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Oil & Gas: The New Bubble

Prices rise as consumption falls

By Mark Huffman
ConsumerAffairs.com

April 24, 2008

• Gas Prices Head Lower as Economy Slows • Gas Price Declines for 9 Days • Gas Prices Continue Downward Trend • Oil Prices Surge By Record $25 a Barrel • Gas Prices Drop for 5 Days • Price-Gouging Probes Spread to 6 States • Investigations of $5 Gas in North Carolina, Florida, and Virginia • Shortages, Price Hikes Follow Ike in Southeast • States Investigate Gasoline Price Gouging Claims • Pumping More U.S. Oil Won't Lower Prices, Consumer Group Says • Oil Prices Fall, Gas Prices Surge • Gas Prices Slide 8 Percent from Record --- • More ...

Gasoline prices are headed to $4 a gallon, with oil prices poised to rocket past $120 a barrel, but does anyone know why?

Consumers might be surprised to learn that the reason they're spending $50 or more on a fill up may have little to do with supply and demand.

In past years U.S. oil shocks were usually caused by supply disruptions. It all began with the Arab oil embargo of 1973, which caused a spike in prices and long lines at gas stations.

There were shortages again in the late 70s, resulting in a spike in prices. While the Organization of Petroleum Exporting Countries did what it could to control, and manipulate, the price of oil, the law of supply and demand prevailed.

In 2005, when Hurricane Katrina devastated the U.S. Gulf Coast, a new trend emerged, in which OPEC had little to do with setting the price of oil. The new pricing power resided on Wall Street, where commodities traders pumped money into futures contracts, pushing prices higher.

Falling demand, rising prices

Today, with gasoline prices at record highs, there is no supply disruption, nor is there a surging demand.

In fact, industry statistics show demand in the U.S. is actually falling. Consumers, faced with escalating prices at the pump, are trying to use less fuel. But it doesn't seem to have any impact at all on the price, which seems to go higher every day.

Oil industry analyst Ed Walker, writing in BusinessWeek, says speculators are driving oil prices higher. It's not being caused, he said, by rising demand or falling supplies.

"Gasoline reserves on hand are at the highest levels since the early 1990s, which is remarkable considering the nation's refineries have been cutting back on the production of gasoline because their margins have declined," Walker wrote in early April 2008.

"In fact, average gasoline reserves on hand have risen since this past October, while oil reserves in this country have gone up virtually every week this year — and only fog in the Houston Ship Channel that kept oil tankers from unloading their crude one week kept it from being every week."

Walker points to some other data that appears to be out of whack. In January of this year, he says, the U.S. used four percent less petroleum than we did a year ago. And world oil production is actually up year over year.

While the Bush Administration has blamed excessive demand for this spring's price spike, the federal government's own data appears to contradict that. Wallace says the Federal Energy Information Administration has forecast gasoline demand to be down in the U.S. this summer for the first time since 1991. They agency also said that U.S. gasoline inventories are at the highest levels in 15 years.

Why?

So, there's plenty of oil and gas, it just keeps going up in price. Why?

The answer may lie in how financial markets have behaved over the last two decades. In the 1990s, investment money poured into the stock market, driving the prices of dot-com stocks into the stratosphere, before they crashed to earth in 2000.

At about that time money started flowing into real estate. Lax lending rules and plenty of cheap money led to huge run-up in real estate values, with speculative money pushing home prices to bubble levels.

Now that real estate has crashed, where is the smart money to go? Commodities, perhaps?

Corn is at $6 a bushel, gold and other metals are at record highs and oil is out of sight. As the prices climb, speculators who bought low are selling high and making a nice return.

Consumers can see what it's doing to them every time they pull up to the pump, but it may soon be worse.

U.S. airlines are once again on the verge of bankruptcy and one airline CEO says it will take a 20 percent fare hike just to stay even. The trucking industry, which the U.S. economy depends on to get goods from one point to another, is paying over $4 a gallon for diesel fuel and will at some point have to pass on those costs.

And ultimately, it will be the U.S. consumer who pays it.

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