Speculation and the Price of Oil
Why pay more at the pump? There are solutions!
July 1, 2008
Fred Foldvary, Ph.D.

Saudi Arabia's King has accused speculators of driving up the price of oil to $140 per barrel. Saudi Arabia has increased output to dampen speculation, but as an oil seller, the kingdom also has an interest in selling more oil when the price is higher. If the Saudi chiefs really believe that oil speculation is the main cause of the rapid rise in the price of oil during the first half of 2008, they have an effective remedy. They can go into the futures market and sell billions of dollars of contracts. Even the news of them doing this would make the price plunge. The fact that they have not done this puts a question mark on their blaming the speculators.

There are real elements in the rise in the price of oil. First there are supply problems. There has been trouble in Nigeria, where rebels have blown up a pipe. The war in Iraq has reduced output there. More fundamentally, the world is experiencing peak oil. Mexico, for example, is expected to reduce its exports substantially during the next decade. Venezuela’s nationalization of its oil industry will dampen investment there. US oil production peaked out thirty years ago. Environmental concerns have limited production in the US, but even if Alaska and the offshore fields were opened up, the oil increase would be minor compared to global output.

The rising demand from rapidly developing economies is the fundamental reason driving up the price of oil. But much of that demand is artificial, due to subsidies. China and other countries subsidize the sale of gasoline. The greater subsidy is implicit, due to not making car owners and drivers pay the full social costs of vehicle use. Worldwide we see congestion and pollution from motor vehicles, indicating that governments have failed to apply the tolls and pollution charges that would eliminate these problems.

The falling value of the dollar relative to other currencies has also contributed to the rising price measured in dollars. When the dollar has less exchange value, the price of oil in euros and other currencies becomes lower, and so the price of oil gets bid up. But oil priced in euros and other major currencies has also been rising. The price of oil has also risen relative to gold, so the rise is mostly fundamental and not due to the value of the dollar.

Speculation does sometimes carry the price of commodities and stocks to extreme levels. This happened to stocks during the Internet boom of the 1990s, to gold during the inflation era of the 1970s, and to real estate during the boom up to 2006.

But attempts to limit speculation are futile, since commodities trade in a global market, and activity will flee to friendlier areas if the US government cracks down. The remedy for speculation is to play their game. Petroleum users could form a group or consortium to sell oil futures contracts. Congress would exempt the consortium from anti-trust laws. Users such as airline and trucking firms would massively sell oil contracts, which would drive the price back down below $100 and create huge profits from the contracts. The fact that there has been no movement to organize selling in the futures market casts doubt on the proposition that speculation has driven the price up beyond the fundamentals of supply and demand.

The main problem is that the market for oil has been distorted by very deep interventions. The cure for the high price of oil is to liberate the market. Here is what is needed:

1. Install toll charges on all crowded streets and highways just high enough to eliminate the traffic congestion. The tolls would be payable with electronic devices in cars, and only apply to places and times that would otherwise be congested.

2. Taxes on fuel would be replaced with pollution charges. That would require the economy-wide installation of remote sensors that measure the pollution as cars drive by.

3. Congestion tolls and pollution charges would also replace regulations on gasoline, engines, and smog tests.

4. Eliminate taxes and restrictions on the use of grease and vegetable oil for fuel.

5. Eliminate restrictions on building oil refineries. Pollution charges and strict liability laws would be sufficient to protect the environment.

6. Eliminate restrictions on building nuclear power plants while making the providers fully liable for any damages to the surroundings.

7. Stop subsidizing alternative energy. Congestion and pollution charges would automatically shift users to environmentally friendly alternatives.

8. Make mass public transit free to users. Tolls will not help much if transit alternatives are not present. If they are useful, urban trains and busses raise land rent, and so they should be paid for by tapping the site rents of the communities. The use of geo-rent (ground rent) would not be a subsidy, just as hotel guests are not subsidized if they pay for the elevators from their room charges rather than with elevator fees.

9. Legalize all private transit. Vans and jitneys should be allowed to operate to carry passengers who seek more frequent and flexible routes and are willing to pay for it. These services should be provided with curb rights, places where they can stop and pick up passengers.

10. Proclaim to the world that the economic rent of oil, the gains beyond normal costs, should be shared worldwide rather than go to the pockets of those who inherited conquered oil lands. Oil rents are not going to be shared any time soon, but those who recognize the injustice should do their best to exclaim it to the world.

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Fred Foldvary, Ph.D.

FRED E. FOLDVARY, Ph.D., is an economist and has been writing weekly editorials for Progress.org since 1997. Foldvary's commentaries are well respected for their currency, sound logic, wit, and consistent devotion to human freedom. He received his B.A. in economics from the University of California at Berkeley, and his M.A. and Ph.D. in economics from George Mason University. He has taught economics at Virginia Tech, John F. Kennedy University, Santa Clara University, and currently teaches at San Jose State University.

Foldvary is the author of The Soul of LibertyPublic Goods and Private Communities, and Dictionary of Free Market Economics. He edited and contributed to Beyond Neoclassical Economics and, with Dan Klein, The Half-Life of Policy Rationales. Foldvary's areas of research include public finance, governance, ethical philosophy, and land economics.

Foldvary is notably known for going on record in the American Journal of Economics and Sociology in 1997 to predict the exact timing of the 2008 economic depression—eleven years before the event occurred. He was able to do so due to his extensive knowledge of the real-estate cycle.