Time for Financial Regulators to Limit Speculation in Oil Market
The big fluctuations in the price of crude oil over the last several weeks gave fresh evidence of the ever increasing influence of speculators on the price every day Americans pay for gasoline. It is long past time for the Commodity Futures Trading Commission (CTFC) to limit the influence of speculators on the oil market - and the pocket books of American consumers.
Big price swings show just how little the major fluctuations in the oil market track the underlying fundamentals of supply and demand. Those fundamentals did not provide any justification for a ten percent decline in prices that occurred last week - any more than they justified the earlier 25% plus run up in prices that has resulted in $4.00 to $4.50 per gallon gasoline across the United States.
Only one thing changed to cause last week's sell off in oil future: speculators decided that oil prices had reached their near-term peak and it was time to take massive profits.
Some Wall Street investment banks have been saying since mid-April that the oil market was about to reverse. Reuters reported on April 11 that:
"Long-term commodity bull Goldman Sachs warned clients on Monday to lock-in trading profits before oil and other markets reverse, with the bank's estimates suggesting speculators are boosting crude prices as much as $27 a barrel."
The speculative bubble in oil prices that has driven up gas prices this Spring has cost Americans billions of dollars - money that goes directly into the pockets of speculators, multi-national oil companies and the bank accounts of royal families in countries like Saudi Arabia and Bahrain.
But speculative bubbles are not inevitable if commodities markets are properly regulated. There are two distinctly different types of investors in commodities futures. Business that produce or use commodities - like airlines, or trucking firms that consume large quantities of fuel - use futures markets as hedging strategies to protect themselves from price volatility. Their goal is to lock in a price range for critical inputs - or, in the case of farmers, for the products they sell. That allows them to invest and produce with the confidence that they can predict their costs or product prices. That kind of predictability is enormously helpful at encouraging them to make the investments they need to plant their crops, buy new airplanes or invest in new plant and equipment.
Financial speculators, on the other hand, don't produce anything. They are gamblers pure and simple. They don't invest in commodity futures to lock in a price or cost. They make money on the fluctuations in commodity prices. They place bets that the price will go up or that it will drop. So they benefit when prices are volatile. They benefit from speculative bubbles. They bid up the price of oil well above the supply and demand fundamentals, since they are simply betting that someone else will keep buy more and more oil futures and the price will keep going up. As soon as the bubble bursts and the price turns, the smart speculator reverses his positions - takes profits and bets against the market - accelerating the market's decline.
Mats Olimb and Tore Malo Ødegård of The Norwegian University of Science and Technology, published as study in 2009 investigating the relationship of speculative interest in commodity markets and price volatility. They describe the effect of speculation this way:
The concern is that if the speculators are dominant in the market, and a speculative euphoria takes hold, self-reinforcing price cycles may take place, where speculative flows of money drive prices and these price movements can attract more speculative money. The result would be high volatility and uncertainty for physical producers and consumers.
The more pure speculators enter the market place, the greater the impact of this pure gambling on market prices. And over the last twenty years the percentage of pure financial speculation in commodity markets has soared.
The Olimb-Odegard study finds that speculative interest in crude oil markets has doubled, from 18% to 36% from 2003 to 2009. They conclude that, "there is a significant relationship between price movements and speculative positions in crude oil."
According to Reuters, Goldman Sachs has estimated that " every million barrels of oil held by speculators contributed to an 8-10 cent rise in the oil price." Reuters continues:
The U.S. Commodity Futures Trading Commission said that as of last Tuesday (April 5), hedge funds and other financial traders held total net-long positions in U.S. crude contracts equivalent to near record 267.5 million barrels.
Using Goldman's estimates, that indicates the total speculative premium in U.S. crude oil is currently between $21.40 and $26.75 a barrel, or about a fifth of the price.
Traders and analysts have cautioned that speculative bets can quickly unwind, dragging prices lower.
At yesterday's Senate hearing featuring the CEO's of the five top oil companies, Rex Tillman, Exxon's CEO, confirmed this analysis. In answer to a question from Senator Cantwell (D-WA) he said that if pure competitive forces set the market price of oil it should settle at the marginal cost of producing the next barrel of oil - which he indicated was now between $60 and $70 dollars a barrel. Oil closed yesterday at just over $98 per barrel, so if he is correct about the marginal cost of production, speculation is currently adding from $30 to $40 to the price of oil.
Over the long haul, oil prices will, of course, continue to rise since hydrocarbon fuels will be in shorter and shorter supply. Their availability is finite, and world demand continues to increase - even as demand for gasoline in the United States has actually experienced a decline.
That is precisely why the Obama administration's focus on new clean energy sources is so critical to America's long-term economic future.
But short-term bursts of gas prices have very little to do with these long-term trends. Turmoil in the Middle East has had very little impact on current global oil supplies and mainly had an effect of creating more speculative fervor.
To limit the impact of pure speculation on our economy, a voices ranging from the progressive Americans for Financial Reform (AFR) to the Air Transport Association, have called on the Commodities Futures Trading Commission to issue rules (which it has the power to do) to cap the total value of speculative positions in any commodity market. This would place limits on the percentage of the market composed of pure speculators, as opposed to businesses (like airlines and farmers) who buy futures to hedge their risk
Currently the CFTC has proposed a rule that would limit any one trader's spot month position to 25% of the total financial interest in a commodity. That would prevent any one trader from cornering a commodity market, but it would still permit total speculative interest to drive markets and drown out the legitimate business related hedging interests.
The story of the recent oil price run-up is just one more indication that the growing financial sector is a cancer on the American economy that must be brought under control. Remember the gang that speculates in oil prices does not produce anything of any social value. They are professional gamblers. They are simply parasites on the economy that siphon off goods and services made by people whom actually produce things for a living. They often make literally billions for themselves in the process while the incomes of everyday Americans have stagnated.
The speculators and Wall Street banks had their power reigned in by the Obama Administration's Wall Street reform bill that passed Congress last year. Now they are doing everything they can to prevent it from being implemented in an aggressive way by regulatory agencies.
Everyday Americans have to insist on an end to the speculative orgy. The priorities and values reflected in the American economy must once again reward hard work and innovation - not speculation and greed.