Flickr: Mike Mozart (Licensed by Creative Commons Attribution 2.0 Generic)

Gasoline prices in the United States have been on a roller-coaster ride since June 2014. For a while, it seemed that they were at a plateau. However, since May the roller-coaster went down again, going through the summer season which goes against the norm of prices holding steady, if not up, from the beginning May to the beginning of September. Why is that?

The short answer is: there has been a buildup in U.S. gasoline stocks (i.e., gasoline glut =240 million barrels) even in the middle of the summer driving season. Moreover, summer gasoline demand did not go up as high as was expected. There has been an increase in global refinancing capacity coupled with changes in regulations in China that have allowed Chinese teapot refineries (which are small refineries with relatively high costs) to export refined products abroad. There was also a surge in capacity utilization which jumped from 86 percent in January to about 93 percent in July of this year. The recent decline in oil prices has also driven down gasoline prices. These factors have important implications for gasoline and oil prices for the remainder of this year.

These factors have directly affected current gasoline prices. Since Memorial Day of this year, the average price of a gallon of gasoline at the national level has dropped by 6.9 percent which is surprising for the summer season. This is the largest drop in the national average price over the same period since 2005. It was only surpassed by the 8.3 percent fall in 2007 over the same period.

U.S. gasoline demand has averaged 9.405 m/bd so far this year, which is a 3.7 percent increase, according to the U.S. Energy Information (EIA). But over the last four weeks of this driving season, the gasoline demand growth is only 1.3 percent over the same four weeks of last summer. This means gasoline demand for this summer is not much higher than the corresponding demand for last summer.

This is surprising because the vehicle miles traveled a year over a year has grown by 3.1 percent according to EIA. If one views the EIA graphs of gasoline demand over the last few years, they can see that the demand for 2016 is converging with that for 2015.

What does all of this mean from the demand side? The gasoline demand for this summer is not much different from that of 2015 despite the increase in the VMT, which did not go well for gasoline prices.

The U.S. gasoline supply for this year has behaved differently from its demand counterpart. Gasoline supply has exceeded demand for the last several years. Recently, there were periods such as September 2015 and January, February and June 2016, where gasoline supply came very close to demand. However, since March 2016 the gap has been widening, showing a solid gasoline glut over demand. Currently, there is a major backup of gasoline tankers at New York harbor, due to the gasoline storage being full; to the point that the tankers are being diverted to other places including Florida and the U.S. Gulf Coast to unload.

Moreover, the United States has been a net importer of gasoline in recent months, adding to the domestic gasoline production.

That said, what does all this say about future gasoline prices? As the summer season winds down, the gasoline glut will rise further and the downward pressure on gasoline prices will intensify, sending those prices much lower than their current levels even if refiners cut production runs. This should in turn be reflected in crude oil prices which may head down into the 30-ish range. The gasoline roller-coaster will keep moving!

Helicopter money has become popular among economists and policy makers as a result of the ineffectiveness of conventional monetary policy in an environment of near zero and negative interest rates. It has become more so after the unconventional Quantitative Easing policy outlived its usefulness and Brexit became a reality. This article defines helicopter money dropping and explains its significance as an unconventional monetary policy in the current economic environment that includes Brexit.

Helicopter Money is a term that represents the act of the Fed creating money to finance fiscal transfers without going through the open market operation. In this case, the government doesn’t need to issue Treasury securities, sell them in the capital markets and add more to government debt. The Fed or the central bank discusses fiscal options (e.g., infrastructure investment, green energy, education spending, etc.) with the government and then supplies the government with the multipliers for those options. Then the government makes a choice out of those options and informs the central bank of the amount of helicopter money that needs to be created. In this case, helicopter money affects aggregate demand without going through the traditional interest rate channel. The mechanism is called the “Pigou effect” or the wealth channel by Milton Friedman who first introduced the helicopter money metaphor.

