We should exorcise the politically convenient notion that high oil prices result from the market maneuvers of greedy “speculators.” It’s convenient because it suggests that a solution to high pump prices — or a partial solution — is to banish the offending speculators from the marketplace. That’s fantasy.

Despite periodic debunking, it returns whenever oil prices surge. In mid-2008, with crude prices approaching $150 a barrel, the Commodities Futures Trading Commission (CFTC) created a task force to study whether speculation caused the run-up. The task force included experts from the Agriculture, Energy and Treasury departments, the Federal Reserve, the Federal Trade Commission and the Securities and Exchange Commission.

Samuelson quotes the conclusion from this task force:

“Current oil prices and the increase in oil prices between January 2003 and June 2008 are largely due to fundamental supply and demand factors. . . . The Task Force’s preliminary analysis to date does not support the proposition that speculative activity has systematically driven changes in oil prices.”

Despite this clarity, politicians hate to admit they are relatively impotent over an issue like high oil (and gasoline) prices.  So, President Obama has resurrected the idea and has once again pointed an accusing finger at “speculators”:

“We still need to work extra hard to protect consumers from factors that should not affect the price of a barrel of oil. . . . We can’t afford a situation where speculators artificially manipulate markets.”

Well, the good news is we don’t have to worry about speculators artificially manipulating markets, as Samuelson reminds us with a lesson in Economics 101:

It’s true that outside investors (a.k.a. “speculators”) have dramatically shifted money into commodities — raw materials. “Commodity index funds,” which invest in a basket of commodities (oil, wheat, corn), have attracted hundreds of billions of dollars. It’s easy to imagine all this money chasing prices up in futures markets, just as speculative stock market frenzies push share prices to unrealistic levels. It’s also wrong.

The stock and futures markets operate differently. In the stock market, herd psychology can lead to speculative bubbles or panics. In a bubble, almost everyone seems to win (until the bubble bursts); in a panic, everyone seems to lose (until the panic subsides).

By contrast, futures markets are “zero-sum games.” One investor’s gain is matched by another’s equal loss. Here’s why. Under the standard futures contract, one investor agrees to buy the commodity (say, 1,000 barrels of oil) at a future date for a given price, and another investor agrees to sell for the same price. If the actual price on the settlement date has gone up, the buyer reaps the gain; if it’s gone down, the seller wins. The loser pays the winner; actual commodities are rarely transferred.

There are measures that policy-makers can adopt to help lessen the impact of high oil prices — and ultimately lower prices themselves.  Chief among those would be assisting in the deployment of vehicle electrification infrastructure and advanced biofuels.  Bashing the bogeyman of speculation doesn’t help a bit.

A Tuesday OpEd in the Wall Street Journal, “The End of the Saudi Oil Reserve Margin,” by Cambridge professor and author Jim Krane illustrates how Saudi Arabia’s space capacity has frequently enabled U.S. military interventions in the Middle East, as the Saudis have always been capable of compensating for disruptions. As Krane writes, “the idea is to have your cake and eat it-to meet U.S. foreign policy goals without disrupting oil markets and antagonizing the American motorist.” The Saudi safety net, which the United States has relied on in the past, simply cannot exist indefinitely, and the article highlights some truly frightening facts. Saudi energy demands are increasing, and disproportionate. Domestic electricity demand is rising 10% per year in the kingdom, which now consumes one quarter of its oil production. Saudi Arabia now consumes more oil than Germany, which has triple the population and an economy almost five times as large. London’s Chatham House estimates Saudi Arabia will be a net importer of petroleum as early as 2038.

Saudi Arabia’s current crude oil production rates are currently at a three decade high (10mbd), and the IEA estimates that the kingdom’s crude capacity currently stands at 11.88 million barrels per day. This means Saudi spare capacity is a mere 1.88mbd, still over half of OPEC’s total spare capacity, estimated to be 2.75mbd. Meanwhile, American and European oil demand is down, American production is up, American crude oil imports are down, and yet there’s no respite in oil prices, with Brent crude remaining above $120 this week. Indeed, the Wall Street Journal reported that the ballooning price of Brent crude futures have reached over $30 above the cost of contracts for delivery in 2018. Democrats are critical of “speculators,” who are perceived to have driven the gulf in oil prices, arguing the current crude oil market currently resembles the housing market before the 2008 crash. Another major factor driving the high prices is the “risk premium” stemming from instability in the Middle East, as well as growing demand from emerging markets. We are not expecting this trend of high prices and increasing volatility to change in the near future. The International Energy Agency estimates that global oil demand will reach a record 91.1 million barrels per day in Q4 2012, a 1.4% increase from the same period in 2011.

