Is Oil Speculation Responsible for High Gas Prices?

Is Oil Speculation Responsible for High Gas Prices?

As Americans watch their wallets empty as quickly as gas prices climb, we all search for answers. Some experts say the seemingly endless rise in gas prices is being driven largely by oil speculation, the practice of buying and trading oil futures -- in an attempt to predict the cost of oil at a later date. Should you blame speculation for your pain at the pump?

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Speculation is Knocking the Supply-Demand Fundamentals Out of Whack

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Speculators and unregulated energy traders have pushed prices beyond the supply-demand fundamentals and into an era of a speculative bubble in oil markets. While some speculation plays a legitimate function for hedging and providing liquidity to the market, the exponential rise of market participants who have no physical delivery commitments has skyrocketed, from 37 percent of the open interest on the NYMEX West Texas Intermediate (WTI) contract in January 2000 to 71 percent in April 2008. Contrary to some public opinion, oil prices are not set by the Organization of Petroleum Exporting Countries (OPEC); rather, they are determined by the actions of energy traders in markets.

Of course, supply and demand has played a role in the recent rise in oil prices. Although gasoline demand in America is down more than 1% from a year ago (with Americans driving 37 billion less miles from May '07 to May '08), global demand—particularly in emerging economies like China, India and oil exporting nations in the Middle East—has skyrocketed at a time when the mature, productive and easily-accessible oil fields are in decline. Simply put, oil is a finite resource with which the world has embarked on unprecedented increased demand. But no doubt speculators are making a bad situation far worse, and Americans need help adjusting to high prices.

Rather than demonize speculation generally, the goal is to address problems associated with recent Congressional and regulatory actions that deregulated energy trading markets that opened the door to these harmful levels of speculation. Enron paved the way, as the company nearly single-handedly lobbied successfully to deregulate energy trading in 2000. Removing regulations has opened the door too wide for speculators and powerful financial interests to engage in anti-competitive or harmful speculative behavior that results in prices being higher than they would otherwise be. At least $30 of the current $145 of a barrel of oil—or about 70 cents of a gallon of gasoline—is pure speculation, unrelated to supply and demand.

Indeed, the U.S. Commodity Futures Trading Commission on July 24 filed charges against crude oil speculators, accusing them of manipulating the price of crude oil on the fully-regulated NYMEX exchange. If energy traders are manipulating oil prices on the regulated exchanges, we must assume that they are engaging in far more brazen anti-competitive activities on the unregulated Over-The-Counter (OTC) exchanges.

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