This accommodating policy definition of helicopter money drop is different from the definition which suggests that the Fed make direct transfers to the private sector financed with the so called base money (assuming it can be reversed in the future) without involving the fiscal policy. This second definition is known as a “citizens’ dividend” or a “distribution of future seigniorage”. The application of their form of helicopter money has happened in Europe in 2016 under the TLTRO lending program, through which the ECB has lent money to banks at negative interest rates, which amounts to a transfer to banks

The advantages are that, firstly the money created and transferred to the government through the helicopter money channel does not add to government debt and secondly it does not crowd out private investment as it does not increase interest rates.

The only requirement is coordination between monetary and fiscal policies as described above.

The disadvantages are that the helicopter money dropping may tear central banks’ balance sheets and make those banks unprofitable for some time in the future. It may lead to hyperinflation; may hinder the Fed’s ability to manage interest rates as a tool for conducting conventional monetary policy; requires a coordination with fiscal policy which is difficult to do; may make the financing of the government debt this way addictive; may make the Fed lose its independence; may not be feasible in a world where central bankers set interest rate to certain targets; and should not be a substitute for conventional fiscal stimulus which can be conducted by tax cuts and infrastructure spending.

Monetary policy has reached its limits after pursuing three Quantitative Easing (QE)’s and one operation swift at a time when interest rates have been close to zero (liquidity trap) and the economy is in a slow growth mode. Thus, helicopter money is proposed as an alternative to QE and could be the most unconventional of all monetary policies. Moreover, fiscal policy is not feasible to increase aggregate demand because of politics in the Congress and the anxiety about the high government debt. Thus, printing money to finance fiscal transfers is appealing now, particularly in the wake of Brexit. Many financial institutes such as Deutsche Bank, Morgan Stanley, Citigroup and others are now considering helicopter money as an alternative monetary policy for Britain after Brexit. For the United States, it is still a thought experiment at this stage but this things may change in the future. Economist Ben Bernanke supports it as a last resort.

Wikimedia: John Messina

Oil prices for Brent and West Texas Intermediate (WTI) dropped to about $26.65 a barrel in February due to a surplus caused by the accelerated production of oil shale and Saudi Arabia’s new policy of maximizing market share. There were forecasts that predicted that prices would fall to $20 and stay there. Instead, prices made a U-turn and surged, reaching $50 a barrel at the end of May this year.  It was predicted that it would reach $50 a barrel in the middle of 2017 when the current 1.4 million barrel a day (mbd) surplus is eliminated and the global oil supply and demand balances. Instead, there are now sweeping forecasts that oil prices will reach $70 a barrel.

Currently, oil prices are not respecting the long-run fundamentals or the confluence of incidental factors that have trumped global market supply and demand. There is a supply disruption that is equal to about 3.5 mbd of OPEC and non OPEC oil due to outages, which is the highest since the 2003 US-Iraq war. Among those outages is the production cut that resulted from the fire that wreaked havoc on the Canadian oil sand-producing units in Alberta. This distribution took about a million barrels a day of Canada’s oil production, which is largely exported to the oil storage tanks in Cushing, Oklahoma. This led to a decline in onshore oil storage in the United States, which was confused by oil traders as an increase in demand and helped drive up oil prices to $50.

Another incidental factor is the disruption of oil facilities in the Niger Delta of Nigeria by the Delta Niger Avengers (NDA), which reduced Nigeria’s oil production from 2.2 mbd to 1.1 mbd. This disruption will stay longer than the cut in Canada’s oil by the Alberta fire, as NDA is now threatening to launch more severe attacks in the Niger Delta.

The more credible factor of the current surge in oil prices is the drop of shale oil in the United States. The drop has been about 900,000 mbd since 2015 and is now accelerating. But this factor is still misunderstood because of lack of sufficient knowledge about the drilled but not completed oil wells (DUCS). There are about 5,000 DUCS in the United States which may come on stream if oil prices exceed $50 a barrel. On the other hand, there has been a significant cut in Capex by exploration and production companies, which may take some time to make up for the ongoing depletion in existing wells.

