn the pumps on. Often that brings the price back down, but lately it hasn't. Why not? Some people accuse the oil firms of hoarding the oil in the ground, as though they have a responsibility to pump it out as fast as possible. But in contrast to the popular belief that American businesses can't see beyond the next quarterly statement, oil firms are trying to maximize the long-term return on the oil in the ground. Pumping it out as quickly as possible now would be financially irresponsible, and from the social standpoint wouldn't do us any long-term good.

And when demand does increase, it would be socially irresponsible not to raise prices, because prices help ration the oil by intensity of demand. If I see the price go up by 25 cents a gallon, it tells me that some people want that gas enough to pay more for it than we did yesterday, and then I have to decide whether I want it as bad or not. If the price increase causes me to not drive to the city for Thai food this weekend, it's evidence that prices served their role of directing resources to their highest valued use. Slocum trots out the old trope that:
most [Ameriicans] lack the financial resources to make such investments [like insulating their homes] or lack access to alternatives to driving in their car.
This is simply false. Take me, for example: It's not uncommon for us to take two or three trips a day to the store, we drive our daughter the 5 blocks to swim practice, my wife drives the 1/2 mile to her work, and I drive the 1 1/2 miles to my work. We could easily change--and to some extent have--and we live in one of the classic no-public-transportation towns. Consumers are actually much more clever at figuring out ways to adapt than Slocum gives them credit for, but this is classic Ralph Nader/Public Citizen type stuff, 'standing up" for consumers while actually holding a vicious disdain for the intelligence of consumers.

The next puzzler:
oil companies are spending more money buying back their own stock then they are on investing in their ageing infrastructure
Slocum doesn't bother to explain why this matters. Perhaps he thinks it's self-evident, but I don't. If a company thought it could maximize it's profits by investing in infrastructure, they would do so, right? If they don't, then obviously they don't think their firm needs that investment. Now, who would I trust to make a better decision on that, the company's CEO or someone working for a public interest group? The CEO has a better incentive to use the business's funds wisely. They don't always, obviously, but what are the odds that outsiders with an ax to grind will, on average, do better? At any rate, Slocum comes dangerously close to suggesting the government ought to regulate such internal business decisions, a recipe for hamstringing the economy without benefiting anyone.

Now, get this one, which shows that Slocum should never--NEVER!--be your company's CEO.
The industry has plenty of incentive to intentionally keep refining markets tight. ExxonMobil’s new CEO told The Wall Street Journal that even though American fuel consumption will continue growing for the next decade, his company has no plans to build new refineries:
Exxon Mobil Corp. says it believes that, by 2030, hybrid gasoline-and-electric cars and light trucks will account for nearly 30% of new-vehicle sales in the U.S. and Canada. That surge is part of a broader shift toward fuel efficiency that Exxon thinks will cause fuel consumption by North American cars and light trucks to peak around 2020—and then start to fall. “For that reason, we wouldn’t build a grassroots refinery” in the U.S., Rex Tillerson, Exxon’s chairman and chief executive, said in a recent interview. Exxon has continued to expand the capacity of its existing refineries. But building a new refinery from scratch, Exxon believes, would be bad for long-term business.
Two points. First, there's the oft-repeated concern that "no new refineries are being built," often trotted out by asshat right-wingers who think high fuel prices are caused by environmentalists. Nice to see left and right come together on something /sarcasm]. But the companies are expanding their current refineries' capacity, because that's a whole hell of a lot more cost effective than building a new one.

Second, Slocum totally glosses over Exxon Mobile's reason for not building a new refinery; they expect fuel efficient cars to negate the need by 2020. Slocum wants Exxon Mobile to invest billions in a refinery that, by the time it could be up and running, would be useful for less than a decade! What kind of fucking moron would suggest that? One who's gone to Vegas to play roulette with other people's money and has his head so far up his ass he can't see where the ball is landing. And consider the effect if Slocum got a magic wish and each of these firms had a new refinery up and running tomorrow: if it brought gas prices back down to under $2, who would buy a more fuel-efficient car? Exxon-Mobile's refusal to expand refinery production too much is not only a good business decision, it's one that should have environmentalists jumping for joy. (And what are the odds someone working for Public Citizen isn't an environmentalist?)

