The real reason gas prices are soaring

An oil-trading pro blames a flood of new investors buying oil ETFs for the recent pain at the pump.

By MSN Money Partner Mar 29, 2011 12:33PM

Image: Buying gas (© moodboard/Corbis/Corbis)By Charles Wallace, DailyFinance


Have you ever wondered why when you go to the gas station to fill up the family car, the price of gas at the pump has just jumped 25 cents a gallon over the past three days? Perhaps you thought the oil companies were just being greedy. Or you believed the nightly news pundit who said that gas prices went up because the crisis in Libya was affecting supplies of oil. One professional oil trader says that you'd be wrong on both counts.


Dan Dicker, who has spent nearly three decades in the oil market, has a profoundly disturbing explanation of why the price of oil, and the gasoline that comes from the crude product, has risen so dramatically in recent months. It turns out, Dicker says, that the price has nothing to do with supply and demand for oil. It's the financial market for oil, filled with both professional speculators and amateur investors betting on poorly understood oil exchange-traded funds, who have ratcheted up the price of gas to such sky high levels.


"There is no supply issue going on here -- what you have is the perception of the possibility of a supply issue," Dicker says. "A whole bunch of people are pouring money into an oil market trying to take advantage of what they perceive to be a real risk in supply. It's a marketplace that I argue should not be allowed to be wagered on like a stock or bond."


Dicker notes that Libya produces only 1.3 million barrels of oil a day, just a tiny fraction of the world oil market. Even if Libyan crude were lost to the world market in the current turmoil, and there is no sign that it is, Saudi Arabia has 5 million barrels a day to use in case of an emergency.


Dicker, who has just published a book called Oil's Endless Bid: Taming The Price of Oil To Secure Our Economy, makes a strong case that if the government stepped in and regulated oil trading so that only investors with a genuine interest in the physical product, such as airlines and heating oil companies, could buy and sell oil futures, then the price of oil would fall by 50% overnight and our economy would be much better off.


Why Greater Regulation Is Needed


"You have to make it so the original intent of commodity markets, to be used almost exclusively as hedging tools, is returned," he says.


Though Dicker acknowledges that is not likely to happen, he points out that when the 2008 economic crisis froze all financial markets and investors stampeded to the sidelines, the true price of a barrel of crude oil became known: $32. It's now hovering at around $110 thanks entirely to investor demand, he says.


One of the reasons Dicker is calling for greater regulation of the oil market is that no one really knows how large it is or what is going on it on a day-to-day basis. In fact, it reminds Dicker of the market for credit default swaps, which brought down the insurance giant AIG and forced the government into a $180 billion bailout.


The market for oil traded financial instruments has been estimated at between $8 trillion and $30 trillion, but there are no concrete numbers because traders don't have to tell anyone how much they are betting either for or against the oil price. Dicker says if the government minimally required oil trading to be conducted in a transparent manner on exchanges instead of the current over-the-counter system, a large number of speculators would leave the market and the price of would fall sharply.


He also notes that the major shift in oil trading has been relatively recent. First, financial firms such as asset managers and pension funds realized they needed to diversify their holdings of stocks and bonds, which had performed badly over the previous few years.


The move was made easier by the arrival in 2006 of electronic trading of oil futures. The formerly cumbersome process of trading oil with a floor trader at the New York Mercantile Exchange was suddenly replaced by a streamlined process requiring only a few keystrokes on Chicago Mercantile Exchange's Globex computer platform.


From a few thousand trades an hour at the old NYMEX, traders now process millions of trades an hour by computer. Dicker estimates the financial market for oil is 15 times greater than the amount of actual oil being traded, with 75 types of futures being sold on exchanges. That doesn't even include all the private, over the counter transactions that take place.


"The amount of money pouring into hard assets, particularly oil, is outsized because it's new and fresh, so you get these outsized moves from $68 a barrel in the summer of 2010 to $100 now," Dicker says.


Why does all this trading drive up the price, when buyers and sellers should theoretically cancel each other out? Dicker says that is primarily because almost all oil investments being sold by the big investment banks are long trades -- bets that the price will go up. While it's also possible to short oil ETFs, no one does. So the price heads ever skyward.


"There is no shorting of the market and the commodity market is not like a stock market," he says. "It is not designed to have only one half of a trade. It is designed to inspire both halves, that's how you arrive at a correct price." Dicker gives the following example: Let's say you live in a neighborhood where all the homes are priced at $200,000. Suddenly an army of buyers arrives who want desperately to move into the neighborhood. You were not really interested in selling before, but now a buyer offers you $400,000 for your $200,000 house. What are you going to say?


"That's what's going on in oil," Dicker says. "You have this army of people who have been flooding into a brand new neighborhood and they've had to inspire somebody to sell and the only way you can do that is pay an outrageous price for it."


The Biggest Winners


Among the biggest winners of the new oil markets are investment banks like Goldman Sachs (GS) and Morgan Stanley (MS), which create new products for clients and then use that information to trade on the products. In 2004 and 2005, Goldman Sachs made $1.5 billion a year trading oil, Dicker says. In the first half of 2009 alone, the firm made $3.4 billion oil trading profits. Firms like Goldman are not taking bets that oil will move lower or higher. Trading simply means naming a spread of buy and sell prices from which they can eke out tiny but regular profits, a business without risk.