There is also political instability in other OPEC countries such as Venezuela, which has the highest proven reserves in the world and Iraq, which possesses the third largest global reserves. In addition, there is no end in sight for Libya, which has been witnessing domestic wars run by proxies of foreign countries.

These factors have brought the geopolitical risk premium back to oil prices and swayed them from the fundamentals. This risk premium had disappeared post June 2014 when the oil market started to develop a large surplus that was sufficiently large enough to make up for any potential disruption. This premium accounts for a good portion of the $50. Risk premiums do not reflect the fundamentals and may disappear quickly once most of the incidental factors vanish, particularly if Saudi Arabia follows through on its threat of increasing its production from 10.2 mbd to 12 mbd.  It is likely that oil prices will not reach $70 a barrel in 2017 and $100 by 2020 once the supply and demand start to rebalance and the risk premium fades.

The post The wavering status of the oil risk premium appeared first on The Triangle.

Let’s start with a very pessimistic metaphor and then apply it to the oil market. Most patients who suffer from cancer discover the disease in the fourth and final stages — when the disease has become fatal.

The Organization of the Petroleum Exporting Countries is like a patient who discovered that they have cancer. Shale oil production in the United States increased by almost a million barrels a year over the period 2009-2013 and OPEC did not notice it. The number of shale producers exceeded 300,000 individual companies.

OPEC increased its output while shale producers added a million barrels a day at the same time.

OPEC could not comprehend the resiliency of the shale producers. Although U.S. oil drillers have idled 68 percent of their oil rigs since October 2014, shale producers increased production due to techniques they developed recently. Oil producers have cut operating costs by 35 percent in the United States and 20 percent in the world. This has helped those companies stand a much stronger blow than OPEC expected.

OPEC does not seem to understand the relationship between oil production and oil rig counts. Our research on this relationship shows that there is a lag between a drop in the oil rig count and the fall in oil output. This lag could be as long as six months. In the United States, oil rig counts dropped from 1609 rigs in October 2014 to 501 rigs in January 2016, a 68 percent fall. Correspondingly, the U.S. oil output dropped by 620,000 million barrels a day, which is seven percent of total production.

OPEC could not figure out the level of the throat-cutting price for the shale producers. A Wood Mackenzie report said that globally about 3.4 million barrels of oil a day was not profitable below $35 a barrel, which is about 4 percent of the world’s supply of 97.07 million barrels a day. The U.S. Energy Information Administration states that the price at which U.S. shale producers would be forced out of the market is lower than previously thought. Being cash negative is not a good enough incentive to force many producers to shut down their oil wells because restarting output can be very costly. Some producers are also able to store production with a vision to selling it when prices go up.

OPEC did not understand hedging in the oil market. Almost all shale producers do hedging. Currently, they use the so called three-part hedging that can protect oil price as far down as $25/barrel. This hedging strategy includes a cap price which could give protection of $65/ barrel, a price floor that may give protection to a minimum price of $35/barrel. Those two prices together are known as collar. The third part is selling put options which is known as a subfloor that can give price protection to as low as $20 a barrel. Oil companies like Callon and Pioneer Energy among others are using this technique.

When OPEC followed the market share policy, it opened the oil spigot to the maximum. The oil price plunged in a disorderly fashion and without an end in sight. Excepting George Bush’s war in Iraq, attacking countries usually plot an exit strategy before they engage in wars. OPEC does not have an exit strategy for its price war, which is really available at hand, but all what it wants is to behead the shale producers even if it has to privatize Aramco, impose taxes on their people, deplete foreign reserves and debase domestic currency.

On the demand side, OPEC was not forward looking. It has not understood the economic slowdown in the most veracious oil consumer in the world. China is struggling and has experienced a fall in economic growth to about a below seven percent rate, down from 13 percent in the good old days. There is also a continuing global slowdown, while OPEC keeps talking about a rebound in oil demand and an oil price of about $50 a barrel.

