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Copyright by John T. Reed

The public is up in arms about gasoline prices. The Democrats say they should elect Obama as a result. Actually, his approach to policy is totally ideological and his ideology is leftist. The left hates burning fossil fuels and sees this crisis an an opportunity to cram bicycles, “alternative” energy, and extreme conservation down our throats. Obama himself has recently said he does not mind the price increase, only that it was not gradual.

The main conclusion I draw from all this is that education in America has fallen to alarming lows as evidenced by the fact that the majority of people seem to think commodity prices are determined by political parties and politicians.

If they were, gasoline would be 85¢ a gallon so the party in power would get re-elected. Indeed, that or something like it is currently the case in various dictatorships. In other words, not only has the education of Americans been neglected with regard to economics and markets, it has also been neglected with regard to logic. I was required to study all three in college.

Let me try to give readers a little perspective.

Lowest gas prices in the world
The United States has the lowest gasoline prices in the world other than in countries where the government subsidize gasoline prices. Most developed countries tax, rather than subsidize, gasoline. The few countries who subsidize gasoline, e.g., Venezuela 14¢ a gallon, do so in order to curry favor with the masses.

Here are some at-the-pump gas prices from a Google search on 6/10/08:

• Montreal: “prices shot past C$1.50 per liter” on 6/9/08 (a gallon is 3.78362400 liters so C$1.50 per liter is C$5.68 per gallon and C$5.68 = US$5.55)
• London: 4.8 pounds which is $9.65.
• Tokyo: 170 yen per liter which is $1.58 per liter or $5.98 per gallon
• Berlin on 4/22/08, it was $8.54 a gallon

You get the idea. So if you are an American who is complaining about gas prices being $4 a gallon, shut up. You’re embarrassing the nation in the eyes of the world.

Profit margins of U.S. oil companies
Much has been made of recent record profits at U.S. oil companies. I am a Harvard MBA. My immediate reaction was to ask what are their profit margins and return on investment numbers? You cannot draw any conclusions out of a record profit figure alone.

According to CNNMoney.com, “The average net profit margin for the S&P Energy sector [big U.S. energy companies], according to figures from Thomson Baseline, is 9.7%. The average for the S&P 500 [Standard & Poors 500, in other words, the biggest corporations in America] is 8.5%. So yes, energy companies are more profitable than many others...but not by an inordinate amount. Google, for example, reported a net profit margin of 25% in its most recent quarter.”

According to Yahoo Finance, ExxonMobil’s recent profit margin was 10.85%. Pretty good. Not extraordinary. For those of you who know next to nothing about economics and business, this means that ExxonMobil’s profit on a gallon of gas sold to you at $4 a gallon is $4 x 10.85% = 43¢. The other $4.00 - $.43 = $3.57 went to oil well owners, government taxes, transportation companies, the mortgage on the gas station, and so forth.

Return on investment
The owners of ExxonMobil have huge amounts of money invested in it. According to the same Yahoo Finance Web page, ExxonMobil’s recent return on assets is 16.63% and their recent return on equity is 35.59%. 16.63% is excellent. The S&P average for that number is 7.97%. The return on equity figure is excellent. The S&P average is 18.73%.

Are excellent returns on assets and equity a crime? No. Actually, all companies including small business and small investors are trying to do just that. I’m not going to research it here because I don’t want this to become a financial statement, but I suspect that oil companies’ returns on assets and equity go up and down over the years according to how the market goes.

Federal income taxes paid by ExxonMobil
Also, the U.S. government imposes income taxes on the oil companies and everyone else. I would expect that their record profits will be accompanied by record income taxes. ExxonMobil, for example, earned $20.322 billion in the first quarter of 2008 and paid $9.302 billion in income tax. That’s a tax rate of $9.302 ÷ $20.322 = 46%. If your income were taxed at a 46% rate, you would scream like a stuck pig.

Barack Obama and various socialist Democrats are threatening to levy a “windfall profits tax” on U.S. oil companies. There is already a windfall profits tax. It’s called the Internal Revenue Code. If you get a big windfall, like winning the lottery, the feds will tax the crap out of you. Your tax rate will probably go up that year (unless you were already in the top tax bracket) and the amount you pay will certainly go up.

Corporate income taxes are really sales taxes on the companies’ products
There is no such thing as a corporation. It is an abstract legal concept. You cannot see, touch, punish, or tax a corporation. You can force the humans who own oil companies—that’s you, remember?—to fill out tax returns and send in some of their income. You can do that twice; once on their personal tax return for dividends received from the corporation and once on the corporate tax return, but ain’t nobody but you paying both taxes. The evil people that the Democrats claim to be punishing with additional taxes on oil companies do not exist any more than the tooth fairy or the Easter Bunny exist. Punitively doing anything to the “oil companies” is shooting your own self in the foot both at the pump and in your personal income taxes.

Some would point at the CEOs as evil villains. For what? Making a record profit? That’s their job. Are the evil because oil prices went up? They have no control over market prices. If they did, they would have always been this high. Are they making too much? Maybe. But they have to pay income taxes, remember. The more they make the more tax they pay.

Do you want to single out oil company executives and tax them at a higher rate? That would be unconstitutional. Violation of the 14th amendment equal protection clause. It would also drive the best CEOs away from oil companies. Just what we need to have the most efficient oil companies and therefore the lowest gasoline prices.

Grow up. There is no boogeyman in the gasoline prices. The closest thing there is to a bad guy is the American consumer with his or her SUV.

A corporate income tax has exactly the same effect as if you imposed a sales tax on the customers of the company. I believe it was Nobel-prize-winning economist Milton Friedman who said that the whole idea of taxing a corporation was ridiculous and that such taxes were merely variable sales taxes on the products and services of the corporation in question.

The investors who own the oil companies demand a certain return on their investment. If they do not get it, they sell the stock. Owning an oil company is an optional activity. If Democrats make owning U.S. oil companies unattractive, no one will want to own them. Then there will be no U.S. oil companies. See how you like the price of gasoline then. You think that cannot happen? There will always be U.S. oil companies? Try to find an apartment in New York City where the government decided to control prices (rents) since 1945. Try to find a U.S. company that makes private planes like Cessna and Piper used to do. Try to find a U.S. company that makes busses. Hell, we’re down to two big U.S. oil companies already. Do you think there is some law of nature that prevents the shareholders of those companies from selling out to foreigners?

