Let’s say you live in a neighborhood where all the homes are priced at $200,000. Suddenly an army of buyers arrives who want desperately to move into the neighborhood. You were not really interested in selling before, but now a buyer offers you $400,000 for your $200,000 house. What are you going to say?

This analogy comes from Dan Dicker in his book: Oil’s Endless Bid: Taming The Price of Oil To Secure Our Economy

“That’s what’s going on in oil,” Dicker says. “You have this army of people who have been flooding into a brand new neighborhood and they’ve had to inspire somebody to sell and the only way you can do that is pay an outrageous price for it.”

Among the biggest winners in the new oil markets are investment banks like Goldman Sachs (GS) and Morgan Stanley (MS), which create new products for clients and then use that information to trade on the products. In 2004 and 2005, Goldman Sachs made $1.5 billion a year trading oil, Dicker says. In the first half of 2009 alone, the firm made $3.4 billion oil trading profits. Who paid the extra $1.9 billion? You did. Firms like Goldman are not taking bets that oil will move lower or higher. Trading simply means naming a spread of buy and sell prices from which they can eke out tiny but regular profits, a business without risk.

But aren’t those buying high supposed to be balanced by those buying low?

Dicker says that is primarily because almost all oil investments being sold by the big investment banks are long trades – bets that the price will go up. While it’s also possible to short oil ETFs, no one does. So that’s heads ever skyward.

“There is no supply issue going on here – what you have is the perception of the possibility of a supply issue,” Dicker says. “A whole bunch of people are pouring money into an oil market trying to take advantage of what they perceive to be a real risk in supply. It’s a marketplace that I argue should not be allowed to be wagered on like a stock or bond.”

Dicker notes that Libya produces only 1.3 million barrels of oil a day, just a tiny fraction of the world oil market. Even if Libyan crude were lost to the world market in the current turmoil, and there is no sign that it is, Saudi Arabia has 5 million barrels a day to use in case of an emergency.

When the 2008 economic crisis froze all financial markets and investors stampeded to the sidelines, the true price of a barrel of crude oil became known: $32. It’s now hovering at around $110 thanks entirely to investor demand, he says.

Delawares Gas Prices 72 Months
Chart Courtesy of GasBuddy.Com

How do we again get it under control?

“If the government stepped in and regulated oil trading so that only investors with a genuine interest in the physical product, such as airlines and heating oil companies, could buy and sell oil futures, then the price of oil would fall by 50% overnight and our economy would be much better off.”

But instead, what we have is a new venue on which to gamble. One promising great rewards.

One of the reasons Dicker is calling for greater regulation of the oil market is that no one really knows how large it is or what is going on it on a day-to-day basis. In fact, it reminds Dicker of the market for credit default swaps, which brought down the insurance giant AIG and forced the government into a $180 billion bailout.

Bottom line, everyday Americans are getting jerked around by these investors. Thanks to them we essentially borrowed money from our Social Security Fund, to put into our gas tanks. Every extra little bit we get from our Social Security Tax cut this year, so far has gone into our gas tank with no benefit at all to our economy. These increases at the pump, all flow up and stop…. at Goldman Sacs and Morgan Stanley (and smart individual investors like me). They don’t go to the gas stations, they don’t go to the oil companies, they don’t go to Libya….

Regulation, Regulation, Regulation…. It worked from the Great Depression of the 1930’s thru to 2006….Only when we deregulated in 2006, and allowed the infusion of computerized investment, did the prices at the pumps begin to soar over “whims” of mid-east crises. –

Remember back in December when individual analysts from Goldman Sachs, Morgan Stanley, JPMorgan, Chase & Co. and Bank of America, Merrill Lynch were quoted across headlines, saying gas would hit $4 this summer?

Of course that’s what they’d say……………..