“I’m a free-market guy, but the government must step in to stop the speculators!” ~ Bill O’Reilly, The O’Reilly Factor Crude oil prices have now doubled this year to over $70 a barrel, and gasoline prices are moving back up quickly, and have even hit $3.00 a gallon in California. American consumers are getting restless again, worried that gas prices might return to $4 or more in the near future, and all this is happening at a time when Americans can least afford it.
Why would gas prices rise in the midst of a deep recession and high unemployment? It makes no sense! On the supply side, gasoline and oil inventories at historical highs, and on the demand side, fewer goods are being transported by trucks, trains and airplanes. So what gives? Why are energy prices suddenly going back up in the midst of a glut? Bill O’Reilly and other populists are blaming the commodity speculators for bidding up the price of oil and gasoline futures on the New York Merc and other exchanges. They want the government to impose higher margin requirements, from the current 10% to 50% or more, to curtail speculation in oil and gas prices. There are two important points to be made about the role of the futures markets in determining the pricing of basic commodities. First, it is true that speculators can push commodities far beyond their fundamental long-term value. We saw that when oil prices rose to $147 a barrel a year ago. That’s when speculators are labeled the bad guys. But don’t forget that it was also speculators who pushed the oil prices down to $34 a barrel in January -- far below their fundamental long-term value. Second, futures markets are not only for speculators, but for hedgers. These are producers who sell and lock into higher prices in order to protect their profits against the possibility of prices coming back down (and they need those higher profits to find new reserves). And they are customers who buy commodity contracts to protect themselves from the possibility of having to pay higher prices down the road. In reality, blaming the speculators for the high price of energy is really attacking the messenger instead of the ultimate culprit. Speculators are looking into the future, and what they see is a very different supply and demand situation for energy. That is, they see a coming shortage in crude oil and a sharp rise in the dollar demand for energy. Let me explain. On the supply side, speculators see surpluses turning into shortages. OPEC and major oil producers are cutting production. In the long run, most of the cheap oil deposits have already been found. New oil deposits have been discovered off the coasts of South America, Africa and elsewhere, but the new reserves are in inhospitable and inaccessible places, such as the deep waters off Africa and Brazil, or the frozen oceans of the Arctic. And deep-water exploration is extremely expensive compared to land-based exploration. Deep-water extraction isn’t profitable unless oil prices exceed $75 to $80 a barrel, compared to $25 to $30 a barrel for some land-based deposits. In addition, governments everywhere are over-regulating the oil & gas market, either by outright nationalization (OPEC nations) or restricting drilling in new oil fields for environmental reasons (Alaska). The Obama administration wants to impose huge new taxes on traditional oil & gas markets (cap & trade). On the demand side, speculators see more consumption of energy products as the global economy recovers and emerging markets expand (China, India, Latin America). They also see a new round of inflation coming, as reflected in a weak dollar. To fight the current depression, governments everywhere have adopted “easy money” policies, pumping trillions of new dollars into the economy, and aggressively running massive deficits -- deficits funded with depreciating dollars. Don’t forget that the price of oil is quoted in dollars, and as the dollar weakens, the price of oil inevitably goes up. A King Dollar policy -- a stronger dollar -- and deregulating the energy markets, would be the best remedies for stabilizing energy prices. But neither one is going to happen, so you better get used to higher gasoline prices. They are inevitable.