Dropping the Price of Gas to $2.50 a Gallon in a Week

by Paul Michael on 28 April 2011 18 comments
Photo: interglossa

If speculation can raise the price of oil, why can't it drop it?

That's the question that's been taking up a big chunk of the conversation between my friends, and I have to admit, it seems very possible.

President Obama announced recently that he plans to withdraw the $4 billion in oil subsidies because the companies are making too much money. They don't need them, they don't deserve them, and that money could go to much better use.

You have no arguments from me on that one. Oil companies need tax breaks like millipedes need more legs. And when Republicans start agreeing with repealing the tax breaks, well, you know this is a non-partisan issue if ever there was one.

But while I applaud President Obama's intentions and motives, I don't see this being the answer. In fact, I think it could make matters worse. And the reason comes down to one word — speculation.

Speculation Drives the Market

Right now, oil prices are being driven up by speculation, not by sudden demand or lack of resources. Yes, the wars are certainly not helping, but they do not account for the price rising by almost $2/gallon since the election of 2008. That's double the price in just two years. Has your salary doubled in two years?

You may recall that a few years ago, the average price of a gallon of regular gasoline climbed well over $4. That was down to oil speculation, pure and simple. The oil companies made astonishing profits, and then the price fell again, below $2/gallon. (See also: Gas Efficient Driving)

What happened? Did we find a massive reserve of oil bubbling below the surface of an easily accessible stretch of land? Nope. It was speculation, too.

Why Can't the President Use Speculation to Lower Oil Prices Right Now?

Is that a very naive outlook? Or could it actually work?

For instance, what if he gave a huge speech tomorrow stating that America is...

  1. ...putting billions of dollars into exploratory drilling.
  2. ...opening up Anwar for oil extraction.
  3. ...cutting major deals with Saudi Arabia and other oil-producing nations.
  4. ...opening up access to our massive oil reserve.
  5. ...siphoning oil from the Iraqi oil fields.
  6. ...demanding a minimum 60 mpg in vehicles by 2018.
  7. ...expanding wind, solar, and nuclear power programs, reducing the need for oil.

What would happen? Oil prices would drop sharply, and quickly.

It's a simple concept. More oil means less demand for what's out there right now, and prices fall. Gold continues to rise in value, but imagine what would happen to the price if an enormous gold mine, abundant in the stuff, was discovered.

Rare Is Valuable; Plentiful Isn't

Similarly, President Obama's intentions to cut the tax breaks mean one thing to me — higher prices. Sure, we get to stick it to the oil companies and save $4 billion, but that's money we aren't going to see any time soon. Remember, the country has quite the debt to pay off. But if oil companies are getting less money, that will only make the price of oil go up. If they aren't getting help to do more drilling, oil is even more valuable.

Now, I'm not saying we do any of the things I suggest President Obama should say. The stock market runs on rumor and, yes, speculation. If there's the merest hint that oil is about to become a lot more plentiful, traders will dump oil in favor of something else. Probably gold. And that's fine by me. I don't need gold to drive to work. Gold does not play a major role in every single thing we use, from the computer in front of you to the food you'll eat today. Gold, silver, diamonds, platinum, and frozen orange juice, they can all hit record highs. But oil, it's one of life's necessities, and it should not be traded in the same way. So, why not use speculation in our favor for once?

I believe gasoline will hit $5/gallon this year. It may even reach $6/gallon. I also believe that some well-chosen words by our government, regardless of actual intention, could help avert that eventuality. Many of my friends agree. But what about you?

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Guest's picture
Nate

Am I the only one who can't see this? Where is the actual article? I tried on 2 PCs with 4 different browsers. This is a common problem on this site.

I see:

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Amy Lu's picture
Amy Lu

Yikes! Thanks for pointing it out, Nate! It should be fixed now.

Guest's picture
Guest

So what? n/a is an article

Amy Lu's picture
Amy Lu

It's our record-breaking shortest-article-ever!

...Or not. The real article should be up and readable now. =)

Guest's picture
Bill

The problem is, it is not 'speculators' causing the rise in oil prices, it is the closing of drilling areas, and the reduction of output by oil partners.

Speculators are simply the bugaboo that the administration is using to cover their actions, remember, during the campaign, Obama stated, that he wanted gasoline prices to hit 8 to 10 dollars a gallon? We are half way there.

The 'speculators' will get the blame, because the willing masses simply don't understand simple economics.

Guest's picture
Guest

"Obama stated, that he wanted gasoline prices to hit 8 to 10 dollars a gallon? "
Got a reference for that?
If you do, I'd love to see it.

Guest's picture

:"not by sudden demand or lack of resources. ""
really? it must be---some blogger said so.
the planet can deliver no more than 87-89 million bpd.
the closer demand gets to that point, the higher the price goes, until demand drops.
the usa already has deals with the saudis, etc.
want to drive the price back to $1.29 in a year?
turn off china and india.
just erase them.
until you can, perhaps you might limit urself to walking or chewing gum,
and sstop attempting both at the same time.

