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The cause of rapid gasoline price hikes

The supply of oil is up, demand is down. Traditional economics tells us the price should be falling. That’s not the case, as you well know if you’ve filled up your gas tank. Why is that? Well, as always, oil companies are prone to using any excuse – say, unrest in the Middle East, for instance – to hike the price. They make more profits that way. Increasingly, however, it’s the speculators who are driving up the price: they make huge windfalls betting on the commodities markets. There’s so much money to be made, in fact, the oil companies themselves get in on the action, making money on the speculation and then boosting profits when the manipulation of the markets leads to real increases at the pumps.

Oil futures represent a contract between a buyer and a seller in which the buyer agrees to purchase a set amount of oil at a fixed price. An airline, for instance, might want the stability of knowing what its costs are going to be months down the road, agreeing to pay today for oil that has yet to be produced. Similar deals have existed for years with other commodities such as wheat. In the case of food, a farmer could plant a crop knowing what he would be paid at harvest. The buyer, say a large cereal producer, would know the cost, without being subject to the ups and downs of the market.

Commodities trading was a fairly small undertaking, involving the industry players themselves. But that was before the likes of Goldman Sachs, JP Morgan Chase and Citigroup got in on the action. Drawn by the betting aspect, they pumped billions of dollars into commodities trading. Deals were no longer about real goods – oil, wheat, barley, whatever – but about bits of paper and simply bits of information being bought and sold, traded and hedged. The speculation outstripped the real investments in commodities many, many times over.

What can be done? Since much of the speculation originates in the U.S., that’s the place to start. Americans, however, have spent decades weakening controls over commodities speculation, though there is some pushback at this point given the high cost of gasoline and the country’s poor economy.

Controls were loosened considerably in 2000, leading to a massive build-up of money in the commodities market leading up to the economic collapse of 2008. A report by the U.S. Senate points to correlations between the influx of money in oil futures markets and the rising cost of oil. The price of oil doubled, tripled and eventually quadrupled in step with the increase from $13 billion to $260 billion in the market from 2003 to 2008.

The crisis created by the financial services industry didn’t stem the tide, however. Quite the opposite: with equities in turmoil, yet more money flocked to future. Despite the same kind of actions that created past bubbles, including the housing bubble still plaguing the U.S. economy, little has been done.

That said, last month some 70 members of the U.S. Congress signed a joint letter that said federal regulators should curb speculation in crude oil markets which has artificially pushed up gasoline prices.
The lawmakers – 23 senators and 47 members of the House – said in a letter to the Commodity Futures Trading Commission that the regulators must stop Wall Street futures traders from dominating the oil market. The commission has flouted a provision in the 2010 Wall Street reform law that required regulators to put tough new trading limits in place by Jan. 17, 2011. “We are disappointed that, more than a year later, the commission has not fulfilled this important regulatory duty,” the letter reads.

“It is one of your primary duties – indeed, perhaps your most important – to ensure that the prices Americans pay for gasoline and heating oil are fair, and that the markets … operate free from fraud, abuse, and manipulation.”

They stressed that gasoline pump prices are up despite high supplies and low demand. According to the Energy Information Administration, the supply of oil and gasoline is greater today than it was three years ago, when the national average price for a U.S. gallon (3.78 litres) of gasoline was just $1.90. Today, the national average is more than $3.70 a gallon at a time when the demand for oil in the U.S. is at its lowest level since April of 1997.

The Dodd-Frank Act to reform Wall Street of 2010 should be limiting the worse of speculative excesses. Instead the rules have yet to be fully implemented in the two years since the law was passed. And Wall Street has no intention of stopping, as witnessed by legal action in federal courts as those making money at everyone else’s expense look to delay or block the new rules.

As many critics have noted, it’s as if the industry and the government learned nothing from the folly of deregulation, nor from the futility of chasing the latest bubble.

You can thank greed and the money that greases the political system for that pain you’re feeling at the pumps.

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