Does oil speculation increase gas prices?

Elizabeth Lizzie. Yeah, her old buddy is back here working, which is nice, giving us um pieces of dry mango. And in between she worked for Emily and so I just haven't been able to lose Lizzie. That's good, but she's not when you want to lose Lizzie's awesome. Stop picking on Lizzie, Chuck. I'm a big fan. I started the Lizzie Fan Club here. Oh yeah, and then I dissolved it. I was gonna say, I have not been

invited to that. That's just me, Chuck. Remember when we were on the call all with a senior White House official yesterday, Yeah, that was kind of cool. Huh yeah White House. Yeah, Obama Administration that's who's in there. Basically we were talking about the UM. Well, we're basically going over the talking points for the energy security policy that he unveiled today as of this recording March thirty one, right,

I was tomorrow the thirty one. So he goes over this or or she's going over this with us and UM. Basically Obama has said that over the next decade he wants to reduce American oil imports by a third, right, And it's something that every president going back to I think Nixon has said that. All right, So it's an

ambitious goal, is what you're saying. Well, not sorary third, but yeah, they all There's a video that John Stewart ran on The Daily Show where it literally showed the same clip from like our last five presidents saying reduced foreign dependency on they have the best researchers on that show. UM. So okay, Well, Obama took his rightful place, following in the footsteps of Richard Nixon, and UM has has said that he wants to reduce our imports by a third

in about ten years. UM. And one way to do that is to UM figure out how to conserve oil, how to reduce use e g. A smarter grid, more windpower, more nuclear um more um clean coal, clean coal was another one. Natural gas, no clean coal, and to basically get online are reserves that we have now. So the big talking point around Washington with the Democrats right now

is that oil is um. That the oil companies have leases on something like seventy nine million acres of UM of oil land, suspected oil land that we were not tapping, right, that's not being used. It just own these leases, right, And then I think like nineteen million acres are actually

being mined for their oil or natural gas. And Obama's position is, hey, you fat cats, um, you need to go ahead and start producing or else we're going to penalize you, like invest in the United States, come off some of these profits and start spending on exploration and production and get American oil out of the ground, which is hugely different than what he was saying he should do before, which is like no ausch or really nothing

like that. Um. So it's it's kind of a big deal that he's really putting oil at the center of his energy security policy. UM. But one thing we asked that they didn't really answer very well is what role does preventing speculation in the commodities market play in energy security? That's my question. I get the sense, and this is one of those topics again that you know, Chuck's little guitar playing English major brain has a hard time wrapping

around this. But I get the feeling that there's not a lot of people in the government they want to talk a lot about oil speculation. It's like, don't bring that up, no, um, which is strange because its whole you know, there's that whole kicking around Wall Street, um during the recession thing that was going on, and that seems to have been largely abandoned. Um. But the question of whether or not oil speculation is affecting oil prices today,

it still remains oils up to UH. I think triple A saying a national average of three sixty right now for unlighted for regular that's a national average. Yea, yeah, that's crippling. And and well, I know the recession ended. I just made air quotes, um, but people are hurting. Uh. Food prices are increasing, oil prices are increasing, Gas prices are increasing, and UM, a three dollar and sixty cent gallon of gas is crippling to the average American. Yeah,

and that's average. I mean you've got to some places like California and there in the summertime they may be creeping up over five bucks a gallon. Yeah, so the money for a gallon of gases, it is a barrel of oil today is trading for opeque. By the way, it stands to make one trillion in revenues in two thousand eleven. That's the course it's on right now. Yeah,

it's a lot of UM. So so uh the there there's this idea out there that oil trading at one fifteen and barrel should actually be trading at something like UM ninety a barrel, and that oil speculation is accounting for UM twenty to twenty five dollars on top of the barrel price, and it counts for a lot of this increase in in UM the price of oil. So this is nothing new. This is going on right now in two thousand and eleven. But it just happened in two thousand and eight. Do you remember when oil hit

four dollars a gallon? It hit four eleven as a national average. This is the highest ever remember two seven, So two thousand seven, two eight, Yeah, I remember when it took the first big jump, um, whenever that was. I was living in l a And I remember it got over two dollars a gallon, and it was a big jump. It was like one weekend it was you know, a dollar or eighty five, and the next weekend it was like to thirty five. Then we would have probably

