In Defense of Greedy Oil Companies and Speculators

The price for regular gas hit $4 a gallon this week, and Americans want to know who is to blame? That's easy, it's greedy oil companies and speculators, that is if we are to believe President Obama’s anti-business rhetoric over the last couple weeks. In fact, he has already a Department of Justice investigation into "manipulation in the oil markets that might affect gas prices, including any illegal activity by traders and speculators."

Even high-ranking Republicans might go along with the investigation. Last week, House Speaker John Boehner discussed possibly accepting the President’s proposed tax hikes on oil companies as part of a deal to lower energy prices, though he later expressed concern that such taxes would further raise gas prices.

Sure, with the high oil prices, energy companies are currently making a lot of money. Last week, ExxonMobile, the largest company in the U.S., reported quarterly profits of $10 billion, earning about 9 cents per dollar of revenue. Royal Dutch Shell, Europe’s biggest oil company, earned 8 cents, and ConocoPhillips’ pulled in 5 cents. But what is “wrong” with that? The prospect of high profits is precisely the lure needed to encourage and allow further investments in producing energy. That is how oil supplies are increased, and that is what will put downward pressure on future prices.

As for currently high oil prices, many politicians conveniently ignore that the spike in oil prices arose when riots erupted in the Middle East. Governments in Egypt and Yemen have fallen. Civil war has broken out in oil rich Libya and the constant shootings of demonstrators continues in Syria. This violence has reduced oil production and caused fear of future reductions in supplies. Nonetheless, Mr. Obama insists: "There’s enough supply. There’s enough oil out there for world demand. The problem is, is that oil is sold on these world markets, and speculators . . . we can investigate if there’s unfair speculation."

But what would happen if riots broke out in Saudi Arabia, which accounts for about 12% of world oil production? Prices would soar. Speculators make profits by buying oil when the price is low and selling it when it is high. Buying oil now, in order to set it aside in case disaster strikes and supplies are interrupted, protects consumers. Storing oil for then will prevent what would have been even higher prices. Higher prices also encourage more conservation, thus making even more oil available if disaster strikes. If speculators didn’t do that and Saudi shipments are halted, the much bigger increase in oil prices would surely cause much worse problems than the current rise in prices.

The speculators are taking a real risk with their own money. If Saudi Arabia and other Mideast oil countries keep producing, speculators will be out of luck, paying a lot for the oil they stored and finding they can’t sell it for very much. Obama surely isn't going to shed tears over the money the speculators lost. If production is cut and the stored oil keeps prices from skyrocketing, who is going to thank the speculators for a job well done?

Alas, Obama seriously believes that government officials, whose money isn't on the line, can do a better job of figuring out how much prices should rise from this speculation. Good luck with that. It is just another sign that Obama doesn't have a clue how incentives work in business.

Obama and even some conservatives, such as the National Review's Rich Lowry, claim that there is nothing that can be done immediately to reduce oil prices. After all, they argue, even if the go ahead were given today, it would take years before we would see that oil. But lower future prices do lower current prices. Just as speculators save oil for future consumption if they think that prices will rise, lower future prices mean that they won't keep their inventories, and selling them off now will lower today's prices.

When the Obama administration virtually shuts down issuing more permits to drill for oil in the Gulf of Mexico, oil prices go up. When the EPA this week forced Shell Oil to stop drilling in Alaska, despite already spending $4 billion, prices went up some more. When the U .S. Fish and Wildlife Service recently announced that it was considering shutting down oil drilling in West Texas and New Mexico because of the Dunes Sagebrush Lizard, it went up some more. Any one of these and other changes might only slightly change world oil production and thus prices, but all these decisions add up. It is also a lot of money for the country in difficult economic times to give up.

President Obama shouldn’t be blamed for most of the recent increase in gas prices any more than he can be blamed for the chaos sweeping the Middle East. But he should also not put the blame on companies or speculators. And he should not make things worse by restricting domestic oil production. As we are all too frequently reminded by the president, he hates business and doesn’t understand economics.

John R. Lott, Jr. is a contributor. He is an economist and author of the just released revised edition of "More Guns, Less Crime" (University of Chicago Press, 2010).