So any tax on corporations—windfall, regular income, whatever—will be passed through to the companies’ customers eventually. So if you are all in favor of taxing the corporations that own oil companies, you are in favor of taxing yourself both as a shareholder and as a consumer. Here’s your sign.

In short, every dollar of tax paid by oil companies either increases the price of gas at the pump and/or increases the income taxes paid by persons who own pension accounts like IRAs and 401(k)s.

Who owns the U.S. oil companies?
According to Energytomorrow.com, U.S. oil companies are owned by a “broad cross section of Americans.” In other words, you own the U.S. oil companies. Oil company executives own only 1.5% of the shares. There is a pie chart of the owners at that Web site. The percentages are:

Mutual funds 29.5%
Pension funds 27.0%
Individual investors 23.0%
IRAs 14.0%
Institutional investors (like Yale University) 5.0%
Oil company insiders 1.5%

I, for example, own some USAA S&P 500 Index shares. Since the oil companies are huge, they are all S&P 500 companies and so my SEP (self-employed pension fund) owns oil company shares. If you own any of the following, you are one of the owners of the oil companies:

Standard & Poor index fund
Wilshire 5,000 index fund
Energy Sector mutual fund
Large cap mutual fund

You probably do own one or more of those things (you should only own either, but not both, of the first two) in your 401(k), IRA, SEP, company pension plan, personal investment portfolio, etc.

Few oil companies are based in the U.S.
Here is a list of oil companies ranked by their oil production (millions of barrels per year) in 1998.

Saudi Arabian Oil Co.* 3028
Petroleos Mexicanos* 1278
Petroleos de Venezuela* 1258
China National Petroleum* 1168
BP Amoco + Arco 963
ExxonMobil 894
Royal Dutch/Shell 859
Nigerian National Oil Co.* 772
Iraq National Oil Co.* 770
Kuwait Petroleum* 757
Chevron + Texaco 756

Here’s a more recent (2006) rankings from Petroleum Intelligence Weekly.

Saudi Aramco
Exxon Mobil
NIOC Iran
PDV Venezuela
BP UK
Royal Dutch Shell UK/Netherlands
PetroChina
Chevron
Total France
Pemex Mexico

Only two—Exxon and Chevron—are based in the U.S. BP is British. Shell is Dutch. It used to be the list was dominated by U.S. companies. The more Democrats beat up on the two remaining American companies, the smaller they will get. Do we really want to drive our two remaining large oil companies out of business or off the top ten? How would that improve our gasoline-price situation?

Energy independence
Politicians and the public are clamoring for energy independence. If you like high energy prices, that would be the way to go. How about everything independence? Let’s only buy clothing made completely in America rather than the Asian-manufactured stuff we have all been buying and wearing for decades. Let’s only buy cars made in America. Ban all imports of wine, high fashion suits, and fruits like bananas. No more rubber-vehicle tires. Use only lumber grown in the U.S., not Canada, to build houses.

Economists are a contentious political lot, but they all agree that Americans and the world are best off with totally free trade. That is, everyone can buy what they want from whatever country they want. When it comes to oil, we should buy the cheapest from whomever has the cheapest. That is essentially what we are doing and so is everyone else. There is a world market for oil and a world market price for oil. Banning foreign oil and only buying American oil would drive the price through the roof. Banning foreign anything would have the same effect on that product.

We see that in part in ethanol. Ethanol from corn, which we have in the U.S., is not as energy efficient as ethanol made from cane sugar. So why are we making ethanol from corn? Because America can only grow cane sugar in Hawaii, which cannot make enough for both food and fuel. So why don’t we import cane sugar ethanol? Because it would make the Fanjul family less wealthy.

Huh?

The Fanjul brothers are Cuban exiles who left that country when Fidel Castro seized their sugar mills. They now own Flo-Sun, Inc., a vast sugar and real estate conglomerate in the United States and Dominican Republic, comprising the subsidiaries Domino Sugar, Florida Crystals, and other properties. Here is what Wikipedia has to say about their political contributions and the resulting tariffs on importing sugar to the U.S. including in the form of cane-sugar based-ethanol.

The economic benefits United States sugar producers receive from protective tariffs and price floors have been estimated to be worth approximately $65 million annually to the Fanjul Brothers and their companies.[2]. The brothers were alone responsible for nearly $1 million in soft money donations during the 2000 election cycle. By including the donations of their family members, political action committees, closest advisors and senior executives, this forms one of the largest blocks of contributors of soft and hard money to both the Democratic and Republican parties.

The 2008 book The Logic of Life by Tim Harford says the U.S. sugar cane growers get $300 million per year from the Fanjul tariffs and the sugar beet growers (Fanjuls) make $650 million. That book also puts the annual political contributions from those who want cane sugar tariffs to continue amount to about $3 million per year.

I would expect those protective tariffs are worth considerably more now. In other words, both political parties sold us and our fuel prices out to the Fanjul brothers in return for past and future political contributions. The purchases of Congressmen and Senators have a heck of a return on investment for the U.S. sugar producers: $3,000,000 in contributions per year for $950,000,000 in increased revenue per year.

By the way, this is also why Coca Cola tastes better outside of the U.S. It used to be made with cane sugar here in the U.S. as everywhere else. Because of the Fanjul protection driving up the cost of cane sugar, the American soft drink companies all switched to corn syrup instead of cane sugar. We try to drink Mexican coke in our family. I wouldn’t be surprised if the Fanjuls do as well. When my oldest son went to Europe on his honeymoon last year, he asked me why Coke tasted better there. I told him about the Fanjuls. I have read some stories in the media that corn syrup-derived sugar may be one of the reasons for the obesity epidemic in the U.S. Cane sugar, believe it or not, is better for you healthwise than corn-syrup sugar, but if we drank cane sugar-based soft drinks, the Fanjuls might have to cut back on caviar. Los Angeles Times writer Jerry Hirsch wrote a story on 8/10/08 about consumers recently demanding cane sugar instead of corn syrup in many products including soft drinks.

Buy oil company stock
If you are hurting as a result of high gas prices, jealous of “record oil company profits” and their high ROA and ROE, buy oil company stock. I do not really recommend that. You should do as I do and put part of your savings into broad-based, low-cost index funds like the Vanguard S&P 500 Index or the Vanguard Total Stock Market Index.

