Oil Prices and Politics

Republicans have tried to place the blame for high gasoline prices on the Obama Administration.  There should be more drilling, they say, the Keystone Pipeline should be approved, and the Arctic National Wildlife Refuge should be opened up to the oil companies.  Never mind that none of this would impact the oil market in the short run and that the long run effects for the global market are either modest or nil.

Feeling the heat, the Administration responded with an initiative of its own.  If oil prices are too high, maybe the markets are being manipulated.  The New York Times reported on the President’s remarks on April 17 as follows:  “With his re-election prospects influenced by the price of gasoline, President Obama on Tuesday demanded more ‘cops on the beat’ to crack down on oil market manipulation, calling on Congress to bolster federal supervision of oil markets and to increase penalties for subverting markets.”

While there can be manipulation of particular futures pricing, no one that the Administration could charge with illegal activity can manipulate the global price of oil.  For example, Saudi Arabia can obviously affect the price of oil by its decisions on how much to produce, but charging them with a violation of the Commodity Exchange Act is inconceivable.  (All signs are that Saudi Arabia is trying to be helpful as international economic sanctions on Iran limit the supply of oil entering into the global market from that country.)  

In fact, the Administration gives away that it has no evidence that high gasoline prices are being caused by manipulation.  Both the President’s prepared remarks on this subject and the accompanying fact sheet are carefully worded.  In his prepared remarks, the President says that “none of these steps by themselves will bring gas prices down overnight.  But it will prevent market manipulation and make sure we're looking out for American consumers.”  The fact sheet is also cautious: “At a time when instability in the Middle East is contributing to rising global oil prices that impact consumers at the pump, it is critically important to give American families confidence that illegal manipulation, fraud and market rigging are not contributing to gas price increases.”

In other words, the Administration knows that more policing of the oil market, especially the oil futures and OTC derivative markets, is not going to bring down the price of oil.  The phrasing of the two White House documents is deliberate and most likely the result of negotiations among Administration officials knowledgeable about the oil market and those focused on politics.  The Administration obviously does not want a written record indicating that it said something stupid, but it apparently does not mind how the press covered this initiative in the current political environment.

This is a separate consideration from whether the specific Administration initiatives are a good idea.  For example, an increase in the CFTC’s surveillance and enforcement staff, as the Administration recommends, is probably necessary given the enhanced responsibilities of this agency to monitor the OTC derivatives market.  But does anyone think the current Congress will pass legislation for a six-fold staff increase, as the Administration proposes?   Also, while granting the CFTC enhanced margin authority over exchange-traded oil futures is, in my mind, not objectionable, but it is unlikely to bring down the price of oil and is unlikely to be enacted by Congress unless some severe problem on an exchange and its margin setting procedures emerge. 

One troubling aspect of this is that the CFTC is supposed to be a market neutral regulator, that is, not caring whether prices go up or down.  The futures markets, after all, are a zero sum game.  The total gains and losses due to market price moves cancel each other out.  In fact, the CFTC used to argue that this is a reason that it should not be merged with the SEC, which it implied had a bias in wanting the stock market to go up.  But if the CFTC uses increases in oil prices to argue the urgent need for more authority but is silent when prices decline, it compromises its supposed market neutrality.     

The arguments that the futures markets are keeping the price of oil higher than it should be are weak.  Proponents of more regulation are on better ground when they argue that futures markets may increase price volatility, but this is very difficult to prove.  The direction of causation is notoriously hard to determine.  After all, greater price volatility can spur more activity in futures market because it engenders a greater demand for hedging and makes speculation more interesting.

Unfortunately, increases in oil prices always seem to engender a lot of political rhetoric and uninformed commentary.  Maybe oil prices will ease a bit, and this will calm down, but no one really knows.