Washington continues to assure the American people that they are capable of planning an affordable, reliable energy future. The current high price of gasoline, however, is a clear example of how government interference ultimately leaves the consumer holding the tab for misguided command-and-control energy policies.

America is the third largest oil producer in the world. Combined, America and Canada produce almost as much oil per day as Saudi Arabia. Oil produced in America, Canada, and Mexico provides almost 60 percent of our domestic consumption. So, when ‘experts’ try to explain away high oil prices by stating that we have no choice but to be subject to state-owned oil companies, many of which are from countries whose leaders interests are antithetical to ours, it is a clear sign that they are either misguided, deliberately misleading, or both.

Their claims that America is home to a mere two percent of the world’s oil are equally disingenuous. While America’s proven oil reserves are equal to approximately 21 billion barrels of oil, that number does not include the resources that the government has placed off limits to energy production.A recent Congressional Research Service study found that the United States has the largest fossil fuel resource base in the world, including over 162 billion barrels of technically recoverable oil. That number doesn’t include the 2 trillion barrels of oil in oil shale that the Obama Administration has placed off limits.

The current administration only offers 2.2 percent of federal offshore areasand less than 6 percent of federal lands onshore for energy production. As a result, at least 60 billion barrels of America’s domestic oil resources are off limits. On top of that, the Obama Administration stopped all drilling in the Gulf of Mexico for the past year and has only recently issued permits, albeit at a snail’s pace. The consequence of that slowdown has decreased oil production in the Gulf of Mexico by 360,000 barrels per day from EIA’s expectations.

Needless to say, the government is playing a major role in the rising price of oil. While oil demand is rapidly rising in the developing world, the Obama Administration has essentially sent a signal to the market that the world’s third largest producer is closed for business. It should come as no surprise that prices are rising.

To see what happens when the opposite signal is sent to the market, look at the expiration of the executive and congressional moratoria on Outer Continental Shelf energy exploration and production back in 2008. The price of crude oil dropped over nine dollars immediately when President Bush rescinded the executive moratoria. When the congressional ban expired, the price dropped even further.

The combined cost of crude oil and taxes comprise 80 percent of the price of a gallon of gasoline. If the price of crude oil declines, the price of gas is sure to follow. But the Obama Administration’s supposed solutions to high gasoline prices will lead to the exact opposite. One proposal being pushed today – to prevent oil companies from using tax deductions that other industries are allowed to use – would raise the price of producing oil in America and encourage companies to look in other nations where the tax rate is lower. In addition, Secretary of Interior Ken Salazar has effectively postponed any new exploratory leases in the OCS until at least 2017. Both of these “solutions” are attempts to deflect blame for the rising price of oil. Unfortunately, these plans add further speculation that oil supplies are set to be even more restricted while global demand grows.

One solution that would put strong downward pressure on oil prices is present in IER’s new model energy legislation, the American Energy Act. The Act directs the Secretary of Interior to lease ten percent of federal onshore and offshore lands, as opposed to the mere 2.2 percent of federal offshore areasand less than 6 percent of federal lands onshore that are currently leased. Opening up these energy-rich areas would promote robust domestic energy production and increase America’s proven reserves by billions of barrels of oil. As was the case with the expiration of the OCS moratoria, the expectation of future supply increases will put a downward pressure on the price of oil.

As anti-energy advocates are quick to point out, oil is a global commodity. What they fail to realize (or hope to cover up) is that American oil production is an important factor in this commodity’s price. If the world’s third largest oil producer is taking steps to decrease production, as the Obama Administration has undoubtedly done, then the market will respond. Until our government indicates a desire to increase domestic energy production, American consumers will be forced to rely more and more on foreign, state-owned energy companies, many of which are openly hostile to the American way of life.

We can – and should – drill our way out of this problem.

What sways global oil prices?
Well, supply and demand – BUT.
Neither supply nor demand are set in anything approximating free markets.