I’m just calling your bluff. If you think it’s so wonderful to be an oil company owner, why aren’t you one? Answer: Because you’re lying. You know the market and government are mainly to blame for high gas prices. You just want someone to be mad at and the oil company employees make a convenient target.

If you think the oil companies are misbehaving and making obscene profits, become an owner, also known as a shareholder, and go to the annual meeting and urge them to be good guys.

Supply and demand
Oil prices are determined, like everything else, by supply and demand. The only way to make prices go down, is to increase supply or decrease demand or a combination of both.

How do we increase supply? By making it as easy as possible to find, refine, transport, and sell gasoline. Right now, those four things are either illegal or extremely costly in the U.S. due to environmental rules. If you are in favor of the environmental restrictions on locating, producing, transporting, or selling gasoline, shut up about gas prices. You are one of the people who forced those prices up.

Taxes
Actually, there is an additional factor that would still be there even demand went to zero or supply became infinite: taxes. The reason Europeans and Asians pay more than we do for gas is their governments levy even more taxes than ours does on gasoline.

To lower oil prices, we should eliminate all taxes on gasoline and the companies that make it. I would not end taxes on the shareholders of the oil companies. And they would have more income as a result of the oil companies no longer having to pay corporate income taxes so the shareholders would pay more taxes in part making up for the loss of the corporate income tax revenue. But the individual shareholders would not increase the price at the pump to compensate for the resulting income taxes. The corporations must.

One reader said we cannot end taxes on gasoline because they pay for road construction and maintenance, and it’s fair to use gasoline taxes for that purpose because they people who buy vehicle fuels are the ones who use the roads. First, we can do whatever we want. Second, the government gets tax revenue from all sorts of taxes. Gasoline taxes are just one of them. Furthermore, the government spends its revenue on whatever it wants. Trust funds like those that supposedly set tax revenue aside for social security, education, and highways, are public-relations myths. If there were no sales taxes on vehicle fuels, they would use income taxes to build and maintain roads.

Finally, the notion that only those who purchase gasoline and diesel use roads is absurd. Blind people use roads. Bedridden people use roads. Hippies who try to use their bicycles as much as possible use roads. Virtually everything travels over roads. They benefit every citizen and business. Paying for roads only out of vehicle fuel sales taxes would be like paying for railroads and subways the same way. It’s dopey on its face.

Buy a smaller, more efficient vehicle
If you own a vehicle that has poor gas mileage, and you’re complaining about gas prices, shut up. You are the main cause of the problem.

I recently visited London, Paris, and Rome. In all three countries, they were driving miniature cars and trucks by U.S. standards. One car, called a Smart Car, was only seven feet long. It was like a pair of motorcycles with a roof.

So not only do we have the cheapest gas by far, we also have the largest vehicles by far. If you drive one of them, stop complaining. You are embarrassing the U.S. in the eyes of the world.

The fact that a great many American drive trucks like pickup trucks and SUVs is absurd. Apparently, this is a function of the insecurity many have about their manhood. Their pickup truck is their buckboard. Women want to drive SUVs so they can be above the other cars. I see. Wouldn’t it have been cheaper to ask a psychiatrist to help you get over that?

One reader thought I was against all ownership of trucks and SUVs. Nope. I am just against it when it is an urban cowboy affectation. If you really need a truck you are an idiot not to have one. But if you rarely have anything to pick up, why are you driving a pick-up truck?

My family has a couple of Lexus cars and a Toyota Avalon. They don’t have the greatest gas mileage, but then we are not complaining about gas prices. We have never owned any sort of truck or SUV. I always thought they were stupid—in part because they burn a lot of gas for their carrying capacity and they typically have more carrying capacity than we—or most of their owners—need. They chose such a large, inefficient car because of the fashion statement it made or some such. Really dumb.

If you want to spend less money on gas, sell your gas guzzler and buy a more efficient, more suitable size car. Until then, shut up about gas prices. They would not be so high if so many people were not as dumb as you about vehicles.

Commute
I work at home. So do my wife and my oldest son. My middle son works at his home some of the time. My youngest son is a college student who works at the college.

If you have a long commute, and you do it all by yourself in your truck, shut up about gas prices. If you want to spend less on gas, shorten your commute or use more efficient means. Until then, you’re the damned problem, not its victim.

Tires, etc.
I heard on TV woman say if we all inflated our tires properly, it would save as many gallons per year as producing oil at ANWR (Arctic National Wildlife Refuge). Sounds plausible. So do that and open ANWR to drilling. Shut up until you do.

ANWR
If you oppose drilling in ANWR, off U.S. coasts, in the U.S., or using oil shale in the U.S. to produce oil, shut up. You are a big part of the reason for the current high oil prices. Democrats say it would only cut oil prices one cent per gallon and would take ten years to do that. So? Every little bit helps. Not drilling there is stupid. The people who say it has to be protected have never been there and never will go there in the future. It is like the the moon in terms of remoteness and its usefulness to Americans for recreation. If we drill in ANWR and offshore and use oil shale and drill elsewhere in the U.S., we significantly increase world supplies. That will lower prices somewhat.

I am not going to believe Democrats or government employees on how long it would take. Until June, 2008, all U.S. presidents opposed drilling in ANWR including the current President Bush. Government studies supported the boss because they studiers wanted to keep their jobs.

One would think that the Republicans could crucify the Democrats for all the environmental BS they have enacted to make it impossible to find oil in the US or refine it here or to at least produce electricity from nuclear power. The Democrats and their environmental supporters are a big reason why it’s so hard to increase supply in the U.S. But, alas, the Republicans cannot use that issue because they nominated Mr. Maverick as their presidential candidate. He also opposes that stuff.

On 6/16/08, McCain flip-flopped on drilling offshore in U.S. waters. He is now in favor of that, although he wants Florida and California to have veto power over drilling off their shores, which means no change because those states will take a not-in-my-backyard position. If we are really going to drill in U.S. waters, they’d better hurry. The Cubans with Chinese help are drilling near U.S. waters offshore of Florida and they may drain the oil under U.S. waters dry from the side of the oil pool that goes out under international waters.

McCain still opposes drilling in ANWR, which he said would be like drilling in the Grand Canyon. Actually, if there is oil in the Grand Canyon, we should drill there, too. It’s a big canyon. What difference would a few six-inch-diameter holes make? And by what logic does Mr. Straight-Talk Express figure that ANWR, a desolate wilderness that virtually no American has ever visited nor ever will visit, is more like the Grand Canyon as a visual national treasure than the ocean off the coast of Southern California or Florida? Maybe he figures that because of global warming, hippies in Birkenstocks will soon be king and riding their bikes in ANWR and he does not want to lose their votes for his 2012 re-election bid.

