Why Demand Does Not Explain $4 Gas

Better late than never. President Barack Obama has called to enforce strict civil and criminal penalties against traders who manipulate the market and cause oil prices to shoot up by creating artificial supply shortages.

The Obama administration has finally woken up to the fact that gasoline prices at the pump are high, straining disposable income. The president, along with Attorney General Eric Holder and Treasury Secretary Tim Geithner, has called for a crackdown on speculation in the oil market. Many think this could be another election ruse. I really doubt that. The latest move by the president makes a lot of sense.

There are many reasons to suspect that oil prices aren't simply dictated by demand-supply issues. Here are a few of them:

1. Drilling (and production) of crude oil increased considerably in the past five years; however, in the same period total gasoline retail sales fell substantially.
In 2011, daily U.S. field production of crude oil stood at a little more than 5.6 million barrels per day -- an 11% increase from 2006 productions levels. In the same period, total U.S. gasoline retail sales fell by a massive 35% to 39 million gallons per day. People are driving less. Period. The graph below should give a clearer picture:

Source: Energy Information Administration.  

In the same period, national average gasoline prices rose 37% to $3.58 per gallon in 2011, from $2.62 per gallon in 2006. Last week, average prices at the pump stood at $3.98 per gallon.

The above data shouldn't come as a surprise to the average American. The discovery of shale oil has changed the landscape of the U.S. energy industry. In the past two years, both and large and small oil companies have been increasing production. Kodiak Oil & Gas (NYSE: KOG  ) along with Continental Resources (NYSE: CLR  ) -- operating in North Dakota's Bakken shale oil reserves -- have ramped up oil production substantially. Traditional natural gas producers Chesapeake Energy (NYSE: CHK  ) and SandRidge Energy (NYSE: SD  ) have also increased their proportion of liquids production. While lousy natural gas markets are to be blamed for this, the fact is, liquids production has gone up. Now I haven't actually mentioned the traditional powerhouses such as ExxonMobil, Occidental Petroleum (NYSE: OXY  ) , and Apache, all of which have increased liquids production substantially in the past five years.

2. World petroleum consumption growth has been less than corresponding growth in crude oil production
As of 2010, global oil consumption stood at 87.1 million Bpd, a 2.35% increase from 2006 levels. In the same period, however, global oil supply grew 2.52%. And if 2011 figures are considered, then global crude oil production grew 2.9%. Unfortunately, the corresponding 2011 consumption data have yet to be released. But logically speaking, even an extrapolation of available consumption data will not see growth in demand exceeding growth in supply.

3. Emerging economies are expected to slow down
Both the World Bank and the International Monetary Fund have cut growth forecasts for China and India for this year. China's GDP is expected to grow at 8.2% in 2012, a fall from 9.2% last year and 10.4% in 2010. Similarly, India's economic growth is expected to slow down to 6.9% in 2012 -- a fall from 7.2% and 10.6% in 2011 and 2010, respectively. This will obviously have an effect on oil demand from these nations.

You can see a shortage of supply is not to blame for high crude oil prices in these countries. In fact, the IMF report goes on to say, "The oil price shock could also trigger a reassessment of the sustainability of credit booms and potential growth in emerging Asia, leading to hard landings in these economies."

Foolish bottom line
The media may project daily events like rising oil prices on the front pages, but the real issue lies elsewhere. In the words of fellow Fool Morgan Housel, this is another bias of titanic proportions. If you are looking to invest in energy stocks, we've got a stock idea for you. Read about it right here in The Motley Fool's special free report on the energy industry and its best prospects. It's free for a limited time, so click here today.

Fool contributor Isac Simon does not own shares of any of the companies mentioned in this article. The Motley Fool owns shares of Chesapeake Energy. Motley Fool newsletter services have recommended buying shares of Chesapeake Energy. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Read/Post Comments (10) | Recommend This Article (11)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 23, 2012, at 12:35 PM, lution wrote:

    Question - a part of the price per gallon is the price of oil. Another piece is the amount of taxes per gallon. How does the tax rate on gasoline in 2006 compare to the tax rate today both as a direct comparison and as a percentage of the overall price?