Next is this, which may have a logic I'm too simple to grasp:
As a result of this strategy of keeping refining capacity tight, energy traders in New York are pushing the price of gasoline higher, and then trading the price of crude oil up to follow gasoline:
Well, I really don't know. But I wonder who's storing all that crude that's not being refined? I'd like to see the storage costs on billions of barrels of crude.

It gets weirder, really:
The U.S. Federal Trade Commission found evidence of anti-competitive practices in the physical refined product market in its March 2001 Midwest Gasoline Price Investigation:
An executive of [one] company made clear that he would rather sell less gasoline and earn a higher margin on each gallon sold than sell more gasoline and earn a lower margin. Another employee of this firm raised concerns about oversupplying the market and thereby reducing the high market prices.
OK, first, one firm's decision to try to keep prices high is not an anti-competitive practice; it's an anti-profit practice. And Slocum only cites one company here. Second, the preference to sell less for more, rather than more for less, is not an anti-competitive pratice--it's just a fuckin' preference! Slocum claims "evidence" (his word) of anti-competitive practices, but he doesn't actually provide evidence that it happened, just that at least one oil exec would like it to happen.

That's only about half of the testimony. The rest is primarily Public Citizen's 5 point plan for reform. It contains much I disagree with, such as how anti-trust law in the U.S. ought to be interepreted, greater regulation and oversight of energy trading markets. It also, however, contains details of the big oil companies nefarious schemes to jigger the market and make more money. Some of them I'll take as evidentiary, such as "In August 2004, a Shell Oil subsidiary agreed to pay $7.8 million to settle allegations of oil market manipulation." Businesses often settle when they're guilty, to avoid paying more, so I have no reason to doubt those specific types of claims. But others are less compelling:
In August 2007, Oil giant BP admitted in a filing to the Securities and Exchange Commission that “The US Commodity Futures Trading Commission and the US Department of Justice are currently investigating various aspects of BP’s commodity trading activities,
All BP has admitted is that they're being investigated, not that they've done anything wrong. Unless Slocum is willing to leave the left-wing of American politics and join the Constitution-hating right-wing, he might want to hang onto that "innocent until proven guilty" ideal.

And then there's this little gem, listed under "Latest Trading Trick: Energy Infrastructure Affiliate Abuse."
n 2003, Morgan Stanley teamed up with Apache Corp to buy 26 oil and gas fields from Shell for $500 million, of which Morgan Stanley put up $300 million in exchange for a portion of the production over the next four years, which it used to supplement its energy trading desk.
Admittedly I'm no expert on the energy industry, but what's the issue here? Slocum makes no attempt to explain what's wrong with an investment firm making a deal to put up 3/5 of the sale price in exchange for "a portion of the production." Isn't that a normal business practice, or am I way off here? Or is the problem that they're using their portion of the oil production to supplement their energy trading division? Why? I admit I could be missing something here, but this sounds like completely legitimate business activity to me, and Slocum makes no effort to explain why it isn't. What I have quoted is 100% of his comment on that topic.

In summary, this is about what I expected from Public Citizen: long on outrage and careful use of leading phrases (speculation, rather than futures markets), and short on supporting evidence and basic economic and business understanding. These ideological groups exist on both sides of the political spectrum, and their common failing is that their "research" is backwards: they've reached their conclusion and then they cherry pick and misinterpret facts until they have a mass of text that seems to support their arguments.