The kingdom’s oil minister insisted this week that oil markets are amply supplied and that it stands ready to boost output. Its council of ministers asserted that excessively high petroleum prices threaten the global economy and that a downturn would lead to an abrupt pullback in prices, hurting the interests of oil exporters and consumers.

 Last week, the transport arm of state-owned Saudi Aramco booked at least nine supertankers — far more than usual — for shipments to the United States, according to traders and Lloyd’s List. Each tanker can carry 2 million barrels of oil.

 And the Saudi oil minister, Ali al-Naimi,told reporters in Doha, Qatar, on Tuesday that the kingdom was producing 9.9 million barrels a day, about three-quarters of which is exported.

 Yet oil markets remain unimpressed. On Wednesday, the price of the West Texas Intermediate grade of crude oil for May delivery rose $1.20 to $107.27 a barrel — about where it was a week earlier. Expensive crude is driving up gasoline prices — a fact the Obama team worries will hurt the president’s reelection prospects.

 “What the Saudis are trying to do is to change the psychology of the market and demonstrate that the market is well supplied,” said Robin West, chairman of PFC Energy, a consulting firm.

In a free market, the laws of supply and demand combine with open competition to produce prices that rise and fall.  Crude prices have been steadily rising — or have been stuck on near-historic highs — because of growing demand.  In a normal market that demand would be pulling new supply into the market until the demand was met and exceeded, at which point prices would begin to fall.  Then either supply drops or demand grows, and prices rise again.  A macroeconomic circle of life, as it were.

Only not for oil:

Naimi said that Saudi Arabia could boost output to 12.5 million barrels a day to meet demand but that customers are not interested in buying more than they are now.

 “We ask the customers, ‘Do you need more?’ And invariably the answer is, ‘No, thank you,’ ” he said, according to Reuters.

 Really?  How could that be?  Here’s the answer:

One major oil trader, who requested anonymity to protect business relationships, said that if Saudi Arabia really wanted to tamp down prices it could lower its asking prices and then customers might buy more. Saudi prices are adjusted monthly, but the trader said Saudi Aramco is “extraordinarily inflexible” in the terms it offers buyers.

In a free market, other competitors would undercut the Saudi price and that would force more flexibility for Saudi Aramco.  But, as some politicians can’t seem to grasp, there is no free market in oil.  That’s why folks who are normally libertarian-leaning on economic matters advocate policy interventions when it comes to energy security.

That’s right.  Some administrations have sought to use the SPR as a price management tool,  but the clear intent behind our Strategic Petroleum Reserve is to compensate for a sudden and unforeseen supply disruption.  Prices rise, as any Econ 101 student will tell you, when demand goes up and/or supply goes down.  The reasons behind today’s high prices are primarily demand-related — and particularly demand in developing countries.  So high prices are probably here to stay and don’t justify an SPR release.

But will there be a sudden supply disruption, the type of disruption that would warrant tapping the SPR?  Herron writes that:

Mr. Cameron and Mr. Obama discussed the topic during a meeting at the White House Wednesday, but didn’t come to any conclusions . . . . The meeting came as oil prices remain very high and the International Energy Agency warned that sanctions against Iran could remove as much as 1 million barrels a day of oil production from an already tight market. . . .

The IEA estimated Wednesday in its monthly oil market report that the EU ban, combined with action from other countries and financial sanctions, could remove between 800,000 and 1 million barrels a day of Iranian oil from the market. With gasoline prices already at all-time highs in much of Europe, and becoming a hot issue in the U.S. presidential election, many industry analysts have begun to speculate that consumer nations could release oil from emergency stocks this summer to blunt the affect of sanctions.

The sudden loss of 1 million b/d is a bit over 1% of total global consumption, and 1 million b/d has historically been thought of as the “cushion” available that keeps the liquid fuels market liquid.  Does that justify a release?

Let’s be clear that the IEA isn’t advocating a release, as Herron notes:

The executive director of the IEA, Maria van der Hoeven, said Wednesday that an emergency release isn’t imminent.