  • Report this Comment On May 23, 2012, at 2:10 PM, PostScience wrote:

    Gas taxes have decreased as a percentage of the overall price.

  • Report this Comment On May 23, 2012, at 2:40 PM, Usurped wrote:

    There is only 1 days supply world wide. 1 day people. Too bad the author writes about economic models that haven't existed since shortly after WWII. Oil/Petro is a world commodity, none of it "stays" in the nation of origin truly. Gawd, I'm embarassed

  • Report this Comment On May 23, 2012, at 3:44 PM, TMFGortok wrote:

    Speculation? Really? That's the boogy-man? What about Inflation? What about economic fears over the fact that we're rattling the sabers against Iran?

  • Report this Comment On May 23, 2012, at 8:06 PM, capsisking wrote:

    Oil is a world commodity as someone mentioned above. I believe the demand for oil in emerging countries will increase over time. the main reason the price is coming down recently is because the dollar is going up against the euro. If your president obama had pushed nat gas earlier or allowed more onshore drilling, maybe he could have brought the price of gasoline down two years ago to benefit the consumer. Now he is using his henchmen like Holder and the EPA to beat up on people like the thugs they are. just like he uses financial regulators to beat up on banks making business loans.Ten levels of approval authority to make a $10, 000 business loan. cant wait to see this guy go.

  • Report this Comment On May 23, 2012, at 8:41 PM, dmawhinney wrote:

    The price of oil (and gasoline as well) is not going down except for some short term anomalies. The oil being found and produced in the last five years is much more costly than the oil coming out of 20 and 30 year old wells by factors of 3x and 4x. You want the oil, you pay the price or it stays in the ground, at least in my wells it does.

    And to think or even consider that this global trading market for oil - thousands of legitimate players who need to take delivery - could be controlled by speculators is ludicrous. For every speculator on the buy side, someone has to be on the opposite side of that trade.

  • Report this Comment On May 23, 2012, at 8:53 PM, dmawhinney wrote:

    There's another problem. Politicians and media members have no clue about the reality of market mechanics, or if they did they wouldn't admit it because they'd be laughed off the stage. So they make these sweeping statements for political purposes - to hell with reality - and the great unwashed public having even less knowledge about this stuff says "Yeah! Yeah! Right on! Bring back $2.00 gasoline."

    I can't believe how many clueless people there are many of them posting on The Fool and some even writing articles for them.

  • Report this Comment On May 23, 2012, at 9:43 PM, NOTvuffett wrote:

    I am embarrassed for the Fool to have run this article.

    Without going into lots of detail about oil being a fungible commodity, etc., etc.

    The futures markets exist as a tool to hedge the price of those commodities. This guy thinks that John Q. Public is getting screwed by greedy traders.

    Isac, you can buy and sell these the same as everyone else. Give me a portion of the proceeds when you corner the market, lol.

  • Report this Comment On May 24, 2012, at 4:01 AM, CaptainWidget wrote:

    I wish to meet this nefarious man one day. The guy who's sitting at his computer buying a billion dollars worth of oil futures per day while simultaneously brain washing the rest of the world, preventing them from counting with shorts....in his nefarious plot to drive up the price of gas and ruin the world.

    I'm sure he's an interesting guy to have lunch with.......

  • Report this Comment On May 24, 2012, at 6:29 AM, devoish wrote:

    Interesting combination of arguments here;

    <<Speculation? Really? That's the boogy-man? What about Inflation? What about economic fears over the fact that we're rattling the sabers against Iran?>> TMFGortok

    I'd like to hear your understanding of how "economic fear" impacts oil prices, if it does not impact oil prices through speculation in oil markets.

    Best wishes,

    Steven

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