Dicker is particularly contemptuous of oil ETFs of the kind that many small investors have used as vehicles to diversify their holdings. "In these markets, the way they are set up, with all the edges with investment banks, the regular investor is just fodder," Dicker says. "The ETFs are the world's worst investment. They've only lasted this long because oil prices continue to rally."


So if gas prices would come down sharply with minimal regulation, why doesn't the government step in and impose limitations as it has done recently for other derivatives, forcing most firms to conduct their trading on exchanges? Dicker believes it is largely because large financial firms with a direct interest in oil trading have made so much money with oil that they can afford to lobby Congress to block any significant reforms.


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Apr 13, 2011 3:57PM
They ought to take all the lobbist out and string them up. It should be against the law. Until it is stopped the common people like you and I will take it in the shorts because our politicians make themselves rich while in office from lobbying companies. They should all go straight to jail and that also includes the politicians found to dealing with them. What we really need is a way to make our politicians do what WE pay them for.
Apr 19, 2011 3:14PM

This article is right on. If the speculators were removed from this equation the true price of crude would reveal itself to under $ 40.00 bucks a barrel. Now I see no reason to hold the worlds economies hostage to Goldman Sacks and MorganStanley. Hey let them speculate with mortgage financing. Oh they already sucked our wallets dry already on that scam.

Apr 19, 2011 2:27PM
If we truly had a free market economy as opposed to the crony capitalism/casino we call a "market right now, supply and demand would trump all. Supply/demand should be the main factor in the price. I don't believe in being allowed to gamble, I mean invest, on the price of oil unless you are actually taking delivery of the product. KEEP SPECULATORS OUT !!!
Mar 29, 2011 1:45PM
The effect of outside speculators in the commodity markets has been known for some time.  But the financial industry is solely designed to rake billions off the top. They then declare themselves geniuses and defame anyone attempting to place a regulation to control this insanity as a socialist trying to destroy the economy.
Mar 29, 2011 6:32PM
Good story.  Great explanation.  Now, I am thoroughly pis__ed off that this is happening.  We need lawmakers that can break this trading cartel.  The paid off crooks called politicians that  we have now will never help us.
Mar 29, 2011 6:35PM
"Hallelujah!!  Someone who's finally telling the truth about this stuff.  It's just greed on the part of a relative handful of people who are causing all this pain.  Next time one of those Repuglican idiots pontificates about the "free market" or "supply and demand" let's ask him whether he or anyone in his family is invested in oil futures...  Then you'll be much closer to the real story about why there's no regulation of these trading vehicles."

Democrats have been in control of Congress for years, even during the $140 oil spike in 2008.  I didn't see them giving back their Goldman Sachs lobby money, did you?   And...GS is a Democrat leaning company.  They always have been.
Mar 29, 2011 4:18PM

I agree with article... It used to be only end user could contract  oil, fuel, etc.  In mid 90's I could buy diesel for around $0.45 /gallon or less per tanker load ( 8,000- 10,000 gallons). Once they open it up to anyone to buy or invest in ( big banks, mutual funds) it sykrocketed.  Today can not even buy a tanker for under $3.40 here..

If outside money was cutoff it, the market price would fall....

Actually we should tax every stock market trade to help pay for the national debt and big bank bailout. My solution would be to put a 3-5 % tax on every stock sold, make every one in commondity market ( wheat ,corn, oil, etc)  either pay for the storage or take delivery of the product... As a farmer if I haul grain to town I have to sell or pay storage ($0.06 / bushel up front per month)

Basically take out spectulation, make these markets a long term investment.. 


Apr 13, 2011 12:41PM
All who are to blame should be hung by the Balls. Why should I pay so much for fuel just to line some other pricks pockets. Its time to get a bike,,, Car Pool.,, Whatever it takes. Maybe a Boycott.
Apr 13, 2011 1:25PM
The President cares about the american people. He cannot do anything to correct this because the President doesn't have that kind of power. The congress would have to change the law and we all know the congress is owned by the banks, oil companies, and financial funds.    I wish we could end speculators by changing the rules SIMPLE..if you want to buy oil futures you have to be able to receive the oil.  where would you like your 100,000 barrels delivered? that would put an end real fast to all this crazy speculation
Mar 29, 2011 3:07PM
A minimum wage earner has to work 2 to 3 days to make enough money to gas up their car - if they can afford one.  The government needs to quit saying we are in economic recovery as long as gasoline costs continue to $4 a gallon and more.  We lose our discretionary spending when that happens and doesn't help our economy at all.  Only the rich get richer in the scenario we are in now.  God help us.
Mar 29, 2011 3:48PM

Speculators helped bring down the housing market and now oil is what they've chased over to...its sickening and Washington stands idle with their thumbs up their collective asses!


you folks who blamed people for forclosing because they bought too much house conveniently 'forgot' all the speculators who bought investment homes then just dumped them when they either could not rent them or, in a lot of cases, bought in areas where umemployment soared and the values dropped...IT WASN'T JUST REGULAR FOLKS WHO GOT IN OVER THEIR HEADS!