Up and down
Oil is a commodity. Commodity prices go up and they go down. That’s life. It’s not caused by any evil small group. It’s the market, which is everyone worldwide who uses oil in any way. That’s 6.7 billion people. Again referring to the logic that you never learned, 6.7 billion people and their $54,311,608,000,000 gross domestic product dwarf George Bush, Dick Cheney, oil company executives, “record oil company profits,” and any of the other Democrat demons you would like to blame for the gas prices. The vaunted power of oil company executives to “gouge” is to the power of the world oil market what the power of a fallen leaf is to resist the wind in November.

If you want lower prices, all you really have to do is wait. Prices go up and prices go down.

Speculators
Many have decided to demonize speculators in this crisis. I would be surprised if any of the accusers could define the word “speculator.” Nor could they name a single speculator. They just use the word because it sounds evil.

Webster’s New Universal Unabridged Dictionary says “speculator” is one devoted to or engaged in commercial or financial speculation. Their pertinent definition of speculate is:

To buy or sell stocks, commodities, land, etc. hoping to take advantage of an expected rise or fall in price; to take part in any risky business venture or enterprise on the chance of making huge profits

That definition is not bad although it sounds a bit non-neutral. I think they should have worded it like this:

To buy or sell stocks, commodities, land, etc. hoping to profit from an expected rise or fall in price; to take part in any risky business venture or enterprise on the chance of making profits large enough to justify the time, effort, and risk involved

According to Websters’ definition, who is a speculator? Homeowners and other real estate owners, persons who own any stock or collectible like art or antiques or baseball cards, persons who own gold or silver. Will Obama be levying a windfall profits tax on all those people? Only if he’s an honest man. No need to hold our breath on that.

All of the definitions I found on line or elsewhere contain mention of risk. None of the accusers on gasoline prices mention risk. That’s because they, like Obama, are intellectually dishonest.

My definition of speculate would be thus:

To purchase a long or short position in a particular asset (including real estate, stocks, bonds, commodities like oil, or collectibles) based on a belief that the market price of the asset in question will move in a direction that is profitable for you while not owning any countervailing position in that same asset that would result in loss for you

Hedgers and speculators
Two kinds of people purchase long or short positions in oil or other assets:

• hedgers
• speculators

Hedgers are smart, responsible persons or institutions who are exposed to some risk regarding price movement of the asset in question. For example, airlines get hurt by rises in oil prices. Oil companies who own oil get hurt by falling oil prices. Since they can neither control (believe it or not Bill O’Reilly) nor forecast such price movements, the only responsible course of action for them is to hedge that risk.

They do that by taking an appropriate position in the futures market for the asset in question. Airlines get hurt by price increases, so they would take a long position (owning oil futures contracts) to make a profit from price increases to offset the loss they suffer as users of oil when prices rise. Oil companies would sell oil short so that they would profit from the short position if oil prices fell thereby canceling out the loss they suffered in the value of the oil they owned. To sell something short means to sell it for today’s price or thereabout, but for delivery at a future date. That way, if the price falls, you get to sell it for, say, $140 a barrel, but you can buy the oil you need, just before the date required, to fulfill the contract at the future lower price of, say, $120 a barrel. Selling securities short has absolutely no resemblance to or connection with real estate “short sales.”

In order for anyone to engage in the intelligent, responsible course of action of hedging, someone else has to take the other side of the position. In some cases, like the airlines and oil companies, they can be each other’s side of the transaction. In effect, they are agreeing that they are both happy with the current price and will buy and sell oil to each other for that price in the future no matter what happens to the market price in the interim.

But there are not always enough opposing hedgers to go around. In that case, speculators take the other side of the transaction. In some cases, there are speculators on both sides of the oil futures contract: one who is betting the prices will rise and one who is betting they will fall. Bill O’Reilly and various politicians want to outlaw or restrict speculators. They’re nuts. Speculators are necessary for the markets to function for the hedgers.

On page 81 of In Fed We Trust, there is this:

Bernanke quietly but firmly disagreed, telling the president that every study he know suggested that specalators dampen, not amplify, the volatility of oil prices.

Irresponsible nut jobs
Speculators are irresponsible nut jobs who believe, in spite of all evidence to the contrary, that they can forecast the future price of oil or whatever they are speculating in. They cannot. No one can. They are betting on their clairvoyance. If they think the price will rise, they buy oil futures. If they think it will fall, the sell oil futures short.

Are the speculators ever right? Sure. About half the time.

Do they make a lot of money when they are right? Yep.

Do they lose a lot of money when they are wrong? Yep.

Wanna play?

You speculated and lost
You are a buyer of gasoline. You probably buy about 12,000 miles worth for each of your vehicles per year. If you had been intelligent and responsible, you would have behaved like an airline and hedged your future gasoline prices. How? Same as the airline example above—by picking up your phone and calling a securities dealer like Merrill Lynch and buying oil futures contracts in an amount roughly matching your expected purchases of gasoline during the period covered by the futures contracts. Then, when oil prices went up, you would have made about as much profit on your futures contracts as the extra amount you have had to pay for gas. In other words, you would have been unaffected by the increase in oil prices. Your incremental price at the pump and your oil futures contract profits would have been a wash.That’s what hedging is about.

But you did not. You chose to speculate on gasoline prices by leaving yourself only on one side of the transaction. Why did you do that? Because you are an irresponsible nut job when it came to gasoline prices. You thought you could predict the future of gasoline prices, namely, that they would only go up gradually in small, inflation like amounts. You placed your bet by staying only on one side of the transaction—basically, by not buying oil futures contracts when you knew you were going to need to buy gasoline in the future, you were, in effect, selling oil short, that is, betting its price would go down. You were wrong. You lost.

Now you’re gonna speculate again
Whatcha gonna do now? You could hedge, by buying oil futures contracts like you should have done in the recent past. But that would lock in today’s prices. If gasoline prices fell, you would not benefit because of your hedge. So, you’re not gonna hedge now either, are you? Instead, you’re gonna continue to act like an irresponsible nut job and speculate. As before, you are betting that prices will fall. If you are wrong, you will get screwed even worse than if you hedge. If you are right, you will be better off having speculated than hedged.