“There is a tightening market, there is no doubt about that” as oil inventories are below the five-year average, she said. “At this moment there is no need to use [emergency oil stores].”

Key is the phrase “at this moment.”  Herron also points out that the “last IEA emergency stock release was in June 2011, after the Libyan civil war shut down 1.1 million barrels a day of oil exports.”

That’s why well regarded DOE Dep Sec Daniel Poneman “said Wednesday that the U.S. is constantly monitoring whether a release is necessary from its Strategic Petroleum Reserve.”

“The president has been very clear, we have every tool available at our disposal,” Mr. Poneman said on the sidelines of the International Energy Forum in Kuwait City. “We are going to keep consulting with our partners globally and the [IEA] to see what tools we need to be using.”

Fair enough.  One thing readers should keep in mind, though.  There are many who oppose energy production in the Arctic National Wildlife Refuge on grounds that we “can’t drill our way out of this” — that the incremental production from ANWR won’t make that much of a difference.  So remember that when we face the loss of 1 million barrels of day on the global stage, the world rushes to tap strategic reserves.  What’s the likely daily ANWR production, according to the US EIA?  Between 1.55 million barrels per day and 1.90 million barrels per day.  Not a sermon, just a thought.

He then suggests that this disparity will widen:

In the United States, a combination of infrastructure constraints and legal impediments makes it very likely that regional price disparities will widen in coming weeks. This is probable even if the government decides to tap the Strategic Petroleum Reserve to bring down overall prices, interviews with industry experts suggest.

Sommers walks us through the global factors tightening supply and keeping prices of fuel pegged to Brent much higher than fuel pegged to West Texas that has resulted in a global benchmark of $126 a barrel on Friday, in contrast to the “American benchmark” of  about $107. :

Factors tightening supplies include harsh weather in Europe, a cutback in exports from producers like Syria, Yemen and South Sudan, growing demand from India and China, and, increasingly, international measures imposed on Iran. Because of concern about Iran’s nuclear program, the United States is restricting bank transactions with Tehran, the European Union has set an embargo on Iranian oil for July 1 and many international insurers have stopped covering tanker pickups of Iranian oil.

Then he does a nice job of explaining the market and regulatory policy drivers that account for the regional disparities, which essentially come down to this:  where North American crude can be efficiently transported and refined into gasoline, it’s cheaper than areas of the US that must rely on imported crude.

First the good news:  Crude oil production has increased sharply in Canada and in the central United States in recent years — including initial production from the Bakken Shale, an oil-rich deposit in North Dakota.

The bad news:  a bottleneck in Cushing, Okla., the midcontinent storage hub.

The bottleneck also creates a glut:  North American oil “is trading at a discount to world prices, because it is landlocked and can’t easily be transported to world markets” — or to refiners in the Northeast or the West Coast, said Andrew J. Black , president of the Association of Oil Pipe Lines. And East Coast gasoline prices reflect the higher Brent crude price, said Tom Kloza, chief oil analyst for the private Oil Price Information Service.

Why is it landlocked?  Partly it’s the directional flows in pipelines (something the Keystone project is intended to help correct).  But what about oil from the Gulf?  Why can’t we just move it around via tanker?  Well, that’s limited in part by an early 20th century law called the Jones Act.  Kind of a precursor to “Buy American” protectionist requirements.

The 1920 Jones Act requires purely domestic cargo to move on ships built in the United States, carrying the American flag and using American crews. Large tankers meeting these requirements are in service on the Alaska-California route, but few are available for additional shipping, according to government reports.

The moral of this tale?  More domestic production does make a difference in prices at the pump.  And well meaning, albeit antiquated, laws do too, but in the wrong direction.

Denning makes several good points:

Brent crude oil is back above $120 a barrel. Looked at on a 12-month rolling average, it is now 6% above its prior 2008 peak. U.S. gasoline demand is down almost 7% year-on-year. This year, Europe is forecast to consume 10% less oil than it did in 2008. Global demand is still forecast to rise, but only in emerging markets.

Oil’s high price greases this transfer of demand from the West to the rest. While mature economies are forced to brainstorm efficiencies, emerging markets offset the pain with faster economic growth and, often, consumer subsidies.

