Saturday, November 29, 2008

How Did The Price of Oil Get So High? And Why Is It Now So Low? The "Enron Loophole"

It's beginning to look like we've reached the bottom as far as gas prices go. That's okay with me, as long as it doesn't return to previously exorbitant rates. I'd rather spend my money on products like books and restaurant food than gasoline whose price has become overly inflated due to speculation. I suspect, however, that prices won't get so high as they did a few months ago--at least not for the reasons that they did back then. That loophole has been closed.

Update 11/30/2008
: I think it important to correctly identify for the financially flummoxed what laissez faire actually means. See below.

Back in June, Republicans were

It's more than coincidental that gasoline prices have gone down markedly since the Enron Loophole was closed on September 30th.

claiming that oil prices had been on the rise because Democrats were blocking off-shore drilling, but they didn't talk much at all about the upward effect on prices due to speculation and the prior deregulation thereof. Although I support U.S. off-shore drilling, because it would have an almost immediate downward impact on the world price of oil, the effect of speculation had a much greater impact on the fact that oil prices reached record levels in 2008, and this factor should not be overlooked.

In the following video, Keith Olbermann talks about how John McCain (or at least his advisors) supported what's come to be known as the Enron loophole, which unleashed the ability of speculators to corner markets and run up energy prices. Olbermann called it "a legalized form of insider trading" which "lets speculators overwhelm trading in oil futures." The result? A huge increase in your energy costs.

By being able to speculate on the future of oil prices, according to Olbermann, the speculators had driven up the price of oil to more than double what it was before the loophole was created, and this speculation had created the potential explosion of a large 'oil bubble'.

Has the bubble finally burst? Yes. Government, which encouraged the bubble in the first place, popped it before it got too large, by closing what's come to be known as The Enron Loophole.

Is deregulation of speculation a good thing? I don't think so--at least not nearly to the extent that the Enron Loophole allowed. It's obviously good not when it's employed by self-seeking shysters like Enron, who nearly brought California to its knees by speculating on electricity there. The robber barons of Enron essentially cornered the California market on energy, and they were able to drive up prices dramatically because of it.

The price of oil has been affected largely by the same type of speculation--until recently.

Speculators have not just been placing bets on the price of energy, they have been been largely able to control future prices in an effort to profit from their insider knowledge, according to Michael Greenberger, former chairman of the US Commodity Futures Trading Commission, who testified before a US Senate committee meeting on June 3, 2008. It was estimated that in the last two years prior to that, the average family spent at least an extra $1500 on energy due to such collaborative speculation. Speculation and its deregulation, according to George Soros, had allowed banks and other financial institutions to purchase and set aside larger reserves of petroleum than even the U.S. has in its entire national reserve.

The Enron Loophole was closed on September 30, 2008. Not long thereafter, gas prices started coming down precipitously (I'm still not sure why the price of diesel remains high). Obviously, other factors, such as declining demand in a weak worldwide economy, have contributed to the downward pressure. However, it's clear that speculative control of large swaths of the oil market caused its price to go up. It's more than coincidental that gasoline prices have gone down markedly since the Enron Loophole was closed on September 30th.

Update 11/30/2008: George Reisman has an intelligent warning to those who claim that laissez faire capitalism is the cause of such bubbles as the recent "oil bubble" and the financial crisis of 2008:
The mentality displayed in these statements is so completely and utterly at odds with the actual meaning of laissez faire that it would be capable of describing the economic policy of the old Soviet Union as one of laissez faire in its last decades. By its logic, that is how it would have to describe the policy of Brezhnev and his successors of allowing workers on collective farms to cultivate plots of land of up to one acre in size on their own account and sell the produce in farmers’ markets in Soviet cities.

Laissez-faire capitalism is a politico-economic system based on private ownership of the means of production and in which the powers of the state are limited to the protection of the individual’s rights against the initiation of physical force. This protection applies to the initiation of physical force by other private individuals, by foreign governments, and, most importantly, by the individual’s own government.


  1. Why did the price of gas get so high? Because there was a Presidential election and high gas prices would surely hurt Republicans (which it did). Why have gas prices fallen? Because the election is over. Mission accomplished.