Speculation is damaging the ability to sustain a healthy economy.

Apr 19, 2011 12:49PM

We as a nation have become so complacent...does anyone remember that we went through this same scenario back in 1970 (s)...the "Alaskan Pipeline" ring a bell? 


Plain and simple it is a matter of many of us have been witness to our local stations inch up the price every weekend or even several times within a is called price gouging and as long as we put up with will happen. 


Our government will do what we allow them to my father would say, "on the back's of the middle class."

Mar 29, 2011 1:37PM
Well, now I understand it is way more complex than I ever thought it could be. I guess the love of money really is the root of all evil. I don't love it, I just pray I get a job, and thus more of it.
Apr 26, 2011 1:42PM
very simple  STOP TRADING OIL!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!
Apr 7, 2011 12:51PM
i know it is the speculators raising gas prices, so why don't the president do anything about it? because he doesn't give a **** about the american people.
Mar 29, 2011 3:44PM
This story supports what many people including myself have been saying right along which is Greed is ruining our country. These traders are allowed to drive oil as high as they want to without any backlash because a lot of our government officials are bought and paid for. The middle and lower class of people in this country do not stand a chance. This is fast becoming, " Land of the Rich and Home of the Poor."  What a damn shame.
Apr 19, 2011 4:42PM
in other words people are buying oil shares and pushing the price of gasoline up...big companies are also involved...buying large blocks of oil commody....then just at the right time the large investor will dump his block and walk away with a large profit...leaving the little investor with a very large loss...its like playing musical chairs..the little guy got to sell before the big guy does or he will get "screwed" the meantime all of us motorists are paying through the nose..because of these "games" the only comfort for us is knowing one of them is going to lose a very large amount of guess is the little guy
Apr 19, 2011 4:21PM

again we see the politicians are in the pockets of big business, their employers! We all better think twice who we vote for in the next election.

The oil companies make billions in net profit every QUARTER, not for the whole year. You would think they can afford to lower the price of gas.

And yet no politicians has ever brought out this matter and face the facts of price fixing.

 For the people in position , It has come to be for my pocket not for the good of the people.

Mar 29, 2011 2:12PM

Dicker says. "A whole bunch of people are pouring money into an oil market trying to take advantage of what they perceive to be a real risk in supply. It's a marketplace that I argue should not be allowed to be wagered on like a stock or bond."


....Well don't even think of regulating it lest Boehner, McConnell, Bachmann, Beck, Limbaugh and Palin turn purple with rage. I used to support the GOP, now I don't support anyone, except Thomas Jefferson, but unfortunately, he's dead now (any chance he could be cloned?).

Mar 29, 2011 4:10PM

so Dirtygirl2 & roadhouse blues,


I think you must have forgotten how the Bush administration made several attempts to regulate Fannie Mae & Freddie Mac and were denied by Barney Frank & Chris Dodd.


Barney's own words:

"Hearing from September 2003 on an administration proposal to alter the regulation of GSEs like Fannie Mae and Freddie Mac. See Congressman Barney Frank's opening statement, which begins at 4:40. It's rather amusing. Here's an excerpt of his opening statement:


"I want to begin by saying that I am glad to consider the legislation, but I do not think we are facing any kind of a crisis. That is, in my view, the two government sponsored enterprises we are talking about here, Fannie Mae and Freddie Mac, are not in a crisis. We have recently had an accounting problem with Freddie Mac that has led to people being dismissed, as appears to be appropriate. I do not think at this point there is a problem with a threat to the Treasury.


The more people, in my judgment, exaggerate a threat of safety and soundness, the more people conjure up the possibility of serious financial losses to the Treasury, which I do not see. I think we see entities that are fundamentally sound financially and withstand some of the disastrous scenarios. And even if there were a problem, the Federal Government doesn't bail them out. But the more pressure there is there, then the less I think we see in terms of affordable housing."


Quite interesting, I'd say.


Here is some information about Mr. Dodd,


"As Banking Chairman, Mr. Dodd was declaiming on the Senate floor that the toxic twins absolutely, positively, no doubt about it, need to be reformed—just not yet. He thus opposed Arizona Senator John McCain's amendment to his financial regulatory-reform bill to shrink the mortgage giants, raise their underwriting and capital standards, cap the taxpayer losses (now $145 billion and counting) and eventually shut down the failed enterprises.......For much of yesterday's debate, Mr. Dodd was visibly angry. Perhaps that is because he was left alone on the floor to defend the most expensive of all federal bailouts. Thanks to his own sweetheart mortgage from Countrywide Financial—a leading Fannie business partner—Mr. Dodd isn't running for re-election. But other Democrats chose to spend yesterday's debate in undisclosed locations. They were no doubt thrilled to enjoy federal witness protection from C-SPAN's cameras as Fan and Fred's longtime opponent, Alabama Senator Richard Shelby, described the various reform efforts they had blocked over the years. "


So, who is opposed to regulation and reform?

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