Which is going to happen. to oil prices? Increase or decrease? I do not know. No one does, including you. Can you protect yourself? Yep, by hedging. Are you going to? I doubt it. So shut up about gasoline price increases.

You could have hedged in which case you would have lost nothing when prices rose. So shut up about speculators. You were one of them. You just bet on the wrong side. It’s not my fault that you did that. It’s not George W. Bush’s fault. (I did not vote for him and do not care for him in general.) It’s not the oil companies’ fault. It’s your fault.

Speculating or hedging on borrowed money
O’Reilly and others are ranting and raving that some of the people who buy oil futures contracts do so on margin, that is, they borrow most of the money to place their bet. They are correct that some borrow to hedge or speculate. O’Reilly et al want to outlaw borrowing money to buy oil futures contracts. That’s nuts. Hedging on margin is the equivalent of an insurance premium.

Borrowing to hedge is responsible and sound. Borrowing to speculate is even more irresponsible and nutty than speculating with all cash.

If you borrow to speculate and win, you make even more money than if you speculated with all cash.

But if you borrow to speculate and lose, you lose even more money than if you speculated with all cash.

Speculation is extremely risky. Speculating with borrowed money is orders of magnitude more risky. Want an example of the latter? Look at all the people who are losing their homes as a result of borrowing huge amount to buy them in the mid-2000s. They were speculating on margin to use the oil futures phrase for it. And they lost.

Like fire insurance
You could insure your home for fire by placing an amount of money equal to the value of your home in the bank in case of fire. Or, you can do as most people do and buy an insurance policy that accomplishes the same thing, but only costs a fraction of one percent of the value of the house. Indeed, if the only way to insure your home were placing the entire amount of money in the bank, hardly anyone could afford to do it and the mortgage lenders would refuse to make loans to those who could not put up all that fire replacement money. Almost everyone would have to be a tenant.

Similarly in oil futures, hedgers like the airlines borrow the money to create the hedge, thereby reducing the amount of cash required down to a fraction of the amount of protection they are getting against price increases from the hedge. If you make them put up the entire amount of the hedge, they will be unable to hedge and would go out of business immediately or shortly after the next increase in fuel prices.

Some of the “speculators” who have been bidding oil prices up are going to get creamed. That’s why God made speculators: to act as shock absorbers to protect the rest of us. They think they can see the future. They cannot. So they get blown away when their predictions go wrong. Any day now, that will happen.

Margin calls
If I do not explain the following, I will get emails saying hedging on margin is different from fire insurance because of margin calls. I am well aware of that. But it matters little.

Let me use a home mortgage example to explain margin calls. This is not the way mortgages work but it could be. The lender says you have to not only put 10% down but you must have at least 10% equity in the property at all times. Let’s say you pay $300,000 for a house, put $30,000 down, and borrow the remaining $270,000. Then the value of the house falls to $280,000. If mortgage lenders could make margin calls, they would call you and say you have to have 10% equity at all times. You now only have $10,000 ÷ $280,000 which is just 4% so you have to put up another $18,000 to bring the current equity to 10% of $280,000 or $28,000. That’s how margin calls work in the securities industry including oil futures contracts.

Why is that not a problem for a hedger? Because he is in a situation where his loss on one side of the transaction is offset by the gain on the other side. In other words, he gets the money to meet the margin call from the profits on the other side or from borrowing against the profits on the other side. If it goes the other way, that is, your selling short or long position makes money, there is no margin call.

You can profit from speculation
If you think being an oil speculator is so great, pick up the phone and call a local stock broker and tell him you want to invest such that you benefit from higher oil prices. You should probably buy oil futures contracts or some other derivative based on oil prices. Take a long position (in which you benefit from future price increases). Bill O’Reilly rails against the fact that some can buy oil futures on margin or credit. Fine. You do that. Speculate on future oil prices using borrowed money. I warn you that Merrill Lynch or whomever you buy through will make you sign a waiver that what you are doing is extremely risky and that you were warned by them about that. Then sit back and enjoy your huge leveraged profits—or your huge leveraged losses—whichever it turns out to be.

I’m calling your bluff here. I doubt anyone will do it. They are too scared that the prices will fall. Well, then, what’s the problem with my solution to leave it all alone and let it sort itself out?

Hoarding
The only way to “manipulate” or push the price of oil up is to hoard it on a large scale, that is, buy it and keep it off the market until the price reaches the level you want, then sell it and hope the sales will not drive the price back down. So where is that hoard? No one can find any evidence of it. The closest thing there is to it is the U.S. government’s strategic petroleum reserve. See below.

The market will take care of gasoline prices as well as the environmentalists and their Democrat allies will permit. Any additional involvement by the government will make things worse. It already has. Remember also, with the market, this too shall pass. But with government involvement in energy policy, there is political will to play hero and install some ratchet law that tends to be permanent because there is little desire on the part of other politicians to spend their political capital to undo the harm done by a prior politician. Market prices are temporary. Government set prices are forever.

Roughly speaking, Robert J. Samuelson said the same things I am saying about speculators in his 7/7/08 Newsweek column.

CFTC report on speculating

In response to the howls from the mob led by Congress, the federal Commodities Futures Trading Commission investigated the role played by speculators, if any, in the summer, 2008 run-up of gasoline prices.

In short, the report said accusations against speculators were bull. As discussed above, anyone who understands business or economics already knew that. CFTC findings include:

• Commodity index funds only own 13% of the contracts by dollar amount—a widely ballyhooed study by a Virgin Islands fund manager had erroneously said such funds dominate the mark
• The market share of the funds was always irrelevant anyway. Whatever they do trade wise, there is another party on the other end of the transaction doing the exact opposite so they cancel each other out.
• Purchasers of oil futures were primarily trying to hedge against inflation and avoid the falling dollar value, not drive up prices.
• Many trades were for hedging purposes, that is, they were insurance policies purchased by buyers or sellers of oil to protect them from adverse market price movements in either direction.
• The higher prices went, the more the “speculators” took short, not long positions, thereby discouraging additional price increases and encouraging price declines. During the first six months of 2008, oil futures traders who took net long positions (and who would benefit from price increases) fell by 11% and more were shorting than going long meaning, as a group, the “speculators” wanted prices to fall, not rise.

Kudos for the CFTC for standing up to the politicians and the voters and speaking truth to power.

