We are about to enter a new hostage crisis. The hostage? The entire United States economy.
Given the destruction and chaos in southern Louisiana, Alabama, and Mississippi we are already seeing a short term minimum of 2o%, and up to 40% disruption in our petroleum distillate production and distribution (things haven't stabilized enough to really know yet). It will be at least several weeks before this even begins to be mitigated, and several months (at minimum), before we are back up to where we were before Katrina.
This is already resulting in gas prices well above $3.00 per gallon in some areas after only three days of disruption, and I believe we will see an average gas price across the nation of between $3.25 and $3.50 per gallon by next week. Gas price futures jumped 13% yesterday, and gas rationing is already occurring in some areas around the country. If a media fueled gas panic sets in we may very well see $4.00 per gallon, to dire consequences.
Before I explain what I mean by" hostage crisis" any further, a few things need to be cleared out of the way.
First, the current commodity price of Oil (somewhere north of $70 per barrel) has nothing to do with it's actual wellhead price, and everything to do with speculators over the last three years. They have repeatedly driven the price up on the slightest pretext, and as the floor hasn't fallen out from under them, they will continue to do so (as is the nature of markets).
Many people have said, falsely, that the reason for the current price per barrel is that China and India are buying all the oil they can. This is true, but they aren't buying it at our commodities exchange price. The natural demand price of oil right now given the current available capacity is somewhere between $40 and $50 per barrel.
What is propping up this speculative market is psychology (as is the case with all speculative markets). The personal assumption is that turmoil in the middle east and high consumer demand will make things more expensive, therefore speculative investors buy oil futures at higher and higher prices, which makes other investors follow them in, thus fulfilling the promise of the trend at which point the trend leaders take their profits out, and then start another round of speculation. The media supports all of this by the nature and tone of their reporting on oil prices, and the difficulties in the mid-east and other oil producing regions...
Second, the current price of gasoline has little to do with the very high price per barrel of oil; and far more to do with the cost of transportation, distillation, and distribution. Even if we were buying the oil at $27 per barrel (the low of the last ten years, when average gas prices were something like $1.25 per gallon) our gasoline would STILL be near where it is today; because there is not enough refining capacity to cover our internal fuel demand, and hasn't been for about three years (massive refinery explosion, shut downs, and environmentalist actions). There hasn't been a new refinery built in the U.S. since 1976, and there HAVE been numerous shutdowns. Our total refining capacity has increased some 25-30% in that time due to improvements in efficiency, but our demand for fuel has gone up enormously (I have seen estimates ranging from 45% to 170% and I have no idea what is correct or how they were derived). Price increases are a natural result.
Again, this is the nature of markets.
Third, the other major component of gasoline prices is speculation and precautionary bumps on the part of the gasoline producers and distributors. The profit margins on gasoline are extremely thin (from 1% - 5%), so any time there is the slightest disturbance in the psychology of the markets, gasoline companies increase their prices immediately to compensate for the presumed future increase in THEIR costs. If the market will bear this increase without a significant reduction in demand, they have found a support level; and prices will not fall below this support level until demand is reduced. This does not translate into profit taking however, because the added revenues are used by the oil companies to provide additional stocks, or invest in infrastructure, which combined with long term elasticity of demand tends to stabilize prices at support levels for relatively long periods of time...
...Unless there is massive speculative turmoil and production issues as there have been for the last three years that is. Then things go all to hell. These factors feed into each other creating a speculation spiral, and effectively an oil bubble. This bubble will last, and grow bigger until one (or a combination of) three things happens.
1. The markets realize the fundamental unsoundness of the speculation, confidence falls out of the market, and there is a price collapse to the $40-50 per barrel level estimated as the demand price at the moment (that's also the price it was when the current gas price jumps started three years ago).
2. Consumer demand significantly reduces (more than 8% over the course of 90 days), causing the futures market to collapse somewhat, though probably not to demand level. 5% can be considered "noise" in a frothy market, but 8% is presumed to be an indicator, and the trend will be established for profit taking, without the subsequent speculation cycle acting as a price support. If consumer demand dropped more than 10% however, and certainly more than 12%, we would see a fall to demand level, or possibly below (in the short term), followed by a restriction of production to act as a price support.
3. Prices increase and stabilize to the point that it becomes economical to extract more oil from the VAST resources available outside of the middle east.
Of the three, I think the most likely to happen is a combination of 1 and 2.
But here is where I am worried:
The economy of the united states is a hostage to the price of fuel. Energy costs are already one of the largest components of production, distribution, operational costs for many consumer goods. These companies have thin margins as it is, and so any increase in energy costs will be directly passed on to consumers. We have a very limited capacity to accept these short term price increases, which if they occur will cause a massive slump in buying.
I believe that terrorists will use the opportunity and economic disruption caused by Katrina to aggressively strike at oil supplies and refining capacity, both in the middle east, and elsewhere. This is their moment to bring the United states down if they have the intelligence and the capability to do so.
I believe that they do, and that we will almost certainly see attempted attacks in the coming weeks.
This additional disruption in the supply chain could cause a world wide oil panic (primarily fueled by the U.S.), and result in oil prices over $100 per barrel, with gasoline prices in the US increasing to over $5 per gallon.
If prices here go over $4, we will immediately enter a massive recession, as all consumer goods become suddenly more expensive. The media will have a field day, which will cause even greater panic and disruption.
Consumer confidence will instantly plummet, thus feeding the recession cycle; until fuel demand and supplies balance, which will take months. The resulting recession could take years to recover from.
Please note that the ACTUAL impact of ANY of the events I've been talking about is relatively small in relation to the outcomes. It is the PSYCHOLOGICAL impact which has created the current situation, and could cause the panic I am so worried about. This psychological impact is fed by peoples lack of understanding of the basic market conditions, and the medias feeding that lack of understanding, as well as their desire to cause harm to the current political administration.
Now I just hope the terrorists are either too stupid, or too incompetent; or our intelligence and defensive resources are too good to let this happen.
