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Bernanke: Excess Speculation Not to Blame for Prices

Crude oil prices have shot up this year not because of excessive speculation but because demand has outstripped supply, Federal Reserve Chairman Ben Bernanke told the Senate Banking Committee last Tuesday.

"Certainly investor interest in oil and other commodities has increased substantially of late. However, if financial speculation were pushing oil prices above the levels consistent with the fundamentals of supply and demand, we would expect inventories of crude oil and petroleum products to increase as supply rose and demand fell. But, in fact, available data on oil inventories show notable declines over the past year," he said in his semiannual monetary policy report to Congress.

"This is not to say that useful steps could not be taken to improve the transparency and functioning of futures markets, only that such steps are unlikely to substantially affect the prices of oil or other commodities in the longer term."

The Senate leadership said it expects to take up a bill short-circuiting excessive speculation next week, and the House Democratic leadership has indicated that it plans to offer a bill that will address speculation in energy markets before recessing in August (see NGI, July 14). The bills are in response to the rising prices for crude oil, gasoline and other commodities. The August futures price for oil was hovering at $132/bbl early Friday, up significantly from an average of $72/bbl for 2007.

"Our best judgment is that this surge in prices has been driven predominantly by strong growth in underlying demand and tight supply conditions in global oil markets," Bernanke said. "Over the past several years the world economy has expanded at its fastest pace in decades, leading to substantial increases in the demand for oil. Moreover, growth has been concentrated in developing and emerging market economies, where energy consumption has been further stimulated by rapid industrialization and by government subsidies that hold down the price of energy faced by ultimate users."

On the supply side, however, "despite sharp increases in prices, the production of oil has risen only slightly in the past few years. Much of the subdued supply response reflects inadequate investment and production shortfalls in politically volatile regions where large portions of the world's oil reserves are located," Bernanke told the committee.

"Additionally, many governments have been tightening their control over oil resources, impeding foreign investment and hindering efforts to boost capacity and production. Finally, sustainable rates of production in some of the more secure and accessible oil fields, such as those in the North Sea, have been declining. In view of these factors, estimates of long-term oil supplies have been marked down in recent months. Long-dated oil futures prices have risen along with spot prices, suggesting that market participants also see oil supply conditions remaining tight for years to come."

"The decline in the foreign exchange value of the dollar has also contributed somewhat to the increase in oil prices. The precise size of this effect is difficult to ascertain, as the causal relationships between oil prices and the dollar are complex and run in both directions. However, the price of oil has risen significantly in terms of all major currencies, suggesting that factors other than the dollar, notably shifts in the underlying global demand for and supply of oil, have been the principal drivers of the increase in prices."

At the other side of Pennsylvania Ave., President Bush last Tuesday dismissed Democrats' claims that domestic producers are not actively pursuing their oil and natural gas leases and that excessive speculation is responsible for escalating crude oil prices.

It's in producers' "economic interest to continue to explore so as to reduce the capital costs of [a] project on a per barrel basis," the president said during a briefing with reporters at the White House. Under current regulations, he also pointed out that producers lose their bonuses if they don't explore federal leases within a set period of time.

"People say, 'what about the speculators'" and their role in driving up energy prices. "I think you can't help but notice there's some volatility in price...On the other hand, the fundamentals are what's really driving the long-term price of oil, and that is demand for oil has increased and supply has not kept up with it," Bush said.

Moreover, he indicated that Congress is blind to the technological changes in the energy industry. There are "new technologies that have come to be and yet we've got an old energy policy that hasn't recognized how the industry has changed."

The president's remarks came one day after he issued a memorandum repealing an executive ban on oil and natural gas drilling in much of the federal Outer Continental Shelf that the first President Bush put in place in 1990. Bush's action now puts the ball in Congress' court, which must lift its 27-year-old moratorium in order to clear the way for exploration and production off the East and West coasts and in the eastern Gulf of Mexico (see related story).

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