Want Cheaper Gas Prices? Forget Domestic Drilling, Regulate Speculation on Oil

It never ceases to amaze me how uninformed many of the people with the strongest opinions on oil policies seem to be. Every time I go to a conservative political event, there is a dogmatic, almost religious call to drill more oil out of our own ground. Even a rudimentary understanding of the global oil markets will allow someone to understand how little impact increased domestic output will have on prices at the pump. When I go to a liberal political event, the answer is always alternative energies – a noble and necessary approach, but still not one that is going to impact the cost of energy in the immediate future and one that  too often comes with special interest payoffs.

Both parties are missing the boat and I'm not convinced it's entirely owed to ignorance. Every economist knows that the biggest and most immediate change that the United States can make to have a positive impact on prices at the pump is to regulate oil futures trading to prevent it from artificially driving up the price of gasoline. The problem? – there's no boondoggle here. It's not a handout to corn farmers in the form of ethanol subsidies or to the oil companies in the form of sweetheart domestic leases – and it would be a moderate restraint on the Wall Street profiteers, clearly a powerful lobby among both parties. That doesn't change the fact that it is the solution and until we the people, stop screaming nonsensical chants like Drill Baby, Drill, and start demanding an answer that will actually work, we'll be stuck with ham-fisted solutions that amount to more tax-payer funded pork to special interests.

Let's start by debunking the myths. First, oil is sold on a world market, no matter where you drill it from. Unless we nationalize the industry here in the U.S., the relatively small amounts of oil (in terms of global supply) that we have yet to tap domestically is going to have minimal impact at the pump. That oil will go to China, India and other countries that have rising demand just as often as it is sold here and because we have limited refining capacity in the U.S., much of it will have to be exported as crude anyway, even if it is to return.

To put it in perspective, even the most optimistic estimates for the amount of oil that could be drilled in the Gulf of Mexico total between a few weeks and a few months worth of supply just in the U.S. And if you use the most optimistic estimates of drilling in the Alaskan National Wildlife Refuge, over the 10 years it would take to extract it, you'd save more oil by improving the fuel efficiency of U.S. cars by just 1 MPG. Again, you can see how this might be very profitable for oil companies who are increasingly eager to find new places to extract their product and grow their record profits, while doing nearly nothing to the short-term prices that have our economy over a barrel.

Now, because we have either already reached or are approaching the moment of peak oil on the planet, we absolutely have to develop energy alternatives to transition us from fossil fuels in something less than an anarchic fashion. Rising demand in developing nations like China and India where new and growing middle classes are adding vehicles to the road at an incredible pace (half a million cars per month in China alone) and increasingly difficult extraction of oil have guaranteed that the age of "cheap" oil is over forever. Like any other business, oil companies grab the lowest hanging fruit first and over the last century have depleted the easiest and cheapest to access oil reserves. As new sources are discovered, they rely increasingly on expensive and less productive technologies that also make modern oil markets vastly different.

We are not investing nearly enough resources into viable alternatives for energy and that must change. In a completely inexplicable strategy, we actually spend more money subsidizing the oil industry than we do advancing clean alternatives. Nonetheless, were we to get serious today and begin properly investing in such alternatives (which I'm all for) we would not significantly reduce demand on a time line that would impact prices in the near future. Like I said, we need to be doing that, because otherwise we are just deferring a much bigger and scarier day of reckoning, but it is still not the short term solution

So what is? First, let's be clear. Supply and demand is not the main problem at current prices. A recent Bloomberg report showed that oil supply was at an 18-year high when oil spiked 15 percent earlier this month. Yes, there has been political unrest in oil rich countries, but Libya only produces 2 percent of the world's oil and Saudi Arabia quickly announced that it would ramp up output to make up the difference if Libya's spigots are less than full flow. The biggest factor influencing price is simple – speculation. The U.S. Commodity Futures Trading Commission told congress in 2008 that as much as half the cost of a gallon of gas is owed to market speculation on future prices. Let's look at how that has come to be.

