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Oil Prices, Market Regulation and the 2008 Elections

On June 6, 2008 crude oil futures surged to an all-time high of $139.12 per barrel, a doubling of price in the past 12 months. U.S. Treasury Secretary Henry Paulson rightly suggested that the increasing price of oil is “a real burden on American consumers.” The surge in oil prices is also threatening millions of poor people forcing them further into poverty, according to a report by the UN Development Programme.

Secretary Paulson has blamed the increase in oil prices on rising demand. However, there has not been any dramatic rise in demand even as economies in China and India continued to soar over the past year. It stands to reason that growth in energy demand is somewhat correlated with growth in gross domestic product (GDP). As an economy grows so will its need for energy. The projected annual growth rate for worldwide GDP is about 4.1 percent annually over the next quarter century. China and India is expected to lead that growth at about 6 percent per year.

Further, the demand for oil is tied to consumption of fossil fuels. According to Energy Information Administration (EIA), the official source of energy statistics from the U.S. government, worldwide consumption of energy from liquid sources, “is projected to increase from 83 million barrels per day (bpd) in 2004 to 97 million barrels per day in 2015 and 118 million bpd in 2030.” This represents a less than 2 percent annual growth in projected oil consumption. Thus, global growth or the Chinese red-scare alone cannot account for a doubling of gas prices at the pump.

On the supply side, the latest EIA estimates show that oil output from non-OPEC countries remain weak but that weakness is somewhat offset by increases in supply from OPEC countries lead by Saudi Arabia, which increased output in May by 300,000 bpd and will increase supply even more once its Khursaniyah oilfield is online. EIA projects that OPEC crude oil production is expected to increase during the third quarter of 2008, contingent on security situations in Iraq and Nigeria.

If neither demand nor supply explains the doubling of prices (and it is certainly not the falling US dollar), it leaves us with one other possibility – market speculation. Reminiscent of the Worldcom saga when telecom analysts like Jack Grubman working in concert with Worldcom CEO Bernie Ebbers put out false information about the “explosive demand for networking infrastructure” once again a group of market insiders are peddling rumors about dramatic demand increases. On May 6, Goldman Sachs speculated that oil could reach $200 per barrel fueled by the surging economies of China and India. “Goldman Sachs was one of the founding partners of online commodities and futures marketplace Intercontinental Exchange (ICE). And ICE has been a primary focus of recent congressional investigations; ….. Those investigations looked into the unregulated trading in energy futures, and both concluded that energy prices’ climb to stratospheric heights has been driven by the billions of dollars’ worth of oil and natural gas futures contracts being placed on the ICE—which is not regulated by the Commodities Futures Trading Commission,” wrote Ed Wallace in Business Week. Speculation coupled with lax regulation is causing untold misery to millions, while the shrewd insiders continue to game the system.

Heck even to play Monopoly you need rules! So how can complex markets trading sophisticated financial products be left without public oversight? In calling for more stringent regulation, the idea is to strike the right balance between fairness and efficiency. William Greider in his book the Soul of Capitalism writes, “With a few important exceptions, the agents of capital operate with dedicated blindness to capital’s collateral consequences, an indifference to the future of society even as they search for the future’s returns. The capital system does not authorize financial agents to think about such things and may well penalize them if they do.”

Undoubtedly futures markets serve an important societal function by allowing appropriate management of risk for both farmers and factories. The markets in and of itself are thus not the problem. It is the unmitigated greed of speculators and the herd mentality of the rest that creates the perfect storm for the development of price bubbles. While regulation may not be a panacea it can certainly help by injecting more transparency into markets like ICE. It appears that lessons from another unregulated energy market, Enron, have been forgotten all too soon.

Thus far both Presidential candidates have parroted the Bush administration’s line that increased demand from China is the reason for runaway gas prices. It is time they take another hard look at the data. Will any candidate favor more stringent regulation to prevent the next speculative bubble? Will they commit to using the Presidential bully pulpit to promote a culture of social responsibility such that doing well cannot come at the expense of doing good? After all the free market envisioned by Adam Smith requires human society to be “bound together by the agreeable bonds of love, affection and are, as it were, drawn to one common center of mutual good offices.”

PARVEZ AHMED is associate professor of finance at the University of North Florida. He also serves as chairman of the board for the Council on American-Islamic Relations. He can be reached at pahmed@unf.edu

 

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