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Gas Prices Rising Despite Surge in U.S. Production, Drop in Demand

February 22, 2012

With their presidential primary process devolving into a farce, Republicans are turning to rising gas prices to bludgeon President Obama. While Newt Gingrich thundered that "gasoline prices are unacceptable," Rick Santorum charged that "We need a president who is on the side of affordable energy."
Sadly for the GOP messengers, the data suggest that something else is afoot in the oil market. After all, domestic crude production began rising in 2009, helping lower U.S. imports to 45 percent of American consumption from 60 percent as recently as 2005. Meanwhile, as BusinessWeek documented, "demand in the U.S. is at its lowest point since 1997." All of which means American motorists are once again at the mercy of the insatiable need of countries like China and the endless greed of speculators here at home.
As McClatchy explained Tuesday, at $3.59 a gallon the average gasoline price appears headed back up to its July 2008, pre-Wall Street collapse high of $4.21. Yet, "U.S. demand for oil and refined products -- including gasoline -- is down sharply from last year, so much that United States has actually become a net exporter of gasoline, unable to consume all that it makes." While the Energy Department said that U.S. inventories of crude oil and refined gasoline "are in the upper limit of the average range for this time of year." And even the "security premium" due to tensions over Iran, which AgainCapital analyst John Kilduff put at $8 to $10 a barrel, doesn't explain this week's $105-plus price.
Instead, McClatchy highlighted, "Once again, speculators [are] behind sharply rising oil and gasoline prices":

Historically, financial speculators accounted for about 30 percent of oil trading in commodity markets, while producers and end users made up about 70 percent. Today it's almost the reverse.
A McClatchy review of the latest Commitment of Traders report from the Commodity Futures Trading Commission, which regulates oil trading, shows that producers and merchants made up just 36 percent of all contracts traded in the week ending Feb. 14.
That same week, open interest, or the total outstanding oil contracts for next-month delivery of 1,000 barrels of oil (about 42,000 gallons), stood near an all-time high above 1.486 million. Speculators who'll never take delivery of oil made up 64 percent of the market.
Not surprisingly, big Wall Street traders on Tuesday projected oil will rise above $112 a barrel; some such as Swiss giant Vitol even suggested $150-a-barrel oil is coming soon. When they dominate the market, as they do, speculators' bids can make their prophecies self-fulfilling.

Writing in the Washington Post, Brad Plummer noted that "a number of U.S. gasoline refineries closed early for maintenance this year, causing pump prices to spike higher in places such as California." Still, analysts like Tom Kloza, chief oil analyst for the Oil Price Information Service and Oppenheimer & Co's Fadel Gheit point to the influence of market speculation. As McClatchy explained:

"Speculation is now part of the DNA of oil prices. You cannot separate the two anymore. There is no demarcation," said Fadel Gheit, a 30-year veteran of energy markets and an analyst at Oppenheimer & Co. "I still remain convinced oil prices are inflated"...
Production and delivery costs for a barrel of oil from Canada are about $75 a barrel. The market-fundamentals cost for a barrel of oil is in that ballpark; above that, speculation sets the prices.
"It's as simple as that," said Gheit, who has testified before Congress and called for regulatory limits on speculation in commodities markets.

A BusinessWeek analysis echoed that conclusion. As Tom Kloza put it, "People are properly puzzled by the fact that we're using less gas than we have in years, yet we're paying more":

Kloza believes much of the increase is due to speculative money that's flowed into gasoline futures contracts since the beginning of the year, mostly from hedge funds and large money managers. "We've seen about $11 billion of speculative money come in on the long side of gas futures," he says. "Each of the last three weeks we've seen a record net long position being taken."

For his part, Plummer argues that "While some analysts argue that speculative hedge fund money is driving up gasoline futures, global forces still appear to be the prime suspect." If this sounds familiar, it should. After all, in the spring of 2011 as now, the rising demand for oil in China and other expanding economies showed, as Carter Eskew rightly concluded, "the United States can no longer impose its will on energy prices."
As we learned a year ago, steadily increasing Chinese imports of oil - interrupted only by the devastating global recession of 2008 - have been driving prices ever upward:

As Paul Krugman explained in December 2010:

Today, as in 2007-2008, the primary driving force behind rising commodity prices isn't demand from the United States. It's demand from China and other emerging economies. As more and more people in formerly poor nations are entering the global middle class, they're beginning to drive cars and eat meat, placing growing pressure on world oil and food supplies.
And those supplies aren't keeping pace. Conventional oil production has been flat for four years; in that sense, at least, peak oil has arrived.

That same month, former Shell executive John Hofmeister concurred with Krugman's analysis:

"We're right back to where we were in 2007 and 2008, in terms of U.S. demand. What's different this time, however, is that Asia's demand is much, much higher than two years ago. And the world is having a very difficult time getting past 85 million barrels-a-day of (crude oil) production."

Nevertheless, fading GOP White House hopeful Newt Gingrich denounced President Obama as "outrageously anti-American energy" and announced this week that with him in the White House, a gallon of gas "easily go down to $2." Gingrich would do well to remember what happened to Texas oil man George W. Bush. Asked by a reporter in early 2001 if his boss would encourage energy conservation, press secretary Ari Fleischer responded, "That's a big no. The President believes that it's an American way of life, and that it should be the goal of policy makers to protect the American way of life." Bush, who came into office pledging to "jawbone OPEC members to lower the price" by early 2008 "hadn't heard" that gasoline would soon hit $4 a gallon. Ultimately, a frustrated George W. Bush suggested the skyrocketing prices at the pump called for a higher power:

"You know, if there was a magic wand to wave, I'd be waving it, of course."

Absent that magic wand, the federal government should continue the impressive increase in domestic energy production, encourage alternative sources and, despite the high-voltage mockery from Newt Gingrich and Mitt Romney, accelerate the transition to much more fuel efficient cars and trucks. President Obama should pursue all those steps and one more.
Crack down on the speculators.


About

Jon Perr
Jon Perr is a technology marketing consultant and product strategist who writes about American politics and public policy.

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