Oil speculation: The great debate

Energy analyst Daniel Yergin tells Congress that trading does play a role in crude's overheated runup - but not the only one.

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By Aaron Smith, CNNMoney.com staff writer

NEW YORK (CNNMoney.com) -- It's the $64,000 question on Capitol Hill this week: what is responsible for the record escalation on oil prices?

Speculators have taken much of the blame. But on Wednesday, one of the nation's leading energy analysts said that it's more complicated than that and the cause is multi-faceted.

"In such circumstances as these, there is a tendency to seek a single explanation," said Daniel Yergin, in testimony before the Joint Economic Committee. "History, however, demonstrates that changes of this scale and significance result not from a single cause, but rather from a confluence of factors."

Yergin acknowledged that speculative traders looking to make a buck on oil have played a role in driving up prices and fanning fears about tightening supplies. But he also pointed to other factors, including the credit crisis and a weaker dollar.

"Financial markets are today playing an increasingly important role in price formation - responding to, accentuating, and exaggerating supply and demand, geopolitics and other trends," said Yergin, co-founder and chairman of Cambridge Energy Research Associates.

Yergin said that markets have helped fuel a "shortage psychology" that the world is "running out of oil."

"As prices go up, this psychology becomes self-reinforcing - at least until the market turns," said Yergin.

The subprime mortgage meltdown has led to interest rate cuts and a weaker dollar - propelling the price increases, he added. Still, prices may be at or near their peak, said Yergin, who urged Americans to adopt a multi-faceted approach to alleviate the energy crisis.

Peak prices vs. peak demand

Yergin said that two years ago, he viewed a range of $120 to $150 a barrel as the "break point" for oil prices. Oil prices are trading within that range. Prices plunged on Wednesday following a government report that showed a buildup in supply, falling more than $4 a barrel to about $132 on the New York Mercantile Exchange.

"As the committee knows, there is much talk about 'peak oil' supply these days," said Yergin. "However, we think something else is at hand - 'peak demand' - at least in terms of U.S. gasoline consumption," Yergin said. "In our view, 2007 may well have been the top, the peak, in terms of U.S. gasoline demand."

The average nationwide price for a gallon of unleaded gas was $4.067 on Wednesday, according to AAA. The highest recorded price of $4.080 occurred on June 16, according to AAA.

Yergin added that America must take aggressive measures to alleviate its oil problems. He said Americans should adopt a three-pronged approach: use of renewable energy sources and newly-discovered oil supplies - such as the discoveries in off-shore Brazil - as well as greater fuel efficiency.

"Alternatives and renewables have and should have an important role to play in our energy economy, and their role will grow," said Yergin. "A great deal of effort is going into innovation, and the impact will be significant. But the timing and scale remain uncertain."

Price bubble, or new reality?

Lawmakers, who are facing voter anger over high gas prices, have introduced nine different bills on speculation. Several of those measures have bipartisan support. Several hearings have been held this week with more scheduled.

Sen. Charles Schumer, D-N.Y., chairman of the committee, convened Wednesday's hearing to examine the state of the international energy markets and the impact of oil prices on the U.S. economy. The focus of the meeting was to determine whether skyrocketing oil prices are a "bubble" or a "new reality."

"I think everyone would like to believe that high oil prices are a bubble, but they might not be," said Schumer. "Many would also like to believe that there is a silver bullet that can pop the bubble. But if there is no oil bubble, or prices temporarily decline and we put off doing the necessary things we have to do - like conservation or investing more in alternative fuel incentives - we'll be even further behind than we are now from breaking our foreign oil dependence."

Schumer also downplayed the role of speculators in driving up oil prices, and he placed blame on the oil industry and the Organization of Petroleum Exporting Countries.

"I think it is interesting that the big oil companies and OPEC are blaming speculators for out-of-control prices, when they may be much more of the cause," said Schumer.

Schumer said the impact of speculation could be curtailed by raising margin requirements and strengthening regulations "but they may not solve the problem in the long-term, particularly if we think these are the only things that should be done."

Yergin hesitated, however, to condemn all forms of speculation. He said that hedging fuel prices was helping the airline industry in a difficult time. Southwest Airlines (LUV, Fortune 500), for example, has prospered while other airlines have lost money, largely because of hedging fuel and therefore avoiding today's skyrocketing prices.

"If they can't hedge, they would be in even worse shape," said Yergin. "So I think that removing liquidity from the market would not be a good thing to do."

Conservation is the key to alleviating the oil crisis, said Schumer, praising the 1970s-era conservation efforts of former California Gov. Jerry Brown in reducing that state's per capita energy consumption to this day.

"We must address the demand side of the oil equation," said Schumer. To top of page

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