Ginger would probably say I've done the same thing: concluded the market is at work and tried to justify it. Given the way blog debates develop, it wouldn't be an unreasonable assumption. However I have been following this issue for a while, I am equipped with a knowledge of economics, and I look up things when I don't know. For example, in reviewing this testimony, I realized that I had no idea why businesses buy back their own stock, so I looked it up. Turns out it's not an underhanded business practice (unless the CEO is trying to pump up his own earnings, apparently, but that's not what's claimed here), but is sometimes the most productive use of a company's cash on hand. See, rather than assume what stock buybacks meant, I read up on it so I would understand. If I had found that it really was a dark and devious practice that harmed consumers, I would have had to adjust my views.

Finally, I couldn't possibly address every claim in a 20 page document, so it will be easy to attack me by saying, "but what about this." If anyone wants to, go ahead. Just don't think it's likely to be a telling blow: I'm perfectly capable of re-reading the testimony again (and again), in order to address any other issue brought up in it.

But I have my doubts Ginger will be convinced. I did this more for myself, so I'd know I hadn't ducked a challenge, not assuming he'd find my logic so compelling that he'd suddenly reverse course, admit my genius, and start a fanclub. I'm not that conceited. But once people have committed to an assumption that the other side is evil (the corporations, that is, not me), they're generally impervious to logic.


Troublesome Frog said...

Good post. I'm starting to notice that the "oil conspiracy" arguments start to look a lot like the 9/11 Truth movement and other conspiracy theories pretty quickly. They're not really coherent theories as much as a list of sinister-sounding tidbits. Nobody can put together a sound story explaining exactly how this manipulation is supposed to be happening.

The futures market example is perfect. You're asking the right question: Where is the oil going?

If you're not an oil producer and you want to manipulate the oil market, you have to take delivery of oil and use it or store it. If you're using it, you're not manipulating the market. If somebody was storing zillions of barrels of oil somewhere, we'd probably know about it. Unless somebody can find a huge lake of oil owned by some shady guy on Wall Street, I think that the "speculation" story is out.

If you're an oil producer who wants to manipulate the market, you have to cut output. There appears to be no evidence of that. Further, the future price of oil is close enough to the present price of oil that doing so is not going to be especially profitable. There's no evidence of reduced output or an incentive to reduce output.

So what gives? Where's the story? I would expect such a story to include how stealth hoarding (or "virtual hoarding" as Krugman called it) is happening or how one could change the price of a commodity in an apparently free market without shifting the supply or demand curves.

Actually, I don't want a story. I want a story that I can draw against supply and demand curves. I've heard a lot of long-winded and logical-sounding explanations, but I can't map any of them out in a way that makes sense quantitatively. As one of my econ professors said, "If you can't draw it, it can't happen." That has been pretty accurate in my experience.

James K said...

As I noted on Dispatches, the other part of this oil conspiracy that makes no sense is that monopoly power cannot exist in the absence of barriers to entry.

If its easy to start up new refineries then every attempt to squash competition will fail. If its hard then that's the problem that needs to be fixed. By its self market concentration cannot produce market power.

James Hanley said...

"They're not really coherent theories as much a list of sinister-sounding tidbits."

I hadn't thought it through to that point yet, but I think you're right. Thanks for stopping by T-Frog.

"monopoly power cannot exist in the absence of barriers to entry...By its self market concentration cannot produce market power."

In the testimony, Slocum himself points to a startup company that has built a new refinery. But instead of following your line of thought, he just asks why, if a startup can do it, Exxon-Mobile can't. And as to market concentration I think he says the largest 10 refiners in the U.S. control 50% of the market, and I'm just not convinced that's an example of too much concentration, compared to other industries (computers, fast food, cars, crayons, etc.).

James K said...

One thing peopel never learn in economics, unless they really focus on it, is the theory of "contested monopoly". This is a monopoly with no barriers to entry.

It can be proven that contested monopolies behave just like competitive markets, the only way to deter entry is to lower prices to competitive levels.

As such there is no such thing as too much concentration. Even if oil refining were a monopoly it couldn't profiteer unless it had barriers to entry protecting it.