On the political side, OPEC should learn that it is not a good business to mix oil and politics because it can cause fire. If some OPEC members have political conflicts with Russia and Iran, this should not spillover to oil prices because this war will bring huge casualties on both sides of the conflict which include major opponents.

Not everyone should feel good that OPEC has a market share cancer. The oil market always needs a regulator. In the 1950s and 1960s, the regulator was the Seven Sisters and since the 1970s it has been OPEC. We need a stabilizing force that reduces volatility in the most volatile commodity market in the world. This time too much of a good thing is bad. Here in the United States lower oil prices are usually beneficial to the overall economy but this time their impact seems be different and overall negative. Their bad side has so far primarily weighed on the energy sector but it also affected a broader part of the economy.

That said, OPEC cannot continue to go in the wrong direction. Could OPEC survive its self-inflicted market share cancer and the world stop suffering as a result? It is time to reconsider strategy.

The post OPEC has market share cancer yet refuses to address it appeared first on The Triangle.

The Japanese central bank — Bank of Japan — surprised the world by deciding to have negative interest rates on commercial banks’ excess reserves. What has motivated BOJ to choose this strategy? Three things about Japan using a negative interest rate strategy: (1) To weaken the yen further and help exports, which is a kind of beggar thy neighbor policy that makes countries engage in currency wars of competitive devaluations; (2) to push banks to make more loans and invest more to stimulate aggregate demand, spur lagging growth and increase too-low inflation, and (3) to reduce borrowing costs for companies and households, stimulating demand for loans.

The world’s central banks are engaging in competitive currency devaluations to stimulate their economies through increasing exports. You may add to the negative interest rate strategy the direct currency devaluations by oil exporting countries like Azerbaijan, Russia and Australia to have a good picture of what central banks are doing. This is not always a healthy policy because it can insert systemic risk into the world’s financial markets.

Is BOJ the first to do this? The answer is no. The Swiss National Bank did it a few months ago for the first time since 1970s, and de-pegged its currency from euro to strengthen the Swiss economy. The Bank of Canada also imposed negative interest rates to deal with the repercussions of the collapse of oil prices on its economy. The Riksbank (central bank of Sweden) has also done it. Sweden is a major exporting economy. Denmark also used negative interest rates to protect its currency’s peg to the euro.

There is no clear anecdotal evidence that negative interest rates work. However, the Fed’s Vice Chairman Stanley Fischer said that central banks that had resorted to negative interest rates to stimulate their economies had been more successful in 2012 than he anticipated. It may work when few central banks are doing it, but will it work when many central banks are doing it simultaneously? I see it as a beggar-thy-neighbor policy, which is a similar strategy to one employed in 1929 that brought the world into the Great Depression. But it could now have powerful effects particularly on real estate. On the other hand, negative rates could spread negative rates spread to a range of fixed income securities including government bills, notes and bonds and which will prevent investors from getting their money back on maturity as it happened in Europe in 2015. If banks apply negative rates on deposits, it may make customer avoid having their deposits eaten by banks.

Research is needed in this direction to figure all those things out.

Don’t you wonder why the Federal Reserve System is currently paying commercial banks a +0.25 percent interest rate on their excess reserves at this central bank? Let me add that the Fed is concerned about negative interest rates in the United States. It wants to conduct a stress test on U.S. big banks over the period June 2016 to June 2019 in a hard scenario that simulates a negative interest rate on the three month Treasury bill rates in the United States. This scenario will be embedded with a severe global recession that would send the U.S. unemployment rate up from the current 5 percent to possible 10 percent. It will be a learning lesson for us to see the outcome.

We are living in a strange world with desperate central bankers.

The post Desperate measures to stimulate economy appeared first on The Triangle.