been like two three or two thousand four. It was a big It was like a fifty cent jump or something like that. Um, don't quote me, I'm going on my feeble memory, but I remember saying at the time, you know what, I just had a feeling, said, this is something different. Gas is never gonna be this cheap again, never gonna go back down. You know, in nine, the average was ninety cents a gallon. Nine it was it

was so twelve years ago a gallon. Now we're all we're at three sixty, we've already hit four and change for an average. I remember feeling a little hondap for like, you know, fourteen dollars. Yes, that was just so beautiful now, so um chuck. From two thousand four to two thousand and eight, the price of a barrel of crude oil increased from thirty one dollars and sixty one cents in two tho four, two hundred and thirty seven dollars and

eleven cents in July two thousand eight. Right, so guess prices grew from one to four oh nine over that same period. There's a lot of things. There's so much that goes into oil production that could affect the markets. Instability right right now, people are taking to the streets of Yemen, in Syria and once in a while in Iran, Um they are um, they are overthrowing the government in Egypt. There's a civil war going on in Libya. Libya's oil production is virtually offline right now. So so well, it

depends on who you're asking. It's actually pretty stable. It's just socialists, which is why everybody's like, oh, that's a dangerous country. If you're America, it is, right, but that's one of the reasons that people said, you know, geopolitics in these instability unstable regions that produce oil has a lot to do with it. But Michigan Senator Carl Levin during a hearing said, you know what, yeah, it's unstable, but it's been unstable for decades and we've been buying

oil from them. No problem. But that's how he claimed at least right, and Hugo Chavez, remember for through SITCO, that's the Venezuelan oil company that's here in the US. Through SITCO. Remember, he used to donate like a million gallons of heating oil to people in the Northeast to keep them alive. And that was like basically him saying like this is what socialism gets you, people of Boston with UM. Yeah, so it's unstable in that he's not

a friend of America. We were not capable of pushing him around, and we need their oil, right, but we have a dayton because people like money, economies like money, and we want to their oil. So everybody's chill out. What's more with this um recent drop in production that that's represented by Libya going in the civil war, Saudi Arabia stepped up and said, you know what, that's three percent of the oil that's produced every day, and we're gonna add an extra three percent to make up for

this temporary shortfall. So there actually isn't any kind of thing in the production or supply side. Well, no, because you mentioned in the article like could it be peak oil, but now it's not peak oil. Well, peak oil, do we not podcast on the end? No, we know we have we need to do that. That's the point where you know there's only a fine it amount of oil. So once we cross that little threshold, it's like all

of a sudden, there's getting less and less oil. Yeah, and there's there's a whole um group of people out there, very educated, smart people. They're not crack pots olas. Sometimes people look at them like that, who believe we have past peak oil and it's gonna take us five years or ten years to figure it out. But by that time it'll be way too late, and the the world's gonna come to a grinding halt for a while until we can figure out what to do. UM. A lot

of people think that we haven't hit peak oil. And if you look at UM the at least the published figures, Saudi Arabia is often accused of fudging on their numbers, and I think they were found to UM a while back. But most people say, no, supply still exceeds demand, which if you look at Mr Adam Smith's The Wealth of Nations, the the basis of the capitalist economy. If supply exceeds demand, prices should remain low. And oil, Isn't that the kind

of thing you want rewriting the rules of base economics. No, because ultimately it's a commodity, and a commodity is something that we can make things out of, or something we need. Wheat is a commodity, we need that. Pork bellies a commodity. That's the most delicious commodities. Um, and oil is a very very vital commodity. So if Carl Levins saying, yeah, that's unstable, but were we we can deal with them. If Saudi Arabia is saying, yes, Olivia's off line right now, um,

but we're gonna make up the shortfall. If if we haven't actually passed peak oil and the supply still exceeds the demand. A lot of people are saying, why is oil so high? Why is it increasing and increasing? And there's a correlation that's going on right now. The the answer to that, obviously for a lot of people's minds, And I'm not taking a position on this because it

is a very controversial thing to say that is oil speculation. Yeah, there's speculation that the speculation is what's driving up the price, right, that's perfect chuck uh. And one of the ways that it's being. UM, I guess suggested is that from I think July of two thousand, eight h there were six D seventeen thousand oil futures contracts on the market, on the oil commodities market. Can we explain what the future is? Well,

