Is US Hidden Inflation at the Root of High Oil & Gas Prices?
by Bill Kunkel
|Tuesday, March 02, 2004
Instead of maintaining or increasing oil production as expected, OPEC cut it. The main reason is likely the falling value of the U.S. dollar.
At its 129th Conference in Algiers, Algeria, February 10, OPEC was expected to leave its production quotas in place. Prices were at record highs, well above the target range of $22 to $28 per barrel. This led some analysts to believe modest increases in production might be upcoming. But OPEC neither held nor increased production. Instead, it cut output ceilings by a million barrels per day from 24.5 mb/d to 23.5 mb/d beginning April 1.
The U.S. and Russia immediately called on OPEC to reverse its actions. In newspapers, warnings of price spikes appeared. The St. Louis Post-Dispatch told readers to expect over $2 per gallon by midsummer. The Las Vegas Review Journal watched prices ride above $2 per gallon and alerted Nevadans to the possibility of $3.
Anticipating the hue and cry, OPEC Conference president Purnomo Yusgiantoro, Minister of Energy and Mineral Resources for Indonesia, acknowledged calls for increased output, "...Crude oil prices have remained high since our last meeting on 4 December, and there have been calls for OPEC to raise its output ceiling to help bring prices down."
"OPEC is sensitive to such calls, especially when they come from other responsible members of the global energy community," he continued. "Indeed, our own day-to-day monitoring of oil market movements itself picks up the same signals. We take these situations very seriously, because we know that, if oil prices pass certain threshold levels--either upper or lower levels--they can have an adverse impact in a broader economic and political realm, which may ultimately rebound on the petroleum industry."
"Why, therefore, have we not taken action on price levels which have consistently exceeded the top end of our price band of U.S. $22 to $28 a barrel for OPEC's Reference Basket since our December meeting?" he queried.
Yusgiantoro said problems lie elsewhere, not with supply: "The principal reason is our judgment that the oil market is already well-supplied with crude. However, the benefits of this are being mitigated by low crude oil inventory levels in the U.S.A., excessive speculation, and continued geopolitical tensions."
"In particular," Yusgiantoro went on to state, "prices are being affected by U.S. crude oil stocks falling beneath the perceived lower minimum operating levels in a regime of just-in-time inventory policies and the high level of non-commercial speculation. These destabilising forces are, to a great extent, treatable, but they are beyond the reach of OPEC."
Calls for Reversal
The U.S. and Russia did not get the message--or chose to ignore it. U.S. Energy Secretary Spencer Abraham told the Houston Chronicle: "We don't comment on specific OPEC decisions...However, I've been saying for a long time...let the market make these decisions. We should let the market govern production and price levels for oil as it does for other commodities. We have a very tight market right now, and I think it's very difficult for OPEC or anybody else to try to just manage it on the basis of the way it's been conducted. I think if we let the market work, it will be better for both producers and consumers."
Russia's energy minister, Igor Yusufov, called on OPEC to raise production and stop international prices from overheating. "The world oil balance is on the edge of resource efficiency. There should be more resources on the market," he said. "I think OPEC should boost its production quota to avoid an explosion on the market."
The Falling Dollar
In a laid back and almost offhand way, OPEC brought up what is probably the real cause of continuing high oil prices: OPEC prices oil in dollars. "...of particular concern to us," OPEC stated, "as oil-producing developing countries, is the falling value of the U.S. dollar against other leading currencies. This can have serious budgetary repercussions, because it reduces the purchasing power of our petroleum revenue and affects the ability of our Member Countries to develop their domestic economies and to invest in additional petroleum production capacities."
"While oil producers cannot take direct measures to support the dollar," it continued, "we can at least minimise the impact of its decline, by ensuring that oil prices remain at reasonable levels." Clearly, OPEC is not interested in cutting prices when it is already losing purchasing power with the decline of the dollar.
Many in the U.S. see the falling dollar as a much more pervasive and ominous threat because it reflects inflation that is not acknowledged in U.S. government statistics, particularly in the Consumer Price Index.
One of the most vocal critics of U.S. inflation statistics is Bill Fleckenstein of Fleckenstein Capital. He writes often on the falling value of the dollar and inflation hidden by hedonics and by government definition that holds down the consumer price index. "It has been," he says, "cleverly defined away."
"Hedonics," Fleckenstein says, "is the way the government transforms price declines into quality improvements." As an example, he states: "buy a PC with twice as much power so the government concludes you really paid only half as much money for it." As for the CPI, the government simply omits selected components. "...We don't see any inflation--not because it isn't there, but because it's been cleverly defined away and further manipulated by looking at the CPI excluding food and energy (or ex any other offending item), which when you step back a minute is one of the silliest notions of all time. You probably spend money every day on food and energy. Energy is so ubiquitous that even a box of Corn Flakes has a high energy component when you think about all the different things that go into the cost of production. The price of oil works its way into just about everything." (For elaboration and details, consult Fleckenstein's weekly column on the MSN Money website.)
Making an example of the declining dollar's effect on energy prices, Fleckenstein said: "...In the last two years, the price of oil has risen from about $21 per barrel to just over $35 per barrel. OPEC's recent decision to cut production was partially due to the depreciation of the dollar...Now, I am not saying that the price of oil would not have gone up in dollar terms anyway, if the dollar hadn't slid. But perhaps it would not have gone up as much...[A] strong currency thwarts price increases; a weak currency causes and exacerbates price increases. In the last two years, the euro has rallied from about 86 cents to around $1.28. At the same time, Europeans have seen their price of oil go from about 24.5 euros per barrel to about 27.5 euros per barrel. That 12 percent increase is obviously a lot less than the 66 percent-plus increase that has occurred in dollar terms. So, the decline in the dollar has affected folks in subtle yet expensive ways that they don't quite recognize."
Find Another Currency?
OPEC's statements say they can minimize the impact of the dollar's decline by ensuring that oil prices remain at reasonable levels. That is likely the main reason for holding production down recently when prices went above the $28 band top. If OPEC doesn't get the support and cooperation of all oil producers now, its only alternative may be to switch its basis currency off the dollar--anybody like the euro?