Oil prices have dropped by 70 percent since June 2014. The Saudi Arabia’s foreign reserves have fallen from a peak of $746 billion in August 2014 to $635.5 billion near the end of last year, a 15 percent plunge, signaling that the Gulf kingdom is eating its foreign reserves quickly. The Saudi government’s budget witnessed a $98.5 billion deficient. The forward currency contract reached a record level and the credit default swap spreads have reached an alarming level. There is tremendous pressure on Saudi Arabia to untie its $3.75-to-$1 peg which it has held for nearly 30 years.

What will happen if Saudi Arabia is forced to abandon its currency peg from the U.S. dollar? While there will be domestic and global geopolitical consequences, the economic consequences of this move will be the most pronounced. Speculators have been waiting in line for a while and may have to continue to wait until 2017, when the currency is expected to get hit hard, rapidly. Given this potential devaluation, the coming imposition of value-added tax and excise tax and the removal of subsidies on petroleum products may lead to a huge surge in domestic inflation. A huge jump in domestic inflation will have implications for domestic political stability. There may also be a flight of capital, similar to what was witnessed in China recently, which will aggravate the devaluation. The Saudi stock market (Tadawul) will crash. Circus breakers will not help.

Regionally, the Saudi devaluation would lead to immediate devaluations in the currencies of the other Gulf countries that peg its currencies to the dollar. Inflation will spread throughout the Gulf region as its countries depend on imports for most of their needs. If this happens, it will be interesting to see how low the devaluation will go. The capital flight from the Gulf will be massive. The Gulf stock markets will crash.

There will be a global ripple effect of the devaluation on many financial markets. The first wave will hit the oil market hard. The oil price will overshoot down without a target. I cannot imagine a floor for the oil price if this scenario takes place. The commodity markets will move down in deep sympathy with the oil market.

The second wave of the ripple effect will be the global stock markets. The panic will lead to massive selling but this may not last as much as the selling in the oil market.

The third wave will affect the alignment of currencies. The devaluation would spread to the currencies of other oil exporting countries including the Russian rouble, the Mexican peso, the Norwegian krone, the Venezuelan bolivar, the Iranian riyal, the Nigerian naira, etc. The currency markets should take more time to settle downs than the stock markets because of the number of countries that can be affected by the currency devaluation.
The bond market will not be spared too. The Organization of Petroleum Exporting Countries and other oil and commodity producing countries will feel the ripple effect. They will be forced to cash their treasury securities to support their domestic currencies. This selling will resonate through interest rates and financial spreads.
If this scenario happens, the endgame will be a global economic recession which would kill any chances for global demand to strengthen and oil prices to recover. We are all in for the long haul!

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Companies in the U.S. and the world are striking deals to merge resources to become more focused and profitable at a time of low interest and innovations are hard to come up. Activists like Carl Icahn and Steve Loeb are also after those companies because they want them to create more values for shareholders. In 2015, the values of takeovers in the world reached $4.35 trillion, half of those are in the U.S., surpassing 2007 as the top year on record for deals.

Most recent examples include the deal proposal by DuPont and Dow Chemicals, which were founded in 1802 and 1897, respectively. These giant companies are in talks to form a combined company that is worth $120 billion. Before that, the news brought another deal between Pfizer and Allergan that will create, if allowed, a giant pharmaceutical company that has a value of $160 billion. These deals are larger than the gross domestic product of some developing countries.

The U.S. government has strict guidelines for mergers and acquisitions which govern takeovers in the corporate sectors. The Federal Trade Commission and the Department of Justice require companies who wish to merge to submit data for two M&A statistics before they are allowed to merge. They are: the Hirschman-Herfindahl index, and the change in HHI.

If the HHI before the merger is above 1,800, the industry in which the two companies want to merge is characterized as “highly concentrated”. In addition, if the increase in the HHI as a result of the proposed merger exceeds 100 points, DoJ will question the merger. It asks for one or more of these four ameliorating factors: 1) Evidence that the merger will bring in new technology; 2) Evidence that the merger will enhance efficiency (e.g., reduces shipping costs); 3) Evidence of tough foreign competition; and 4) Evidence that one of the two companies is facing bankruptcy.

