In a capitalistic marketplace, there evolves a set of products known as “commodities”. These are products where producers are not differentiated:
A commodity is a basic good used in commerce that is interchangeable with other commodities of the same type; commodities are most often used as inputs in the production of other goods or services. The quality of a given commodity may differ slightly, but it is essentially uniform across producers. When they are traded on an exchange, commodities must also meet specified minimum standards, also known as a basis grade. [ref]
Corn is a commodity. So is wheat. Just about any farm product produced in bulk falls into this category: potatoes, oats, soybeans, rice, cocoa beans, etc.
Metals are traded as commodities as well, because metal is metal once it is smelted and purified: gold, silver, copper, iron, etc. are all traded as commodities.
Once it comes out of the ground, crude oil gets traded as a commodity, as does natural gas. Even refined products become commodities, for example gasoline or jet fuel.
Some commodities are graded, some are not. Pure gold is pure gold – it is the same no matter where it comes from, no matter how old it is, etc. One atom of gold is the same as every other atom of gold. An orange, on the other hand, has a lot of variables. So oranges get graded based on things like color, shape, taste, etc. Some oranges can be sold for a premium in a grocery store for eating because they are essentially perfect. Other oranges look like crap, but they taste fine, so they become orange juice. Juice oranges are very cheap compared to grocery store oranges.
With a commodity product of a certain grade, there is a global price for the commodity that rises and falls constantly. So we hear on the news all the time things like this:
U.S. West Texas Intermediate crude surged more $1.56, or 3.1 percent, to end Monday’s session at $52.22 a barrel, the highest closing level since April. WTI hit a session peak of $52.28, about $3 below its 2017 intraday high. International benchmark Brent rose $2.01, or 3.5 percent, to $58.87 by 2:09 p.m. ET, having touched the highest level since July, 2015. [ref]
“Brent” or “West Texas Intermediate (WTI)” are simply different grades of crude oil with slightly different characteristics that are important to refineries:
Sulfur content of crude oil is the most important indicator of quality. The lower the content, the “sweeter” the oil and the easier it is to refine. Crude with high sulfur content is sometimes referred to as “sour”, and while it is still valuable, it requires more work to remove the impurities and therefore is generally traded at a lower premium.
API gravity, which compares the crude’s density to water, is also an important indicator of quality. The higher the API gravity, the lighter the oil. Lighter oil is easier to process than heavier oil and consequently fetches a typically higher price on oil markets. [ref]
Brent oil comes from the North Sea area of the planet. WTI oil comes from the Texas area of the planet. Both are considered to be “light” and “sweet”. If oil is “sour” and/or “heavy”, it is still a commodity, but it has a lower grade and a lower price because it typically takes more work/equipment at the refinery to turn it into gasoline (and other petroleum products).
In capitalism, all of this seems to “make sense”. And since we are all immersed in capitalism since birth, it all seems completely normal. For example: The idea that gold is a commodity because gold is gold “makes sense”. The idea that oil prices fluctuate every day “seems normal”. But have you ever thought about what is going on behind the scenes with commodity pricing in capitalism? All of it is an amazing mechanism for concentrating wealth and raising prices.
The Information Hidden by Commodity Pricing
Here is a simple example of what occurs under the hood. Crude oil at a certain grade is a commodity, sold at a commodity price worldwide. But think about how the commodity price works. There is one commodity price, regardless of the cost of production, and the price comes from “supply and demand”. So let’s imagine that there are three suppliers in the oil market:
- For one supplier, the oil is near the surface and trivially easy to extract from the ground. It costs $20 per barrel in actual costs to bring a barrel of oil to market.
- For the second supplier, it is more difficult to deliver a barrel of oil (they had to drill a mile deep or pressurize the field to get the oil to the surface), so the actual cost of production is $40 per barrel.
- For the third supplier, the cost is $60 per barrel (they are extracting oil from tar sands, and this process is a lot more expensive).