we'll go back. I just wanted to get this one last stat out, and we'll go back to the beginning, UM, and then July or January two thousand eleven. So July two seventeen thousand, January two eleven, one million UH futures contracts on the oil market, it's right. And between those two times, after the last bubble burst, it's been creeping up and up and up. Prices have basically commensurate with oil futures contracts. So it really looks a lot like

it could be oil speculations driving up the prices. So let's talk about oil speculations. Yes, and my mind starts to melt starting now, all right, Josh, the future and you're gonna tell me with this, But UM, any kind of future is a contract between a buyer and as seller.

Buyer agrees to purchase a fixed amount of a commodity that it fixed price, and oil future we're talking about oil obviously, So it's different than actually buying into a commodity because you're just betting on whether or not it will be higher or lower at the end of your contract. That correct, A future is a derivative and a derivative of as any kind of financial contract or instrument that's the value of which is based on the value of

something else. It's you know what it is to me, to my little brain that doesn't think about the stuff, Well, is it's a made up way to make money almost, That's exactly right. It's like someone created this and said, hey, this doesn't even exist, but as long as there's someone buying and selling it, it does exist. Because so a futures contract is very standard. It's not an exotic financial instrument, but the way that it's being used in the derivatives

market is um extremely exotic and volatile. So, Chuck, you have a bunch of oil, and I I have a refinery over here in my backyard, and uh, well, I'm I'm saving up it for a better life for it. Um, So I want to buy some oil from you, all right, But I think that oil, the price of crude is going to go up. You know, A year from now per barrel, right, and I'm going to so I'm gonna go ahead and buy it for the market price now right, and um, you're going to sell me a futures contract.

So we have an agreement that a year from now in um, at the end of March two thousand twelve, the that contract expires because you have to I have to buy that oil from you, okay, but not now a year from now. Right now, if I'm right and oil goes up, say I, I'm buying a hundred barrels at fifty bucks of barrel. That's our future contracts, our

contracts for five grands um. If it goes up. If the price of oil goes up to fifty two dollars of barrel a year from now, I just got fifty barrels of oil for two hundred bucks less than I should have paid. It's a good deal for you, it is. But the future's um contract is also. Um. Well, it's a bet, right because the price of oil could go down. I said in two thousand twelve, and the MARCHI done. Twe I'll buy those fifty barrels of oil from you for fifty bucks. But if the value of oil in March,

she does twelve forty eight bucks of barrel. Then I'm paying two more than I could have if I just bought on what's called the spot market, which is I go to you, I want your oil right now, and you sell it to me for whatever the market prices. Right. And if this sounds weird, it's not so different than betting on whether or not a stock will go up

or down. It's the same thing. It is, but in a lot of ways, it's just kind of it's it's saying it can Also it also comes into play if if I don't need oil right now, but I'm gonna need it in the future, and I think it's gonna go up right now. When the real bet comes in, that's when when I'm when I'm saying that I think it's gonna go up, I'm gonna go long. It's called going long. Yeah. And at the end of this contract,

you're actually gonna get oil. Correct, if you're holding the contract and that I have with you, um, then yes, So that has to buy oil from you that is a country and be like give me my money, I'll give you your oil. Right. But that's an important thing to distinguish because that is a future and that means actually oil is being traded at some point, right, And that's a normal thing. Right. Okay, Now that's going long. If I'm betting that oil prices are going to go up.

If I think oil prices are gonna fall, I'll go short. Right. So it's virtually the same thing. We go into a contract, right, So Chuck, let's say conversely, Um, you you think that oil is gonna go down, so you're happy to sell me a future's contract, right, Um, the price of oil goes down, right, we we say, we say, for you know, five grand, Um, the price of oil goes down to forty eight bucks of barrel, and you buy that contract back from me at the market price you just made

two bucks. Okay, Okay, So there's going short and there's going long. But as you said, in a standard commodities market that there's not a secondary derivative derivatives market going on, then ultimately there's going to be an exchange of oil the secondary derivatives market. You never get caught with the contract when it expires. Your trading contracts day by day, moment by moment, as the price of oil changes up