Any of those factors may convince the judge to let the merger go through despite bad data on the two statistics. The HHI in the jarred baby food industry which includes Gerber, Heinz and Beechnut, is greater than 4,750, and thus this industry is considered very highly concentrated. The judge rejected the merger between Heinz and Beechnut on the basis of lack of increases in efficiency as claimed by the two companies, and also their lawyer confused in court total revenue and total profit which students in Econ 101 don’t. In the highly consolidated beer industry, the judge allowed Millers and Coors to merge because they convinced him that by combining the two plants for Coors with the six plants for Millers which are placed in different locations, could reduce shopping costs and increase efficiency. The merger went through.

The companies have been merging and consolidating for a long time, and thus concentration has increased in many industries. Thus, HHIs in many U.S. industries have gone up significantly, and with them is monopoly power and anti-competitiveness. Given the difficulty of convincing the judges of the merits of ameliorating factors, the companies now merge in two steps: in the first step they combine the two companies in a much larger company, and then in the second step they split into smaller and more focused businesses. Pfizer and Allergan want first to form a giant combined company but this may be challenged by the government. To hedge against that, those companies will split the combined company into two businesses: a company that will produce the old medicine, and the second will produce new medicine. The second company may be considered as evidence of creating new technology which may be viewed as an ameliorating factor. In this breakup, those businesses can also increase prices of the well-known old medicines and then match that former increases by following increases in the new medicines, which means more monopoly power.

This new trend is also followed by the proposed deal between DuPont and Dow Chemical which also want to form a giant company but then will break it up into three smaller businesses along the line of vertical mergers. The objective is to consolidate, add more value and then increase market power.

Wall Street welcomes this new trend, hoping it will create more values. But is it good for the American consumers? Well, if it increases companies’ monopoly power, it will not be good for all of us and may lead to a loss in social welfare. Let us wait and see what the regulators will say about those recent mergers.

The post Now trending in America: mergers and acquisitions appeared first on The Triangle.

Overall inflation (the combined finished goods and service inflation) in the United States’ economy has been below the 2 percent target since 2008. Attempts to inflate prices through rounds of quantitative easing to avoid falling in the deflationary trap have not produced the desired results. While service inflation just started to tick up since 2008, the goods inflation has followed a bell-shaped trajectory.

If an economy falls into a deflationary trap, it will be difficult to climb out of it. Japan has spent two decades in a deflationary trap. New technologies, robots, high unemployment, low wages and a glut of commodities, particularly oil, have worked together to keep inflation below target in the U.S. and other countries.

Last month’s jobs report shows that the unemployment rate has reached 5 percent, which is the lowest rate in six years and is very close to the Fed’s estimates of the 4.8 percent full employment unemployment rate. Moreover, the wage rate increased by 2.5 percent in that month, which is greater than the 2 percent that has prevailed since the Great Recession.

Labor is a service and a factor of production. Thus, it is an important ingredient in producing many services such as information, transportation, insurance, healthcare, telecommunications, banking, real estate, legal services, advertising, employment services, waste collection, computer training, etc.

The service sector is more than 70 percent of the U.S. economy, and correspondingly the service inflation is about two thirds of the overall U.S. inflation. The service inflation has recently been rising and the U.S. Bureau of Labor Statistics considers it the best gauge of inflation. This inflation is expected to spill over to the goods inflation and also increase inflation expectations which have been anchored since the 2008 global financial crisis.

This assertion of rising service inflation and ensuing possible increases in inflation expectations have many implications for the U.S. economy, ranging from changes in interest rates (including mortgage rates) to consumer prices to exchange rates. Expected inflation increases interest rates, which in turn affect financial spreads around the world, and also impacts exchange rate differentials, which all affect general consumer prices.

