Have Your Say Every Day.
Free Republic Runs ONLY On Your Donations.
Make Yours NOW and End the FReepathon!
Posted on 05/11/2011 6:31:50 AM PDT by SeekAndFind
As the price of oil climbed over the past few months, a growing army of commentators and pundits grimly hinted about "speculators" who were manipulating the oil market and profiting from the misery of the American people. In the darkest depictions, these speculators were alleged to be aligned in a vast, global cabal bent on squeezing money out of the U.S. middle class by driving up the price of crude.
These rumblings about speculators are hardly surprising: They echo the groundswell that emerged three years ago, the last time that gas prices exploded. For that matter, there's no doubt that oil speculators exist: Oil futures are traded on the New York Mercantile Exchange (NYMEX), as well as on London's Intercontinental Exchange (ICE) and through direct sales. But do those speculators wield the diabolical, nearly omnipotent power over the market that some critics claim, or are they -- like the drivers who are now paying close to $4 a gallon for gasoline -- merely riding pre-existing trends?
Supply and Demand vs. Speculation
In all likelihood, the answer is a bit of both. The traditional explanation for gas prices is that they move based on supply and demand: Put simply, there is a limited supply of petroleum available on world markets at any given time, and as a rapidly growing number of people in emerging economies like China and India buy cars and become drivers, Americans must compete for fuel in an ever-more-crowded marketplace.
With more drivers clamoring for a share of that limited supply of gas, oil companies, refineries and gas stations can charge more, and the price goes up. But rising prices may lead drivers to cut back on their gas consumption, which increases the available supply and pushes the price back down.
According to speculation theorists, this supply-and-demand equation is being short-circuited by commodities traders, who push the price of gas up in order to reap a quick profit. These traders buy oil futures at low prices using mostly borrowed money, encourage the price to rise, then sell the futures at the new, higher price and collect the difference. Meanwhile, when oil producers see the market rising, they try to hold on to their crude so that they, too, can sell it at an inflated price -- which reduces supply further. Between the traders and the producers, oil prices shoot up, torturing drivers.
The Disappearance of Oversight
Up until a few years ago, oil speculation wasn't really a problem: Crude oil futures could only be bought and sold on the NYMEX, where they were regulated by the Commodity Futures and Trading Commission (CFTC), a government organization that was created in 1974 to -- you guessed it -- protect the market against speculators. For decades, the CFTC did its job well, watching over sales of oil futures and ensuring that investors didn't drive up prices to make a profit at the expense of consumers. But in 2000, everything changed.
That year, two events effectively crippled the CFTC. The first was the passage of a provision of the Commodity Futures Modernization Act -- sometimes called the Enron loophole -- that made it legal for companies to trade oil futures outside of the NYMEX in what are called over-the-counter (OTC) trades. The same year, the London-based Intercontinental Exchange made it possible for investors to buy and sell European oil futures, and offered a platform for OTC trading. In addition to driving up the global price of oil, futures trading on the ICE began to have a direct impact on U.S. gas prices in 2006, when the ICE gained the right to list U.S. oil futures. Since the CFTC could only regulate trades on the NYMEX, those events made it possible for speculators to escape oversight.
While it's difficult to prove whether or not speculators are directly responsible for high gas prices, most analysts agree that some portion of the current high cost of gas is attributable to the buying and selling of oil futures. After the sharp rise and steep fall oil prices took in 2007 and 2008, investigators found that 81% of gas contracts on the NYMEX had been held by speculators. In fact, 11% were held by a single company, Vitol. With that kind of pull, anti-speculation analysts argue, there's no question that oil traders can manipulate oil prices.
We Have Met the Enemy and He Is Us
But are gas speculators really the diabolical masterminds that some analysts have made them out to be? Fred Rozell, director of retail pricing for the Oil Price Information Service argues that these investors aren't malicious.
"Oil is a good bet for investors who are looking to reap a solid return on investment," he says. "This is especially true in the current economic climate, as a slowly improving economy points to increased consumption and tensions in the Middle East are fueling fears of a supply disruption." In fact, Rozell notes, many of these oil speculators are 401(k) plans that benefit middle-class consumers.
Beyond that, there's always a seasonal increase in the price of fuel. In the spring, gas companies switch over from their winter-grade fuel to their summer-grade. The summer mix contains different additives that, according to the EPA, cut down on pollution. To make the summer-grade fuel, refineries have to briefly shut down, a move that causes the price of gasoline to shoot up. Rozell calls this seasonal increase the "petronoia rally," as the brief gas shortage fuels paranoia among consumers and investors. He notes that gas prices usually peak in early May, then slowly decline.
What Can Be Done?