  2. I used to think that high prices were due to speculators, then I thought it was due to increasing demand in China and India also peak discovery. Now, I'm not sure. Maybe all these reasons, but it is undeniable that prices have decreased since the loophole was closed.

  3. Speculative highs and lows are always temporary. In the end, fundamentals prevail. That applies to natural resources, tech stocks, real estate and everything else.

    You really can't blame all of this on the Enron Loophole. Was there a "tech stock loophole" that drove tech stock prices through the roof in the 1990s? Was there a "residential real estate loophole" that was suddenly closed that caused housing prices to drop? Was there a "gold loophole" that caused gold to drop from nearly $1000/oz in the early 1980s to less than $300/oz?

    Bubbles come and go and they always will, even without Enron Loopholes. Fundamentals of supply and demand make sure of that (except for natural monopolies, course).

  4. Frank,
    Now you have to see that in monopolizm prices are fluctuating not because of the principle of supply and demand. The principle of supply and demand works in ideal capitalism, which is practically nonexistent in real life. In real life there has never been a free market. In real life monopolies are running the show. Therefore in monopolizm prices are dictated by the monopolies. They influence our representatives and pass laws thus pushing and pulling the economy in their favor. You have to see now that leaving everything in the hands of monopolies IS A LOOSING PROPOSITION.

  5. Ken,

    It's no where close to as simplistic as you make it out to be.


    I agree that increasing demand and fears of peak oil contribute to the increasing costs. There are many reasons for increasing prices. However, 2008 saw a huge spike in costs as the speculators found another market to control, and once they couldn't control it anymore, the price found its relative equilibrium.


    I agree that monopolism causes the kinds of problems you're describing. What I have suggested in other articles, though, is that monopolies almost always are created and fostered by government. You say

    if real life there has never been a free market

    You're absolutely right if by "life" you mean our lifetimes. The New Deal destroyed a great deal of what used to be a free market. The Great Society made it even worse. We have 15 cabinet departments, 9 of which now regulate the economy. Walter Williams points out:

    They are the Departments of: Transportation, Housing and Urban Development, Health and Human Services, Education, Energy, Labor, Agriculture, Commerce, and Interior. In addition, there is the alphabet soup cluster of federal agencies such as: the IRS, the FRB and FDIC, the EPA, FDA, SEC, CFTC, NLRB, FTC, FCC, FERC, FEMA, FAA, CAA, INS, OHSA, CPSC, NHTSA, EEOC, BATF, DEA, NIH, and NASA.

    Here's my question to you: Can one be sane and at the same time hold that ours is an unregulated laissez-faire economy?

    He's right on. We've never had a free market in our lifetimes, so to blame very many of our economic problems on a supposedly free market is obtuse and misguided.

  6. Frank,
    I am not blaming the free market for all our economic problems. On the contrary. I have blamed monopolies for that. How could I blame the free market for economic problems after having said that practically there never was a free market? I have said that a free market is only in ideal, such as capitalism is only in ideal. I have said many times that at any point in time there were only different degrees of monopolism rather than capitalism, or free market. Maybe you remember times with more of free market and less of monopolies. But it must have been at least 200 or 150 years ago. I have also said that mature monopolism is when the people's government is being controlled by monopolies. I agree that currently it has grown to gigantic proportions. But you are arguing that it is the government regulating the economy by subsidizing and bailing out. I am saying it is the monopolies through the government which they have under their complete control. You are saying we need to restrict the functions of the government. I am saying not all. I am saying we need the government to protect us against monopolies, to prevent them to poison the environment. I am not for subsidizing and bailing out. I am against the government regulating the economy. I am for a free market as much as it is possible.

  7. Anonymous,

    My apologies.

    It sounds like what we are each saying is more similar than I thought, although I do see our differences. The end result, though, is that I agree with you, that we need to elect people to government who are much more honest than most of the people who are there now, and that we need to get rid of monopolies. I still do think, though, that government functions are far in excess of what they should be.

  8. It's not that we fear peak discovery, we have reached peak discovery. Demand will only increase from here as the middle class in India and China increase.

  9. I know that you probably oppose all subsidies, but you should research the million solar roofs in California program. It's based on a scale so that when the market demand increases subsidies will decreased.

