Politicians Still Misunderstand Oil Markets

 | Jun 27, 2014 | 6:06 PM EDT  | Comments
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Oil and water do not mix. It turns out that oil and politics do not mix either. Unfortunately, Washington, D.C., seems attracted to oil, and it seems that politicians cannot resist putting their thumb on the scale.

Yesterday, 15 U.S. senators co-sponsored a bill to control oil prices. These Democrats claim they want the Commodity Futures Trading Commission (CFTC) to invoke emergency powers to stop speculators from taking advantage of turmoil in Iraq to drive up oil prices. A copy of the bill can be found here.

This bill is bewildering. First, the CFTC already has congressional authority. As the bill points out, the CFTC has all necessary tools to manage the very markets the senators describe in their legislation.

Second, the legislation refers to and relies on an article written well over two years ago. That article appeared after U.S. politicians declared victory in Iraq. In short, that article has little connection with the current Syria-Iran outbreak.

Third, politicians somehow believe that oil traders should ignore market risks. They want oil traders to focus on domestic supply and demand and little else. Specifically, these 15 senators want "to eliminate excessive speculation, price distortion, sudden or unreasonable fluctuations, or unwarranted changes in prices, or other unlawful activity that is causing major market disturbances that prevent the market from accurately reflecting the forces of supply and demand for energy commodities."

Finally, these policymakers appear to misunderstand oil markets. The U.S. is a net importer of crude oil. As such, West Texas Intermediate prices will respond to international oil markets (Brent, OPEC and others).

Oil Prices, Domestic and International
Energy Information Administration

It appears the proposed legislation is more about appeasing voters about increasing prices for gasoline. It will go nowhere.

Republicans have played similar games. Do you remember "Drill, baby, drill"? It was a campaign slogan used at the 2008 Republican National Convention. It was reused several times later. In the 2008 vice presidential debate, Sarah Palin said, "That's what we hear all across this country in our rallies, because people are so hungry for those domestic sources of energy to be tapped into."

Four years later, presidential candidate Newt Gingrich recycled same idea when he unveiled his plan for $2.50 gasoline. He called it "Drill Here, Drill Now, Pay Less." His plan came down to a simple idea: If the U.S. accelerated domestic drilling, gasoline prices would fall.

America drilled. Baby, did they drill. However, as drilling increased, domestic oil prices moved in the wrong direction. The result was exactly opposite what politicians had predicted.

Domestic Oil Prices and Production
Energy Information Administration

That is not to say increased drilling caused oil prices to increase. The markets caused prices to increase. In fact, as the graph illustrates, there is no correlation between domestic oil production and prices.

Domestically, prices had no connection to demand. According to the Energy Information Administration, domestic demand for petroleum products peaked in 2000 at 20,631,000 barrels per day. It remained flat until 2007. From 2010 to 2013, average demand fell to 18,991,000 barrels per day.

However, oil is a fungible commodity. As such, domestic oil prices are influenced by international markets. Increased domestic production helps keep international prices in check.

This leads to the final point. Many Americans seem unaware that domestic refiners sell into foreign markets. Since 2011, the U.S. has been a net exporter of petroleum products. In fact, last March, the U.S. exported a record 3.8 million barrels per day of oil and refined products to other countries.

If those exports were forced to remain in the U.S., gasoline prices would drop. However, producers are free to sell wherever they wish, including foreign customers.

Nobody is trying to stop exports, including Washington politicians. Exports help GDP, they help business, and they help produce new taxes for federal, state and local governments. Exports help the economy.

In typical Washington fashion, oil policies are confusing. On one hand, 15 Democratic Senators want low and stable oil prices. On the other hand, nobody wants to stop exports.

To add to the confusion, there is pent-up supplies and a massive pipeline waiting federal approval. Producers waiting to supply U.S. with cheaper crude include Suncor (SU), Canadian Natural Resource (CNQ), Enbridge (ENB), Encana (ECA), Talisman (TLM) and others. Of course, critical to the safe and economic transport of all that new oil is TransCanada's (TRP) Keystone XL pipeline.

Canadian oil and the Keystone pipeline cost the U.S. government nothing. In fact, both help North America's energy security. They increase energy independence. They offset potential cutbacks in Middle Eastern oil production. They provide the U.S. military and diplomats with added leverage against our enemies. Washington needs to get out of the way and let the oil flow.

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