Supply, globally, is in the hands of a small number of nations that have cheap oil – mostly in the Persian Gulf. Because they make so much money pumping each barrel, and because their oil sells first, they can ramp up their production to aim for whatever target price they think the market, long term, will bear. Higher production in more expensive oil provinces – like deep water off Louisiana, Canada’s tar sands, or Arctic Alaska – drives prices down for a while, but only until the Gulf States cut productuion to make crude more expensive.

Demand, in turn, is also the result of a cartel. When oil prices rise, demand is very slow to diminish – because drivers, trucking companies and airlines have no effective substitute for petroleum. The manufacturers of cars and trucks, in turn, have accepted petroleum’s monopoly, because it keeps their life simple – until, as happened to GM, Ford and Chrysler, oil prices soar beyond the level they had anticipated.

Because the US uses 25% of the world’s oil with about 3% of its reserves, we are the world’s biggest oil importer – and oil accounts for about half of our trade deficit, averaging $300 billion a year. Since the Gulf oil producers desperately want that $300 million, and since they produce the cheapest oil, we can’t effectively end that drain on our economy on the supply side.

What we must do, on the demand side, is break the monopoly petroleum enjoys on our transportation sector. We need to take our cars off the gas nozzle and plug them into the grid; power our trucking fleet with electricity or natural gas; shift much of our freight loading from road to rail; and use cutting edge technology to slash the waste of fuel that currently accounts for most of our oil bill.

A simple national policy – cutting our imports of oil by 5% a year until we eliminate them – would not only reduce the amount of oil we import and hence what we pay, but would also signal to investors that there will be a reliable market for efficient, petroleum free cars, trucks and planes. And reduced US demand will bring down world oil prices below what they otherwise would be, providing a great economic stimulus to our allies and dampening the global power of the largely unfriendly petro-states.

It's supply and demand -- and the part we control is demand!

As surely as the wind follows the rain, political posturing and bickering follow spikes in gasoline prices. And the proposed solutions to high energy costs are all too often driven by politics rather than objective realities.

With gas prices nationally topping $4 a gallon this week, U.S. leaders -- true to form -- are ramping up their partisan energy rhetoric. It brings to mind an observation by an unlikely source, Groucho Marx, who observed that “politics is the art of looking for trouble, finding everywhere, diagnosing it incorrectly and applying the wrong remedies.”

Since factors such as supply, demand, and uncertainty drive oil and gas prices, there’s little politicians can do to directly “control oil markets.” When reflecting over the history of government attempts to do so, it’s apparent such efforts make a bad situation worse. Yet, while there is no single action that the President can take to lower oil prices immediately, there are actions that he and Congress can take to impose downward pressure on them.

In the last two days, the market has initiated a large correction in crude oil prices that should soon show up at the pump. What led to that correction? A few factors seem to be responsible: no terrorist reaction to Bin Laden’s death, a stronger dollar, an unexpected increase in supply, and further evidence that a weak economy is constraining demand.

Crude oil prices are set on the world market. While effects of the global recession constrain demand in the U.S. and Western Europe, strong demand in China, India, and other parts of Asia has put upward pressure on prices. Yet, federal actions to increase our domestic supplies would have the opposite effect.

Although the U.S. could not add a great deal to global supplies, in the near term any increase is positive and would help change expectations about the future. America is still rich in oil resources, but political roadblocks constrain our firms from producing our full potential. This bureaucratic red tape takes, perhaps, several million barrels a day off of the world market.

Our current leaders cannot undo all of the wrong headed decisions of the past, but they certainly don’t have to make more.

Beyond increasing supplies, positive actions to address our debt and deficit problems would strengthen the U.S. dollar and, therefore, help lower crude oil prices. Moreover, a stronger economy incentivizes investors to shift capital from commodities like crude oil to companies that produce goods and services. Creating a more rational, less punitive regulatory system would also make investing in domestic energy production more attractive than investing in other countries.

It’s true that Washington can do little about instability in the Middle East and North Africa which imposes a risk premium on crude prices; yet our legislators’ hands are hardly tied.

As Charlie Brown was noted for saying, we have met the enemy and it is us!

