How much are you paying to fuel Wall Street oil speculators? A new, very timely St. Louis Federal Reserve research paper, Speculation in the Oil Market finds 15% of oil price increases are due to speculation and is the second most powerful mover of prices beyond actual physical demand. Demand itself accounts for 40% of the total oil price increase. Increasing the supply of oil was not the top driver of price decreases according to researchers. Oil production not correlated to price decreases is backed up by an Associated Press analysis.
The past decade has seen a surge in the financialization of commodities—that is, the creation and trading of financial instruments indexed to commodity prices. According to estimates (Masters, 2008), assets allocated to commodity index trading rose from $13 billion in 2004 to $260 billion in March 2008. Many policymakers and economists have observed that this rapid and unprecedented growth in commodity index trading coincided with a boom in commodity prices; some have extended that observation into a conclusion that speculation by financial traders—and not supply and demand—drove the recent bubble in commodities.
While some are dismissing speculation as the result of economists Juvenal and Petrella's work, think about it for a second. Fifteen percent of $100 dollars a barrel oil is $15 dollars.
Taking a low correlation of Brent crude, a dollar increase per barrel is roughly equivalent to a 0.33¢ increase in the price of gas, or alternatively a $33/barrel price increase is correlated, roughly to a $1 per gallon gas increase. Looking at 15% of $123 oil, we have a $18.5 speculator surcharge per barrel. Roughly 50-60¢ was added to the cost of each gallon of gasoline just due to speculation. That's significant!
The Brent crude oil price, which is the European oil benchmark and the West Texas Intermediate, or U.S. oil price, have diverged recently, but both over the long term are highly correlated to gas prices (the blue line, scale at the right above).
There are actually many factors affecting gas prices, beyond the price of crude oil. James Hamilton has another great post explaining the differences across the States. James Hamilton also points to the futility of releasing the strategic oil reserve.
I see no evidence that last year's SPR release accomplished anything, and would not expect the outcome of another release this year to be very different.
Considering demand is the primary driver of gas prices, the fact gas demand has decreased implies a 15% speculator surcharge on a gallon of gas might be too low estimate.
Yet in spite of these statistics, many note the CFTC won't and can't stop speculation until the end of the year. A group of Senators have introduced a bill in the Senate, all crafted to stop oil speculation right now:
A group of senators Wednesday introduced a bill to make federal regulators invoke emergency powers to rein in speculators responsible for rapidly-rising gasoline prices. The legislation would set a 14-day deadline for the Commodity Futures Trading Commission to implement rules to stop excessive speculation by Wall Street traders in oil futures markets. The bill by Sen. Bernie Sanders (I-Vt.) is cosponsored by Sens. Richard Blumenthal (D-Conn.), Sherrod Brown (D-Ohio), Ben Cardin (D-Md.), Al Franken (D-Minn.), Amy Klobuchar (D-Minn.) and Bill Nelson (D-Fla.).
With all of the blame game goin' on, oil price spikes are correlated to recessions, so why play around and allow this key critical commodity to become so volatile? Even using the St. Louis Fed's much lower percentage estimate of oil speculation, it still significantly raises gas prices. As it is, the few players in oil speculation are going to court to stop CFTC regulations. Wouldn't it be better to simply remove speculation from the energy demand and supply equation?