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May 17, 2011

Speculators and the Gas Price Blame Game

May 17, 2011
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John Stossel recently wrote an intriguing op-ed about the perception that speculators are the cause of the spike in oil prices. Indeed, the sentiment is widespread among the populace—a new CNN/Opinion Research Corporation survey that came out last week indicated that 59 percent of respondents said oil speculators deserved a “great deal” of blame for gas prices, with an additional 31 percent believing that they deserved “some blame.”

Speculators are characterized as cogs in the Wall Street greed machine who seek to make a quick buck off betting on oil commodity futures, an idea that many are all too happy to entertain in this post-financial meltdown age. However, the argument that speculative activity has caused this most recent escalation in gas prices ignores the fact that there has been speculation on commodities for centuries, and as Stossel writes, the players are “no more greedy or clever than they have been all along.”

The answer is, in fact, much more simple than politicians want you to believe as they lay blame at the feet of oil companies and speculators. It’s a straightforward matter of supply and demand. World crude oil and liquid fuels consumption grew to the highest level ever in 2010, with 86.7 million barrels per day (bpd) consumed in total. Most of the increase can be attributed to countries outside the Organization for Economic Cooperation and Development (OECD)—China, Brazil, and those in the Middle East—where rapid economic growth and quality of life improvements have led to increasing amounts of energy being used. Fatih Birol, chief economist at the International Energy Agency, said growth in worldwide oil demand is exceeding growth in new supplies by 1 million bpd per year, with much of the new demand coming from China. Factor in Organization of the Petroleum Exporting Countries (OPEC) production restraints that seek to maintain favorably high oil prices, anticipated losses in Gulf of Mexico production, and recent global disruptions, it is unsurprising that oil commodity prices have spiked.

Furthermore, the U.S. Federal Reserve’s second round of inflationary monetary policy (QE2) has prompted investors to flee a devalued dollar in favor of non-income generating real assets, like oil and precious metals, and makes crude cheaper for investors using foreign currencies. As in 2008, when the first round of the Fed’s inflationary monetary policies began, oil prices have steadily risen since Federal Reserve Chairman Ben Bernanke’s announcement that the easy money policies may continue past the end of QE2 this June.

Speculators are merely a symptom of oil spikes, not the cause. Birol, in an interview with CNNMoney, said, “Speculators are only responding to what is going on in the markets… We don’t see enough oil in the markets. The major driver is supply and demand.” Furthermore, speculation even serves as a stabilizing function in a market that would otherwise be exceedingly volatile. In his op-ed, Stossel writes:

“Speculators help keep prices stable. When they foresee a future oil shortage—that is, when prices are lower than anticipated in the future—speculators buy lots of it, store it and then sell it when the shortage hits. They know they can charge more when there’s relatively little oil on the market. But their selling during the shortage brings prices down from what they would have been had speculators not acted.”

To reinforce the point that speculation is a legitimate economic function and that federal intervention would ultimately prove to be worse than the status quo, Stossel cites the 1958 Congressional action to ban speculation on onion prices. That’s right, Congress passed a law, amid mass public outcry, to ban speculative activity on the price of onions. The end result? Onion prices are actually some of the most volatile of all goods, and a study by the Financial Times found that the ban actually did the opposite of the intended effect.

Instead of trying to meddle with the market, Washington should focus on removing the roadblocks to domestic energy exploration to give America more leverage in the oil game. When President Bush finally lifted the U.S. embargo on its own offshore oil in July 2008, the price of oil dropped $9.26 per barrel while he was giving the speech. Crude oil traders and speculators believed that oil supplies would increase in the future, reducing prices. However, it is interesting to note that the market had a fairly apathetic response to President Obama’s recent proposals to increase domestic production.

The only marginal decrease in oil prices since the President’s announcement is indicative that players in the market do not anticipate that the proposals—which are simply reversals of policies implemented during the Obama Administration—will significantly increase the supply of oil. To impact oil prices on the scale of what happened when the Outer Continental Shelf (OCS) moratorium was lifted in 2008, the Administration will need to adopt an energy policy that includes exploration in ANWR, more of the OCS, and more than the current 3 percent of onshore federal lands that are available for leasing. Until the Administration takes these major steps to produce more oil at home, its recriminations against speculators and shadowy market manipulators hold little water.

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