Commodity futures contracts have a vital role in the economy. They allow companies to promote stability by locking in somewhat fixed costs of raw materials needed for their products. In terms of oil, many companies from electric utilities to heating oil providers have to buy massive quantities of oil on a regular basis. To protect from price shifts, they enter agreements to assure future demand by committing to current price. Any business will tell you that when a customer can guarantee to keep buying the same amount at the same price, it goes a long way to ensuring a healthy market for both supplier and consumer. Now, Wall Street has always wanted to bring this game to their casino and though FDR was shrewd enough to see this and put in place strict regulations on the trading of such futures, both Democrats and Republicans have been reducing those limitations regularly ever since.

Part of the problem today is that oil is bought and sold electronically at incredibly rapid speeds for the pure purpose of profiting off of artificially inflated prices – and because powerful financial titans make a lot of money doing so, nobody has stopped them. A system that is designed to allow both parties to prosper by someone selling oil to someone else who takes possession of it, stores it and uses it, is now anything but. The vast majority of trades occur only on paper by players who have no use for and never intend to take possession of the oil. If the CFTC simply ended paper speculation (which recent financial reforms empowered them to do) and said that all oil sold in futures contracts has to physically change hands, the number of players, trades and price spikes would diminish drastically. The data suggests that pump prices would be somewhere around $2 to $2.30 a gallon, were such a policy to be enforced at current supply/demand.

So, why hasn't this happed? Simple, as I pointed out earlier, like most obvious political solutions that aren't implemented, there's no boondoggle for someone writing big checks to politicians. It's only the taxpayers' ability to eat and the economic recovery from the worst downturn in nearly a century that's at stake, so why should we expect political action? Wall Street pay is at a record high, despite our deep recession. Clearly they've learned to keep milking the udders no matter the cost to the rest of us. Instead of putting the brakes on them, we are maintaining a policy that fattens the pockets of the very institutions that brought the economy down at the expense of the people who bailed it (and them) out.

Right now, the CFTC is 3-2 in favor of the Democrats in terms of composition. Two of the three Democrats favor such regulation (the two Republicans are opposed – one is an 18-year Goldman Sachs vet). A third Democrat, Michael Dunn also stands by the moronic statement that he doesn't think such regulations would impact prices. Dunn, appointed by President Bush, is the senior member and his seat expires this June when President Obama will be able to nominate a replacement. Here is perhaps one of the most crucial battles the President will be able to wage and one on which we should demand he show political courage.

We are learning ever so painfully how important stable and relatively-low energy prices are to our national economy. In 2008, when prices at the pump went well over $4, economic activity took a nosedive. Every commodity got more expensive and it looks as though $5 is the threshold as to when too much money goes into gas tanks and inflated prices on necessities like food and utilities to allow for enough discretionary spending to keep our consumption-based economy afloat. This number seems to be the start of a tailspin even in good times and remember we are on the upswing of a very long and fragile economic recovery that all indications suggest would not withstand such downward pressure.

This is a very telling truth about the American economic system and one we'd better start working on long-term solutions for. Like I said, it is painfully clear that the factors involved will never allow for supply to match rising demand, so oil will never be "cheap" or plentiful again no matter where we drill. Furthermore, we Americans are hedged to a degree in that oil is sold in U.S. dollars and unlike other countries, we do not have to convert our currency or purchase massive reserves of someone else's to feed our addiction. Should that change, as many countries would like to see, given the dollars increased devaluation and perceived instability owed to rising debt, the U.S. would suffer the sort of consequences that would push us above that $5 a gallon threshold, so real investment in viable alternatives is an absolute must.

In the meantime, we need to protect ourselves from the economic collapse that continued price manipulation can bring by regulating the trading of oil futures. In that sense, the most important "election" in terms of its impact on the average American's pocketbook is the nomination and confirmation of Mr. Dunn's replacement on the board of the CFTC, something that would otherwise occur unnoticed by the general public. So, if you care about your country and want to see better prices at the pump, do something truly patriotic – peel off the ridiculous drill baby drill bumper stickers and tell President Obama that you demand he fight for the confirmation of someone committed to ending the sleazy, greed-driven manipulation of oil prices for profit that is threatening our economic recovery.

Dennis Maley is a local author and the editor of The Bradenton Times. He can be reached at dennis.maley@thebradentontimes.com. His editorial column appears Thursday and Sunday. An archive of his columns are available here.