The non-free market in oil manages to invert the old trope about the rich getting richer and the poor getting poorer.  Due to shared dependency on oil, rich Western countries and poorer emerging markets both get hurt, but it works out that the rich get poorer and the poor get richer slower.

Eventually, however, both mature economy and emerging market strategies fail in the face of the petro-stranglehold:

At some point, though, oil prices overwhelm everyone. Efficiencies take time to develop: The faster way to lower consumption is recession. In emerging markets, high oil prices stoke inflation and make subsidies unmanageable.

There are signs of this already. Weak European economies importing oil, such as Greece’s, suffer most. Priced in euros, Brent has breached its earlier 2008 peak already. The U.S. shows more resilience, helped by cheap natural gas and rising domestic oil output. Industry, notably auto makers and airlines, have also retooled for a world of high oil prices.

But the U.S. also has its limit. According to RBC Capital Markets, at $4 a gallon, the average driver’s 2012 gasoline bill would be the highest in real terms since 1980. Based on gasoline’s current price structure, $4 a gallon implies an oil price of $128 a barrel.

That is very close to BofA Merrill Lynch’s estimate of the $130 tipping point for the world economy. At that level, says strategist Francisco Blanch, energy costs would equate to 9% of global gross domestic product, a point also reached in the dire years of 2008 and 1980.

“Tipping point for the world economy” is a place we don’t want to be.  The crisis is coming and we know what is causing it.  And it’s too late to avoid it this time, again.

The Iran situation has already raised the price of crude oil as much as 20 percent, according to oil experts. On Wednesday, the price of the benchmark American crude settled at $107.07 a barrel. That is about four dollars higher than on the same day in 2008. Later that year, oil and gasoline prices surged to new records, including a record nominal high of $145.29 a barrel for oil and $4.11 a gallon for gasoline in July. (In today’s dollars, that would be $150.87 for oil and $4.27 for gasoline.)

What do increased prices mean to consumers?  Kraus provides some useful facts:

For the typical driver who pumps 60 gallons a month of regular unleaded gasoline, a 50-cent increase in price means an extra expense of $30 a month.

From a macroeconomic perspective, Kraus cites Neal Soss, cheif economist at Credit Suisse:

“As a rule of thumb, a penny a gallon is worth a bit over $1 billion in consumer purchasing power if it is maintained a whole year. A dollar more would be something in excess of $100 billion, which is about the size of the Social Security tax cut.”

So much for efforts to goose the recovery with the payroll tax holiday.  But what’s truly shocking about this piece is what Kraus notes as the optimistic scenario:

if tensions ease in the Middle East, experts predict that energy prices will fall, with gasoline at the pump potentially dropping 50 cents a gallon or more because supplies are relatively strong in many parts of the country. Some analysts say the world price of oil could fall to $80 a barrel if tensions eased.

Oh how far we’ve come if $80 per barrel oil is good news.  It is truly difficult to understand why there’s not more attention to this issue — beyond the gotcha campaign rhetoric.  Our recovery will not get off the ground — or if it does it will be depressingly short-lived — as long as we are hostage to global oil prices.

Yes, national average gasoline prices have increased for the past 20 days in a row.  Today, they reached $3.70 for Regular—the “cheapest” option (accessed February 27, 2012).

This is not new—prices have been trending steadily upward in general since they collapsed at the end of 2008 (see; Regular Gasoline Prices, January 2008-Present).

But it is a potentially worrying sign for the U.S. economy.  Total U.S. gasoline consumption is already down significantly as drivers have attempted to reduce their expenditures (see; U.S. Motor Gasoline Demand).  Rising prices will force consumers to cut back even further, including on other non-oil items, and could undermine economic growth.

Reduced gasoline demand is of benefit to the nation.  However, reductions that result from weak economic performance are far from ideal.  This is demand destruction.

The transportation sector accounts for 70 percent of total U.S. oil consumption, and improvements in fuel efficiency and a transition to alternative technologies do have a small effect on reducing oil use on a year-to-year basis.  But there are 230 million vehicles on U.S. roads.  Fleet turnover takes time to reduce gasoline demand.  That demand has been falling so rapidly likely means that people are simply traveling less (particularly as a result of persistent unemployment/under-employment), making fewer discretionary/non-essential trips, and using more transit, carpools and other options where and when available (see; Annual Vehicle Distance Traveled).

