The Fix for High Oil Prices? Regulate the Speculators
But is the current situation such an emergency? No way. After all, as I wrote last month on DailyFinance, Libya represents a mere 0.5% of U.S. oil imports, and Saudi Arabia is increasing its production to make up the difference. There has been no sudden increase in demand for oil, nor has there been a truly significant drop in supply. In fact, refineries -- which convert crude oil into gasoline and other chemicals -- are operating at a relatively low 88.4% of capacity, according to the U.S. Energy Information Institute.
So why are oil prices going up so much? Speculators.
Oil speculators using cheaply borrowed money to bet on rising oil prices and a falling dollar are playing on media-fueled fear to make big profits. The good news is that stopping those speculators would be easy: Regulators should demand higher margin requirements. By cutting off their easy ability to gamble with cheap debt, the regulators could push speculators out of the market and relieve consumers from pain at the pump.
The Politics of Regulation
Last time we had a huge run-up in oil prices was 2008 when oil hit $147 a barrel. When the Commodities Futures Trading Commission -- the body that's charged with keeping the trading pits honest -- investigated, it discovered that 81% of the trading volume in oil was being conducted by speculators. Put another way, businesses that actually use the oil, such as airlines, were doing just 19% of the trading. The vast majority was done by hedge funds and investment banks to make a quick buck.
The Dodd-Frank financial reform law requires the CFTC to do something about speculators, but they've managed to delay the implementation of so-called position limits until 2012. According to Heatingoil.com, the CFTC will be at least a year late in complying with the Dodd-Frank requirement that it limit speculators' ability to drive up oil prices.
Let Real Supply and Demand Dictate Prices
So, thanks to the CFTC's inaction, the level of speculation in oil prices is at record levels. According to Heatingoil.com, trading volume on the NYMEX from oil traders who don't take delivery -- so-called "net long positions," hit a level not seen in four years in January.
The fuel that keeps these speculators going is cheap capital -- supplied by our friends at the Federal Reserve. But again, it's easy to stop this: Simply require those speculators to use much less borrowed money when they trade.
Last month, two exchanges did just that -- but it wasn't enough. According to Bloomberg, the New York Mercantile Exchange (NYMEX) in February increased its margin requirements 20% to $6,075 per contract, and the International Exchange (ICE) increased its margin requirement 7% to $5,200.
If consumers had a say, NYMEX and ICE would double those margin requirements today, and you'd then see oil and gasoline prices drop to the levels dictated by supply and demand rather than Wall Street greed. Shutting down the speculators' ability to gamble quite so much with borrowed money would be a better answer than releasing oil from the SPR when we don't have a real supply emergency.