Economic principle of substitutability
One of the basic principles of economics, that subject Americans apparently have not studied, is that a rise in the price of one product causes people to switch to other products that can be substituted for the product with the newly higher price. For example, you can substitute the following for gasoline:

walking to your destination
mass transit
car pooling
bicycling
phone call
video conference
email
mail
mail order rather than in-person shopping
electric lawn mower
higher mpg vehicle
staying home
shorter commute
vehicles that use other fuel like electricity, ethanol, hydrogen, propane

We may not be energy independent, but we are staying-home independent. Indeed, media stories recently have said that Americans are cutting back on vehicle travel miles because of the high gas prices. Voila! QED. If you don’t like gas prices, substitute one of the above for gasoline. If not, shut up about gas prices.

Investigate
Democrats are calling for investigations. They do that every time the price goes up. The investigations always come to the same conclusion. There was no illegal price collusion. I think the number of such investigations and conclusions since the gas lines in 1973 is now up to about 12.

Federal emergency reserve
Some have called for either a cessation of putting oil into the U.S. government’s federal underground storage (a continuous ongoing operation) to ease upward pressure on oil prices. Others have called for releasing oil from the emergency reserve to increase supply and lower prices.

Neither should be done. When the emergency reserve was established, criteria for using that oil were established. The criteria make sense. This is not the sort of emergency contemplated by those who created the reserves in the 1970s.

I can think of one good reason to sell that oil now. The government is terminally stupid. They will probably screw up and a fire will burn all that oil. Any strategic reserve we have should have been scattered all over America instead of pumping oil into salt caverns on the Gulf Coast. In a sense, the oil in ANWR and the other U.S. places the environmentalists won’t let us drill is our strategic reserve. Unfortunately, it will take a considerable amount of time to start pumping oil from those places because we cannot do any preparation. We’d better hope the emergency, when it comes, is a slow-moving one.

Bill O’Reilly
One of the reasons the American people are so ignorant about gasoline prices is Bill O’Reilly. Whenever the subject is oil, nothing but childish nonsense comes out of his mouth. I have seen experts like Ben Stein and Wayne Rogers try to explain it to him—to no avail. His mind is closed on the subject and whenever it was open in the distant past, he seemed to have learned his economics from some Communist grade school dropout.

His 6/17/08 “Talking Points” on the subject were the worst yet. He has become the Joe McCarthy of oil, hurling wild accusations at all sorts of innocent people. He’s either very dumb or very dishonest—a moron or a demagogue who will say anything to get high ratings. I wish one of the people he is accusing would sue him, put him on the witness stand and have a judge repeatedly order him to stop spinning and start answering the questions of opposing counsel. Plus we would get a verdict from the judge or jury on who the real no-spin guy is.

When gas prices were going up, O’Reilly could not stop ranting and raving about the greed and malevolence of he speculators and oil companies. Then they went down by about a third. O’Reilly must therefore believe that the fall in prices is the result of the Mother Theresa-like altruism and generosity of the speculators and oil companies. So why has he not said that on his show? When will he? Don’t hold your breath. The spin stops there unless Bill himself is doing the spinning.

On 8/14/08, O’Reilly explained that the speculators made their profits and left, that’s why prices fell. O’Reilly is an idiot. Speculators wish they were that smart and powerful. Rush Limbaugh, who is a college drop out, nevertheless has an infinitely better handle on the issue than O’Reilly with his masters degree from Harvard (JFK School of Government). Limbaugh points out that there are two kinds of speculators: long and short. Investors who hold long positions profit when prices go up. Short sellers profit when prices go down.

Accordingly, consumers should be erecting statues of short sellers of commodities if they believe O’Reilly’s claims that “out of control” speculators manipulate prices. O’Reilly should be having the oil futures short sellers on his show to praise them to the heavens for their altruism.

Speculators and oil companies are always greedy. But prices go up AND down. Therefore, obviously, greed does not control prices. A zillion market and government forces do.

The truth is prices of commodities like oil go up and down. C’est la vie. Whining and hurling wild accusations when they go up and treating falling prices as an entitlement is childlike. The best solution is to get out of the way of the market. That will not produce free or cheap commodities, but it will produce cheaper commodities than any other approach. Government involvement—through restrictions on purchase or sale of futures contracts, drilling, tax policy, mandates, etc.—is almost always bad for consumers. But they are too ignorant to recognize it. And politicians who know better are too dishonest to advocate or vote for the best policies.

‘Alternative’ energy
See my article on energy.

My short answer is, hey, this is a free country. You want alternative energy? Fine. Do it. If it makes sense, you don’t need me or the government to get involved. We all see media stories all the time about some nut job who went “off the grid.” They got solar and a Prius and a compost pile and triple glazed windows. Do it! Do it! Do it! Ain’t nothing stopping you but the mind-blowing cost of the crap. If there were such a thing as alternative gasoline, it would cost $15 a gallon without subsidies. Actually, it costs $15 a gallon with subsidies, it’s just that part of the price is paid with your taxes and the rest with your credit card at the pump or the electric-car-recharging station..

Enjoy. If you’re an environmental wackjob, look at the bright side. The high gas prices are helping global warming by causing you and others to burn less fuel. If you’d stop whining about gasoline prices, that would head off even more release of carbon dioxide.

Do everything
I saw an editorial cartoon that showed Democrats and Republicans bickering about their pet energy programs while an Incredible Hulk in a rage representing the American people screamed, “Do everything!”

Should we do everything?

No. But that comes closer to the correct approach than anything the politicians have or will come up with.

