Blame for $4 Gas Begins at Home

05/05/2011 4:47 pm EST


Howard Gold

Founder & President, GoldenEgg Investing

Unprecedented crude-oil speculation, exacerbated by the Federal Reserve, is causing much more of our pain at the pump than emerging-market demand, writes editor-at-large Howard R. Gold.

In three weeks, when Americans take to the road on Memorial Day weekend, they’ll have a rude awakening: Gasoline may well sell for over $4 a gallon.

It’s pretty close already. As of Monday, retail gasoline nationwide averaged $3.963 a gallon, according to the US Energy Information Administration. It topped the $4 mark in California, New England, and the Midwest.

That’s up nearly 40% from a year ago, and around 150% higher than its recent low of $1.60 a gallon, set in December 2008. Sticker shock, to say the least!

Naturally, Americans are looking for a culprit. Egypt, Libya, Syria, the oil companies—all have been trotted out as reasons gas prices are sky high.

And indeed, supply disruptions tied to the recent protests in the Middle East and North Africa have taken their toll, as has slightly tighter inventories at refineries.

“The supply part of the market has been behind the recent run-up in oil prices,” said Aaron Brady, a director of research at IHS CERA, based in Cambridge, Mass.

But that’s not the whole story this time around, not by a long shot.

Rampant Speculation Drives Today’s Market
Speculators have run wild in the energy pits as crude-oil prices, which account for around two-thirds of the price of gasoline, have soared.

Brent spot prices have skyrocketed from below $72 a barrel last July to around $125 a couple of weeks ago, almost a 75% increase. (Brent fell below $120 on Thursday amid fears of weaker US energy demand.)

Crude’s lows last June and July coincided with the recent lows in stocks, and the big moves in both have come since late August, when Federal Reserve Board chairman Ben Bernanke announced a new round of monetary “quantitative easing” (QE2).

Since then, stocks, oil, grains, silver—you name it—have taken off while the US dollar index has sunk, as a weak dollar and easy money have driven the “risk-on” trade across a range of asset classes.

The evidence couldn’t be clearer in crude oil.

Stephen Schork, the Villanova, Pa.-based editor of the Schork Report, has never seen the frenzied speculation he’s seeing now.

Last week, according to Schork, large speculators—those who don’t deal in the underlying commodity—held 263,000 net long (long minus short) crude-oil futures contracts, according to the Commodities Futures Trading Commission’s weekly Commitment of Traders report. At 1,000 barrels a contract, that represents 263 million barrels of crude oil.

He said the nation’s Strategic Petroleum Reserve has 293 million barrels of light sweet crude, so if the speculators actually took delivery, they “could replace nine out of ten barrels” in the SPR.

And remember 2008, when oil hit $147 a barrel before heading into a recessionary freefall? Congressmen grilled hapless regulators about whether speculators were driving up prices. Learned studies were produced to “prove” it was all due to supply and demand, and that speculation had nothing to do with it.

Well, it turns out they were right, but only in comparison.

Even back in those dark days, speculators held an average of 53,264 net long crude oil contracts, said Schork. That compares with an average of 223,000 net long contracts in 2011.

The weekly high in 2008 was set in April, at 114,742 net long contracts. This year, an all-time high was set March 8, with a whopping 275,000 or so net long contracts, he told me.

If you do the math, we’re averaging four times the net long speculative volume in crude oil we saw in 2008, and this year’s peak was 2.4 times that of 2008.

Supply and demand indeed!

“China and India don’t explain why we jumped from $85 to $115 in a month and a half,” said Schork, who estimated there’s a $20-$25 a barrel speculative premium in crude prices.

NEXT: The Real Culprit


The Real Culprit
And have you heard a peep about speculation from either side of Pennsylvania Avenue this time? I thought not. Neither have I.

But to find the real culprit, you may have to stroll down to 20th and Constitution, the headquarters of the Federal Reserve Board.

The big move in oil and other risky assets came after Ben Bernanke rolled out QE2. And the US dollar index, which tracks the greenback against six major currencies, has plunged nearly 20% since its peak of around 89 last June. It hit a three-year low Wednesday, below 73.

Meanwhile, the euro, which bottomed just below $1.20 last June, is now trading close to $1.50, a 25% gain.
“There is [an] inverse relation between oil prices and the US dollar,” Schork explained. “As the dollar falls, crude oil rises, and that’s the result of speculation.”

And he connected the dots all the way back to the Fed: “The perception is that the policy of the independent Fed and the Treasury Department is to debase the US dollar. As long as that perception continues, oil will remain high.”

So, that means Bernanke’s policies are at least indirectly responsible for the higher prices we’re paying at the pump.

The chairman actually discussed high gasoline prices at last week’s news conference.

“…Essentially all of the increase in the demand for oil in the last couple years, in the last decade, has come from emerging-market economies,” he told reporters.

“And…we've seen disruptions in the Middle East and North Africa…that have constrained supply…and that, in turn, has driven gas prices up quite significantly.

“There's not much the Federal Reserve can do about gas prices, per se, at least not without derailing growth entirely, which is certainly not—not the right way to go,” Bernanke concluded.

Translation: I feel your pain, but our hands are tied.

But There Is an Easy Solution
Now, I’m not a knee-jerk Fed basher. I was always skeptical about QE2, but I thought Bernanke’s earlier easy-money policy was the right medicine for an economy heading off a cliff. And I think it’s outrageous for people like Dr. Marc Faber to compare the Fed chairman to the international criminal Robert Mugabe of Zimbabwe in any way.

But it’s clear that speculation is driving gasoline prices higher, and that it’s all tied to a weaker dollar, which itself is caused largely by the Fed’s loose monetary policy.

So the way to drive gasoline prices down again—besides a bigger drop-off in demand than we’ve seen—is to strengthen the dollar.

“If we get any sort of rally in the dollar versus the euro, I think we will see a significant correction back to where we were at the start of the year—oil in the $85 to $90 range,” said Schork.

That would bring gasoline prices down closer to $3 a gallon than $4. I’ll take it!

It’s happened before. On July 11, 2008, said Schork, oil prices peaked, and the dollar bottomed against the euro four days later.

This time, the Fed could boost the dollar by finishing QE2, beginning to draw down its massive bond holdings, and eventually raising short-term interest rates again.

Think about that when you see how little $20 gets you at the filling station on Memorial Day weekend.

Howard R. Gold is editor at large for and a columnist for MarketWatch. You can follow him on Twitter @howardrgold and read more commentary on his Web site, His new political blog, The Independent Agenda, debuts soon.

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