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Wallace's World

Blame High Oil Prices on Speculators and Bernanke

Watching traffic around Dallas and Fort Worth, you'd never know the U.S. was experiencing any kind of gasoline crisis. Many drivers on the freeways apparently think Texas has already approved the proposed 85 mph speed limit.

Most don't realize that driving a vehicle that's rated at 30 mpg on the road at 85 miles an hour will cut its fuel efficiency by around 35 percent. That makes the gas they are currently paying $3.79 for cost $5.11 in reality. It's reasonable to assume, too, that if we really cared about the cost of gas, we would do everything we could to mitigate that cost. We don't. We complain about prices but seem unwilling to do anything about them.

Americans think they know whom to blame for high gas prices. The usual culprits are people who drive too fast, inefficient engines, OPEC, and even China. Sure, those are all factors, but that's like blaming the housing bubble on the lumber industry or a surfeit of carpenters. It's no great mystery who is responsible for higher gas prices. As I and others have written in the past, the biggest culprits are the speculators gaming the futures markets to line their own pockets. We know all that. What might come as a shock is that they are being enabled by the Federal Reserve.

This explains why the market for oil and gasoline is currently costing consumers and industry far more than necessary. Until recently it was impossible to tell whether the speculators were accurate in telling the media that high worldwide demand for oil has caused prices to skyrocket once again, pushing gasoline prices $1 a gallon above where they were at this time last year.

It's true that rail traffic is up in the U.S.—a sure sign of a strengthening economy—and it's equally true that cargo shipments worldwide are back to pre-Great Recession volumes. However, MasterCard (MA) and some oil analysts are saying that domestic gasoline consumption has dropped anywhere from 3 percent to 3.7 percent over the past five weeks; for a country that at times burns 400 million gallons of gasoline a day, that's no small drop. In futures trading, such a decline in demand should effect a comparable cost reduction in what buyers are willing to pay for fuel for resale. That's not happening.

Goldman Outs the Speculators

Meanwhile, the media continue to say that gasoline prices are directly tied to oil pricing, which isn't quite true. Oil and gasoline are sold to different sets of buyers. One needs to buy crude for refining and the other sells gasoline at retail; these are legitimate hedgers. Then there are speculators, who jump into the market in search of profits on all fuels. To prove once again that no one in the investment banking business actually knows anything about oil, Goldman Sachs (GS) advised its clients on Apr. 11 to get rid of their commodities holdings, including oil. The Guardian quoted Goldman's advice as warning: "The record levels of speculative trading in crude have pushed their prices up so much in recent months that in the near term, risk reward no longer favors holding those commodities."

"Record levels of speculative trading in crude" have pushed up oil prices? Funny, all we've been hearing is that today's oil prices are justified because of abnormally large demand, owing to the world's improving economy.

On the same day, the Financial Times reported that in March, the Saudis "throttled back their production of oil"—which seems to contradict their promise to replace any oil lost to world markets because of the Libyan Revolution. According to analysts, the Saudis produced an extra 300,000 barrels a day, which was enough to satisfy buyers. That assessment certainly is true in the U.S. We started this year with 333 million barrels of oil on hand. Today we have 359 million barrels. Some shortage.

Leave it to Bank of America (BAC) to issue a completely different forecast for oil on Apr. 13, giving 30 percent odds that oil could hit $160 a barrel sometime this year. Now the waters are truly muddy. As one investment bank claims it's time to bail because speculators have put crude oil into bubble territory, another suggests it's time to load up on oil because the price will go even higher.

Let's Quit Blaming China

If anyone knew what was going on in the crude oil market, you wouldn't have so-called investment banking experts taking diametrically opposite positions. So whom do we blame for all this confusion—or for high prices that force the average American family to shell out an additional $700 to $1,000 for gasoline this year, while companies such as American Airlines (AMR) say they face another fuel crisis? To start with, let's quit blaming China.

Last year, China imported just 4.79 million barrels of oil per day. According to China Daily, official government figures show that the country is importing oil at a rate that's growing by only 5 percent this year, or 239,000 more barrels per day. Moreover, China has raised bank rates twice this year in an attempt to cool its roaring economy. Both times, oil prices declined slightly worldwide.