Research should be done on understanding the time lag it takes for service inflation to manifest itself in the overall inflation. The longer the lag is, the better the adjustment of the economy to a stable inflation environment will be. It is known that present inflation feeds on past inflation through changes in inflation expectations and it could get out of hand.

At this time, we should pay more attention to service inflation than to the consumer price index.

The post The balancing act of inflation and deflation appeared first on The Triangle.

In a vote of 261-159, the United States House of Representative passed a resolution to support lifting the 41-year old ban on U.S. oil exports. However, the U.S. Senate is still divided and the debate on removing the ban has pit the senators from states with oil production against those with refinery operations. The Obama administration also opposes lifting the ban and threatens to veto the related bill. Congress first put the ban after the 1974 oil embargo in an environment that was not favorable to the nation’s economy, inflation, and trade and energy sector. This intervention in the market mechanism immediately sent gasoline prices soaring, and now there is a fear among politicians that if the ban is lifted, fuel prices will increase and they will be blamed.

The oil export ban has been one of the oil industry’s top priorities. A coalition of more than a dozen of oil companies has lobbied Congress for more than a year to lift the ban. The push for the ban removal has recently been motivated by the shale oil boom, which has increased domestic oil production by more than 40 percent since 2008. The lift should allow those companies to sell the U.S. trapped oil at a higher price in the world’s markets. The exported oil may fetch one extra dollar or so per barrel to those companies, compared to selling it at home under the ban. We should note that the world’s oil market is one great common pool, and thus is global and not regional. Therefore, any small amounts of exported oil will not affect the global 93 million barrels per day oil production significantly, and again, we should not expect any considerable increase in oil prices in the U.S. and the world. Some studies even expect a small price decrease as a result of increased competition among oil producers, the U.S. oil companies are already allowed to export ultralight oil (condensates blended with heavy crude by refineries), which is lightly processed as well as other processed oil products such as gasoline.

This measure is likely to allow those companies to produce more oil: though not substantially so, as more production may lead to lower prices. Currently, U.S. oil production has plateaued, even starting to decline in the last three months as a result of the collapse in oil prices. This pushed small shale oil prices to marginalize expensive oil wells. The collapse also reduced capital investments significantly, which should negatively impact future oil production.

Recent studies show that lifting the export ban will not lead to a material increase in gasoline prices because oil companies are now selling U.S. produced gasoline overseas and will not be able to sell much more gasoline abroad since the ban does not apply to gasoline and other refined products exports. Moreover, large refineries in Saudi Arabia and United Arab Emirates are coming on stream, which will strongly compete with American gasoline in global markets.
Moreover, a recent study produced by the energy consulting firm IHS shows that lifting the ban has also some benefits. This study demonstrates that a lifting of the ban would bring in $750 billion in new investments which in turn would increase oil production by 1.2 million barrels a day. It would also create about 360, 000 new jobs, which justify some lifting of the ban.

The U.S. is not unified in what to do with the ban. The chemical companies oppose lifting the ban because oil is the feedstock for their chemical products which means that their costs will rise. The oil refineries also oppose the lift because they believe that this measure would increase the price of gasoline to American drivers, thereby reducing the demand for this fuel. A U.S. design of experiment study estimates that the U.S. refineries would lose $22 billion lower by 2025 because of higher prices of refined products. The ban conflict between oil companies and oil refiners is now known as the battle between the “Crude” and the “Refined”. The environmentalists also oppose this measure because it may encourage the production of more fossil fuels which could hinder the efforts to move to a low-carbon economy. They also cite the example that lifting the Alaska oil export ban in 1996 worsened the then existing price differential between the West Coast and the national gasoline to support their argument in favor of keeping the prohibition. The Alaska crude oil exports measure was ended in 2000 after the differential widened over time.

