Use scare tactics on investors to lower cost of oil

In May, President George W. Bush went to the Middle East with hat in hand to ask the Saudis to increase oil production. The Saudis publicly declined, stating that there was plenty of oil out there. In fact, according to data from the International Energy Agency, global output of oil exceeds global demand for oil by 600,000 barrels daily.

A month later, the Saudis began announcing increases in production in increments of 200,000 barrels per day. The “no” they initially gave Bush was probably for public consumption only, although it is unclear whom they think they are still fooling. The modest increase, perhaps an eighth of the kingdom’s reserve production capacity, is only adding to the reported surplus. So, by even a first-year economics student’s interpretation, the price of oil should be falling.

Of course, it is not. This is because of the betting. Investors, largely unregulated, are betting the price of oil will continue to go up. So far it has been a safe bet. Other investors see those investing in oil futures making money, and it seems like easy money, so they bet as well.

The odd thing about this form of betting is the more people bet one way, the more likely they are to win. The very investments these people are making are driving up the price of oil. The more people bet, the more the price climbs. This would be a perfect scenario except for a single word many of us who have lived through tech stocks crashing and home values tumbling have come to know too well – “bubble.”

The Saudis were not asked by Bush to increase supply of oil because of some supply and demand model spread across a desk in the White House’s West Wing. The Saudis are not increasing production in order to drive the actual price down based on scarcity. This strategy is a pinprick, by design. A pin pointed at the bubble.

These parties are hoping to get the price of oil down to its actual price, its natural price, minus the bubble because they know it is like the children’s game of musical chairs, and if they can scare investors into believing the music is about to end, the betting will end. If the betting ends and there is a rush to get out, the price will drop to its natural level, perhaps somewhere around $100 per barrel.

Bush and Sen. John McCain’s call for restrictions to be lifted on offshore drilling in U.S. coastal waters is less about creating new supply and more about showing investors that the profitable but unreasonable ride on that bubble at everyone else’s expense is over. It would take decades to realize new supply from new drilling off the coast, but the promise of it and the threat of falling prices may give those betting a reason to pause.

It is unclear if those investing in oil futures can be so easily spooked. It may take something more dramatic such as a one million barrel per day increase in Saudi oil production, signed agreements for new refinery construction to begin immediately within the United States, a lift on the offshore drilling bans both congressional and executive, and a massive new investment in alternative energy that does not involve the global food supply. Finally, these should be unrolled all within the same 24-hour period, very publicly. They need to get the attention of those betting on and simultaneously driving up the rising price of oil.

Kevin St. Jarre of Madawaska is an author, a consultant and a teacher.