Supply and demand are the key factors in the global price of oil. Growing economies around the world, especially China and India, are competing and increasing demand for limited supplies of the oil being produced. So, the high price of oil should be no surprise. If you draw a line through the median price of oil since 2000, it points directly at $100 per barrel.

It was this same demand in 2007 and 2008 that pushed prices as high as $144 per barrel, and astute economists warned then that the high price of oil would precipitate a worldwide recession. We must find new sources of energy.

A 2009 study from Sandia National Labs shows how biofuels can meet the increased demand for energy, as much as 90 billion gallons. The United States has the biomass resources, the technology and the manufacturing experience to lead the world in this endeavor. What we need is the foresight to direct capital investment to build the needed infrastructure.

A coordinated set of policies have been enacted over the past five years that can help direct capital investment, if Congress and the administration maintain the commitment to making them work.

Growing volumes of speculators who trade for profit (big banks, hedge funds) and colossal growth of volume from Exchange Traded Funds (ETFs) are destroying the price determination of the underlying fundamentals of supply and demand of commodities. Speculators are speculating with speculators, and ordinary people like you and I are encouraged to buy ETFs that invest in commodities to either rebalance our portfolio or hedge against inflation. One is doing short term trades to turn a profit. And the retail investor invests without realizing that these passive ETFs buy commodities without consideration to the underlying price of the commodity. No matter how high or low the price is – they buy. The result is commodity pricing that does not reflect the underlying supply and demand of the impacted commodity. High volatility and high prices have occurred at late. And retail investors do not realize that they are contributing to higher and volatile energy and food prices.

We need to do two things. Set speculative position limits and prevent ETFs from participating in the futures market. We need to put the people who really care what the price of the commodity is back in charge of this market – namely, producers and consumers. If you are not aware, even in large markets like crude oil, the largest of our oil company trades are an insignificant portion relative to the volumes of speculators.

Setting speculative position limits prevent speculative traders who really do not care what the price of the commodity is from controlling too large a portion of the market. Make no mistake that speculators pay a valuable role in the futures market but their volume has become way too large.

Banning ETFs are necessary. People forget that futures markets were never intended for retail investors. Passive funds that buy or sell at any price have a destructive impact on the price discovery of the commodity. A better and safer way to invest is in company stocks who are either producers or sellers of the commodities.

There are numerous economic, political, natural, geological, scientific, logistical and psychological factors that can be part of the explanation of oil prices. Many of these can be found in my recent article on oil prices and Libya in The National Review. http://www.tnr.com/article/world/88014/libya-saudi-arabia-opec-oil-gas-prices-summe.

The booming economies of East Asia, especially China, are driving a large part of demand increases worldwide for various types of oil. The recent disasters in Japan tend to mitigate that rising demand. But when Japan starts to rebuild oil demand could increase sharply -- and about the same time period as the driving season in the US. The sharp increase in the price of oil and gas has also cut into the demand for them in the short run. If these prices continue to rise then the long run demands could decline permanently. India's rise is also part of the increase in oil demand, but also the better economies in Latin America and the Middle East are driving increased oil demand. Russia has also had an increase in demand over the last few years. The EU has on average seen declines in demand and their economies are not as strong as they could be.

Politics can also drive oil prices. One of the most important political developments on this lately has been the "Arab Spring" and its potential spread. If it heads into Saudi Arabia or if strife breaks out in Iraq, Iraq or other large oil producers, like Algeria, which is right in the line of fire of the rebellions and has a restive population, then oil prices will zoom to $200-300 easy. Venezuela also has potential political problems as does Mexico, and well beyond what it is happening now. Nigeria has also seen strife and could see much more. In the longer runs Russia and many Central Asian states could be in trouble.

Then we have the potential for natural disasters in many oil producing states, including the threats of earthquakes, hurricanes and more. Then there is the long run looming threat of global climate change, which could have serious implications for the oil industry. What are we doing on that? Not much.