Who else can we blame? One could look at refinery utilization and find out exactly why gasoline supplies have fallen over the past two months, thereby raising the price of gas: In the week before last, U.S. refineries ran at just 81.4 percent of capacity—a mere 39 percent utilization rate on the East Coast. That's less than the first week of April 2009, at the bottom of the economy's post-meltdown crash, when refineries ran at just 81.8 percent of capacity.

Now let's look at the big picture to see why gasoline prices are so incredibly high. Remember that our refinery utilization a week ago was only 81.4 percent. In the same week in 2005 it sat at 93.7 percent, with 212.2 million barrels of gasoline on hand. Even at that exceptionally high refining rate, we were down by almost a million barrels three weeks later. By contrast, we have dropped our inventories of gasoline from 223.2 million barrels to 209.7 million barrels since the first of the year and we still have only slightly less gasoline on hand than we had at the same time in 2005, amid blistering economic growth. Our refineries then were running at nearly 10 percent greater utilization.

The Fed's Cheap Liquidity Flood

The problem starts with Ben Bernanke, no matter how many of his Fed presidents claim they are not to blame for the high price of oil. The fact is that when you flood the market with far too much liquidity at virtually no interest, funny things happen in commodities and equities. It was true in the 1920s, it was true in the last decade, and it's still true today.

When Richard Fisher, president of the Dallas Federal Reserve, spoke in Germany late in March, Reuters quoted him as saying: "We are seeing speculative activity that may be exacerbating price rises in commodities such as oil." Fisher added that he was seeing the signs of the same speculative trading that had fueled the first financial meltdown.

Here Fisher is in good company. Kansas City Fed President Thomas Hoenig, who has been a vocal critic of the current Fed policy of zero interest and high liquidity, has suggested that markets don't function correctly under those circumstances. And David Stockman, Ronald Reagan's former budget director, recently wrote a scathing article for MarketWatch, "Federal Reserve's Path of Destruction," in which he criticizes current Fed policy even more pointedly. Stockman wrote: "This destruction is namely the exploitation of middle-class savers; the current severe food and energy squeeze on lower income households … and the next round of bursting bubbles building up among the risk asset classes."

Let's not kid ourselves. Oil in today's world is worth far more than the $25 a barrel it sold for over a decade ago. But the ability of markets to function properly, based on real supply and demand equations, has been destroyed by allowing ridiculous leverage and the unlimited ability to borrow the leverage at historically low interest rates.

Fortunately for our elected officials, they've got the public convinced that the biggest threat from government is taxation and deficits. In reality the public should be infuriated with the rising costs of nondiscretionary items such as food and gasoline, which current Fed policy actively enables.

Whose Side Is the Fed On?

As far back as 1979, when then-Federal Reserve Chairman Paul Volcker started moving to stop inflation in its tracks, Jimmy Carter's White House said one of the benefits that higher interest rates would confer on the public would be to slow down speculators in the oil market, who were taking advantage of that year's turmoil in the Middle East. This isn't a new argument.

The economy is getting better and that's a good thing. But some claim gasoline could go to $5 a gallon this summer. The good news is that skyrocketing oil prices, like slasher movies, are truly frightening only the first time you watch one. They get less scary with repetition.

But being less scary doesn't change the basic facts. Markets need both hedgers and speculators to function properly. When they lose balance, they no longer function according to true supply and demand.

Ben Bernanke doesn't seem to understand that while he is allowing huge profits for banks and investment firms so they can recover massive losses from the financial meltdown, he is intentionally damaging what could be a much stronger recovery with the misery he's causing the average American consumer.

Maybe he does understand and just doesn't care. There's always China to blame.

Ed Wallace is a recipient of the Gerald R. Loeb Award for business journalism, given by the Anderson School of Business at UCLA, and is a member of the American Historical Assn. He reviews new cars every Friday morning at 7:15 on Fox Four's Good Day, contributes articles to, and hosts the top-rated daytime talk show, Wheels, 8:00 to 1:00 Saturdays on 570 KLIF AM. E-mail:, and read all of Ed's work at his news site,

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