Understanding the oil price increase

If you listen to the oil giants’ decision makers like Royal Dutch Shell’s Jeroen van der Veer, they have nothing to do with the very volatile pump prices. Consider that in the late 90s, oil was at an incredible $10 versus its current price of about $66 per barrel. In 2001, oil prices hovered around the $20 per barrel mark, so look where we are now.

Presumably, demand did not spur a price increase, or supply dictated a steadfast rate. But is there a real shortage to speak of now? Do we see queues forming around gas stations like we did in the 70s when we had to line up literally for rationed gas and wait in line for hours?

That is hardly the case now. Supply is apparently not the problem, although it would not hurt these oil giants to develop new sources. Admittedly, costs are now prohibitive, but looking at the oil giants’ financial returns for 2005, a little R & D would not hurt them crucially and may bring astronomical results in a few years’ time. These projects may last as long as 10 years, like Shell’s Sakhalin project in the far eastern region of Russia, reputedly one of the largest integrated oil and gas projects designed to supply liquefied natural gas. It is expected to be operational by 2010. Anyway, if these oil giants had started their development and exploration projects back in the early 90s, when crude oil cost was at a reasonable level, we would have exciting results by now. Now, no one seems to want to dip into their slick pockets which, considering the dire straits we consumers are in, are shockingly awash with petro dollars. The biggest player of the major five, Exxon Mobil, reported earnings of $36 billion for year 2005. It was perfect timing for Exxon’s CEO to retire just then, earning for himself a whopping $100 million as a going away present from a company that earned several billions anyway. Most of the other players felt that this left a bad taste in the mouth. A hundred million in retirement, not counting about $250 million in restricted stock options, in times like these when oil concerns are as big as global terrorism and high up in every government’s list of priorities? It is scandalous, to say the least.

But that is not the only reason for our woes. As if the problems in Iraq, Nigeria and elsewhere are not enough to drive crude oil prices higher, we now have other quiet players figuring heavily on the future oil prices. These warriors work quietly on the trading floors, and where before they traded heavily on copper, zinc and other futures commodities, they now trade heavily on oil. They are called hedge fund managers, presumably because they can expertly hedge volatile prices by buying for clients well in advance. In anticipation of summer, for instance, these traders would load up on oil commodities, and have expertly learned to discern where to lean in buying up what they call the energy complex. Energy does not simply mean gasoline – it is still broken down into heating oil, light crude, etc. I guess it will take a lifetime for us mortals to learn the complexities of this game, but those who have mastered it and have used their expertise in the best possible timing have raked in millions in dollars in profit. These days, one does not have to be a top trader to rank as a millionaire – even the middle level traders, all young and in their twenties or thirties, have happily joined the ranks of these new millionaires, simply by trading energy commodities, the hottest commodity in the market today.

How does it work? It is largely speculative. At current trends, these traders speculate that by, say July, oil prices will be considerably higher, so by now they will be factoring in what they perceive as safe margins and selling the commodity at prices higher than current prices. They would be selling the energy commodity at $70, for instance, when current price is only at $64. Whoever buys will have an adequate supply and a comfortable cushion and need not to worry even if the price hits the roof come July. Pre-buying vital energy requirements for a pre-arranged future date allows them a comfortable leeway. Of course, when the pre-arranged time comes, the contract is expected to be delivered.

Because it is such a vital commodity, the large end users watch the index prices closely. These are the airlines, hotels, heavy industries whose operations are heavily dependent on fuel.

The gamble on the seller’s part (presumably, he feels the market will soften up in the next few months, which is why he is gearing up to part with a few million barrels) and the buyer’s part (he obviously feels that, on the contrary, prices will continue to soar) is what keeps the trading game alive. Now, more than ever, energy trading is at a feverish pitch, and this has led the oil giants to point an accusing finger at the commodities market as one of the real culprits behind the upsurge in oil prices. Imagine that these futures traders have timetables of two, three, even four years, speculating on oil prices.

While they play around with the figures, we bite our nails and wait with bated breath when the next oil price increase is going to be. Whether it is the commodities market that dictates the market prices, or the volatile situations in Iran, Nigeria, Venezuela, etc., whether it is the global threat of terrorism that disrupts normalcy and sends panic signals to an already jittery globe, whether the abnormal conditions resulting in below-par oil production in several oil-rich countries contribute its share to the panicky state of oil in the oil market, here’s the bottom line: we, the consumers will take the brunt.

Nestle replies

Remember that article we wrote in this column regarding the claimed unwarranted raid on the Columbia International Food Products plant reportedly initiated by Nestle ("Chocolate Duel Results in Unwarranted Raid?" – Philippine STAR, April 29, 2006)? We also mentioned there that we were willing to print the other side of the issue should Nestle wanted to. And they did. But for one reason or another (The letter was addressed to Philippine STAR and not to our column’s e-mail address and this writer does not hold office at the STAR) I just got hold of the letter from Mr. Pedro N. Dy-Liacco (Dated May 10, 2006) this week upon my return from an out-of-the-country trip and if I may just reprint the relevant parts of the letter.

"We regret that we at Nestle cannot give our side of this issue in much detail through the press and in public as there is already a legal process in progress and we might be cited for contempt if we do so.

"However, we wish to clarify that Nestle was not involved in any forum shopping when the criminal case was initiated on our behalf after the civil case, which had earlier been filed, was withdrawn at our instance.

"Nestle, upon advise of its counsel, initially filed a civil case in December 2005 in Makati. We eventually withdrew the civil case after many months of futile attempts at serving the summons due to the maneuverings of the other party. A criminal case was then filed in order to effectively protect our intellectual property rights against the owners of the other brand. Our laws allow both civil and criminal cases to be filed to protect the consumers from unfair competition and infringement of trademarks."

And we are reprinting parts of the letter from Nestle in the spirit of fair play and responsible journalism.

B&L is soon to be back on TV

That long-running business and lifestyle TV magazine (at 15 years probably the longest-running on Philippine television), Business & Leisure, actually the original TV version of this column, shall air starting July over the Solar Cable TV Network.

We haven’t really decided what day we ought to air the show-Sunday or Monday evening, at 10 or 11 o’clock. Would you like to help us decide? Write to us your preference. And we’ll give the first 20 people with different addresses who would e-mail us a "free" Business & Leisure T-Shirt.

Mabuhay!!! Be proud to be a Filipino.

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