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April 26, 2012

Market Failure: Wall Street Speculators and Gas Prices

GaspumpOn April 17, Michael Greenberger and Tyson Slocum addressed congressional staff on oil speculation and gave it to them straight: excessive speculation in oil futures is significantly increasing prices at the pump right now.

Greenberger, a professor at the University of Maryland's Francis King Carey School of Law and formerly a Futures Trading Commission director in the Division of Trading & Markets under chairperson Brooksley Born, discussed how a smoothly working oil market should consist of 70 percent investment in real product and 30 percent futures speculation for liquidity, making it easier for investors to enter and exit the market. This balance would allow the market to react appropriately to drivers like supply and demand.

Today's oil market, by contrast, contains 80 percent futures speculation and only 20 percent actual product investment. The result is a market with volatile reactions to any "prediction" about oil, be it definitive agency or administration action or something as indefinite as a news piece on the Middle East.

For instance, citing a paper Greenberger wrote on Unregulated Excessive Speculation and Oil Market Price Volatility, in June 2007 the price of WTI crude oil was $65 per barrel, but by July 2008 this price rose more than 126 percent to $147. Despite predictions in mid-July that crude oil would rise to $200/barrel by year’s end, the price then sank to the low $30s by winter 2008/2009. But in the absence of any final regulatory legislation, it rose back to $75 in 2009, stabilizing in the $65-75 range until the price later broke through the $80 level on reports (which turned out to be unfounded) that the U.S. Commodity Futures Trading Commission chairperson did not have support for a strict position limit regime. During this time supply and demand remained relatively constant.

The fact is that the oil market is overwhelmed by speculators gambling with future prices based on guesses about what might happen later, while relegating the remaining 20 percent that is indicative of supply and demand to the sidelines, where it has little effect on the price per barrel.

As a point of contrast, the natural gas market has regulations in place capping the total amount of speculation investment. That market experiences no such artificial price increases due to excessive speculation, and as such, the high current supply of natural gas has driven prices down. The oil market can and should be similarly regulated to react to market indicators.

Slocum, director of Public Citizen's energy program, emphasized the need for real regulation of the oil speculation market. The lack of incentives in place to deter excessive speculation means there is no reason for actual market forces to determine the market’s direction. Until actual punishments and disincentives are implemented for those who drive oil prices up for their own gain, the oil market remains vulnerable to those betting oil prices will go up.

The high prices at the pump are spurring many politicians and pundits to call vehemently for increased domestic drilling, insisting it will cause gas prices to drop. Slocum addressed this rhetoric head on, calling it a "fallacy." Further, one will not find this idea championed by oil companies or the American Petroleum Institute because it is patently untrue. As oil prices are determined on the global market and America lacks the resources to significantly affect global oil supply, there is no reason why increased domestic oil drilling will drive down prices. Greenberger cautioned as well that removing excessive speculation, while important, will not bring prices at the pump back down to their former cheap level. Our transportation infrastructure was built on the basis of cheap gas and nothing is going to bring us back to that reality. Therefore, we need to both address the failings in the oil market to keep the prices as true to supply and demand as possible, and simultaneously move toward non-oil-based transportation alternatives.

-- Athan Manuel and Ryan Kriz Gardner, Sierra Club's Lands Program

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