With high gas prices threatening America's fragile economic recovery, many people are asking what can be done to curb speculation. Last month, the Department of Justice launched the Financial Fraud Enforcement Task Force, which is tasked with fighting illegal oil speculation. While this might help somewhat, the sad fact is that most oil speculation occurs legally on the NYMEX, the ICE and in OTC trades. Ultimately, the solution is to increase the power of the CFTC.
Last year's Dodd-Frank Wall Street Reform and Consumer Protection Act was designed to do just that: Among other things, it gave the CFTC the power to regulate OTC trades. However, conservative opponents of the law have fought against its implementation: U.S. Reps. Darrell Issa (R-Calif.) and Michele Bachman (R-Minn.) introduced legislation to repeal the law, and Rep. Frank Lucas (R-Okla.) recently proposed H.R. 1573, which would delay its implementation until 2013.
If the Dodd-Frank Act's provisions go into effect, they could go a long way toward stabilizing gas prices, which would be a major boon for consumers. If not ... well, public transportation is looking more and more attractive.
I might be argued that the market prior to the changes noted above was actually restrained to the point where prices were artificially low.
Release of the restraints allowed a true market and true prices
I personally believe speculation by those interested only in price movement, and not about hedging or delivery is more responsible for our $4 gas than supply / demand.
I’d like to see leverage in the commodities market substantially reduced as it creates artificial market action and volatility. If one wants to speculate then you will need the ability to cover your contracts like a non-margin cash account.
False. That only applied to US trading. Most of the world's oil is produced outside the US and our major oil producers all work outside the US. Trading exists in multiple other countries and has for quite some time.
I am not an expert but in futures for every buyer there must be a seller with the opposite view. It is a zero net sum game. You can not always buy futures at low prices.
I do not see how futures encourages the price to rise. If two guys are on one side of the street negotiating over the purchase of a barrel of oil and there are two guys on the other side of the street watching and betting on the eventual price of the oil, how is it that the bettors in any way influence the deal. They don't.
Supply and demand is what drives the price.
Somewhere around $4/gallon, the American economy starts to shut down; people start driving to work, to the grocery store, and possibly to church on Sundays, and that is it.
Wow... this author builds a strawman of uncommon magnitude. And yet it’s still a strawman.
Speculators my butt! Oil refiners buy crude through spot contracts in Oklahoma. Crude inputs into US fuel production is down over 1 million barrels per day from last year and two years ago while demand is pretty steady. This results in less gas production. Why are inputs down? We produce about the same amount of crude domestically but imports are down. Add the new ethanol refining requirements for gasoline and we have higher gas prices.
http://www.eia.gov/totalenergy/data/monthly/pdf/sec3_5.pdf
When Libya oil is off the market ( 1.8 Million Barrels, Saudis cut 800,000 because of Obama did to Mubarak). The Mississippi river is threatening the Oil refineries. Investors take information and bet on one side which way would you bet.
The reality of the crude oil futures market is that for every buyer there is a seller. The futures market isn’t like the stock market where you can buy and hold a security for years and get a long term return. The futures market is a zero-sum game...for every winner there is a loser.
If the exchange increases the margin requirement then that higher margin requirement affects both the buyer and the seller.
One more thing...real oil is traded on the spot market and the prices on the stock market are usually differnt than the futures market because issues like refinery grade, shipment and delivery are a factor.
Free Republic Runs ONLY On Your Donations.
Make Yours NOW and End the FReepathon!
From your link.
Motor Gasoline Production:
2011 3-Month Average 8,571 mbpd
2010 3-Month Average 8,578 mbpd
Less than 0.1% decline. You discuss crude oil but neglect other liquids. And total output is actually up.
NYSE Spot Market is the same WTI oil to the same location, Cushing, OK.
The prices between next month futures and spot rarely very much at all.
http://eia.doe.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=RWTC&f=D
http://eia.doe.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=RCLC1&f=D
The average difference is about 1/2 of 1% this year.
For everyone buying in the futures market thinking the price is rising, there is someone else selling thinking this is the time to cash out.
Ed has been all over this topic for years - nice post -wish a few people would read the entire story and some of his other reseach.
There are 24 contracts in the cue at any one time and they vary in price significantly. Only the last contract is close to the spot market prices.
The contract that sees the most trading activity is the one that is 3 months from expiration...and that is quite frequently different than the spot market price.
http://futures.tradingcharts.com/marketquotes/index.php3?market=CL
Are you talking about different delivery dates? If the price of oil never changed over time there would be no future markets at all.
The contract that sees the most trading activity is the one that is 3 months from expiration
Your own link shows the volumes of trading to be nearly ten times greater for next month compared to 3 months away.
...and that is quite frequently different than the spot market price.
Is it really surprising that oil 3 months away is significantly different than oil 3 days away?
Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.