Streetwise Professor

October 8, 2012

You Won’t Get a Harrumph Outta Me

Filed under: Commodities,Derivatives,Economics,Energy,Politics,Regulation — The Professor @ 3:23 pm

Gas prices in California are topping $5/gallon, and politicians are in a frenzy, making claims of manipulation.  Diane Feinstein is taking the lead:

Feinstein, in a letter to the Federal Trade Commission (FTC), called for the agency to implement broad monitoring of oil-trading markets and investigate possible “collusion.”

“Publicly available data appears to confirm that market fundamentals are not to blame for rising gas prices in California,” she wrote, citing state data that showed gasoline production last week was almost as high as a year ago and that gasoline and blending components were equal to this time last year.

The California senator cited Reuters’ Friday report on the “short squeeze,” in which traders said refiner Tesoro Corp had to scramble to buy fuel from other companies to meet commitments.

While traders told Reuters that no single party appeared to be withholding supply intentionally and that there was no suggestion anyone conspired to drive up prices, Feinstein wrote: “An FTC investigation is likely the only way to determine whether this reported squeeze took place.”

Look.  I’ve seen this movie many times before.  There is a localized spike in gasoline prices.  Politicians start screaming “We must do something about this at once! Immediately! Immediately! Harrumph! Harrumph!”  The FTC scurries to do an investigation, and finds that fundamentals explain the spike.

They also find something I’ve included in my classes for 10+ years: that Federal environmental policy is directly culpable.  The key here is that these spikes tend to be localized.  Why? Because due to EPA regulations, there are highly localized formulas for gasoline.  Which means that when there is a supply disruption in a particular locale that requires a specific gasoline blend, supplies can’t be shipped in from other markets because the refineries serving those markets produce a different blend.

This happens in the Chicago area with some frequency.

You may think that the environmental benefits of customized gasoline blends are sufficiently great to justify the occasional-and inevitable-price spikes that such a system produces.  If so, you should STHU about the price spikes. But then you wouldn’t be a politician, who wants it all ways all the time.

This story brings up another pet peeve of mine.  (Yes, there are many.  I know.)  Specifically, the promiscuous and imprecise use of terms related to manipulation.

Feinstein seized on a statement in a Reuters report that Tesoro had been the victim of a “short squeeze.”  Now, this term can refer to a a manipulation, in which the holder of a large long forward position-a position larger than the quantity that can be delivered at the competitive price-demands excessive deliveries of the commodity, driving up the price, and liquidating some of its long position at the supercompetitive price.  The demand for excessive deliveries is an exercise of market power.  The firm demanding delivery is deliberately squeezing the shorts.

This term is also commonly used to refer to a situation where a firm or firm is short, and has to cover under tight supply conditions, but where nobody exercises market power. Here the short is squeezed by tight but competitive market conditions.

Note that the same term is used to refer to two very different situations: one in which somebody exercises market power, and one in which nobody does.

I strongly suspect that Tesoro was caught in the second kind of squeeze.  One way to determine this is to see if Tesoro bought back contracts.  If it delivered on 100 percent of its contractual obligations, one of the longs to whom it had sold couldn’t have exercised market power: that requires the liquidation of some contracts at the supercompetitive price.

But use of ambiguous terms that can have diametrically opposed implications fuels political fires from the likes of Feinstein.  (Scary thought.  She’s the smarter and more honorable of the two senators from CA.)

So my prediction. Much harrumphing for as long as prices stay high in CA. The FTC will dutifully investigate. It will conclude that the spike was produced by an adverse supply shock that could not be ameliorated by increasing supply from other markets. The politicians will greet this report with stony silence. But the harrumphing will begin anew with the next spike.

But you’ll never get a harrumph from this guy. Not until there is credible evidence of manipulation.

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  1. Harrumph! I want some votes.

    Comment by scott — October 8, 2012 @ 3:50 pm

  2. Let the show start

    Comment by Anders — October 8, 2012 @ 8:32 pm

  3. I say the FTC should be allowed to do another of these reports only if Feinstein promises to hold a press conference when the report is completed in which she reads and publicly endorses the results of the report, then apologizes to refiners, oil traders, and anyone else she has accused of violating the law.

    Comment by Mike Giberson — October 9, 2012 @ 6:16 am

  4. @MikeG-not holding my breath.

    The ProfessorComment by The Professor — October 9, 2012 @ 12:29 pm

  5. Have you seen or heard any reports about 2 refineries going out of commission in the land of the fruits and nuts on the Left Coast, SWP?

    That would also certainly affect prices.

    Comment by elmer — October 9, 2012 @ 5:00 pm

  6. I’d always wondered about this!

    “when there is a supply disruption in a particular locale that requires a specific gasoline blend, supplies can’t be shipped in from other markets because the refineries serving those markets produce a different blend.”


    Comment by David Hoopes — October 9, 2012 @ 6:50 pm

  7. I’m currently reading Daniel Yergin’s The Prize, his epic history of the global oil industry. One of the recurring themes is for the US foreign office to be persuading the oil majors to form consortia, share information, and cooperate with one another in order to prevent oversupply and/or ensure availability of the vital resource on which the nation’s security depends; whilst simultaneously the US justice department is launching antitrust suits against the oil majors for doing precisely what the US foreign office persuaded them to do. Consistency has not been a feature of US energy policy for some time, it appears.

    Comment by Tim Newman — October 10, 2012 @ 4:02 am

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