Speculators are driving up gas prices - Opinion

@CNNMoneyInvest March 21, 2012: 5:55 AM ET
In the blame game over rising oil and gasoline prices speculators often take center stage. Better Markets' Dennis Kelleher argues speculators are at fault.

In the blame game over rising oil and gasoline prices speculators often take center stage. Better Markets' Dennis Kelleher argues speculators are at fault.

In the blame game over rising oil and gasoline prices speculators often take center stage.

Dennis Kelleher argues speculators are to blame. Kelleher, a former securities lawyer, is president of Better Markets, a non-profit organization dedicated to Wall Street reform. He's testifying before Congress on the matter on Wednesday.

Better Markets President Dennis Kelleher
Better Markets President Dennis Kelleher

Gas prices have skyrocketed more than 40% in the last few months and are almost $5 a gallon in many places. Americans once again want to know why costs are climbing so high and so quickly. The answer? Not the Persian Gulf, but Wall Street.

Why Wall Street? A few years ago Wall Street invented "commodity index funds" that have poured some $400 billion into speculating in commodities.

Now, there is broad agreement -- from airlines to coffee chains to farmers to President Obama -- that excessive speculation in commodity markets is needlessly driving up prices.

So it's not a question of if, but how much of an effect does this speculation have on Americans' rising food and energy bills?

Surprisingly, the same bank that created those index funds also admits that speculation has driven up prices needlessly.

In a report last year, Goldman Sachs (GS, Fortune 500) said that when speculators open contracts worth one million barrels of oil, the price of a barrel rises by 10 cents across the whole market.

That doesn't sound like much, except that when you total up all the speculative buying you get a premium of $23.39 per barrel, according to one estimate.

What's behind the gas price spike

The hundreds of billions of dollars poured into the oil and agriculture markets have had a marked effect.

As in any market, when dollars go in, the market has to adjust -- in this case with prices going up.

Even though more contracts can be created so that these new buyers can be accommodated, there has to be an incentive for sellers to come into the market and take the other side of those contracts. That incentive comes in the form of higher prices.

Making matters worse, all these speculative commodity contracts periodically expire and then have to be repurchased, or "rolled," which also increases the upward price pressure.

To better grasp this issue, it helps to understand the difference between commodity markets and capital markets.

Commodity markets -- including those for wheat, corn and crude oil -- are very different from capital markets, which exist for anyone to speculate in stocks.

The commodity markets, however, are for commercial purchasers and producers to control their risks by hedging against future price moves.

Commodity futures markets were created so that wheat farmers and oil producers could sell their products today -- even though they won't produce and deliver them for months.

A food company that uses wheat to make cereal could pay a farmer today for delivery in a few months. The farmer can then plant his crops knowing there will be a buyer at a set price come harvest time.

Similarly, commercial buyers can plan today because they know what price they will pay tomorrow. Commodity futures markets allow buyers and sellers to match up and ensure that they get paid.

Speculators are allowed to participate on a limited basis because there aren't always enough sellers to match the demand for buyers, or buyers to match the availability of sales.

For decades, market participants have known that commodity markets work best when speculators make up 30 percent of market activity, with the remaining 70 percent devoted to commercial traders.

With the new tidal wave of investment, that ratio has flipped. Now, speculators are about 70 percent of activity in many commodity markets and commercial hedgers only about 30 percent. This is largely the result of investment banks creating and selling "commodity index funds" that gamble on, and usually drive up, food and energy prices.

Our organization, Better Markets, has conducted a comprehensive study showing that this "invasion of the commodity index funds" has radically changed the price structure of commodity markets.

Wall Street fights rule limiting oil speculation

In the past, prices were based largely on supply and demand, but they are now driven up by investors placing self-fulfilling bets on higher prices for oil, wheat and other products.

The study finds strong evidence of a direct causal link between speculative buying and selling, and changes in commodity price curves resulting in increasing prices.

To combat this and, in particular, to remove the speculative price distortion, commodity index funds should be prohibited.

Congress included language in the Dodd-Frank Act to "diminish, eliminate, or prevent excessive speculation."

The Commodity Futures Trading Commission took a good first step in October by establishing a ceiling on speculation across the physical commodities markets, though more needs to be done to ensure that Americans will stop getting gouged at the pump and the dinner table.

Yet, Wall Street never gives up, even after striking out in the legislative and regulatory arena.

It is now attempting to get a federal court to overturn this modest, sensible regulation designed to protect American families and businesses to protect their tremendous profits and bonuses.

This must stop. Excessive speculation defeats the very purpose for the commodity markets, which have been taken over and distorted by speculators gambling on future price moves.

If speculation is stopped, prices can be again tied to supply and demand, and not the whims of Wall Street. And that, in turn, will provide relief at the pump. To top of page

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