Thursday, June 19, 2008

Gas Prices: It is the Speculators!

Yes, there are evil speculators. It appears that we have speculators in oil futures to thank for gas at $4.50 a gallon.

According to an article by Dick Morris and Eileen McGann, brokerage firms like Morgan Stanley and Goldman Sachs arranged a way for institutional investors to get around federal limits on oil speculation.

Before 2002, "the federal Commodities Futures Trading Commission (CFTC) sharply limited investments by those outside the (oil) business . . . " to prevent speculators from driving up oil prices.

However, the brokerage firms got around those policies by moving "their operations to London [and] setting up the International Commodities Exchange. Now they can buy all the oil futures they want."

As a matter of fact, speculation in oil futures is extremely cheap because the current rules call for only 5% in the way of margins.

As a result, the volume invested in oil futures has expanded from "$13 billion at the end of 2003 to $260 billion by March of 2008. Consequently, the oil futures market is beginning to look like the housing bubble or sub-prime market. Speculation that prices will continue to rise is the engine that fuels the influx of money that actually keeps prices rising.

Excess Profits Tax. In this context, an excess profits tax on the oil companies looks like a highly appropriate policy. Perhaps the oil companies are driving the speculation in oil futures themselves. But it's obvious that the oil companies are making huge profits off the current wave of speculation.

As a result, there's no connection between the extraordinarily high profits of the oil companies and their actual performance in the marketplace. That's a result that isn't good for the oil companies themselves let alone the American economy as a whole. Flush with "unearned" profits, the oil companies have little incentive to be careful, thorough, or smart in figuring out what they're going to do with all the money.

It's best for all concerned if the federal government takes a significant chunk of the current oil boondoggle and applies the money to investment in alternative energy, paying down the national debt, or withdrawing troops from Iraq.

Breaking the Speculators. The federal government also needs to take the further step of breaking the speculators in oil futures. And I mean break them--make sure the big players lose their jobs if not their shirts. The trick is to instantly increase the supply of oil and the best way to do that is to take oil out of the Strategic Petroleum Reserve and put it on the market.

Of course, it could be objected that the increase in supply from the Strategic Petroleum Reserve would be marginal.

And that's true.

But the oil futures bubble is like the housing and sub-prime bubbles in that it depends on investor confidence in infinitely increasing prices. Releasing oil from the Strategic Oil Reserve doesn't have to dramatically increase the supply of oil to bring the oil bubble crashing down. All it has to do is to shake speculator confidence that prices will continue to rise.

And the bubble will be killed.

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