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Why Demand Does Not Explain $4 Gas

Isac Simon
May 23, 2012

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: