ECONOMY
Why So High?
Rising gas prices and the high
cost of a declining U.S. dollar.

By Thom White

On January 2, 2008, the New Year's first day of trading, crude oil in New York sold for $100 a barrel for the first time ever. At the time of the U.S. invasion of Iraq in 2003, a barrel of crude sold for about $27.00.

Americans have won the war to "secure our oil." Five years later, our military holds a commanding position over the export of that grand supply of Iraqi petroleum. The Times (UK) reported (1/31/08), "Oil production in Iraq is at its highest level since the U.S.-led invasion of 2003, reaching 2.4 million barrels a day, thanks largely to improved security measures in the north." Yet, if we are in control over more supply than before, why has the crude oil price in the U.S. almost quadrupled since our victory?

After gas prices came down during the first Reagan-Bush term, Americans spent most of the 1980s with gas under a dollar a gallon, and then most of the '90s with gasoline hovering around $1.00 to $1.25. Now it is almost $3.00 a gallon anywhere you go, and this is only January, the "low season" for gas prices.

For some reason, especially during the last few years, starting in February, prices at the pump begin to climb for months on end. Gas attendants across the nation get busy changing the prices multiple times a week, and always "up," "up," and more "up," until sometime in early summer when there is usually a slight reprieve, and they knock it down a nickel for the driver's benefit.

War Spending and the Declining U.S. Dollar
by Rick Aster

In case the creeping rise in gas prices over the last few years has been a bit of a blur to you, our anonymous friends at Wikipedia dot-org, have highlighted some of oil's record-setting milestones during the early 21st century (trust this wiki-info at your own risk):

The price on the New York Mercantile Exchange (NYMEX) has been above $50/barrel since March 5, 2005. On March 16, 2005, the price surpassed the October 2004 high of $55.17 to close at $56.46. In April 2005, the price began to fall, reaching $53.32 on April 9. It then reversed course and headed to an all time high of $58.28, driven mainly by lingering concerns of a prolonged weak dollar. In June 2005, crude oil prices broke the psychological barrier of $60.00.

By early 2005, crude oil was already double the price it had been two years prior. Rumors of a planned U.S. bombing attack against Iran's nuclear facilities caused supply worries, and kept crude oil prices high. Then, during the last week of August 2005, a hurricane battered the Gulf Coast, and the city of New Orleans ended up getting flooded after the storm. Supply routes were blocked, and panic ensued. On Aug. 30, oil went up to $70.85 a barrel during the middle of trading day, the first time the price had ever climbed over $70.00. Americans would pay record gasoline prices for weeks that September, especially in the South and Midwest:

In the United States, gasoline prices reached a record high during the first week of September 2005 in the aftermath of Hurricane Katrina. The average retail price was nearly $3.04 per gallon. The previous high was $1.42 per gallon in March 1981, which would be $3.20 after adjustment for inflation. By comparison, the average retail price of a "litre of petrol" in the United Kingdom was 86.4 pence in October 2006. This equates to $6.13 per U.S. gallon.

Prices came back down after the disaster in New Orleans, but not to previous levels. Two-dollar gas was here to stay, and stories about the proposed U.S.- Israeli assault on Iran lingered, causing spikes on the market. Crude oil hit a six-month high of $64.00 a barrel on March 29, 2006, when, according to The Associated Press"... it was rumored that Iran fired a missile at an American ship in the Persian Gulf."

Then, right in the middle of "driving season" in 2006, the war on the Middle East was expanded with Israel's assault on Lebanon. The price of gasoline escalated to over $3.40/gallon in California, and near or over $3.00 in most other parts of the U.S. Ongoing "unrest" in Nigeria also cut supply, and a combination of events would help set a new string of crude oil records:

Regular gasoline prices were averaging $3.03/gallon across the U.S. in August 2006, slightly below the post-Katrina peak of $3.057. Adjusted for inflation, these U.S. prices were the highest in 25 years [since 1981]. … In July 2006, crude oil for August delivery traded over $79.00 a barrel, an all-time record. … Hostilities in Nigeria alone caused a supply disruption of 675,000 barrels/day. On August 7, British Petroleum (BP) shut down its Prudhoe Bay, Alaska, field due to pipeline corrosion, bringing supply down by almost 400,000 barrels/day or about 8% of the total U.S. production.

In the fall of 2006, crude oil prices dropped for a sustained period, and in Austin, for example, gasoline was just a smidgen above $2.00 for a few weeks:

By October 3, the crude oil price closed at $58.68 a barrel, its lowest close since mid-February. Reasons for the recent price decreases included easing tensions with Iran, ample supply, and the lack of hurricane activity in oil-producing regions of the Gulf of Mexico.

But starting in February 2007, gas prices went nothing but up, up, and away. By mid-May, people in the Midwest and in California were paying up to $3.49 a gallon. Texas had an average gasoline price over $3.00, and according to a AAA study, the average gas price in Texas had gone up exactly a dollar a gallon in the space of only four months. Prices eventually subsided during the summer, but again, always finding balance at a new, higher price. The crude oil price, which had stayed around $60.00 a barrel for most of the year, took another great leap forward in the Fall 2007:

On September 12, 2007, oil prices rose to an all-time high of $80 per barrel, which surpassed even the [inflation-adjusted] highs of the early 1980s. … On October 19, 2007, US light crude rose to a new height of $90.02 per barrel due to a combination of ongoing tensions in eastern Turkey and the reducing strength of the U.S. dollar … On November 7, 2007, light crude oil reached another record, closing at $98.10 per barrel.

When crude oil barrels hit a record $98.00 (up $35.00 in just six months), MSNBC's John W. Schoen appraised the situation (11/07/07) and gave a list of factors, including the weakening dollar and supply worries, that were driving prices sky high:

The average price for a gallon of regular gas shot up 14 cents in the latest week to $3.01, according to numbers released Wednesday by the Energy Department. That's still below peak price of $3.21 in the week in May, but up 81 cents from this time last year [2006].

Despite brief pauses, crude oil prices have risen relentlessly since May, as a strong global economy continues to burn through supplies as quickly as producers can replace them. A falling U.S. currency, meanwhile, has increased the price in dollar terms and stoked buying by investors looking for a place to hedge the dollar's decline. …

Buyers of oil are worried about more than the falling dollar. Until earlier this decade, global oil production capacity included a bit of slack, most of it controlled by the Organization of Petroleum Exporting Countries, which tried to manage prices -- with mixed success -- by increasing or withholding production. That supply cushion has been all but eliminated as global demand, fueled by rapidly growing economies, has risen faster than new supplies are found and developed. …

At the same time, oil producers, both state-owned oil companies and private global giants like ExxonMobil and Chevron, haven't been able to increase supplies fast enough to meet that new demand. Part of the problem is that the cost of developing new supplies -- everything from drilling rigs to the people who operate them -- has skyrocketed. The cost of building new oil and gas production facilities has roughly doubled since 2005, according to a report released Wednesday by Cambridge Energy Research Associates. …

Meanwhile, political instability in major oil producing regions -- from Nigeria to Venezuela -- threatens to further crimp the flow of oil. Recent U.S. saber rattling with Iran has added to concerns about possible supply interruptions.

Oil: High demand or high inflation?

Steep gasoline price increases are often related to pressures on supply, refining costs and refinery slowdowns, and signs of war. But the price rise in the U.S. is not a reflection of the value of oil going up, but more a sign of the eroding value of our unit of measure: the U.S. dollar.

Crude oil and gasoline are just two commodities whose price has gone through the roof on the world market in terms of U.S. dollars. The New York Times reported (1/20/08):

The price of copper has tripled in five years. Zinc has doubled. Wheat and soybeans rose 70 percent in 2007. Futures prices of crude oil, gold, silver, lead, uranium, cattle, cocoa and corn are all at or near records.

Some economic observers have noticed the inflationary trend in the dollar for years. In the spring of 2004, Richard C. Leone and Bernard Wasow sounded the alarm in the Los Angeles Times (4/1/04) on the reasons for a price spike in the U.S. in particular:

Gasoline and heating oil prices in the U.S. are at an all-time high and rising. But it may surprise Americans to learn that in Europe, they've essentially remained steady. Because oil is oil wherever it's used, why the cost difference? … Between the end of February 2002 and the end of February 2004, the price of oil in dollars rose by 51% (from $20 a barrel in 2002 to about $32 a barrel), but it rose by only 4% in euros. Over the same two-year period, the value of the dollar plunged from 1.16 euros per dollar to 0.80 euros per dollar. In this situation, it is perfectly rational for foreign suppliers of oil to charge more in dollars to make up for the falling value of our currency. …

They then went on to explain that the decline of the U.S. dollar compared to other currencies was tied to the huge deficit spending by the Bush Administration:

Thanks to the unbalanced policies of the last few years, the U.S. will be pumping out trillions of dollars of new federal debt. Financial markets -- and oil producers -- are afraid that a future glut of bonds will drive down the value of these bonds and, sooner or later, drive up U.S. interest rates. The prospects of falling prices of Treasury bonds and a weak dollar have depressed European demand for U.S. Treasury bonds, so the value of the euro has further risen relative to the dollar.

Gasoline prices in 2004 were on a noticeable upswing, even though the U.S. had just won the war in Iraq to "secure our oil." People began to ask the question, "What's the deal with the gas price?" An April 19, 2004, Business Week article by Robert Kuttner aimed to give readers "The Real Reasons For Your Pain At The Pump." He offered the reader some perspective, drawing a connection between current events and the country's first "oil shock" in 1973 that resulted soon after the devaluation of the U.S. dollar in 1971 by the Nixon/Kissinger administration:

… in all this public debate, hardly anyone is talking about what is probably the most important reason behind the current run-up in oil prices -- the weak dollar.

Those who recall the first OPEC oil shock in 1973 will remember the central role played by the weak greenback. In the period from 1971-73, the U.S. ceased being able to maintain the Bretton Woods system of fixed exchange rates, with a dollar pegged to gold at $35 an ounce. Dollar devaluation ensued, followed by floating exchange rates. For OPEC, this reduction equaled a huge cut in revenue, because oil is priced in dollars. Since OPEC is a cartel, it has a fair amount of pricing power. Dismayed by the lost income, and irritated at Western support for Israel in the 1973 Arab-Israeli war, the OPEC nations decided, for the first time, to use that power to extract a large oil price increase. The U.S. economy suffered accordingly. … Fast forward 30 years. The dollar has again lost a large part of its value (over 40% against the euro since 2002, and more than 20% against the yen). For oil-producing countries, this equals another enormous revenue loss, and they are raising prices to make it up.

But in Kuttner's view, the price of crude oil is just one problem of a seriously lagging U.S. economy:

… median wages have not kept pace with inflation. Consumer and business debt are high … The economy also suffers from a chronic trade imbalance that is increasingly structural. With fiscal policy exhausted, the Federal Reserve has had to come to the rescue with very cheap money. Extremely low interest rates, of course, yield a weaker dollar.

Energy analyst Bill Powers published an editorial in his Canadian Energy Viewpoint publication (March 2004) in which he asserted the world was witnessing, "the early stages of a monumental decline in the value of the U.S. dollar … there is no doubt that the falling US dollar has raised concerns over whether it is prudent for oil exporting countries to price a significant portion of their GDP in a depreciating currency."

While most traders are simply demanding more dollars for valuable commodities, the currency's weakness has led some oil marketers to cease accepting payment in U.S. dollars, preferring the exchange in either euros or Japanese yen. Bill Powers reported how Iraq was the first country to cease accepting payment in U.S dollars. As both a political move, and in order to avoid the creeping "inflation tax," of the U.S. dollar, Iraq began in 1999 to sell oil using the newly unveiled European currency, the euro. Some have suggested Iraq's refusal to accept the U.S. dollar as legal tender may have been one motivation that propelled the Bush administration's strong desire to topple Saddam Hussein's government, even before the events of Sept. 11, 2001. In any event, soon after the U.S. conquest of Iraq in 2003, Iraqi oil producers changed policies and accepted dollars again in exchange for their output.

In his commentary, Mr. Powers speculated that this move toward the use of competing "fiat currencies," like the yen and euro, may only be temporary, and that within a decade, the Arab crude oil producers may tie the value of oil to that of a commodity, specifically gold:

While many have argued that pricing oil in euros will lead to higher oil prices, not much attention has been given to the possibility of oil being priced in gold. While this might seem like a fringe idea, those who have an appreciation for gold's place in many Muslim oil-exporting countries believe the pricing of oil in gold is inevitable.

The launch in late 2000 of the e-dinar, a Muslim currency that is backed by gold held in a vault in the Dubai International Airport, has allowed many Muslims an alternative to Western currencies. The e-dinar program is an electronic form of the historic Muslim gold dinar. The gold dinar dates back as far as 700 A.D. and was in circulation until 1924, when the Ottoman Empire collapsed.

One e-dinar is backed by 4.25 grams of 24K gold. E-dinar account holders can have their account balances exchanged into any major currency or take physical possession of an equivalent amount of gold. … I am rather confident that several Muslim countries will price their oil in gold before the end of this decade. The simple reason behind this change is that the US dollar and the euro are going to steeply depreciate against the value of gold.

The Independent (UK) published a report on the dollar's decline, with the headline declaring it a "shunned currency." According to Andy McSmith's report (11/17/07):

Professor Riordan Roett, of Johns Hopkins University in Baltimore, told Bloomberg News: "There is a loss of confidence in the dollar and the US. It may only reflect the widespread dismay with the Bush administration, but it is obvious that the next administration, of either party, will have a steep uphill struggle." As well as reaching its lowest level against the euro, which has been trading at more than $1.47, the dollar has also fallen to its lowest level against the Canadian dollar since 1950, sterling since 1981, and the Swiss franc since 1995.

Its plight was made still worse by a jarring signal from China that it was switching to other currencies. Cheng Siwei, vice-chairman of the Standing Committee of the National People's Congress, told a conference in Beijing: "We will favour stronger currencies over weaker ones, and will readjust accordingly."

The warning was reinforced by a Chinese central bank vice-director, Xu Jian, who said the dollar was "losing its status as the world currency." …

China has stockpiled £700 billion (more than $1,000 billion) worth of foreign currency, and has only to decide to slow its accumulation of dollars to weaken the currency further. Last month, in a humiliating turn of events, the central bank in Iraq, four years after the United States invaded, stated that it wished to diversify reserves from a reliance on dollars.

Korea's central bank has urged shipbuilders to issue invoices in the local currency and take precautions against the weakened dollar, and three of the world's big oil exporters, Iran, Venezuela, and Russia, are demanding payment in euros rather than dollars. Iran insisted that Japan should make all its payments for oil in yen, rather than dollars.

Gasoline price outlook: 2008

Whenever people are concerned about where price of oil is headed, they often turn to the Organization of Petroleum Exporting Countries, an international price-fixing cartel, to see what they think. Leaders from each of the OPEC member countries meet on a regular basis, and the New York Times reported on their December 2007 meet-up:

According to informed observers, at the meeting in December 2007, OPEC members seemed to desire a high but stable price that would deliver substantial needed income to the oil producing states, but avoid prices so high that they would negatively impact the economies of the oil consuming nations. A range of $70-80 a barrel was suggested by some analysts to be OPEC's goal.

In the run-up to their pricing strategy meeting on February 1, 2008, in Vienna, Austria, several OPEC ministers suggested their national marketers will likely demand more than $100.00 a barrel in 2008. The Midland Reporter-Telegram (1/20/08) reported that Libya's minister believes "prices are more likely to increase and exceed $100 [a barrel] than they are to decrease," while "Venezuela suggests $100 oil is justified because of the higher costs associated with production, and because of the dollar's declining purchasing power. Bloomberg [news] noted Rafael Ramirez, the state's oil minister, suggested the cost of goods and services for oilfield development have tripled."

However, Indonesia's OPEC minister "will propose OPEC boost supplies [because] OPEC doesn't want prices to stay so high." United Arab Emirates oil minister, one Mr. al-Hamli told the media, "OPEC is prepared to provide more crude to the market if needed; however, he's said today's prices are not being caused by a shortage of supply."

The Midland Reporter-Telegram also published some predictions for 2008 by the Energy Information Agency (EIA), a division of the U.S. Department of Energy:

According to the EIA's latest Short Term Energy Outlook, the oil market will remain tight throughout 2008. They forecast crude will average $87.00 per barrel during the year, an increase of $15.00 on their 2007 average. However, because of higher production capacity coming from OPEC and non-OPEC nations, the EIA sees prices falling $5 in 2009 as spare capacity reaches about 4 million barrels per day. The EIA also estimates regular gasoline will average $3.14 per gallon during 2008, up 33 cents from last year and 56 cents from 2006 (average price of $2.58).

Contact Thom White @ CITIZINE@CITIZINEmag.com

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