Gas Prices, Sanctions and Speculations

One thing almost every American is acutely aware of these days is the price of a gallon of gasoline. Up until the last two weeks, prices had been steadily rising, fueling fears that prices wouldn’t level out until they reached the $5.00/gallon mark or more. However, prices appear to have peaked with the national average having now dropped to $3.92/gallon. In 2011, we reached a high of $3.99/gallon, with the record high of $4.11/gallon set in July of 2008.

The pushes and pulls that effect gas prices are a complicated web mainly interweaving the financial markets and the political landscape. Prices are also affected by hurricanes, massive oil leaks, terrorists and other such events that disrupt the flow of oil. Financial speculators have been blamed for more than half the spike in oil prices as they have been buying up futures contracts, judging them as good investments. Much of these future speculations are being driven by the belief of the U.S. and its allies that Iran is pursuing a nuclear bomb; an accusation Iran denies.

Oil futures are agreements to buy or sell 1000 barrels of oil at a specific date in the future (anywhere from 1 month to 7 years) at a specific price. Traders bid on the price of oil based on what they believe the future price will be by estimating supply and demand. Once locked into a futures contract, the buyer will get the barrels of oil for the price paid regardless of whether the price per barrel has changed or not.

Speculators who buy oil futures at higher than current market (spot) prices cause oil producers to stockpile their oil supply and sell it at the higher (future) price. Stockpiling of oil effectively reduces the supply and drives up both present and future prices, and continually puts pressure on future prices… and so on, and so on and so on. Bloomberg had this to say about the current oil futures situation:

“Talk to oil analysts these days and chances are they’ll tell you that more than half the spike in the oil price is due to speculators—specifically noncommercial users. That’s jargon for investors who are buying up futures contracts not because they intend to use the oil, but because they think it’s a good investment. These aren’t airlines or refining companies; these are money managers betting that the price will go up. And so far they’ve been right, thanks to themselves.”

Much of the world’s oil supply is located in regions that have historically been prone to political instability, often fueling the decisions of the oil futures speculators. Iran, the world’s 5th largest producer of oil, at more than 4.2 million barrels per day, continues to pursue its nuclear ambitions, causing much uncertainty in the region and around the world. The U.S. and its allies have been playing a game of cat and mouse, threatening everything from economic sanctions to military intervention as tensions between Iran and the west mount.

President Obama, with the recent approval of Congress, is moving forward with tough new sanctions aimed at isolating Iran’s central bank from the global economy. The sanctions, which go into effect at the end of June, will be placed on foreign banks that continue to purchase oil from Iran. The decision to go forward with sanctions was based on a February report from the Energy Information Administration which revealed there is enough crude oil available on the world market to put the squeeze on Iran’s oil exports without harming the U.S. and its allies.

Only time will tell if these political moves and the reactions of the financial markets will keep gas prices steady and even possibly continuing to drop or if they will start another upward journey, steadily marching toward that oft promised $5.00/gallon.