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

Published Sunday, March 20, 2011 3:00 am

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. 

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Gas SHOULD be regulated, like other utilities. Oil Co. have way too much control over Washington. Why do you think that in 1986, the most fuel efficient cars (Ford Escort for example) got an avg. 29MPG and a 2011 Ford Fiesta gets avg. 33MPG. -1986 Toyota Tercel avg. 29MPG, a 2011 Toyota Camry avg. 33MPG, a 1987 Ford F150 avg. 14MPG, a 2001 Ford F150 avg. 17MPG. REALLY? 25years later, with enforced restriction on emissions implemented and met by manufacturers. Yet an improvement of only 5 or 7 miles per gallon. I wonder whose controlling those type of laws being implemented in Washington? ENOUGH IS ENOUGH!!!
Posted by Bob Strang on February 23, 2012
 

Here are the relationships:

1. US oil is sold at the price of world oil, no matter where it is drilled (adjusting for grade or quality of oil).
2. Cost of gasoline, diesel, heating oil, and jet fuel is directly related to price of world oil.
3. Countries that produce huge quantities of oil (e.g. the USA) have the same price of gasoline at the pump (excluding taxes) as countries which produce no oil (e.g. Germany).
4. The US consumes 20% of the world?s oil and produces 9% of the world?s oil.
5. Increasing US oil production would/will have a trivial effect on world oil production and it is world oil production which determines both the cost of oil and the cost of gasoline at the pump.
6. Any benefit to increasing US oil production, at the level of the consumer of gasoline, diesel, heating oil, and jet fuel will flow both to the USA and to the rest of the world. As China currently consumes more oil than we do and as they are rapidly increasing their consumption, while we are flat, China will benefit more from increased US oil production than we?ll benefit, though the benefit to both of us will be trivial.

- Larry Weisenthal/Huntington Beach, CA
Posted by Larry Weisenthal on March 30, 2011
 

Typical, leftist drivel... The investor is bad. The oil Corp is bad, we've found all there is, it'll take too long, it won't do any good, save the earth, we need more regulations and fees and taxes against all those evil rich guys, blah, blah, blah, surrounded by wasted words. Words that we've been bombarded with for the last 50 years that have NEVER proven true or done anything but hinder this country. The department of energy was SUPPOSED to get us off foreign oil... 35 years later, we're importing more than ever.

We all know that drilling for our own oil will not significantly reduce the price of gasoline. I wouldn't expect an oil producer to sell me his product for less than he can sell it elsewhere any more than I would sell my car to a lower bidder when I have a higher bidder with cash in fist standing right there.

What it WILL do is drastically reduce our dependency on foreign oil, in the event of another (continued) foreign upheaval. It's a matter of uninterrupted supply. NOT a matter of price. In a real bad situation, like what is developing in Africa and Middle East, between our coal, oil and natural gas, it wouldn't matter what was going on over there nearly as much. Who knows? We might've even been able to export some. (Wouldn't that be novel).

You want the price of gas to come down? Start walking!
Posted by Tad MacKie on March 20, 2011
 

I agree with you, Dennis, that the CFTC is the key to quickly reducing gasoline prices. If you compare Oil to Natural Gas on strictly an energy (BTUs or Therms) basis one would see there is an appx. 6 to 1 ratio, so Oil should be about $25/BBL BUT IT'S $100/BBL!!! That means there's a $75 of SPECULATION in the price. YES, the CFTC should immediately restrict the number an amts of Oil futures. This would have an immediate effect on the pump price of gas.
We all know that there's an excellent reason (i.e. legitimate hedging) to Oil Futures but this runaway SPECULATION is unnecessary, and quite destructive to U.S. But did you know, George Soros is the largest Oil speculator of them all.

Unfortunately, I can't totally agree with you because, the U.S. has proven oil/Natural gas reserves that if drilled, could make the U.S. TOTALLY INDEPENDENT, in the intermediate term. So, get the CFTC to act --- but DRILL, BABY, DRILL.
Posted by Steve Vernon on March 20, 2011
 

Rather than forbid futures contracts on oil or other commodities, it would be more effective to impose a transaction fee on every contract. Even a modest one percent would substantially discourage the machine-driven lightning trading that increases volatility without making markets more secure. Traders would have to be seeking gains greater than the fee to make the transaction worthwhile, so they would be in them for the longer term. If we can impose a sales tax on virtually everything else, why not on the futures contracts as well?
Posted by Jonathan Friendly on March 20, 2011
 

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