Geology in combination with technology and economics can also have strong effects no oil markets. The new potential for getting unconventional oils out of the ground to refineries and to market could be a real game changer. Any new technologies that would move transportation, the biggest user of oil in the world, to new energy sources, could also be serious game changers in the medium to longer runs. Basic science in combination with engineering and entrepreneurship could change the shape of energy markets, but that could take many decades.

Then there is the psychology of markets. Risk adverse people can be "played" by risk takers on global oil markets via speculation. And this is a big part of the oil markets worldwide. How much of the price is determined by this is tough to divine from the other hundreds of variables involved.

There are hundreds of variables and tipping points possible in oil prices. Some of these are described above, but underlying all of these variables are storage amounts and excess capacity on the global and regional markets. The less storage available and the less excess capacity available the more affect these other variables will have.

Then there is the complexity of the oil itself. What sort of oil are we talking about? Light, sweet or sour, heavy, unconventional, spot market or the hundreds of other definitions?

What can be done about this in the short run?

Not much, unless you want to drop the speed limits to 40 mph of the price of oil goes to $300. By then it will be rather late to react. Also, this would mess up our logistical systems. Tax the gas? Not in this congress? Start R&D? This may take decades to produce the real changes needed in our transport systems, which are the key to oil use worldwide. Tax crude use in industry? Not going to happen here. Push for energy efficiency? This may be possible and will take time to be effective. Mandate oil use amounts? This is politically not possible unless we are facing much graver crises.

We can allow drilling offshore and the exploration and production of unconventional oils, but this will take time to increase output significantly. Normally it is 5-10 years from find to production. From basic exploration to full production and transport deep offshore or more difficult areas could take many years. Phasing in oil drilling to phase it out over 4-5 decades might work to help wean us off oil, but then we need an alternative that works. Do we really have that now? Nope.

We could also allow more Canadian oil to flow into the US and this is a no brainer. You could see my congressional testimony on this: http://foreignaffairs.house.gov/112/sul033111.pdf But this could take a couple of years at least to get up to speed.

We need a bridge to future energy systems that are more sustainable, but this will take a long time to build. We have hardly begun. Now is the time to begin-- before the real oil shocks hit -- and there is a good chance they will. The shocks to come could be the wake up we will never forget. Imagine the economic and unemployment shocks for much higher oil prices.

Anyone for finally getting moving on this?

These shocks may come in the short run, a few months, a few years or more. It is hard to tell, but we do not have a system to react to such shocks and we have not diversified our transport systems enough to make the oil shock effects less intense.

We have an oil based economy in agriculture and more. We see the risks and yet we continue to doddle and dither on the small stuff?

Wake up please.

For all the talk of how to bring down oil prices, one must first understand two things. First, there is no free market for oil, and second, its price is set as a global commodity.

There is no free market for oil. More than 90 percent of proved conventional global oil reserves are held by national oil companies that are either fully or partially controlled by foreign governments whose interests are often at odds with our own. A cartel of producers works to manipulate price through supply. And because oil is produced in limited areas, and often must transit long distances to reach consumers, the supply is highly vulnerable to disruption, whether through man-made actions (unrest in Libya, for example) or through natural occurrences (hurricanes, for example).

Oil is a fungible global commodity that essentially has a single world benchmark price. Therefore, a supply disruption anywhere in the world affects oil consumers everywhere in the world. A country’s exposure to world price shocks is a function of the amount of oil it consumes and is not significantly affected by the ratio of “domestic” to “imported” product. That does not mean that there are not significant advantages to producing more oil domestically—there are—but price is not likely to be among them, except insofar as increased domestic oil would add to the global total and possibly a reduced risk premium in the price because oil from the US is less geopolitically risky.

Understanding those basics is key to understanding the fundamental truth that faces us every time prices spike: there is no immediate fix. There is nothing we can do to bring prices down quickly. That is not a political statement. It is a fact. It is also why a strategic, long-term policy to reduce our dependence on petroleum is so critical. We can’t fix this price spike, and we can’t end price spikes in general. But we can make ourselves less vulnerable to the next one, and the one after that. That must be our national goal.