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Tuesday, July 22, 2008

The Slimy Truth About Oil Prices

You've simply got to love the over-simplified, under-reporting modern day media. Just when you think they've managed to dumb the news down, they find a way of dumbing it even, um, downer. My favorite dumb news story of the year has to be the continuing saga of oil prices, with every pundit proclaiming his or her theory as to why you're paying twice as much for gas as you did two or three years ago.

Some of these wiseguys peg the pricing to a mythic relationship between supply and demand. "We're using up oil faster than we can produce it," they whine. "What we really need to do is drill or more oil. That way, there will be more supply and the prices will drop."

Um, no. Hate to tell you this, but it doesn't work that way and hasn't worked that way for several decades. If you really want to know why the price of gas and oil has broken through the roof, you can blame the screen on which you're reading these very words. Yup, it's not supply and demand that's messing up your driving vacation.

It's technology. And this is how it happens:

First, understand that half of any solution is in identifying the problem. Once you figure out what the problem is -- and I mean really identifying the problem as opposed to accepting what drools out of any talking head, you're going to find that there's plenty of oil out there. Tons. Thousands of tons. Millions of barrels. Check out your history books and start looking up the last time the world's major oil suppliers actually reduced their output of crude. While you may find one or two events, you'll find plenty more instances in which the members of OPEC who cut their production were undercut by other members who increased production to make up the difference.

Second, if you look at the price of oil from 2006 to 2008, you'll see a massive increase in the price, but no major difference in the amount of oil produced. Starting to smell something funny? If supply and demand were really to blame for oil price increases, wouldn't the amount of oil being delivered throughout the world be shrinking?

Well, it's not. In fact, the Saudis just turned the spigot by something like a half million barrels a day and prices actually went up.

So if supply isn't affecting anything, and demand isn't affecting anything, how would technology affect anything? Easy: Because it's the job of technology to transmit and manipulate information, it's technology by which market makers choose their actions. And since the technology is interpreted and manipulated by humans, what appears to be raw, technological data is actually raw, human emotion at work.

Consider the fact that the average barrel of crude is traded back and forth ten to twenty times before it ever reaches its refinery. That's a lot of people buying and selling, speculating -- and hoping -- their investment goes up. Which means the oil market itself is driving up the price of oil. Not the oil companies. Not the arabs. Not OPEC. It's good old American free market capitalism, powered by nano-bits of data and genuine human greed -- and panic -- that determines the price of oil.

Think I'm out of line? Let's switch from the sticky stuff and go for the green. Throughout July, 2008, the most battered sector of the stock market was the financial sector. Prize stocks like Bank of America (BAC) and Citibank (C) got taken to the cleaners. Bank of America, perhaps the strongest banking organization in the country, saw its stock slide from the mid-30's to $19 a share. Why? Did all of BAC's investments and value suddenly evaporate? Of course not. But you'd never know that if you watched the market -- and the media -- panic about the future of financials. Those of us who prefer truth to tantrums quietly bought more BAC at $20 or $22 and saw the stock climb back into the low 30's a few days later.

Same thing is happening to oil. It's not the people who produce it or refine it or drive Escalades and Hummers that are driving up the price of oil. It's the guy glued to his trading screen, basing his calls on what other traders looking at their screens are doing. It's the internet, baby.

And all this time you thought it was for downloading free porn.

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