U.S. energy policy and gasoline prices in particular, have become an increasingly hot topic in the political sphere.  However, it is not simple, it is very complex, and it cannot be reduced to sound bites.  Exacerbated by the intense politicking of a presidential-election year, there is a lot of rhetoric.  From renewable energy to speculators to domestic production to vehicle technologies to withdrawing oil from the Strategic Petroleum Reserve.

“Domestic oil production is the solution.”  Wrong.  “Domestic oil production is not the solution.”  Also wrong.  Increased domestic oil production must be part of a broad strategy to help strengthen supply security, grow industry, reduce the trade deficit, and create jobs, as other efforts focus on transitioning the nation’s vehicle fleet to viable alternatives.

Last year, the average household spent more than $4,000 on gasoline—more than in 2008 when oil prices reached an all-time high.  The American people are hurting.  What is required is not rhetoric or sound bites.  What is required is a real solution.  What is required is a coherent and comprehensive vision for U.S. energy policy based on facts.  What is required is the courage and determination to see such a vision enacted.  What is required is action and it is needed now.

Once gas prices spike, there are little to no immediate options available to policymakers. Furthermore, rising gas prices have serious economic implications. Every economic recession within the past four decades has been preceded by or occurred concurrently with an oil price spike. The current spike has effectively consumed the entire stimulus intended by the payroll tax cut. As SAFE CEO Robbie Diamond said on Wednesday, “The payroll tax cut enacted by Congress and the President gave American families an extra $108.6 billion in take-home pay in 2011 compared to 2010. However, increased gasoline prices cost U.S. households $104.4 billion in 2011. Consumers were essentially given a tax cut that was put into one pocket, but then taken from another to pay for higher gas prices instead of spurring economic activity.”

These economic threats—in addition to the constraints on foreign policy due to oil geopolitics—are well known and established. The solutions are clear: increase domestic supply, reduce oil demand, and diversify the nation’s energy portfolio. However, despite the consensus on the rhetoric, there has been a continued lack of progress. “The President and bipartisan members of Congress both have called for an all-of-the-above energy strategy,” said Diamond. “Rising gas prices and the geopolitical threats in the Middle East have once again created a wake-up call to improve our energy security for the long-term. All that is needed now is action.”

Meanwhile, the House GOP are back to the drawing board with the transportation and infrastructure reauthorization bill. The original bill—threatened by veto, and unpopular with both transit advocates and fiscal conservatives alike—will be revised to cover a shorter duration (two years), cost less, and reverse the plan to separate federal transit funding from the Highway Trust Fund. Speaker Boehner’s spokesman Michael Steel has stated that the vision of linking infrastructure developments to expanded American energy production will remain.

“America is pumping more oil out of the ground than it has in years thanks to a surge in onshore drilling. U.S. refineries are producing more gasoline and diesel than ever. And Americans’ gasoline consumption is at an 11-year-low.  So with all that supply and not much demand, why have gasoline prices risen high enough this year to resurface as a national political issue?”

To say that the global economy and geopolitics drive oil and gasoline prices is not the same thing as saying American policy-makers can’t do anything about the dangerous linkages between high energy costs and dismal economic performance.

As Fowler reports:   “Experts say that over the long run, increased oil production in the U.S. might temper global prices, and getting that oil to more refineries across the country could help bring down prices at the pump. But for now, U.S. prices remain tied most firmly to Brent, which is being driven mainly by factors such as China’s sharp economic growth, even as that has moderated recently.”

So one side of the equation is increased domestic production — something we are enjoying under this Administration due to actions taken by previous ones.  And of course much more can be done there.

The other side of the equation is diversifying our fuel mix so our economy is less dependent on petroleum from any source.  Congress took strong action on that front in the Energy Policy Act of 2005 and the Energy Independence and Security Act of 2007 when advanced biofuels were given market incentives and new R&D authorizations.

The next step is to turn our abundant domestic natural gas into a much more common alternative transportation fuel — both directly, where it makes sense (in the freight sector, for example) and indirectly, through the generation of electricity for an increasingly electrified personal transportation system.

Demand is down today due primarily to a poor economy and high prices.  In future, demand will drop as cheaper (and cleaner) alternatives take more and more market share away from petroleum — spurring, not impeding economic growth.