Gas/Petrol Profits; Who Made a Bundle, Who's Losing Their Shirt?

I lost my shirt at a gas station once.

 

That must happen quite a bit with you, it looks like you also lost your shirt at your wedding.

My understanding is that the speculators (aka futures traders) buy from the originators, and sell to the refineries (after that it's refined products, not light sweet crude or heavy crude or whatever). At the end of the month, the futures for that month are settled, and sometimes you see some larger price movements right at the end of the month. But it's the originators who make the big bucks - the refiners and retailers are just passing along the price of the raw product they receive and their costs at handling & processing it.

Of course, those who are vertically integrated (own oil wells, refineries and gas stations, like Exxon/Mobil and Venezuala Petrogas/Citgo) do quite well because they own the oil wells and still sell the finished product at a high price. But even Exxon is dwarfed by Saudi Arabia's Aramco, Russia's Rosnef and other nationalized oil producers. They still pump out oil at a fairly cheap cost to them, but get to sell it at a high price (see the building spree going on in Dubai as an example of where the oil money goes, Russia might bail out Iceland). That's because demand has increased more than supply. In some cases they'd like to drill more, but this brings in another group of people who are doing pretty well - the companies that supply the oil rigs, particularly deep-sea. They are in high demand right now, everybody wants more, but they can only be built so fast (another reason opening the OCS and ANWR really won't make much short-term difference). And there's only so many geochemical engineers out there who can find the oil as well. (I won't get into peak oil issues just yet).

 

I think the answer to the OP's question lies in futures trading, and is essentially the same with oil as with all other commodities:

The producer of a "partial" product (wheat on its way to becoming bread, crude on its way to becoming gasoline, pigs on their way to becoming bacon, etc.) is concerned that he might not get enough for his product next month to pay for the cost going into it today. So he offers a futures sale: You promise today that you will pay a set price on a set date for a set qualtity of a stated product.

Meanwhile, a baker or a refinery or a butcher is afraid that the raw materials for his product may cost too much next month, so he buys the futures contract, promising to pay next month according to the contract.

This all makes a lot of sense and is a good idea. The problem arises because in a free market economy, anyone can buy or even sell futures contracts. Maybe I buy wheat futures because I think the price is going to go up. I have no intention of ever buying the wheat; I'll sell the contract and take a profit or a loss on my gamble. But if enough people are buying up wheat contracts, they can drive up the price because they are jumping into the demand side of the scale. I can even sell wheat futures I don't own. I just have to buy up enough futures to meet my commitment before the due date. But the futures markets (just like the stock market) make that easy to do. So you have a lot of people gambling on the prices of things you and I need every day, and by so doing they can greatly distort the prices of those things.

So the "lost" money is going into the pockets of futures speculators: gamblers who contribute nothing to production. To be fair, sometimes they lose money also, if they bet wrong. But the big speculators probably have inside information, so they win more often than they lose. And of course, if a really big speculator loses catastrophically, the government gives him our tax money so he can continue to speculate, because he generously shares some of his winnings with the candidates of both parties.

The solution I would offer is to make futures contracts non-negotiable: Permit only the producer of a commodity to sell futures in that commodity, and require the purchaser of a futures contract to take physical delivery of the product. Fewer people would buy pork belly futures if they knew that on a set date a truck was going to come to their house and dump a lot of bloody dead pig on their lawn.

 

I believe a futures contract can be stated in whatever terms the parties agree on, but I think it's usually a set quantity. If the seller of the contract is unable to supply the specified quantity, he is legally obligated to buy enough futures contracts (or enough of the commodity itself) to fulfill the contract. Of course, if the seller goes bankrupt, then the buyer is out of luck, or must try to make a claim on the seller's assets in the bankruptcy proceedings, in competition with all the other claimants.

In farm country, where I lived for a long time, farmers typically sell futures on only a part of their expected crop. They lock in a price on that portion, while leaving themselves a safety margin in case that year's crop is less than expected. If there is a crop failure, they are still obligated to fulfill the contract, either by buying the promised grain at current prices, or paying the difference. Of course, you could write a contract for 100% of your crop, which would be zero in the case of a failure, but I don't know if such contracts are ever written.

Because the futures market is so large, in practice if you are unable to supply the commodity it is a simple matter of paying the difference in money, assuming you have, or can borrow the money. Of course, if the price has gone down, then you make money even when you do not have enough of the commodity to sell, because you buy contracts at the lower (present) price and sell them at the higher price to fulfill your contract.

It can happen that the price falls and the buyer of the contract cannot afford to buy the commodity because he can no longer sell his product for enough. He is legally obligated to buy the commodity, or to re-sell the contract at a loss, or pay the difference, but if he goes bankrupt then the seller is out of luck.

Now imagine a situation where everything we consume has been bought and sold via futures contracts by way of many different speculators, constantly trading in the contracts among themselves, and maybe buying and selling derivative contracts to protect themselves against losses in the original futures contracts, and all is well while prices are on the rise; but once prices start to fall and buyers can no longer afford to meet their obligations, and try to cash in on the derivatives (essentially insurance against loss, but since it's not called insurance there's no regulation) and it turns out that the sellers of the derivatives don't have the money to cover their bets, then the whole system comes down like a house of cards. The commodities are still there. The consumers are still there. But the financial system is unable to get the commodities to the consumers.

That's not precisely what's happening now, because for the moment it's mortgages, not commodities, that have imploded. But the system is analogous. Right now, folks cannot get mortgages, and credit generally has dried up because illogically the people who got burned on mortgages now won't invest in anything; but if commodities implode in the same way, there'll be no food or gasoline available. They'll exist, but we won't have access to them.

All these markets start out as efficient ways for a humongous financial system to function, but for lack of regulation and oversight they wind up being casinos for speculators, and a fine way for the folks running the system to rob the rest of us, and to add insult to injury, when they screw up and get wiped out, we have to bail them out because the consequence of a total financial collapse is that gasoline and food and everything else we need stops moving from where it is to us.