Demand for crude oil is high, so the price of oil is $100 per barrel. Under the paradigm of “commodity pricing” in capitalism, all three suppliers receive that same amount of money for their oil. The price of oil has absolutely no relationship with the cost of production, and therefore is completely irrational. The first supplier is making a profit of $80 per barrel for no reason whatsoever. This kind of irrationality is normal operating procedure in capitalism.
Then something absolutely perverse can happen in a commodity marketplace like this. If it wants to and is able to, the first supplier can arbitrarily triple production to increase the supply. Because of “supply and demand” rules in capitalism, this action can lower prices to $50 per barrel. Now the third supplier will go out of business, because it is losing money on every barrel of oil it creates. Then, once the third supplier is gone, the first supplier can decrease production to lift prices again, but prices may now go even higher because of lower overall supply. Again, it is utter insanity to do things this way, but completely acceptable in capitalism.
Or a low-cost supplier can cut production to decrease supply, and therefore cause prices to rise under “supply and demand” rules in capitalism. Because prices rise in the commodity marketplace, the low cost supplier may not lose any money at all by cutting production. Conceivably, depending on the size of the price spike it creates, the low cost supplier could profit even more, even though it is producing less oil. This is exactly what occurred during the OPEC oil embargo in the 1970s. OPEC cut production and oil prices spiked upward.
And think about the fluctuating prices that “supply and demand” causes. The cost of production between yesterday and today at all of the suppliers does not change in a 24 hour time span. But the price of oil can fluctuate up or down wildly, for reasons that have nothing to do with the cost of production. Some random rumor can spike prices up in many cases – there may be no rational basis whatsoever for the world commodity price.
As consumers, we see and feel the effects of commodity pricing on a regular basis. A war (or even the perceived threat of a war) in an oil rich country will cause a spike in crude oil prices. This price spike immediately gets reflected into gasoline prices at the pump, often the very next day. But then the price spike retracts (e.g. the rumor of war dies down), and prices at the pump take weeks or months to reflect this change. All of this is utterly absurd and irrational, and the system exists so that trillions of dollars in profit can be extracted from consumers on a whim. It is impossible to imagine a more ridiculous system for setting prices.
Think about how commodity pricing would work in a rational system. It’s simple: the price reflects the cost of production. The first supplier would receive $20 to cover its cost of production, the second supplier would receive $40, and the third supplier would receive $60. The price in the market would be the weighted average.
A rational price would then bake in the cost of R&D. If the marketplace needs oil, and if oil fields have a finite life span, then there needs to be exploration and drilling. Some new wells will work, some will be dry. This is part of the process. So consumers pay for the cost of R&D.
A rational price would also bake in the real cost of externalities – something that is completely ignored by capitalism today, to the detriment of the entire planet. Today, a consumer can purchase a gallon of gasoline, burn it in an engine, and in the process spew 19 pounds of carbon dioxide into the atmosphere. The 19 pounds of CO2 released per gallon of fuel, multiplied by hundreds of millions of cars, ships, locomotives, airplanes, tractors, etc., means that gigatons of CO2 are released into the environment every year without any restrictions. This too is insanity. The release of gigatons of CO2 every year is causing a massive, planet-wide environmental train wreck, in the form of rising CO2 concentrations in the atmosphere. Rising CO2 levels are causing increases in average temperatures, as well as ocean acidification. The whole situation is utterly absurd, but completely normal in capitalism.
In any sort of rational economy, no one would be allowed to emit CO2 into the atmosphere. Either: 1) the CO2 would have to be captured immediately and sequestered in some safe way, or 2) the emitted CO2 would have to be extracted back out of the atmosphere and sequestered in some safe way. Both of these activities would have costs, which would be reflected in the price of crude oil or gasoline. The correct accounting for externalities, and the related changes in pricing, would totally alter the marketplace for crude oil. It would also have prevented the environmental catastrophe that humanity now faces.
There is no way to express how absurd – insane really – the rules of capitalism are once you take the time to actually think about them. The way that commodity pricing of crude oil and gasoline has been managed over the last century has been an utter disaster for both consumers and the environment. As we conceive of and create a new economy, these problems inherent in capitalism must be eliminated so that all humans on the planet can prosper.