and down throughout the day. You're making money off of those fluctuations by buying and selling, by shorting and longing um, the the price of oil on these contracts, and that is speculation that, okay, leads to what's called an artificial market. Supply and demand no longer applies to the commodity itself. Supply and demand is also subject to the two the the financial instruments as well. Yeah, the whims of who has a lot of money and can affect a market

with a big purchase. So that's called an unstable market because it's you don't it's very violable. It's not it's not nearly as steady as a real tangible market. No. I mean, if you look at if you look at uh, you know, um, it's just a regular commodities market where there aren't any futures or derivatives um trading by anybody besides the people who actually will end up with this stuff. There's the changes, the fluctuations over you know, a month or a year or a quarter are you know, pennies

or a buck or two. Here it's when investment banks and hedge funds, who, by the way, when interest rates are very very low, tend to turn to the commodities market for to safely park their money. Right, because they're not gonna make much much money when interest rates are low. Um, they turn to the commodities market when they get involved. That's when things start going from thirty bucks of barrel in two thousand and four two hundred and forty dollars

a barrel in two thousand and eight. Right, And that's what happened with the housing uh bust, all of a sudden, Wall Street Housing wasn't a good place to put any money, So Wall Street flocked over to speculation futures, oil futures, right, and and um, we should say in that this is this is all very much debatable. This is if you believe that oil speculations affecting oil, this is how it happens. Right. They were just explaining that that's what we do. Well,

what we just explained was how derivatives trading works. This is no secret. It's the effect that it has, that's what's that's what's debatable. So the people who believe that there is consequences for oil for derivatives trading to say that here's what happens. Right, if you want, if you want to get your hands on actual oil, right you aren't going to be able to keep up with an investment bank or a hedgephone manager who is buying up futures. So you're gonna need oil now, and you're gonna have

to stockpile. It's one good thing about oil is you can stockpile it for a while, right well, and oil producers can hoard it. That that's exactly right as well, But there's you could also the derivatives market in futures can also inadvertently force a horde among people who actually use the oil, who are buying oil for use, not just trading in the derivatives market by saying, Okay, I can't buy futures because they're just too expensive right now, so I'm gonna buy whatever I can get my hands on.

So the spot market that deals in actual oil right that moment has a higher demand, which means the actual price of oil goes up, which means those oil futures go up even further, which means prices across the board rise, especially for gasoline. That's right, and when big companies like Goldman Sackson City Group are these huge financial institutions are

buying up tons and tons of uh are speculating. Then that's going to have a really big sway on the market that alone will right, they stand and gain tons of cash, tons of cash. But imagine if you not only stood to getting tons of cash from the secondary market, but you're an oil producer as well. Yeah, and all of a sudden you're aculating on your own production or

buying oil features. If you buy a bunch of oil features from higher price, you can actually the market um trades on rumor, right, So people are like, well, somebody's buying up a bunch of this stuff, and the prices actually rising, right, so that a lot of people are gonna be willing to pay more and more and more. If you're an oil producer doing that, then you're going to stand again through the financial instruments and through the

actual sale of your oil. And there was an investigation into this um the the secondary oil markets that found that in the New York Mercantile Exchange alone, which is the commodities market, or one of them for the us UM, eleven percent of the oil futures contracts were owned by vital which is a Swiss oil producer. So how, Chuck, how can an oil company be allowed to artificially inflate the price of oil for its own gains, And how can investment banks be allowed to drive up the price?

That is, in fact, what's going on. How can they be allowed to drive up the price of a commodity as valuable as oil If normally it should be something like thirty or forty or fifty dollars a barrel, and it's double or triple or quadruple, what what experts believe it's actual value should be. Well, it shouldn't be able

to happen, because they're starting in with our congress. There was something put in place called the Commodity Futures Trading Commission, the CFTC, and they were put in place specifically to prevent this kind of thing from speculation artificially inflating prices of commodity. So they were like, they've realized a long time ago this could be a real problem. Let's put this thing in place and let's make them keep it in check. So if you were trading on that exchange,

you gotta file reports every day. The Commission looks them over, keeps an eye out for speculation. They know if somebody is trying to corner the market. There who and they try to stop it. But quite a few things have happened to nooter for the most part. The CFTC. Yeah, because you can create a federal agency and empowered all you want, but if successive presidents disagree with you about the value of that that agency, they can neglect it,

they can strip it of its powers. They can as you say, new to it and not even have the courtesy to put noodle noodicles on it afterward, just leave it laying there, you know. So in two thousand, the very big thing happened. Prices were still pretty low for oil, less than thirty bucks of barrel, but a little company called en Ron started lobbying Congress to remove regulatory powers of the CFTC. And basically what the deal was. The

