Freedomnomics

Article published Tuesday, March 13, 2012 at Fox News.

Yes, government policies could help bring down the price of gas -- today

By John R. Lott, Jr.

With the price for a regular gallon of gas topping $3.80 on Monday, angry politicians are blaming the higher prices on speculators and greedy oil companies.

On Friday, President Obama announced that he was “making sure that my Attorney General is paying attention to potential speculation in the oil markets.” 23 Senators and 45 congressmen, all Democrats except for one independent, are calling for urgent action against the “speculators” they hold responsible.

These members of congress want the Commodity Futures Trading Commission to use its new regulatory powers under a law Obama signed two years ago to limit the amount of oil that speculators can buy.

This isn’t a new concern.

During the 2008 presidential campaign, Obama campaigned against "the special interest politics that put the interests of Big Oil and speculators ahead of the interests of working people," and surely implied that an Obama administration would end these high prices by clamping down on speculation.

Possibly that is why a new Washington Post/ABC News survey released on Monday shows that soaring gas prices have taken a toll on Obama, with 50 percent of American's strongly disapproving of Obama's economic performance -- the highest in the poll's history.

Unfortunately, neither the Democrats in Congress nor Obama appear to have a clue how markets work. Everyone wants lower prices, but many politicians seem unable to understand that what speculators really do: they actually smooth out wild swings in prices. Speculators make profits by buying oil when the price is low and selling it when it is high.

When prices are expected to rise in the future, they buy oil today and sell it when they think the higher price occurs. They will keep doing this until the gap between today’s prices and tomorrow’s expected price virtually disappears.

Tensions have risen over the last few weeks as Iran threatens to block oil shipments through the Strait of Hormuz if Israel attacks their nuclear facilities. With up to 20 percent of the world’s oil supply at risk -- an amount equal to the entire production from Saudi Arabia, Kuwait, Qatar, and the United Arab Emirates -- steep price increases are a real possibility.

The risk immediately increased oil prices. Speculators aren’t waiting for Israel to actually attack. By buying oil now in order to set it aside if supplies are interrupted if the conflict occurs, consumers are actually protected. Storing oil for this possible crisis will prevent what would have been even higher prices.

The Democrats obviously think speculators are not justified in their attempts to start bidding up prices. And, indeed, Israel’s attack might never occur. Yet, if speculators didn’t do that and oil shipments are halted, the much bigger increase in oil prices would surely cause these very same politicians to really call for the scalps of everyone in the oil business.

Speculators are taking a real risk with their own money. If no attack occurs and prices fall, few in Congress are going to shed tears over the money that the speculators would lose. If the attack takes place and prices only rise a fraction of what they otherwise would have gone up, who is going to thank the speculators for a job well done? Higher oil prices today reduce consumption and increase inventories and thus reduce how much prices will rise if disaster strikes. The possibility of higher prices when disasters strike also gives oil companies an incentive to put aside more oil to cover those emergencies. All this ensures that the overall increase in price will actually be less. Still government policies can help lower gas prices today.

Democrats and even some conservatives claim that there is nothing that can be done immediately to reduce oil prices. After all, they argue, even if the go ahead were given today to drill for more oil, it would take years before we would actually see it.

But lower future prices do lower current prices.

Just as speculators save oil for future consumption if they think that prices will rise, lower future prices mean that they won't keep their inventories, and selling them off now will lower today's prices.

Thus, President Obama's bans on drilling raise prices in the future, but also raise them now. The US is only a relatively small part of a worldwide market for oil, but relatively inelastic demand for oil even small changes in quantity can produce significant changes in prices. Despite all the subsidies for so-called “green energy,” what is being produced there doesn’t come close to offsetting the energy lost from this oil production.

Unfortunately, this crazy regulation of speculators is all too typical of the regulations that we are seeing imposed on other industries. No matter how well meaning, politicians who don’t understand how markets work can do real damage to the economy.

High gas prices have long been in the making. But punishing speculators, while politically popular, will only hurt consumers.

John R. Lott Jr. is a FOXNews.com contributor. He is an economist and co-author of "Debacle: Obama's War on Jobs and Growth and What We Can Do Now to Regain Our Future.".

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