Monday, June 16, 2008

Misunderstanding And Empowering Speculation -- We CAN Drill Our Way Out

Over the past few weeks I have heard an increasing meme that speculation is what has driven up the price of oil.

While it is true a portion of the price increase has been strictly profit driven, "speculators," the majority of the speculation is warranted by the supply and demand in the markets. The profit driven speculation is only feasible because of the artificial restrictions we have placed on oil supplies.

In the current oil market unreasonable speculation is simply a symptom of the problem. That problem being the lack of a stable supply of crude oil.

Current oil production levels are virtually identical to demand with very little excess capacity available in the event of an interruption. Political instability, weather hazards, refinery breakdowns, terror attacks, kidnapping/attacks on oil platforms and hostage taking, and other interruptions in production increase the risk that oil supply will not be able to meet the demand in the future.

That is where the market comes in. If you are a large consumer of oil you purchase futures contracts, offering to buy oil in the future, at a set price that the seller has to deliver at that price -- no matter what interruptions occur between now and then. In order to make a profit traders have to build in a premium in the cost of oil to offset that ever increasing risk.

Increasing domestic production -- Drill Here, Drill Now, Pay Less -- would greatly reduce much of the speculation by mitigating many of the uncertainties. From the list above, if you developed domestic supply in various regions of the US (Both coasts, Rocky Mountains, Alaska, Plains) you would mitigate the major effects of weather, political instability, terror attacks, attacks on platforms, and many other interruptions because there would be additional supplies from the remaining stable US regions. Increasing refining capacity would help mitigate the effects of refinery breakdowns.

This fundamental misunderstanding of the oil markets and the refusal of the Democrats to allow increased energy production has empowered the speculators in ways not seen since the markets began trading, resulting in a direct increase in the price of gasoline. The Democrat's tactic of deflecting blame to the oil companies only serves to increase the speculation as additional restrictions and increased taxes on domestic oil producers historically leads to reduced domestic production. (Interestingly as the polls show less people blame the oil companies the debate is shifting to speculators!)

Pelosi, Reid, and crew keep repeating that we can't drill our way out of this, but they are just as wrong and misinformed about this as they were 14 months ago when Reid declared the surge a failure.

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