  10. Frank,
    It is good we found some common ground. We both favor the free market over the dictatorship of monopolies. My point was that government functions are far in excess of what they should be only because the monopolies have hijacked it and are growing extra limbs to the government to push and pull the economy in their favor. It is not the other way around. A pro-people government would not do that. The more the monopolies had a grip on our government the more they have caused it to grow in functions, all of those growths are predominantly to regulate the economy. There is hardly any department designed to keep those monopolies in check and punish them for speculating the prices and shoveling gigantic profits. Again, if left to free market things would be much smoother. Unless by free market one means freedom for monopolies to do whatever they want including hijacking the government and influencing the economy in their favor.

    But even though it is necessary to elect more honest people to the govern on behalf of people=socialist, I think eventually the monopolies will take over. The misfortune is that you are looking for a perfect system t take care of itself. THERE IS NO PERFECT SYSTEM. If the people do not constantly purge their government, things will inevitably go out of their control. So,everything slipped of our hands only because we were slothful, we did not do our job, we were wasting our time in seeking and having pleasures. Instead we were supposed to actively keep our representatives in check. In other words to take care of the system. Again, NO SYSTEM WILL TAKE CARE OF ITSELF. INCLUDING THE FREE MARKET.

  11. Frank,
    Have you paid attention at the Preamble of the Constitution?

    "We the People of the United States, in Order to form a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defence, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity, do ordain and establish this Constitution for the United States of America."

    The promotion of GENERAL WELFARE is one of the main reasons of the Constitution.

  12. Also read the Article 1, Section 8 - Powers of Congress

    "The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States;"

    It appears that first function of the Congress is to collect taxes to provide for the common DEFENCE and general WELFARE.

    It seems to me, after all, that our Constitution is pro people=socialist. As it should be, since it is from, by and for the people. In other words to defend the people's freedoms and rights, not of the monopolies. And, since the taxes are to be collected from the capitalists (from those who are making profits) not from those who are working for them (you would not argue against the idea that individual income tax is unconstitutional), therefore it is logical that taxes collected from capitalists are to be used to fund everything in the country, including the general Welfare. So, the redistribution of wealth is the first function of the Congress, our government. I guess even Benson has not read the constitution.

  13. I generally follow and agree with what you've said--particularly that the Income Tax is a dumb idea. But I do not agree with your apparent definition of "general welfare". In a limited sense, wealth IS redistributed, but only for clearly delineated government functions. What you seem to be describing is "specific welfare", which is Constitutionally left up to the states. Read Article 1 Section 8 of the Constitution to get an idea of what the Federal Government can do. Ezra Taft Benson is very familiar with that.

  14. Ryan,

    Sorry that I forgot to respond to your statement about subsidies. I'm not sure how I feel about subsidies--in particular as it relates to energy and thus could be considered part of a national emergency (to cut our dependence on foreign sources of energy). The idea in California that "It's based on a scale so that when the market demand increases subsidies will decreased" certainly seems to me to be a positive innovation. I'm interested in researching this further if you have more info.

  15. Frank,
    First, it is not my definition. The "general Welfare" is the Constitution's definition. Why do you think, though that by "general Welfare" the Founding Fathers did not mean also "specific welfare"? And when you say that according to the Constitution it, the "specific welfare," is left to the Sates, you are actually asserting that it is one of the functions of the State Governments. Or maybe I am missing something.

  16. Of course they meant "general welfare" and not "specific welfare". When something benefits the entire country, such as its defense, uniform bankrupcty laws, and uniform weights and measures, then it is a federal government responsibility. Anything not granted to the federal government in Article I Section 8 is deferred to the states by the 9th Amendment, which says:

    The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.

    The federal government is supposed to take care of the "general welfare", while the states take care of the "specific welfare".

  17. So, you are saying the states are supposed to take care of the 'specific welfare.' With 'specific welfare' you, of course, mean sheltering the homeless, feeding the hungry and providing necessary medical service to those who cannot afford it. Benson was against all of these. He is very specific about it in his booklet "The Proper Role of Government." Are you also against 'specific welfare'?

  18. Yes. States can take care of those issues much more effectively. When the Feds do it, it eventually causes big bailouts and economic collapse.

    I agree with Benson.

  19. Benson was against the concept of a welfare system. He was advocating to terminate it gradually. He did not want even the states to implement any welfare system. Are you for or against any 'specific welfare' system implemented by the states?


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