Guest's picture
Bear Baiter

Baltbear, what exactly happened in the last few months to cause oil to double in price? Please enlighten us? Was it the same catastrophe that hit us last time oil double in price, which was proven to be pure speculation?
If we reach our limit, we will see a steady climb over time. This is nothing of the sort and you know it. Maybe you should sssstop trying to sound clever and go back to the rock you crawled out from.

Guest's picture
Guest

The central bank should sell oil futures.

Guest's picture
Steve

sorry, but you missed one of the main (probably the main) reason for high gas prices -> the weak dollar, now at its lowest point since 2008 testing the all-time lows ever for the dollar. The Fed has essentially printed money by monetizing the federal debt.

Oil is priced in $, so as dollars get weak oil price correspondingly increases. That's the vast majority of why prices have skyrocketed.

Guest's picture
Guest

Elaborating on what Bill said above:

I am sick and tired of people blaming ONLY speculation (like this article) for the rising oil prices. If you have any understanding of economics, you'll understand that without a market where speculation - or risk taking - can take place, oil prices will be much, much higher. Why? Fear. How? When a person who has access to oil - or better yet, possess rights to oil produced in the short term future - fears that there will not be enough supply of oil to meet demand, he will hold on to that oil for his own use. Either that, or he'll hold on to it knowing that he'll be able to get a higher price in the future if the supply shortage does materialize. Multiply by this many times over, and this exacerbates the already presumed short supply situation, and the price of oil will skyrocket.

A speculative market allows the concerned consumer to buy more oil on the open market from a willing seller. This alleviates some of his fear knowing that should his oil supply run out, there is a place where he can go out and get some oil. Yes, there's a risk he'll pay more for it in the future than he can now, but there's also the possibility that he may pay less (Google for Southwest Airline's experience with hedging against rising fuel prices).

The converse is also true. If the person with oil fears that the price of oil in the future will be much lower than today, he will attempt to unload his oil to minimize his potential losses. Again, multiply this many times over, and the price of oil collapses all because of fear. An open speculative market will allow the person to 1) sell the oil to someone who is optimistic about the future price of oil, or 2) hold on to the oil and risk loss in value or potentially capture the upside.

Yes, when asset prices rise, the market will draw in speculators. Look at what happened in the real estate market recently or the tech bubble of late '90s. Better yet, look at gold prices. But over time, an open market that allows speculation spreads risk across a large number of buyers and sellers. This means that the volatility in prices and demand/supply will be moderated, even if what we see looks like huge swings in prices. Believe me (or ask any competent economist), if an open market didn't exist, the flow of oil both out of the ground and from buyer to seller would effectively seize, and the world economy that is so dependent on oil would quite literally come to a halt. The number of "leaching" speculators is relatively small. It is the farmers, airlines, and various industries that wish to avoid wild swings in the price they pay for oil who are the major players in the market.

Don't let the ignorant voices shouting stoke your fear. Remember that the world is more nuanced than can be expressed by a slogan or a party line. If ever someone points to that one thing as the cause of a problem, it is usually wrong. When talking heads or ignorant writers do this, take it as an opportunity to find out what is REALLY going on. Civilized world depends mightily on educated citizens.

Guest's picture
Guest

Look at the commodity price crash yesterday- now tell me that the speculators are not to blame for the high price of oil- why is this not causing outrage across America!

Guest's picture

I love socio-economic-political arguments/debates. Everyone gets so fired up :) I agree the market is controlled by speculators, but I also think the markets are so connected now days, that just saying hey, we are going to increase supply by any means won't cure the problem. As the other posters mentioned, there is still a weak dollar, booming demand in India and China, gold sky high, and an unstable world economy.

I believe speculators lead to these wild market swings and well as these more frequent boom and bust bubbles we get in the past 10-20 years, but its not going to be solved by just addressing one market. My 2 cents.

Guest's picture
Bill G, ayden, north carolina

get it down to $ 1.85 at the pump!! it can be done they need to just do IT!!!!

Guest's picture
Guest

Uhm, minor point but gold IS actually rather important in making computers!! It's the best conductor and is used in all kinds of circuitry

Guest's picture

Commodities pricing has always been a bit of a mystery to me, especially when it comes to gasoline. There are just so many variables to consider. I think Steve makes an interesting point about the declining purchasing power of the dollar. It seems logical to me that if the dollars purchasing power slips, you’re not going to be able to buy as many things as before. Everything else equal, it seems to me that the only thing we as consumers can do to deal with the rising cost of gas, is to try our best at managing our fuel consumption. I know gas is one of those things that you simply must buy, but there are many ways that we can all save a bit here and there. I would recommend this artilce for a few easy tips on saving gas. http://blog.mangomoney.com/how-to/six-ways-to-drive-farther-on-your-dollar

Guest's picture
Guest

I believe all energy should be nationalized. Energy should only be one dollar a gallon, etc. If this was to happen you would see the economy take off like a rocket.People would go back to Sunday drives with the family,buying lunch,stopping for ice cream,shopping,etc. In other words, you would give people back their disposable income.Everything this country needs. Compared to what we have today,There is no downside.

Guest's picture
Ralph

I wish gasoline cost $10 per gallon. That would cause some serious change.