What we should do is:

• Remove barriers to finding, refining, and transporting energy resources within the U.S. and its waters.
• End all local, state, and federal taxpayer subsidies related to energy. They are merely hidden taxes that force us to buy extremely expensive energy paying part of the price at the pump or the gas or electric bill and the other part an April 15th through our taxes. Ethanol appears to be the main culprit of this type at present.
• End all local, state, and federal tax credits related to energy. Ditto what I just said above. Windmills and solar collectors often get these.
• Repeal all government mandates that force companies or and American citizen to change what they do for energy-related reasons. Miles-per-gallon requirements on vehicle manufacturers are typical examples of this stunt. Essentially you pay more for the vehicle and less at the pump but probably more overall because you are being forced to make a tradeoff that you would not make on your own if you had a choice. Hybrid cars are an exammple of this. Over the life of the car, you would probably spend less money per mile over all with a non-hybrid. It’s a pay me now or pay me later choice. Hybrid cars cost a lot more up front and less for gas later. Non-hybrids cost less up front, and more for gas later. Technically, you should discount thhe capital cost and operating cost to its prevesnt value to compare. Hybrids probably have a higher present value, that is, overall cost per mile, than non-hybrids.
• Remove political, as opposed to safety, barriers to use of nuclear energy. Nuclear is alive and well and producing 20% of U.S. electricity right now, not to mention powering all of our recent aircraft carriers and submarines as well as large amount of electricity in other countries like France. If we went to all electric cars and nuclear power, OPEC would dry up and blow away.
• Repeal existing political restrictions and refrain from imposing new political restrictions on trading of energy or energy futures contracts in commodities exchanges.
• End extraordinary targeted taxes levied on, or threatening of such taxes on, energy producers like Obama’s promised windfall profits tax on oil companies.

Free market
In short, the quickest route to the cheapest transportation, heating, cooling, electricity, and other uses of energy resources is the free market, not the government. The current situation is caused primarily by government interference, not the free market. More government interference will make it worse, not better.

“Alternative” energy approaches like wind, solar, bio fuels, and so forth will be eagerly adopted by the public and business WHERE THEY MAKE ECONOMIC SENSE. All that the government will accomplish is to force their use where they do not make economic sense. Essentially, Obama’s pushing wind and solar is nothing but the burning of taxpayers’ money on the altar of leftist ideology. They have the simple-minded notion that because wind and sunlight are free, energy generated from those sources is free or at least cheaper than burning fossil fuels. In fact, that manifests great ignorance of the laws of physics. There is a great deal of portable energy in a barrel of oil. To create an equivalent amount of energy from wind takes a substantial investment in the tower, blades, and generator as well as transmission lines and transformers and such from the windmill to the distant users. Similarly, solar collectors are extremely expensive and have the same transmission line requirements. Both also have additional maintenance and replacement costs over time.

Furthermore, the cost-effectiveness of both wind and solar varies extremely depending upon how much wind or sunlight there is at any given location. Roughly speaking, the best places to harvest wind are miserable weather places where people do not want to live. In my area, there are a zillion windmills in the Altamont Pass, and almost no houses. It is almost constantly extremely windy there. The electricity generated there must be transported at considerable expense to the places where people do want to live. Similarly, solar works best in other places where people do not want to live, like Death Valley or the Arabian desert.

No two windmill or solar installations have the same economics. They all cost about the same for the generating equipment, but the amount of wind, sunlight, and the distance to users varies from place to place.

Also, wind only works when the wind blows and solar only when the sun shines. So in order to have electricity all the time, you need to build both a wind or solar generating system and a current style fossil fuel burning or nuclear power plant to supply electricity when the wind is not blowing or the sun is not shining. That’s like being forced to buy two cars: one that runs on gasoline and one that runs on hydrogen. While the ability to run on wind or solar when it is available would save some fossil fuel at those times, it would greatly increase the capital cost of building both the wind and fossil fuel or both the solar and fossil fuel systems. Storage of electricity generated when the wind is blowing or the sun is shining for use when there is no wind or sunlight would fix the problem, but such storage is currently so expensive and inefficient that it is not practical.

Don’t believe me? So where is your windmill? Or your solar collector? Open your yellow pages and call your local windmill and solar collector distributors and have them come to, and install that crap, at your property. Here is what I predict will happen. You will be astonished at how high the cost is in relation to the electricity saved. And you will be astonished at how hard it is to get the necessary permits. Enjoy. If you are dumb enough to want such a non-cost-effective energy source, you probably were dumb enough to elect the nut jobs who made it so hard to install “alternative” energy generators.

Whose fault?
Whose fault are the current gasoline prices? Partly environmentalists. Mainly U.S. owners of low-mileage vehicles. “Speculators” and U.S. oil companies probably have nothing to do with it. U.S. oil companies used to own a lot of oil. Nowadays, I expect that U.S. oil companies are net buyers of oil. That is, they are middlemen who buy more oil than they own. Only owners of oil benefit from higher oil prices. Buyers of oil, including both wholesale buyers like the oil companies and consumers, are hurt by higher prices—unless they hedged. The oil companies probably did, You could have but did not. The culprits in this in the leftists who have gotten anti-fossil fuel and anti-nuclear laws passed and the man or woman you see in your mirror in the morning.

‘Peak oil’
I see mention in the media of “peak oil” repeatedly. The idea is that we have found as much oil as we’re going to find and that henceforth the amount of oil in the world will go down. If so, prices would just climb higher and higher every month from here on out.

They told us that in a book called Energy Future which came out in 1979 at the height of the 1970s gas lines oil crisis. (Gas stations would often put out a red flag indicating that they were closed for the purpose of selling gasoline. When they put out a green flag, indicating they had gas, lines would form often stretching around the block. Then they adopted odd and even license plate rules, but big shots were exempt and people would get into heated arguments at gas stations with people who were not abiding by the rules. The gas lines disappeared overnight when “Energy Czar” William Simon abolished government allocation rules in one fell swoop.) They said oil would never be cheap again.

You can see an annotated graph of the history of oil prices at http://www.wtrg.com/prices.htm. What it says is that oil prices, stated in 2007 dollars, were the same in 1999 as they were in 1947. 1999, of course, was 20 years after Energy Future said cheap oil was gone forever. When Energy Future came out, oil was about $30 a barrel. Today, it’s about $130. It also says that the median oil prices, in 2007 dollars, since 1947, has been $19 a barrel.

No permanent shortages
During the 1970s energy crisis, the late CBS correspondent Eric Sevareid did one of his nightly commentaries on the oil “shortage.” Sevareid was born in 1912 and died in 1992. He lived through the Depression, World War II, and all that. He said throughout his life, the media had repeatedly run stories that the world was running out of this or that commodity from food to copper to oil what-have-you. He further said that the world, in fact, never ran out of anything. Those stories were all false alarms—Chicken Little “the Sky is Falling nonsense.” The shortages were always temporary.

How can this be? Aren’t the quantities of copper, oil, etc. on the planet finite?

Yep. They are also humongous.

Aren’t we using these commodities in greatly increasing quantities with each passing year?

Yep.

So how can we not run out?

More supply, less use
Because the higher the real (adjusted for inflation) price of something goes, the harder people work to figure out better ways to find and produce it and the harder people work to figure ways to substitute something else that’s cheaper for it.