CFTC um had regulatory powers over the official exchange. So Enron says, hey, New York Mercantile Exchange and uh, CFTC, I'm sorry. And Ron said, hey, you know, we've got the software that allows futures to be traded over the counter, which is something outside of the formal exchange market. Right. It's basically like I can say, hey, Chuck um, you've got a bunch of futures like in your pocket, can come to your house and buy it and it will be a legitimate exchange. But it's over the counter. It

exists outside of the market, that's right. And that became known as the Enron loophole because all of a sudden, O t C trading was allowed for futures exchanges with no government oversight because it was out of the jurisdiction of the CFTC. So, josh, that was one thing happened in two thousand. Then another little thing came along, uh called the Intercontinental Exchange. The IC was set up in London,

and that was to trade European oil futures. And the funny thing about that is it was headquartered here in Atlanta, so it's headquartered in Atlanta, but it's European oil futures, so the CFTC didn't have any oversight over them because it was European, right, So, um, you could trade American oil futures on this exchange. Well six years later, that's when they set up the American terminals. Think about it, like, the time in London and the time in New York

are totally different, and that's kind of a problem. So really, if you can get these commodities, the same commodities trading on the same time zone. You can really create you you have a more robust market, that's right. And now all of a sudden, the CFTC couldn't even regulate these formal exchanges on the formal formal formal market, even though it was based in Atlanta. They set up trading post trading post terminals inside the United States in New York.

But it's almost like the O t B. Like horse racing is illegal, but you can this race is in Cuba, right, and but you can bet on it in you know, on the Lower East Side. And so as these things just kept going and going, um, the the CFTC just lost any jurisdiction whatsoever. And rafty people that are coming up with these things, they basically saying like, let's set up away where we can make gobs of money outside of regulation, and I mean outside of regulation. People have

no ideas. I was reading some blog post and it was about how the aluminum market was being cornered by somebody, and they thought it was some hedge fund manager and they had an idea who but not enough to publish. But they have no idea who's buying what there's it's all. It all exists in the shadows the derivatives market too, because it's outside of the jurisdiction of this federal agency

that was created specifically to police these things. You know, I'm never gonna be wealthy because I'm one of those dumb schlubs who it's just like, let me go out and near my paycheck. And I'm not like against the stock market, like I'll invest in the stock market and set up my foreone can on that. But I'm not. I can't even fathom the kind of what causes someone to think of like, hey, how can I really make

tons of money with no oversight? And I'll invent this way to trade ether and not really the people would buy ether of them. They probably, especially drug dealers. Patrick Bateman would have eaten you alive. Oh man, I'd be so dead. So um. There was a July two thousand eight or by the International Energy Agency that concluded that speculation didn't really have anything to do with it. They're like, no, no, no,

that's not what's driving oil prices up. There's another report the next September contradicted the i e. A report said, now there's actually a lot of correlations between this big influx of money and oil futures and the rising cost of oil. I mean, I'm a dummy. To me, it kind of looks plain that that's probably what's been happening. But there's probably a lot of people are going to right and say, oh, what you guys didn't consider was

X y Z. No. There's there's a lot of factors that that um that go into producing and buying and selling oil, and there's no way you can cover all of them. And that's not the point. And I don't think that's anybody who's accusing the speculation of influencing the price. That's not the point of anybody, because it's not there's nobody who's going to say this is a of the problem.

There's other stuff that does have this effect. I think what gets people to say speculation is hav an effect is because there's people out there who's like, it has no effect, and it's just not possible that a million futures contracts can't have some effect on the end price.

And it is just correlated, it's not causal. So quickly right along with it it was I don't know, and I mean, ultimately what it comes down to, is uh, the average American who's still you know, maybe unemployed, paying tons of money for food, is getting you know, reamed at the pump still and if there's anything that could be done to reduce that without causing harm to the to the markets, why not. But hey, good news, Josh.

