Why Oil Prices Are So High

In the late 1990s, we had the stock market bubble. That popped. Then we had the housing market bubble. And that popped. Last week the market for crude oil bubbled to an all-time high, nearly $140 per barrel. We seem today to be forever blowing bubbles. Maybe we should stop and ask why.

After all, back in the middle of the 20th century, our economy didn’t careen from one bubble to another. Why now all the bubbles — and busts? Here’s why. We’ve become too unequal. We have too much wealth concentrated in too few pockets.

Grand concentrations of private wealth, history tells us, have a nasty little habit of nurturing wasteful and witless speculation. Wasteful and witless speculation, news reports last week revealed, just happens to be the economic joker in the deck that's turbocharging our current surge in crude oil prices.

The speculation now doing so much damage at America’s gas pumps comes mostly out of hedge funds, those shadowy mutual funds on steroids open only to the deepest of deep-pocket investors. This special status largely frees hedge funds from any federal financial oversight and regulation.

Hedge funds can essentially do whatever they choose. They typically make their money playing games with money. In the oil market, for instance, they have no interest in ever using the oil they sign “futures” contracts to buy. Instead, they buy and sell the futures contracts — with borrowed money.

That can be risky. But the rewards can be staggeringly huge. A sweet deal for sweet crude can stuff hundreds of millions, even billions of dollars, into hedge fund manager pockets.

Futures contracts have been around, of course, for years, and such contracts can serve a useful purpose. Airlines, for instance, can use futures “to lock in” the price they’ll have to pay for oil in the future. But manic trading in futures has no redeeming social value. Such trading, as billionaire investor George Soros told a June 3 U.S. Senate hearing, only serves to help inflate commodity price bubbles.

Government regulators of commodity markets used to recognize this reality. They placed rules on commodity markets that limited speculative trading. Those rules for energy, by the end of 2000, had almost all been deregulated away.

Since then, commodity trading volume has jumped six-fold. This speculative shot in the arm, Consumer Federation of America research director Mark Cooper believes, is adding at least $40 a barrel to the price of oil, about a third of the recent going price.

Congress has taken notice, and lawmakers have begun discussing reform fixes. But the hedge fund industry is trying to shift that attention, arguing that oil price hikes simply reflect the vagaries of global supply and demand. Any congressional probe into commodity speculation, billionaire hedge fund manager Boone Pickens noted earlier this month, would be a “waste of time.”

Many independent observers couldn't disagree more. Last week, in the Financial Times, widely respected London School of Economics analyst Meghnad Desai noted that nothing happening in the real-world market for oil — like growing demand from China — can explain the current oil market.

Oil prices, Desai adds, are now climbing at a rate that “would mean an unprecedented doubling in price every eight months.” Letting this situation continue will likely force the global economy “into a serious crisis.”

Can anything prevent that crisis?

“The best way to counter speculation,” says Desai, “is to make it less profitable” — and that could be done easily by charging speculators more to do trades on the oil commodity market than those traders who are actually involved in the “making or taking delivery of oil.”