Up, Up, and Away?

Very few short-term measures can guarantee lower or more stable oil prices. But there are some steps we can take to address price concerns.

In this March 29, 2013, file photo, a worker switches well heads during a short pause in the water pumping phase, at the site of a natural gas hydraulic fracturing and extraction operation outside Rifle, in western Colorado. (AP/Brennan Linsley)
In this March 29, 2013, file photo, a worker switches well heads during a short pause in the water pumping phase, at the site of a natural gas hydraulic fracturing and extraction operation outside Rifle, in western Colorado. (AP/Brennan Linsley)

Two years ago, oil sold for just $70 per barrel. If you asked energy analysts back then what circumstances would lead to oil prices hitting $125 per barrel, they would have told you that only a catastrophe could lead to such unprecedented high oil prices such as a terrorist attack in the Saudi oil fields.

Yet this week oil closed at $124 per barrel without horrific events occurring. And this price climb could just be beginning. A Goldman Sachs analyst predicts that prices of “$150-$200 per barrel seems increasingly likely over the next six to 24 months.”

What is going on here? A confluence of events, including the low value of the dollar, increased demand, instability in some oil producing states, and speculation, have created a perfect petroleum storm that continues to drive prices up, squeezing low- and middle-income families in an oil vise that grips tighter every day. To ease price pressure on families, a series of measures have been proposed in the Senate that would shift tax incentives from big oil to clean renewable energy and reign in speculators, gougers, and OPEC. It would also stop filling the Strategic Petroleum Reserve, which would instantly provide 70,000 barrels per day of additional supply.

Congress should also consider a “fuel price reliefbate” to provide immediate assistance to low- and middle-income families as they cope with higher fuel and food prices. And long-term measures, such as stricter fuel economy standards and incentives for plug-in hybrid cars are also necessary to reduce U.S. oil consumption and greenhouse gas pollution.

Are High Gasoline Prices Beneficial?

Some progressives and environmentalists believe that there is nothing wrong with high fuel prices because they will reduce oil consumption, increase efficiency, drive innovation, and reduce global warming pollution. All of these are valuable long-term benefits of higher prices. But these benefits are unlikely to occur in the short run.

Despite rising prices, U.S. oil consumption in 2007 was “essentially unchanged from 2006.” The Department of Energy predicts it to drop by 1.6 percent this year, with slightly less than half of this decrease due to the use of ethanol and the rest due to high prices. The Department of Energy predicts that consumption will rise again in 2009.

So although high prices have had only a little effect on demand, it has led to a giant transfer of wealth from American families to big oil companies. Families have doubled their spending on gasoline from 2001 to 2007 (measured in 2001 dollars). These dollars have bloated the coffers of big oil companies. The big five oil companies—BP, Chevron, ConocoPhillips, ExxonMobil, and Shell—made $556 billion in profits between 2001and 2007. They hauled in another $37 billion in the first quarter of 2008, and are on a pace to break last year’s record profit of $123 billion.

Median family income in real dollars is, meanwhile, slightly lower now than it was in 2001. The oil companies are growing fat on money from everyday citizens, while Americans are squeezed by higher fuel, food, and health care costs.

A limit on emissions under a global warming cap-and-trade system would likely increase gasoline prices. But such a plan should also include funding measures to reduce the economic effect of these higher prices on those who are least well off. In addition, a cap-and-trade program should include policies that provide affordable alternatives to driving alone in one’s car. This would free people from paying more at the pump because they lack viable cheaper, more efficient alternatives.

Unfortunately, such a comprehensive greenhouse gas reduction law does not yet exist. Families are left spending more income on gasoline without viable alternatives. Making families suffer from high prices by handing over more of their hard earned money to ExxonMobil serves little useful purpose at a time when median household income is lower than it was seven years ago. Instead, we ought to provide assistance to these families while we make systemic changes to reign in profiteers, reduce demand, increase clean energy options, and reduce global warming.

How We Got on the Oil Escalator

Analysts suggest that there are five primary factors contributing to the year-long rise in crude oil prices: the low value of the dollar, increased demand from China and India, dwindling supplies, political instability in some oil producing nations, and an assumption from speculators that prices will continue to rise.

The International Monetary Fund has also found that “the depreciation of the dollar has amplified the oil price surge in dollar terms.” The value of the dollar has dropped in the last year compared to the Japanese yen, Chinese yuan, and European euro. The value of the Japanese yen and the euro both rose by 12 percent between 2007 and 2008, and the value of the yuan increased by 9 percent. Because oil is priced in dollars, these nations’ stronger currencies provide them with more purchasing power in 2008 than a year ago.

Of course, the greater currency value has been offset by the rise in oil prices. But because of their stronger currencies, other countries have been less affected than the United States. A barrel of oil costs 56 percent more in yen, euros, and yuan in 2008, but it costs 100 percent more in dollars.

The falling dollar in tandem with the global credit crisis also has institutional investors and speculators alike shifting investments into liquid, dollar-based commodities, particularly oil, which adds further fuel to the run up in oil prices.

Even though China and India combined use less oil than the United States, their demand continues to grow much faster. Between 2001 and 2007, oil consumption in China grew by 35 percent, and India’s use grew by 15 percent. U.S. demand meanwhile grew by only 5 percent.

Some scientists also believe that higher demand and dwindling supplies could soon lead to “peak oil.” This is the point at which supply is low enough that extraction becomes too expensive.

The United States imports about 58 percent of its oil. Canada supplies approximately 20 percent of these imports, and Mexico contributes 10 percent. Another 30 percent comes from regimes that are less friendly and stable, including Saudi Arabia (13 percent), Nigeria (8 percent), and Venezuela (9 percent). Because world supplies are so tight, even the threat of supply disruption in these or other significant oil producing states can boost oil prices.