Since the ban constitutes a market intervention, it leads to market distortions and misallocation of resources. However, the U.S. is not self-sufficient in oil as it still imports a significant amount of oil from Canada, Saudi Arabia, Venezuela and Mexico and exporting oil means. Lifting the ban all the way is not the optimal policy but partial lifting is beneficial to the U.S. economy. Therefore, the ban should partially be lifted so that eventually about two million barrels of crude oil can be exported per day.

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As a long-time oil economics researcher, I have spent more than a quarter century doing research on oil markets. Most of my research considered the spot prices in relationship with other financial and macroeconomic variables. Other researchers insist on working with futures markets because they argue that futures prices are forward looking and thus are a precursor of spot prices.

Most of the time, those prices diverge depending on how they process fundamental and transitory factors. When there is an oil glut in the market, market participants see the spot prices are going down without taking the futures with them. In this case, the oil market is characterized by contango, thereby the futures are above the spot. In other times, when a shortage is perceived to exist in the market, the spot is usually above the futures at contact maturity. The futures or forward curve would typically be downward sloping (that is, inverted), meaning as the contract goes further in maturity longer futures prices fall more. In this case, the market is characterized by (normal) backwardation.

This characterization of the movement in oil prices is relevant to what’s currently happening in oil prices. In the period from June 2014-January 2015, the benchmark oil prices (both Brent and WTI) plunged by about 60 percent, reaching about $46 for WTI and $46 for Brent. Of course, the drop has been exaggerated by the working of pessimistic oil speculators, OPEC’s change in policy and the prospective of a lifting of Iran’s economic sanctions. Those speculators then were bidding on an oil market that is well supplied and awash to the brim by oil, equivalent to a global oil surplus that exceeds 1.5 million barrels a day. Starting January 2015 and until now, the same oil prices have regained 40 percent of its June 2014 value. The rebound this time has been manipulated by optimistic speculators who have inflated the ongoing modest growth in oil demand and considered it as an antecedent of a drastic price rebound. Those speculators may have also exaggerated the implications of a perceived topping in the U.S. shale production.

The oil market had played this dancing game before, starting in 2008. In August of that year, futures prices started to slide down swiftly, plunging from $145.44 a barrel on August 14, 2008 down to $32 barrel by the end of December 2008. After the down game ended, the bouncing game started in early 2009 and oil prices had accelerated to well above $100 in October 2014.

Regardless of what the speculators are doing now and then, the futures and physical oil markets do not always see eye to eye particularly in the short run. The futures market sees a growth in the oil demand and is moving futures prices up, while the spot or physical market perceives a mounting supply and is sending its prices below futures prices. This means currently we have again a contango in the oil market.

It will be remiss if I do not cite similar conditions centering on June 2014. The physical market foresaw weakness in spot prices but the futures market prophesied strength going forward. However, in October 2014, the futures price started a new drastic drop, which ended in January 2015, shaving off about 60 percent of its value. Since then, the futures price bounced back and restored 40 percent of its June 2014 level.

Which market should we believe? Under short run abnormal conditions such as the current one, the futures market is myopic and is very vulnerable to the actions of zealous speculators. If this is the case now, then the futures market is not sending us the correct signals about expected future oil and gasoline spot prices, thereby another drop in the oil prices is not far off and more fluctuations are still in offing supported by the adaptability of efficient oil shale producers to switch production on and off as the price reaches a certain level. High quality oil is now being pumped in several oil-producing countries (i.e., Norway, Azerbaijan. Iraq, Venezuela and others) and is loaded on tankers but they have no buyers in sight. A large amount of Iranian oil is highly likely to come to the market if the oil sanctions are lifted. The conflict in Yemen, which may have added about $10 a barrel to the risk premium component of the oil price, may have outlived its usefulness. Added to those factors the expected new rise in the U.S. dollar which has a dampening effect on oil prices.

This could be another future opportunity to invest in oil stocks when the prices are on the second leg down. Still, caution is warranted as we await a repeated game since the oil market has become crazy.

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