If Greedy Speculators Drive Up Fuel Prices, Why Do Prices Fall?

Published June 7, 2012

In an April 17 Rose Garden speech, President Barack Obama blamed “speculators,” whom he called “an irresponsible few,” for the rise in the price of oil. But energy and finance experts say the President fundamentally misrepresented, or perhaps doesn’t understand, the roles that traders and financial markets play in protecting consumers from supply interruptions and sudden price spikes.

President Obama said, “We still need to work extra hard to protect consumers from factors that should not affect the price of a barrel of oil.”

“That includes doing everything we can to ensure that an irresponsible few aren’t able to hurt consumers by illegally manipulating or rigging the energy markets for their own gain,” he continued. “We can’t afford a situation where speculators artificially manipulate markets by buying up oil, creating the perception of a shortage, and driving prices higher—only to flip the oil for a quick profit. We can’t afford a situation where some speculators can reap millions, while millions of American families get the short end of the stick.”

He called on Congress to provide funding “to put more cops on the beat to monitor activity in energy markets.” He added, “In the meantime, my administration will take new executive actions to better analyze and investigate trading activities in energy markets and more quickly implement the tough consumer protections under Wall Street reform.”

Congress has not provided funding and Obama has not taken new executive actions. At the time of Obama’s address oil prices were approximately $105 a barrel. At the beginning of June oil prices were approximately $20 a barrel lower.

Factors such as war talk, monetary manipulation, and growing or slowing economies drive fuel price changes, says economist Robert Wenzel of EconomicPolicyJournal.com.

Monetary Policy Effect

Blaming oil speculators is a cynical attempt by government officials and apologists to divert attention from the impacts of government policies, he says.

Jerry Taylor, a senior fellow in energy and environmental policy at the Cato Institute, says government actions have had little to do with recent price fluctuations, though he agrees oil speculators have had no impact.

“One thing that’s been going on is [Federal Reserve Chairman] Ben Bernanke doing a rollercoaster with the money supply,” says Wenzel. “Last year it was growing at over 15 percent on an annualized basis. Now it’s down to 4 percent, so the money isn’t there to bid up prices.”

But he expects the money supply rollercoaster to start climbing again soon.

“We’ll probably get a QE3. It might be coming soon,” he says. QE3 is the term being used to describe a possible third round of “quantitative easing” since 2008. QE is a term used to describe an infusion of money created by the Federal Reserve.

“Judging by markets today, it looks like there could be a global push of money,” Wenzel says. “That would reverse all the price declines and start pushing prices up again. It’s dangerous as far as price inflation is concerned. When central banks start printing money, at some point price inflation will really heat up.”

‘Fed Prepared for Action’

On June 7 Bernanke told the congressional Joint Economic Committee, “As always, the Federal Reserve remains prepared to take action as needed to protect the U.S. financial system and economy in the event that financial stresses escalate.”

Bernanke did not specify what action the Fed might take, but he has twice had the Federal Reserve buy bonds and other assets from commercial and investment banks. This puts more money onto their balance sheets with the idea of increasing the flow of money into the economy.

Joint Committee Vice Chairman Rep. Kevin Brady (R-TX) warned against more bond buying at the hearing. He said it could raise the risks of rapid price inflation.

“It is my belief that the Fed has done all that it can do and has perhaps done too much,” he said.

Supply and Demand

Cato’s Taylor says the biggest fuel price increases have been in the Eastern Seaboard markets where Brent crude oil dominates. Fuel prices there have tracked with changes in Brent crude prices.

“Why did Brent crude go up? Because Brent production is down and demand is up,” he says.

West Texas Intermediate oil is used outside the Eastern seaboard. Supply of WTI has better matched demand, which explains why gas prices did not spike as high outside the Eastern Seaboard, he says.

“I don’t see any room for speculators in this story,” Taylor says. “Price changes follow changes in supply and demand. When you open a newspaper and see reports about how oil increased $1.50 today, you’re getting misinformation. They’re reporting what happened to futures contracts due 30 or 60 days in advance.”

Liquidity Providers

Taylor notes most contracts are not settled through actual delivery of oil. Instead, oil producers and buyers use futures to try to lock in prices and reduce price swings that can happen because oil supply and demand cannot be perfectly matched weeks in advance. Speculators assume price risks by brokering futures contracts to match buyers to sellers. They provide market liquidity.

Taylor says futures contracts could affect spot prices in two ways.

One is if futures prices are far higher than spot prices, prompting some buyers to take delivery of oil and store it for future sale. If that were happening, however, there’d be big increases in inventory. Taylor says there is no evidence for this.

The second way is if high futures prices tempt oil producers to cut production to boost it in the future. “We don’t see any evidence of that happening, either,” he says. “It’s normal supply and demand changes. There’s no evidence at all that speculators are driving prices.”