“Exxon Mobil reports outsized profits. So did Shell. It’s all got politicians teeing up evil-oil rhetoric, except they are leaving one thing behind: the facts.” Let’s see what this little Marketplace ideological hack job serves us as “facts”:

Oil prices are set by global forces.

Since the mid-1980s, actual negotiations and deliveries of oil contracts have been made by taking the price of crude oil determined in spot and futures markets—where traders buy and sell futures contracts to either hedge against price fluctuations or to, plain and simple, speculate. The regional base price of the New York Mercantile Exchange (NYMEX) is represented by West Texas Intermediate—the type of crude that flows into the United States from its main ports in Texas Gulf Coast. In contrast, the regional base price of the Singapore exchange is that of the Dubai crude. Even though the volume of trade in these markets may be very high, only a fraction of all trades ends up being realized, whereas most transactions are either “compensated” before expiration or rolled into newer futures contracts.

While traditional speculative activity takes “the price risk that hedgers do not want,” index speculators take only long positions by buying and holding a basket of commodities futures. Because these baskets are based on one of the commodity futures indexes (SP-GSCI and DJ-AIG), such speculative activities are named “index speculation”. But because these indices are based on the aggregation of different commodities (e.g., cotton, copper, corn, wheat, crude oil, natural gas) with varying weights (petroleum-related products account for 58% of the weighted average of SP-GSCI and DJ-AIG), the index speculators are insensitive to individual prices; they are only interested in the value of the index. As index speculation as an activity became popular (practiced by hedge funds, pension funds, university endowments, life insurance companies, sovereign wealth funds, banks, and oil companies themselves), the volume of money that flowed into the indexes grew from U.S.$50 billion in 2002 to U.S.$300 billion in 2008, and along with the influx, the price of crude oil has increased dramatically (Wray, 2008, pp. 66–67). Without doubt, increasing prices may have also encouraged further index speculation—but it is important to acknowledge the role that speculative activity plays in determining the price of oil in the short run.

Increasing importance of spot and futures markets in determining the price of crude oil might give the impression that, provided that the speculative excesses of traders are regulated, the oil markets are becoming more and more competitive and the price is approximating toward the market-clearing equilibrium price. Yet, it is equally possible to interpret the increasing importance of futures markets both as a smokescreen to distract the general public from the enduring collusive arrangement between OPEC NOCs, IOCs, and the governments of oil-consuming, advanced capitalist economies, “allowing them all to bypass anti-trust regulations,” and as a mutually agreed upon mechanism for price formation, which would limit price competition among producers (Roncaglia, 2003, p. 656). To the extent that the supply of oil continues to be controlled by OPEC and the global demand of oil continues to grow at a secular pace, the futures markets, at their best, merely reflect these underlying oligopolistic forces (see also Hamilton, 2008).

Moreover, while the high oil prices driven by the speculative activity in commodities markets may bring windfall profits for both NOCs and IOCs, in the long run, high oil prices are not necessarily the best configuration for the economic interests of oil-producing economies either: Sustained high prices tend to provoke consumers to substitute away from oil-based sources of energy, slowing down the demand growth and rendering the market susceptible, once again, to overproduction. In fact, price instabilities caused by speculative activities have adverse effects on the macroeconomic stability of both net-exporter and net-importer economies. In short, the post-1970s reconfiguration of the oligopolistic control of the oil industry is not necessarily a stable one and requires continuing attention, maintenance, and management—if necessary by means of military intervention and occupation.

Seven Sisters are not as powerful as they used to be.

While it is indeed true that there is a strong nationalization movement in the oil industry (which is underway since the 1960s), the notion that IOCs (International Oil Companies) are not as powerful as they used to be is highly debatable. The argument regarding the rise of nation-states as emerging powerful actors in the geopolitics of oil is made by Michael Klare in his Rising Powers, Shrinking Planet: The New Geopolitics of Energy (Metropolitan, 2008). Yet, while nation-states and their NOCs (National Oil Companies) are today much more powerful then they used to be, IOCs still hold power over the markets for a number of reasons. To begin with, they retain control over important aspects of industry. Recall that the oil industry needs to mobilize expert knowledge and expansive technology at multiple layers, ranging from “upstream” activities such as exploration and production to “downstream” activities such as refinery, trade, retail distribution and marketing. While NOCs are increasingly controlling some aspects of “upstream” processes, IOCs still control the relevant aspects of “downstream” processes. Consider, for instance, the fact that US-based IOCs control at the very least the largest market for oil—US currently consumes 25% of global production.

