Over the past three weeks the average cost for a gallon of gasoline in the United States has gone from $3.14 to the current average of $3.50. If one listens to the media reports and oil companies the explanation behind this dramatic increase of 11% in just a few weeks comes the trouble in the Middle East. As the story goes, the uprisings in Egypt and Libya are serious cause for concern for the United States oil supply, and this justifies the increase in crude oil prices. However, no one is asking whether this speculation really is justified given the current set of circumstances in the Middle East.
At this point there has been no disruption to the crude oil supply in America from the events in the Middle East. The BP oil spill caused a larger disruption to the crude oil supply in America than anything that has happened in the Middle East thus far. Gas prices have gone up not because of a lack of supply of crude oil, but because of increased demand. It is normal for prices to go up from increased demand from consumers. If Americans consume more gas or use more oil to produce products, and the supply stays the same, then prices can be expected to rise. However, Americans have not started consuming 11% more gasoline over the last three weeks. What is driving prices up is not increased demand from consumers, but instead from speculators.
Much like people who buy and sell stock oil speculators make profits by buying a contract for “future” oil and then preferably selling the contract at a higher price on a later date. Most oil speculators make more money if the price of oil goes up. What is worse, speculators themselves help control the price of oil by buying or selling the contracts. If a huge number of oil speculators rush to buy oil futures then this causes the price of oil, and subsequently gas, to skyrocket regardless of whether the actual supply of oil goes up or down. Much like the price of a stock can go up or down based on a report of an impending merger or bankruptcy, the price of oil can spike based upon a rumor no matter how unsubstantiated it might be.
The difference with oil speculation, as opposed to speculation on stocks, is that the futures market impacts every American in dramatic ways. Not only do Americans spend hundreds more at the gas pump when oil prices go up, but they also see prices increase on thousands of other products and services which are impacting by oil prices (plane tickets for example).
There is a real debate about whether this kind of speculation is healthy for any economy. Some call oil speculation an “artificial market” since the prices are not set by supply and demand of the producers and consumers, but instead set by the speculators who are buying a future supply of oil based on some presumed demand in the future. From July of 2004 to July of 2008 the price of a barrel of oil went from $31.61 to $137.11. The price of gasoline went from $1.93 per gallon to $4.09. These increased prices were almost entirely attributable to speculation. The supply of oil and gas did not triple over the time period. The demand from consumers certainly did not triple as the economy actually slowed down over that time period.
There is a great deal of evidence that the speculation on Libya may be based on overblown fears to say the least. Libya produces about 1.6 million barrels of oil per day, which sounds like a great deal until one realizes that this constitutes only 2% of the total global output. In addition, 85% of the oil Libya produces goes to Europe, not the United States. Both President Gaddafi and the rebels have pledged not to destroy the oil facilities in the country. According to the worst-case estimates, Libya’s production has gone down by about 50% since the revolts in that country. Saudi Arabia has promised to make up for what oil production is lost in Libya, and as the largest producer in the world the Saudis are more than capable of fulfilling that promise. Despite these facts, the trouble in a country which produces 2% of the world’s oil has managed to increase the price of gas in America by 11%.
But alas speculators argue that the trouble in Libya could spread to other countries. For sure there have been uprisings in other places like Bahrain and Iran, but none of these countries constitutes a major oil exporter that the United States relies upon. Saudi Arabia has seen some protesters, but nothing like the widespread movements seen in Egypt and Libya. Oil speculators started buying oil at the unheard of price of $200 per-barrel on news that there were some protests in Saudi Arabia. It is worth noting that there are currently protests in Wisconsin, but no one seriously thinks that the United States crude oil supply is in danger. Overall, the “bets” on an endangered oil supply are built upon a speculation which is built upon even more speculation. Investors are guessing that not only will the uprisings spread, but that the population in each country will suddenly decide to cut off their major source of revenue once they magically overthrow the government in power. Meanwhile, Americans pay hundreds more at the gas pump every year.