In two thousand eight, Congress introduced the Consumer First, Hey how about that Consumers First the Energy Act in May two thou and that would have extended oversight for the CFTC to foreign lands, probably would have helped a lot, and it died on the Senate floor a month later. A month later. Yeah, they said consumer First, let's kill it. They're talking about it now, like, um, this whole Obama pushes basically making the oil companies out to be bad guys.

So the Democrats are really taking their they're banging the war drumb against oil companies right now. And then investment bankers are a fun target too. So this is this is coming up again, but it's coming up like it did in two thousand and eight because oil speculation is rampant. And I know everyone thinks we're we're anti capitalism, but that's not true at all. It was just just play fairly. Just play fair at the very least, admit that you're

having the effect that you're having. That's that's what I think would gal anybody who who is like, yes, oil speculation as an effect. UM. And it's not just oil. By the way, If you want to read a really cool article UM on speculation commodity speculation, UM, read Frederick Kaufman's The Food Bubble. It's he tries very hard but fails ultimately in the end to connect Goldman Sacks trading wheat and creating a wheat bubble that created the food crisis in the riots in Haiti and Egypt in two

thousand and eight. UM and it's he came so close, but he wasn't able to UM. But it's worth a read anyway. It was in Harper's like last year. Interesting. Yeah, so that is oil speculation. UM. It's us speculating on oil speculation, or speculating as little as we as we can write. UM. If you want to learn more about that type in oil in the handy search bar how stuff works dot com. We have a bunch of cool

stuff on the side about that. UM and I said oil, followed by handy search bar, which means listener mail Josh, I'm gonna call this uh sperm donation. Uh. Dear Josh, Chuck and Jerry. What I'm gonna say Lizzie today? Because Jerry has left us tell you it again? Dear Josh, Chuck and Lizzie. My name is Melanie'm a college student from Seattle attending full time school in South Korea. I was listening to how twins work and it made me

think of my own unique family situation. My mom and legal father, her husband could not have a child together, so they decided to get a sperm donor. The laws are looser now, but twenty years ago information was more closed off in secretive. I grew up not knowing really anything about my real dad until just about a month ago. In late February, the day before I was to depart back to South Korea, I got a letter in the mail from my real father. He lives in Athens, Georgia.

Pretty cool. We have been communicating through Facebook and email, and I've discovered that we have quite a bit in common despite never knowing each other. Of course, you do Jean's baby, it's all the Jenes. I wonder if it turned out to be biker Lee. We have very similar handwriting, religious,

spiritual beliefs, paranormal, paranormal experiences, TVs TV show taste. He is a nurse and that was the first job I ever wanted, so it's not really And he was a journalist in my main talent in a large interest of mine's writing. On top of all this, five years ago or so, my mom received a letter from a lady who had registered the same donor number. So, in short, I also have a half brothers. That's very cool. Um. We were able to meet once actually my senior year,

and also discovered we had several things in common. My boyfriend was a part Japanese guy named Max, and as was his best friend, a part Japanese guy named Max Wow, same political views, both played guitar, same favorite band, half brother, half sister reunited. Does she say the same favorite band? She doesn't mention what the band is, but she said, this leads me to my request that we do an episode on sperm and egg donation and how relationships can develop.

So let's add that to the kittie to the queue. Yeah, let's do that, Melanie A thanks a lot, Melanie, And we got to come down to Athens for a little while. Right, No, she did not come down, she just was in contact. You definitely have to go to Athens, and while you're there to make sure you eat at Harry Bassett's. I strongly recommend the chicken Rochambo and they do not kick you in the crotch when you ordered. I promise this

isn't like of a prank. No no, um. If you were produced outside of the traditional means of reproduction, we want to hear about it. Yeah, good one, Um, wrap it up. Sending in an email to stuff podcast at how stuff works dot com for more on this and thousands of other topics. Is it how stuff works dot com. To learn more about the podcast, click on the podcast icon in the upper right corner of our homepage. The how Stuff Works iPhone app has a ride. Download it

today on iTunes. Brought to you by the reinvented two thousand twelve camera. It's ready, are you