NPR Story: "Energy Costs Drive Up Prices of Nearly Everything"

Energy Costs Drive Up Prices of Nearly Everything
by Christopher Joyce

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Morning Edition, June 18, 2008 · When oil prices go up, so do natural gas prices, and both increases have a ripple effect on the economy. Shampoo bottles, pantyhose, buttons — you name it, and it requires oil or gas to make it.

Is Another Bubble Behind Soaring Gas, Food Prices?
by Maria Godoy

First, there was the dot-com bubble, when wads of investor cash made millionaires out of pimply teens seemingly overnight. When that burst, investors sought safety in housing, lulled by the false conventional wisdom that "real estate never goes down." We all know how that turned out. Now, as Americans feel their pocketbooks pinched by skyrocketing fuel and food costs, lawmakers on Capitol Hill have been holding a raft of hearings into whether speculative frenzy is once again to blame.

Here, a look at whether a "commodity bubble" is in the works.

Why do lawmakers think speculators are driving up food and energy prices?

It all has to do with what's been going on in commodities futures markets. Traditionally, these markets were used by players such as farmers, miners or refineries — who either produce the commodities being traded, or rely on them to do business. Activity on futures markets helps set the benchmark global price for food and energy.

In recent years, however, commodities markets have seen a flood of new money from institutional investors — such as hedge funds, pension funds and index funds linked to commodities. Investment from commodities-linked indices jumped from $13 billion in 2003 to $260 billion today, according to Michael Masters, the head of Master Capital Management LLC, a hedge fund. These investors aren't in commodities because their business depends on it; they're simply looking to make a profit from fluctuations in prices (that's the classic definition of speculation, and it's perfectly legal). But many lawmakers and other critics blame these new investors for driving up prices.

So how much of the jump in oil and food prices can be attributed to increased demand, and how much is due to speculation?

Investors have almost certainly helped push prices higher than they otherwise would be, but no one knows how much higher. In May, Masters testified before Congress that institutional investors are largely responsible for soaring food and fuel prices.

But other market experts aren't so sure. On Tuesday, for example, Merrill Lynch analysts issued a note arguing that speculative frenzy isn't to blame; supply and demand is, along with low interest rates that have made emerging markets more liquid and hungrier for raw materials. They point out that even commodities that aren't traded in funds — such as coal, rice and steel — have seen big appreciation.

Even lawmakers who blame speculators for soaring prices also acknowledge the reality of increased demand for food and energy from emerging markets such as India and China.

Is there evidence that market manipulation is at work?

None that has been documented. There's no disputing that the jump in food and oil prices has been astounding. Since January 2007, the price of crude has leaped from $60 to more than $130 a barrel. And prices for corn and other staples have reached record highs. But there's also no evidence that market manipulation is at play.

Nonetheless, those suspicious of the spike in energy prices are quick to point to so-called "dark markets" — energy trading markets that were deregulated in late 2000 at the request of Enron. Some people suspect nefarious transactions are taking place in these unpoliced markets, and that traders are raising prices basically at will. Again, there's no actual evidence that that is the case.

What kind of legislative solutions are lawmakers proposing?

Most proposals focus on energy speculation. On Tuesday, the Senate held a hearing looking at whether the Commodity Futures Trading Commission has the tools it needs to police the world's crude oil markets. In the last eight years, the commission's workforce has shrunk more than 20 percent, while the volume of trading it is supposed to keep an eye on has multiplied six-fold. Lawmakers are considering adding more staff and additional tools as a safeguard against possible market manipulation.

One proposal would limit the number of contracts that institutional investors — such as banks and pension funds — are allowed to hold. Another would require traders to put up more collateral in the energy futures market, to avoid what CFTC Acting Chairman Walter Lukken calls "excessive speculation."

Would this help lower prices?

Not likely. Even if investors are bidding up crude prices higher than supply and demand would dictate, unless market manipulation is occurring — and so far, there's no proof of that — increased oversight wouldn't help lower prices. And it could very well be that current oil prices do, in fact, accurately reflect current conditions: a world where economies and populations are growing very fast, and where refinery capacity is stretched.

What role does the weak dollar play in all of this?

The dollar's weakness is a big factor. The price of crude is set in dollars, so when that price fluctuates, Americans feel the pinch more acutely than, say, Europeans buying oil with the stronger euro. And as investors flee the dollar, they are lured to other more promising options, including oil.

Will it help if the Fed tightens monetary policy?

Yes and no. Fed Chairman Ben Bernanke has said that he's more concerned about rising inflation than economic growth — a signal that the Fed's interest-rate cutting spree may be at an end. Higher interest rates are a double-edged sword. On one hand, they would make the U.S. dollar more attractive to foreign investors and bolster the currency. And that, in turn, would make it cheaper for Americans to buy oil. But higher rates would also make it more expensive to do business, and for U.S. consumers to take out a mortgage or buy on credit.

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Comment by Stuart Berman on June 25, 2008 at 9:43pm
A good corollary is that a few years ago when the Asian economies were suffering a downturn the price of natural gas and oil was declining. Consumers were told to brace for a rise in these prices but were treated to discounts as there was a glut of oil and natural gas. What people didn't consider was that this downturn was like a rubber band - those years of reduced demand would quickly rebound with a vengence giving us the condition we are in today.

There is some reasonable theory that in several years the price of crude will plummet again as supplies increase and demand shrinks again (due to alternative fuels, more drilling, more capacity, a shift in consumer usage).

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