Friday, November 07, 2008

What's With the Price of Oil?

Note: I wrote this post several weeks ago, but am only getting around to posting it now.

Last week, while the Dow Jones index was showing a precipitous decline, my thoughts turned toward "opportunities" to protect the current value of my savings. I've always been cautious regarding investments, to the point of (perhaps) hurting myself. Even when things looked rosy, I hesitated to buy into the American economy. For far too long the financial system has felt like a shell game. It doesn't seem like we make anything anymore, although (of course) I realize that isn't really true. Still I get the feeling that, more than anything else, the "success" of the dollar has much more to do with how fast people can keep it moving. So much of the time it seems like nothing is being produced in that process.

I'd be the last person to try and claim any expertise when it comes to understanding market forces. But now I am suspicious of so many who have put themselves forward as experts. There have been so many layers of complexity and obfuscation that no one really can provide a straight answer that will describe the current situation. Most of the time it appears that people are merely making decisions based upon "gut feelings". A consensus builds that the current climate is favorable, or alternatively that it is perilous, and ordinary folks tend to accept whatever conclusions are put forth in the name of "conventional wisdom". Ultimately if the argument can be framed in terms of supply and demand, then the argument is all the more convincing.

So what makes the price per barrel of crude drop so quickly at the same time the market is tanking? Logic suggests that as the US dollar value decreases, the cost of gasoline should rise (and vice-versa). Yet one of the most dramatic downturns of the economy in 100 years has been accompanied by sharply decreasing prices. One could suggest that the oncoming recession (or depression, or whatever) is has been affecting the demand for oil. After all, less activity requires less fuel. However, I'd be surprised if the markets are really responding that fast. One could also point to the frenzied speculation on energy commodities over the past year. That could certainly be playing a role as well.

The interesting thing is that when I talked about investing in oil commodities to a friend who many recognize as a "financial wizard", he advised me against it. His outlook on the potential recovery of the banking and credit systems is intensely pessimistic, and he expects oil prices to continue on a steep decline. And yet that still seems counterintuitive to me, as I would expect a functional resource of undeniable utility to retain (or even increase) its value during a sustained economic downturn. People may look to cut costs, but they still need to get to work. Add to that the variable of home heating costs during the upcoming winter, and everything appears further out-of-whack. It's hard not to suspect that there are shenanigans at work.

I've never gotten around to a formal study of the phenomenon, but it seems to me that gasoline prices always fall before a presidential election. I realize that oil trading is tied to the US currency, and that certainly complicates the picture even more. Ultimately we are at the mercy of these fluctuations, and it's disturbing that external forces could be manipulating the situation to make us act in a particular way. Alternatively, oil could merely be caught up in the huge sell-off of Wall Street, with everyone (including hedge funds) rushing to liquidate all their assets at once. I wonder if this affected the election cycle, with the challenge of energy independence seemingly at the top of everyone's list. I hope this crucial issue doesn't get relegated to the back-burner again.

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