In fact, if we were to have a historical perspective, we will be able to see that even the emergence of OPEC and the increasing role that national oil companies (NOCs) take in controlling the “upstream” of the industry did not necessarily lead to the demise of IOCs. On the contrary, as the industry shifted from an era of “free flow” to that of “limited flow” after 1974, IOCs continued to remain highly profitable: They not only continued to account for nearly 10% of the net profits of the entire U.S. corporate sector (even better than their heyday in the 1930s), but also the rates of return of the large, U.S.-based IOCs remained above that of the Fortune 500 average—the dominant sector of the U.S. capital. [All of this is extensively discussed by Jonathan Nitzan and Shimshon Bichler in their highly influential Global Political Economy of Israel (pp. 220–223).]

This is, in part, because IOCs have continued to work with the governments and the NOCs of the resource-rich nation-states by entering into upstream joint ventures and by continuing to control downstream business. But this is also because the costs of expanding the oligopolistic coalition (now including not only Seven Sisters but also so called “Big, Big Oil” are borne by the consumers of petroleum (both as a means of consumption and production): In comparison to the free-flow era (1920–1973), the average price of crude oil has tripled during the limited-flow era (1974–2008), from $15 to $45 (in 2008 dollars) (see British Petroleum’s latest Statistical Review of World Energy for more updated values). Because resource-rich countries do not always have the necessary wherewithal to explore and exploit their resources, they tend to be dependent upon the expert knowledge and financial power of IOCs.

Moreover, even this division of labor struck between NOCs and IOCs, where the former controls exploration and production and the latter refinery and distribution, is not a stable arrangement. Even though IOCs seemed to have survived the nationalization wave of the 1970s unscathed, retaining their profitability, they nonetheless produce only 35% of their total sales and own only a mere 4.2% of the total reserves. For this reason, they have continuing incentives, along with the U.S. government, which has historically supported them, to reestablish their control over the upstream end of the industry. In this regard, the new Iraqi Oil Law of 2007, which marginalizes the role of Iraqi National Oil Company by opening nearly two thirds of the oil reserves to the control of IOCs, constitutes an instance in which the IOCs and the U.S. government explore the possibility of tilting the balance of power within the post-1970s oligopolistic arrangement in their favor. Notice that the news item excludes Iraq as well as Nigeria, Angola, etc. from the list. Most recent political developments in Middle East and North Africa, and especially in Libya, will need to be carefully analyzed with this silent struggle between IOCs and NOCs in mind.

US firms pay higher taxes.

There is no reason for not believing the point made here—unless there is some material mistake that I don’t know. But the real question from an ecological perspective is what is to be done with these oligopolistic windfall profits: Should we spend on developing alternative renewable energy sources and mechanisms, or should we spend on the military-industrial complex and exploration and production of increasingly riskier and difficult-to-extract oil?

Further Reading

Bromley, S. L. (2005). The United States and the control of the world’s oil. Government and Opposition, 40, 225–255.

Bromley, S. L. (1991). American hegemony and world oil: The industry, the state system and the world economy. University Park: Pennsylvania State University Press.

Caffentzis, G. (2008). The Peak Oil complex, commodity fetishism, and class struggle. Rethinking Marxism, 20, 313–320.

Caffentzis, G. (2008–2009). A discourse on prophetic method: Oil crises and political economy, past and future. the commoner, 13, 53–71.

Hamilton, J. H. (2008). Understanding crude oil prices (NBER Working Paper No. 14492). Cambridge, MA: National Bureau of Economic Research.

Mitchell, T. (2002). McJihad. Social Text, 20(4), 1–18.

Mitchell, T. (2009). Carbon democracy. Economy and Society, 38, 399–432.

Nitzan, J., & Bichler, S. (2002). The global political economy of Israel. London: Pluto Press.

Roncaglia, A. (2003). Energy and market power: An alternative approach to the economics of oil. Journal of Post Keynesian Economics, 25, 641–659.

Wray, L. R. (2008). Money manager capitalism and the commodities market bubble. Challenge, 51(6), 52–80.

End


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