Greenspan Blames High Oil Prices on Speculation and Supply

August 1st, 2008 10:47 AM

Former Federal Reserve chairman Alan Greenspan spoke with CNBC's Maria Bartiromo Thursday, and although a number of press outlets reported his concerns about the economy being close to a recession, his comments about high oil prices being a function of speculation and lack of supply went largely unnoticed.

This boycott seems especially absurd as Congress is currently deadlocked on an energy bill that would offer Americans any hope of relief at the gas pump (photo courtesy Reuters).

With this in mind, Greenspan said the following on Thursday that should not only be relevant to media members, but also to our political leaders that are about to take a five week vacation without having come close to addressing America's energy crisis:

There are long-term structural problems in the oil market which is the big, dominant element in the commodities thing, largely because of the fact that there's a trend which is very difficult to project mainly, that underlying consumption while rising as much as oil in the ground, the reserves of oil, is running far in excess of the rate of increase in the productive crude oil capacity because we're not investing enough to take the oil out of the ground and to essentially create a sufficiently large flow to not balance the demand that's coming mainly from Asia. The problem that we have here is that because there has been this pressure, the buffer is gradually disappearing between supply and demand.
There's been underlying pressures on prices which starting in 2004 caught the eye of the financial system, and if you look at the data that the Bank for International Settlements publishes, essentially on the notional value of basically crude oil futures, it's going flat, and that it just goes straight up. What that means is that we are moving forward a price increase which was going to happen anyway. And I think this is indeed speculation, but it's good speculation in that by creating prices moving forward more quickly than the would have, you essentially curb the level of consumption far sooner, and therefore the peak of prices which we'll ultimately get to without the speculation, is cut off.

In plain English, Greenspan basically said that the rate of increase in the demand for oil has surpassed the rate of increase in its production. Once folks on Wall Street -- and investors around the world -- noticed this, they began aggressively buying futures contracts on the various commodities exchanges thereby driving prices up well beyond what they would be today based upon current supply demand forces.

In effect, investors have brought oil prices to where they would be at some point in the future based upon their speculation of what that price might eventually be. As such, we are potentially paying a price for gas, heating oil, etc., that mightn't have been reached until years from now if such speculation didn't exist.

The following chart demonstrates Greenspan's point (courtesy

As you can see, just as Greenspan stated, oil began its breakout in 2004 "when underlying pressures on prices...caught the eye of the financial system." At that point, speculators began aggressively buying futures contracts driving the price from $30 a barrel to almost $150 in four and a half years.

Unfortunately, Maria didn't ask the former Fed chief what prices might be today if not for this speculation. Regardless, if Greenspan is right, and today's prices are a function of both speculation AND supply, Congress should be creating an energy bill which addresses both.

Sadly, the Democrats only want to deal with speculation, and are totally stonewalling any efforts by Republicans to increase supplies through drilling in the Arctic National Wildlife Refuge and the outer-continental shelf (offshore).

Maybe if media began hammering this point that supply needs to be dealt with as well as speculation, folks like Speaker Pelosi and Majority Leader Reid would acquiesce rather than going on a five week vacation that they don't need anywhere near as much as the nation needs an energy bill.

As a post facto addendum, folks on the left love to make the case that any new drilling efforts will have no impact on prices for many years. However, if Greenspan is right -- and, as NewsBusters readers know, I've been making this same point for a very long time!!! -- any change in the future supply demand ratio will indeed impact prices today as speculators change their view of prices in the future.

Again in plain English: today's prices are a function of what speculators believe prices will be in the future based upon supply and demand. If America was to increase its future supply by beginning the process of drilling in ANWR and additional offshore sites, speculators would reduce their price expectations in the future which would force a liquidation of contracts today.

Such a liquidation could create a rush to the exits on commodities exchanges all around the world bringing energy prices down quite sharply and quite quickly.

Frankly, any elected official that doesn't agree with this lacks the financial knowledge to be in a position of authority concerning this matter.