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August 29, 2008

Why does gasoline cost so much?


Pissed off about high gasoline prices? Wait until you read this...

Oil prices have dropped approx. 20% since last month, but why is gasoline prices still so high? They're dropped a little, but not by the 20% it should have.

It all kind of stinks of... price fixing. Which is illegal.

Back in July, the U.S. House and Senate held almost 30 different hearings on the role oil speculators have had on bumping up the price of oil.

Here in Canada, Canadian lawmakers have held their own two-day hearing into the cost of gasoline. Much smaller in scope, but important because they narrowed the focus to the price at the pump and how it was radically different from what was happening in the oil market on a regular basis.

When oil prices go up, so does gasoline prices, right? And when they go down, gas prices go down too, right? Wrong. Frequently it seems as thought gas prices just stay high as the various gas companies play a shell game (yes, that was a pun) to come up with excuses to keep the prices high.

"I've been following Hurricane Gustav," says Jeff Rubin, chief economist at CIBC World Markets, when asked about the parliamentary committee hearing. Rubin didn't deny that speculators are playing some role in the price of oil, but the point he was making was that the oil industry loves to keep the prices high, and almost any event in the media can be used as a scapegoat to boost prices. Problems in Iraq, Iran, Afghanistan, Venezuela, Nigeria, the Gulf Coast of the United States, Alaska or in Alberta or Newfoundland Canada can all be used as an excuse to boost oil prices. Competition from China, India and Europe can also be blamed, the weak American dollar, etc, etc.

Its all one big blame game for why the prices of gasoline and oil are so high. Depending on what is happening in the news, even if it isn't hurting oil supplies, can dramatically effect, bolster or maintain high oil prices. The problem lately it would seem is that oil speculators seem to have had a drought of credible news topics.

"It's not about the Bank of Canada, the House of Commons or the Finance Ministry. Instead of playing the blame game, I would redirect our energy towards lessening our dependence on oil," says Jeff Rubin.

Canada, a major oil producing country, isn't likely to do much about it. We're making huge profits off of the oil industry right now. High oil prices? So much the better. We can roll in the profits.

Sure, it will hurt the prices of commodities and inflation will skyrocket, but who cares? Might as well enjoy it as it lasts.

And that's the mantra the oil industry in general is going for. Keep the oil prices high as long as possible to get as much profit out of it as we possibly can.

Sure, as Jeff Rubin suggests, people can cut back on their oil and gasoline usage. Drive less, drive smarter (hypermiling for example) or buy a hybrid car. Its going to be many years before hydrogen cars are available anyway for mass market production.

The rapid rise of oil prices and market speculation is undeniable. In the 20 years prior to 2003 there was plenty of spare oil capacity, and nations who were members of the Organization of the Petroleum Exporting Countries could influence the price occasionally by simply turning the tap on and off. OPEC's power to control the oil prices kept risk-averse speculators out of the market for many years. (Earlier this year OPEC predicted oil prices might reach $170 US/barrel.)

In 2000 the United States ended its regulation of energy markets, letting speculators trade in oil futures without much oversight from the Commodity Futures Trading Commission. In 2003 there were about 50 financial institutions trading oil on the New York Mercantile Exchange. Today that number is closer to 400. In 2007 billions of dollars flooded the commodities markets after the sub-prime mortgage meltdown, turning oil into an asset class and making oil and gold prices skyrocket due to over investment.

Every investor suddenly jumped off the mortgage and banking bandwagon and jumped on the oil and gold bandwagon (gold prices are less effected by geo-politics thankfully). Nothing else could explain a barrel of oil jumping from $70 (U.S.) to $147 and back down to $115 within a year.

U.S. legislators are looking at putting up speed bumps that would reduce the influence speculators have on commodity prices, including limits on the number of oil contracts an investor can hold, and stricter disclosure requirements. If it wasn't for the oil speculators the price of oil would likely be closer to $80 a barrel today.

There's also the Peak Oil Theory that global oil production has reached or will soon reach its maximum and slowly decline as oil resources become more scarce in years to come. That theory has a lot of investors thinking positively about the future of high oil prices...

And lawmakers and regular citizens looking at a future of skyrocketing energy costs and high gas prices.

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