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Why Are Gas Prices So High… So Suddenly? - Part 2

We recently discussed rapidly rising gas prices … and, as always, looked at supply and demand, which should give us a clear idea of why prices change. We observed that, since 2003, supply rose a little over 7% and demand increased a little over 8% and PRICE has almost DOUBLED.

At the end of 2007, demand exceeded supply by about 1.4%. Perhaps the supply/demand curve indicates extreme volatility and 1.4% more demand does drive the price much higher. The math doesn’t quite make sense, though, but we don’t have enough details to explain it, one way or the other.

Which leads us to believe there’s more to the picture.

First, we know OPEC controls their output… so they are artificially manipulating supply. That is undoubtedly ONE factor… but that’s been the case for many, many years. Why have prices increased so dramatically recently?

An aside: If U.S. oil companies tried to band together and control prices like OPEC does, our anti-trust laws would bring them down. But our laws don’t apply to other countries. However, we DO tacitly condone OPEC by continuing our relationship with them. Oil is very important to the U.S. economy and originally, we agreed to support OPEC in return for a reliable supply of oil. Historically, the Middle East has been a war-torn area and we agreed to “protect” Saudi Arabia from neighboring countries in order to ensure continuity in oil production.

That said, it seems OPEC has exploited their power and we’re paying the price (along with the rest of the world). I’m not necessarily suggesting we would want to exacerbate the situation in the Middle East, but maybe we should reconsider the extent of our military support of OPEC countries.

But that’s another discussion.

Another factor would be the value of the dollar… at least for us here in the U.S.A. But quickly rising oil costs is a worldwide phenomenon, so that doesn’t really explain it.

One factor undoubtedly affecting the rapid increase in oil prices appears to be SPECULATION. I suspect that THIS is what is making prices so volatile right now. Supply and demand are teetering on the edge (with regard to price)… and speculation is tilting the balance significantly. Big time money is betting prices will increase… and buying oil futures accordingly. There is so much of this activity that, to a certain extent, it has become a self-fulfilling prophecy.

Oil is a commodity and is traded world-wide. It seems we can do about speculation. Well, except from a securities regulation perspective. In the U.S., there are already limits to how speculators can use margin (credit) to buy securities. Perhaps we should look at oil futures and how they may be allowed to trade on margin. Indeed, the world banking community should consider doing the same thing.

While I’m not in favor of government interfering with the markets, that doesn’t mean we should advocate the use of credit in speculating. In other words, if someone wants to use their own money for trading, fine… but if they want to leverage their money (use credit) to trade oil futures, perhaps this should not be allowed. While I’m sure it wouldn’t eliminate speculation, seems like it would have to dampen its effect.

More to come on this topic….

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