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What is
causing energy prices to increase?
Financial forces A significant force now in the energy market place is the affect of commodity investment. Crude oil is a commodity that is traded on many world commodity exchanges. Commodities are traded in what are called “futures contracts”. As you may have guessed, they are contracts to provide and deliver a contract (42,000 gallons) of oil at a given price, during a given month in the future. These contracts can also be insured with something called an “option”, which provides financial protection in the event prices fall, or if prices rise. Free market commodities exchanges provide a mechanism for protection, but also add volatility to these markets. One main contributing factor of volatility is the influence of investment commodities trading. These are trades of futures contracts that don’t involve the actual delivery of the product. In most of these cases the contract is sold before it matures yielding the seller a profit or loss depending upon the market price at the time of sale…which brings us to the situation we face today. Starting with the sub-prime mortgage debacle that began in the Fall of 2007, our banking industry has been dealt a severe blow. Writing down billions of dollars in losses, our banking industry (and our economy) was facing dire consequences. To help bail out floundering lending institutions, the Federal Reserve has responded by repeatedly lowering interest rates. While this has been a life line for many banks, it has crushed the value of US currency, and has spawned run-away inflation, in many consumer products. The US dollars decrease in value has also spurred a flood of commodity investment because commodities are viewed as “inflation resistant” investments. The bottom line, food and energy have spiraled out of control.
Long term forces Without a doubt, supply and demand are what inevitably drives any product or service. These forces are what are referred to as “fundamentals”. The world as a whole has an insatiable appetite for energy, much of which comes from oil or natural gas. The world consumes over 85 million barrels of crude oil a day, and without a doubt the supply is limited which will cause the price continually increase. The supplies will actually never “run-out”, they will simply become impractical and too costly to recover due to their location. As an example, there was a great deal of publicity over recent crude oil finds in the Gulf of Mexico, and in North Dakota. Both of these finds are significant but will be costly to recover due to their geographic locations. The Gulf of Mexico discovery is more than 25,000 feet deep, which only a few years ago was considered an impossible to recover. It goes without saying that as technologies are developed and deployed to recover oil in hard to reach places; it is going to come at considerable cost.
Excess capacity In years past, there was a considerable amount of excess crude oil capacity in the world, sometimes as much as 5 or 10 million barrels a day. That meant that if there was a shortage or an abrupt increase in demand, countries like Saudi Arabia, or Kuwait could simply open a few valves and add several more million barrels of oil to the supply. That supply “cushion” no longer exists, and in fact the world now walks a tight-rope of supply and demand that provides a razor thin margin of a few million barrels of oil a day. The lack of excess capacity adds to the increased volatility in energy markets and has resulted in a great deal of the long term increases we have seen over the past 5 years.
Short term forces There are many short term forces that affect energy prices. Among them are natural disasters (hurricane Katrina impacted 25% of our national regional supply), political unrest, terrorism, refinery disruptions, etc.
When will it all end? Long term supply and demand will always prevail over time, so with a limited supply, oil and gas will continue to rise over time. The short term affects of commodities investors on the other hand can change at a moments notice. If the Federal Reserves deems enough is enough (and stops lowering rates), the US dollar may gain some traction which in turn would most likely cause a mass exodus of commodity investments (and lower prices). The slowing of the economy will also eventually have a profound affect on demand, and at some point the fundamentals of supply and demand will kick in and lower prices. Until then, we simply have to take one day at a time and practice conservation and sensible use of our precious energy resources.
Is there anything I can do? Yes. You can start by practicing common sense energy conservation. Nothing fancy, just turn down the thermostat, and take a quicker shower, the basics. If you want to go further take a look at our Saving Energy section of our website, it has a lot of great tips for saving energy. There are even heating systems that can cut your bills by 40%. You can also take advantage of our Oil price Protection program. This gives you and opportunity to secure your fuel at a fixed or capped rate for a year.
Gary L. Sippin
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