The effects of global energy trends and geopolitics add to the price hikes. As global demand for oil surges, driven by China and India, production in several stalwart supplier nations has been steadily declining. Aging, Soviet-era infrastructure in Russia, the number two oil producer in the world, has led to sluggish production in recent years. The transition to a new presidency as Vladimir V. Putin gives way to his successor Dmitri A. Medvedev adds another element of uncertainty to predictions about Russian oil production. And in Indonesia, declining oil production due to dwindling supply has made the country a net importer since 2005, and is now spurring the government to consider dropping its membership in OPEC.

Violent conflict is another major cause of supply uncertainty. The recent crises in Nigeria are a particularly apt example. Nigeria, the largest oil producer in Africa, has long been divided along ethnic and religious lines. Terrorist attacks on oil facilities and pipelines frequently disrupt production and oil security, which often sends markets reeling. A rebel attack on a Royal Dutch Shell oil facility over the weekend led to a $3.65 spike in prices. Because of these and other attacks, “Nigeria’s exports are at least 550,000 barrels a day less than the country’s capacity.”

The steady climb in oil prices over the past year suggests that speculators cannot go wrong by betting that oil prices will continue to climb. Such expectations create an incentive to buy as many oil futures as possible, because selling the oil several months later will ensure a tidy profit. Some public officials believe that “25 percent of the premium for petroleum products is a result of speculation and not supply and demand.”

What We Can Do

Very few short-term measures can guarantee lower or more stable oil prices. The Consumer-First Energy Act, however, sponsored by Sen. Harry Reid (D-NV), would address at least some of the aforementioned concerns.

The bill takes direct aim at speculators, price gougers, and OPEC by enhancing the federal government’s powers to investigate and prosecute price gouging and market manipulation. The president would have the authority to declare an energy emergency and more severely punish those who attempt to profit from supply disruptions or other circumstances. Thirty states already have such laws.

Oil markets are open to manipulation since they are essentially unregulated. Traders can avoid domestic oversight by routing oil trading through the Intercontinental Exchange in London rather than the New York Mercantile Exchange. The Senate bill would prevent “traders of U.S. crude oil from routing their transactions through off-shore markets in order to evade speculation limits and also impose reporting requirements.” The bill would also require traders to increase the “margin requirement” on oil so that traders would have to put up significantly more of their own money to finance futures deals.

Sen. Maria Cantwell (D-WA) believes that these provisions would put “a cop on the beat to patrol the markets for any illegal activity or manipulation and help ensure Americans are paying prices that are not just fair, but based on supply and demand fundamentals.”

Courts have ruled that the government cannot take action against price fixing by other countries. The Consumer-First bill would also provide the U.S. Attorney General with the power to bring enforcement action against any nation that colludes to set the price of oil or natural gas.

Critics argue that these three measures will do little to immediately reduce the price of oil or gasoline. But they could help reduce upward price pressures as soon as they become law by creating a “chilling” effect for those who would flout them. Because such behavior would be illegal, it may make practitioners more hesitant to undertake these forms of market manipulation that contribute to higher oil prices.

The Consumer-First Energy Act would also begin to reverse the tidal wave of money washing into big oil companies’ bank accounts due to record high oil prices. It would close tax loopholes worth $17 billion over 10 years. It would use this money to extend or create tax incentives to encourage investment in energy efficiency and clean, renewable energy such as wind and solar. The House has attempted to take these steps on several occasions, but Senate efforts to shift incentives from oil to clean energy failed by several votes to muster the super majority need to pass it.

The bill would further spur investment in clean energy by establishing a windfall profit tax on big oil companies that do not invest in clean renewable energy. As of mid-2007, the big five oil companies have invested approximately 1 percent or less of these profits into renewable energy, despite their record profits. The revenue from the new tax would go into an Energy Independence and Security Trust Fund for investments in renewable energy and efficiency.

The plan would provide a small amount of price relief halting additions to the Strategic Petroleum Reserve, which is already at 90 percent capacity. This added oil supply could promptly reduce gasoline prices by 3 cents to 5 cents per gallon.

The windfall profits tax and closed loopholes would direct incentives and spending away from big oil companies and toward efficiency and renewables. Such measures should increase the use of both, and incentives to purchase more fuel efficient cars and plug-in hybrids could also reduce oil demand and prices.

We also need to provide relief for low- and middle-income families given the sharp rise in fuel and food prices. We propose using $15 billion of the funds from closing oil company tax loopholes and recovering $10 billion in lost royalties from offshore oil and gas production to pay for a rebate to families based on need, and not on gasoline consumption. This plan would also provide a $4,000 reliefbate to 300,000 independent truckers. This “fuel price reliefbate” proposal would provide some assistance to all families earning less than $75,000 per year, which is 80 percent of all households. Significantly, it would provide assistance to families that don’t have cars, but are paying more for food and other goods due to high oil prices. (Anywhere from 14 percent to 35 percent of low-income households do not own cars, depending on which numbers one uses.)

But we also need to pass measures such as those in the Consumer-First Energy Act to provide some downward pressure on prices by curbing price gouging, speculation, and collusion. But lower, more stable prices will ultimately only occur by reducing consumption in the United States and worldwide. Significantly more efficient motor vehicles, clean sustainable biofuels, and investment in transit are all essential elements to reduce this demand. The next president must pursue these policies with vigor before prices hit $200 per barrel of oil and $5 per gallon of gas.

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Daniel J. Weiss

Senior Fellow