The biggest result of the 1970s gas lines was that people started buying Japanese cars which were smaller and had higher gas mileage back then. Young people may not believe it, but U.S. car makers had the biggest market share in the U.S. in the 1970s and before. Japanese and other Asian cars were considered undersized for the American market. But when people with low mpg cars suffered in the 1970s, they switched en masse to Japanese cars. (My family of five now owns five Japanese cars.)

That switch resulted in the U.S. car makers losing their lead in the U.S. market—a lead they never regained. In 2007, U.S. car makers fell below 50% market share in the U.S. for the first time ever. Recent media stories said that sales of Ford trucks and SUVs, like the giant Ford Excursion SUV that the CEO of Ford apologized for when it was introduced—have plummeted since gas prices went up dramatically. I am not surprised. Oil producers and “speculators” should worry when the read stories of American again switching en masse to smaller cars.

Reed’s Rule: We never run out of anything
Based on all this and my own 62 years of observing the world and the various doom-and-gloom scares that did not come true (see my articles on financial doom and commodity shortage scare stories), I posit the following Reed’s Rule:

The world will never run out of anything. Whenever real (adjusted for inflation) market prices increase, business will find and/or make more of the thing in question and the public will use less of it thereby bringing the price back down in real terms in the long term. The only exception to this rule is when governments interfere with the free market in which case artificial shortages and price increases will occur.

The implication of this rule is that oil prices will always return to about $20 a barrel in 2007 dollars over the long run if various governments do not artificially hold down supply.

100 years ago
100 years ago, who cared about oil?

In 1906, the U.S. produced 126.5 million barrels of crude oil. In 2007, the U.S. produced 8.5 million barrels per day or 3.1 billion barrels for the year.

100 years from now, who will care about oil? In the nineteenth century, the main environmental issue was the huge amount of horse manure, horse urine, and dead horses generated by all the horses used everywhere in the U.S. for transportation and power. Part of the problem was the din from horseshoes on the paved streets and the lack of air-conditioners and open windows. City dwellers had trouble conversing inside their homes and businesses because of the wheels and horseshoes clattering on the pavement. Horses were generally replaced by motor vehicles around the first twenty-five years of the twentieth century—thereby setting the stage for the current sky-is-falling worries about gasoline.

Chill. Things change—at an accelerating rate. Things will be more different between 2008 and 2108 than between 1908 and 2008.

Entrepreneurs are endlessly and amazingly ingenious about figuring out ways to make a buck from the desires of consumers and businesses. Right now, they want cheaper ways to travel, heat, cool, light, and so forth. Unless they are stopped by leftists, the entrepreneurs will fix it. Someone once said that profit begets competition and excess profits beget ruinous competition. Bill O’Reilly constantly says, the oil companies are making excess profits. If they are, rest assured that other entrepreneurs are plotting to take those profits away from them with more efficient cars, more efficient solar reflectors, sweaters, shorter commutes, etc.

Hubris
The notion that we humans can exhaust the supply of any commodity, or affect global temperature, is human hubris. The planet is huge. I took a Caribbean cruise in December. For most of it, you could stand on the deck of the ship and look 360 degrees and as far as you could see there was nothing but water. No boats, planes, birds, floating trash, or fish. Nothing. And that was in the heavily traveled Caribbean. The ocean did not seem to care whether a guy in Lima, Ohio was driving an SUV. And that was just the surface of the earth. Oil and other minerals come from below the surface. The earth has a lot more volume than it has surface.

Not making any more land
In one of my areas of expertise, real estate investment, people are fond of saying, “Buy land, they aren’t making any more of it.” In fact, they are making more of it. The collapse of Communism in the 1990s resulted in an amazing about of land moving from government ownership to private ownership. Furthermore, as anyone who has ever driven across the U.S. can attest, “they” made a hell of a lot of land the first time around. It’s very hard to worry about a shortage of land when you are driving across Kansas or eastern Nevada or Alaska and so forth.

The notion that humans will passively allow the real price of anything to go up indefinitely reveals a lack of self confidence in human ingenuity and ignorance of history and economics. At the turn of the century (1900), New York City was worried that the number of horses in the City was going up at a rate that would soon cover the entire City with several feet of horse manure. That did not happen, in part because of the spread of use of the motor vehicle. Virtually every commodity has temporarily been in short supply and seen a price spike throughout history. Don’t mean nothing. All such shortages passed within a year or two.

Rest of world will reveal the best policies
The notion that the Democrats can indefinitely get away with artificially creating shortages for the benefit of global warming or the spotted owl or wetlands or the environment is incorrect. It’s a big world. U.S. Democrats may temporarily get away with such nonsense. But sooner or later Americans will notice that other countries are not suffering from the same shortages. We have already noticed that France’s nuclear policy appears to have been far smarter than ours and it now looks like we are going to make belated use of nuclear power plants because of the French example.

As I said in my energy policy article, the gas lines in the U.S. in the 1970s did not occur in Japan or Germany, even though they were also targets of the OPEC Oil Embargo. This in spite of the fact that the U.S. was the world’s largest oil supplier at the time and Japan and Germany had next to no oil at all. (The U.S. is no longer the world’s largest oil supplier because of Democrat anti-fossil fuel policies. We are the Saudi Arabia of coal, which can be turned into oil, shale oil, and maybe offshore oil if we were allowed to drill to find out.) Congressional investigation revealed that the gas lines in the U.S. were not caused by the OPEC Oil Embargo. They were caused by the U.S. government allocation rules. Japan and Germany let the free market set the prices throughout the OPEC Embargo and they never had any lines of cars waiting to fill up as a result.

Get the government completely out of the way
The government needs to get completely out of the way of the free market with regard to energy, including ending all subsidies, drilling bans and moratoria, tax credits, etc. When they do, we will get exactly as much drilling, “alternative” energy, new refineries, nuclear power plants, better-mileage cars, ethanol, hybrid cars, etc. as works best. The free market will build wind mills, solar collectors, and all that—if and only if they make economic sense, which is the only way anyone should “invest” in those things.

Half the harm that is done in this world is due to people who want to feel important. They don’t mean to do harm– but the harm does not interest them. Or they do not see it, or they justify it because they are absorbed in the endless struggle to think well of themselves.
T.S. Eliot in The Cocktail Party, p.111)