How Speculators Are Driving Up Oil Prices

Consumer advocates have, in 2008 and lately, blamed Wall Street oil market traders for driving up crude prices, and with them the price of gasoline. Now, the consumer advocates have some unlikely company.

Wall Street giant Goldman Sachs said today that oil prices have risen too far, too fast and said the price simply isn't supported by market fundamentals. In an email to clients today, Goldman Sachs chief energy analyst David Greely said the recent run-up in prices looks to be ahead of itself.

"While prices are back at levels of spring 2008, supply-demand fundamentals are significantly less tight," Greely wrote. "We believe that the market will experience a substantial correction toward our $105 a barrel near-term target for Brent crude oil in coming months."

A shock

That last part was a shock to the market, since Brent prices recently topped $127 a barrel. The price of Brent plunged nearly $20 today, largely due to Greely's forecast. The drop, in the absence of any other market forces, largely makes the case that the recent run-up in oil prices is mostly trader-driven.

Prices for oil were rising long before the turmoil in the Middle East. The price of crude began to rise in the Autumn of 2010, at about the time demand for gasoline goes into winter hibernation. For the first time ever, the national average price of gasoline was $3 a gallon on Christmas Day.

Today, the national average price for self-serve regular is $3.791 a gallon, with forecasts of $5 a gallon in some areas by Memorial Day. But while worries about how spreading unrest in the Middle East might affect world oil supplies in the future, there is plenty of oil now, with the loss of Libyan output hardly causing a ripple. U.S. stockpiles remain nearly all time highs.

Less demand equals higher prices?

In its summer forecast, the U.S, Energy Information Administration projects weaker fuel demand but much higher prices, an economic anomaly. Usually, when demand falls, prices come down.

But gasoline prices usually follow crude oil prices, and for the last five years or so, crude oil prices have been subject to the whims of oil traders, most of whom never take delivery of a drop of petroleum.

Instead, they purchase futures contracts for crude oil, betting that they will be able to sell their positions later for much more than they paid. Commodities traders do the same thing. So do traders who buy stocks.

However, in the case of oil, the effects on the economy are significant. Both businesses and consumers end up having to pay more for transportation, taking money away from other areas of the economy. In 2008, sky-high gasoline prices could well have been a major contributor to the recession.

Which is why even some on Wall Street are cheering Goldman for calling out the speculators today, and perhaps halting - at least temporarily - oil's dizzying climb.