Chapter 3

The worrying rise of oil and gasoline prices

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Summary

Video: Paul Hodges discusses the rising price of oil

What’s the cause of today’s soaring gasoline prices?

Is it lack of supply?  Are inventories too low?  Is OPEC holding the West to ransom?  Or is it due to strong demand from China and other emerging countries?

These are all arguments put forward as the ‘conventional wisdom’ used to justify the high cost of oil.

In Chapter 3,  we argue that the real cause of the problem is a lot closer to home, in Wall Street and the financial community.

Our analysis suggests that:

  • The Commodity Futures Modernization Act passed in 2000, thanks to lobbying by the now-defunct Enron, helped to put crude markets in the hands of the speculators.
  • Oil and commodity markets have since become a casino, where fundamentals of supply and demand have become irrelevant.
  • For example, between 2005 and 2008, the share of trading undertaken by financial players in crude markets soared from 20% to 55%

Today, the prices of oil, gasoline and other fuels are being set by high speed computers, trading in micro-seconds.  Andy Haldane, an executive director at the Bank of England, has recently pointed out that if supermarkets ran these programs, “the average household could complete its shopping for a lifetime in under a second.  Imagine.”

These computers thrive on the cheap money that has been pumped out by the Federal Reserve in its quantitative easing programs.  Thus oil and gasoline prices rose in 2009-2011, despite record-high inventories:

  • Between January and the end of April 2011, the price of Brent crude oil (the main global grade) rose from $93/bbl to $126/bbl, a 35% rise
  • This occurred whilst the Fed was providing $600bn to financial players via its QE2 (quantitative easing) program.
  • Prices then drifted lower, due to the end of the program.
  • But Wall Street was already successfully lobbying for QE3 to begin.

Higher oil prices make life very difficult for us as individuals.  We have to pay for gasoline and energy to drive our autos and heat/cool our homes.  The situation is even worse in poorer countries such as China and the Middle East, where food and commodities take a higher share of people’s incomes.

Equally, they leave us with less money to spend on the more discretionary items that drive consumption and GDP growth.

Plus, of course, there is the worrying fact that since 1970, every time oil prices have reached today’s levels (in inflation-adjusted terms), their rise has been followed by a recession.

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