Posted on 05/18/2008 11:05:09 AM PDT by seowulf
The price of crude oil today is not made according to any traditional relation of supply to demand. It’s controlled by an elaborate financial market system as well as by the four major Anglo-American oil companies. As much as 60% of today’s crude oil price is pure speculation driven by large trader banks and hedge funds. It has nothing to do with the convenient myths of Peak Oil. It has to do with control of oil and its price. How?
First, the crucial role of the international oil exchanges in London and New York is crucial to the game. Nymex in New York and the ICE Futures in London today control global benchmark oil prices which in turn set most of the freely traded oil cargo. They do so via oil futures contracts on two grades of crude oil—West Texas Intermediate and North Sea Brent.
A third rather new oil exchange, the Dubai Mercantile Exchange (DME), trading Dubai crude, is more or less a daughter of Nymex, with Nymex President, James Newsome, sitting on the board of DME and most key personnel British or American citizens.
Brent is used in spot and long-term contracts to value as much of crude oil produced in global oil markets each day. The Brent price is published by a private oil industry publication, Platt’s. Major oil producers including Russia and Nigeria use Brent as a benchmark for pricing the crude they produce. Brent is a key crude blend for the European market and, to some extent, for Asia.
WTI has historically been more of a US crude oil basket. Not only is it used as the basis for US-traded oil futures, but it's also a key benchmark for US production.
‘The tail that wags the dog’
All this is well and official. But how today’s oil prices are really determined is done by a process so opaque only a handful of major oil trading banks such as Goldman Sachs or Morgan Stanley have any idea who is buying and who selling oil futures or derivative contracts that set physical oil prices in this strange new world of “paper oil.”
With the development of unregulated international derivatives trading in oil futures over the past decade or more, the way has opened for the present speculative bubble in oil prices.
Since the advent of oil futures trading and the two major London and New York oil futures contracts, control of oil prices has left OPEC and gone to Wall Street. It is a classic case of the “tail that wags the dog.”
A June 2006 US Senate Permanent Subcommittee on Investigations report on “The Role of Market Speculation in rising oil and gas prices,” noted, “…there is substantial evidence supporting the conclusion that the large amount of speculation in the current market has significantly increased prices.”
What the Senate committee staff documented in the report was a gaping loophole in US Government regulation of oil derivatives trading so huge a herd of elephants could walk through it. That seems precisely what they have been doing in ramping oil prices through the roof in recent months.
The Senate report was ignored in the media and in the Congress.
The report pointed out that the Commodity Futures Trading Trading Commission, a financial futures regulator, had been mandated by Congress to ensure that prices on the futures market reflect the laws of supply and demand rather than manipulative practices or excessive speculation. The US Commodity Exchange Act (CEA) states, “Excessive speculation in any commodity under contracts of sale of such commodity for future delivery . . . causing sudden or unreasonable fluctuations or unwarranted changes in the price of such commodity, is an undue and unnecessary burden on interstate commerce in such commodity.”
Further, the CEA directs the CFTC to establish such trading limits “as the Commission finds are necessary to diminish, eliminate, or prevent such burden.” Where is the CFTC now that we need such limits?
they seem to have deliberately walked away from their mandated oversight responsibilities in the world’s most important traded commodity, oil.
Enron has the last laugh…
As that US Senate report noted:
“Until recently, US energy futures were traded exclusively on regulated exchanges within the United States, like the NYMEX, which are subject to extensive oversight by the CFTC,including ongoing monitoring to detect and prevent price manipulation or fraud. In recent years, however, there has been a tremendous growth in the trading of contracts that look and are structured just like futures contracts, but which are traded on unregulated OTC electronic markets. Because of their similarity to futures contracts they are often called “futures look-alikes.”
The only practical difference between futures look-alike contracts and futures contracts is that the look-alikes are traded in unregulated markets whereas futures are traded on regulated exchanges. The trading of energy commodities by large firms on OTC electronic exchanges was exempted from CFTC oversight by a provision inserted at the behest of Enron and other large energy traders into the Commodity Futures Modernization Act of 2000 in the waning hours of the 106th Congress.
The impact on market oversight has been substantial. NYMEX traders, for example, are required to keep records of all trades and report large trades to the CFTC. These Large Trader Reports, together with daily trading data providing price and volume information, are the CFTC’s primary tools to gauge the extent of speculation in the markets and to detect, prevent, and prosecute price manipulation. CFTC Chairman Reuben Jeffrey recently stated:
“The Commission’s Large Trader information system is one of the cornerstones of our surveillance program and enables detection of concentrated and coordinated positions that might be used by one or more traders to attempt manipulation.”
In contrast to trades conducted on the NYMEX, traders on unregulated OTC electronic exchanges are not required to keep records or file Large Trader Reports with the CFTC, and these trades are exempt from routine CFTC oversight. In contrast to trades conducted on regulated futures exchanges, there is no limit on the number of contracts a speculator may hold on an unregulated OTC electronic exchange, no monitoring of trading by the exchange itself, and no reporting of the amount of outstanding contracts (“open interest”) at the end of each day.”
Then, apparently to make sure the way was opened really wide to potential market oil price manipulation, in January 2006, the Bush Administration’s CFTC permitted the Intercontinental Exchange (ICE), the leading operator of electronic energy exchanges, to use its trading terminals in the United States for the trading of US crude oil futures on the ICE futures exchange in London – called “ICE Futures.”
Previously, the ICE Futures exchange in London had traded only in European energy commodities – Brent crude oil and United Kingdom natural gas. As a United Kingdom futures market, the ICE Futures exchange is regulated solely by the UK Financial Services Authority. In 1999, the London exchange obtained the CFTC’s permission to install computer terminals in the United States to permit traders in New York and other US cities to trade European energy commodities through the ICE exchange.
The CFTC opens the door
Then, in January 2006, ICE Futures in London began trading a futures contract for West Texas Intermediate (WTI) crude oil, a type of crude oil that is produced and delivered in the United States. ICE Futures also notified the CFTC that it would be permitting traders in the United States to use ICE terminals in the United States to trade its new WTI contract on the ICE Futures London exchange. ICE Futures as well allowed traders in the United States to trade US gasoline and heating oil futures on the ICE Futures exchange in London.
Despite the use by US traders of trading terminals within the United States to trade US oil, gasoline, and heating oil futures contracts, the CFTC has until today refused to assert any jurisdiction over the trading of these contracts.
Persons within the United States seeking to trade key US energy commodities – US crude oil, gasoline, and heating oil futures – are able to avoid all US market oversight or reporting requirements by routing their trades through the ICE Futures exchange in London instead of the NYMEX in New York.
Is that not elegant? The US Government energy futures regulator, CFTC opened the way to the present unregulated and highly opaque oil futures speculation. It may just be coincidence that the present CEO of NYMEX, James Newsome, who also sits on the Dubai Exchange, is a former chairman of the US CFTC. In Washington doors revolve quite smoothly between private and public posts.
A glance at the price for Brent and WTI futures prices since January 2006 indicates the remarkable correlation between skyrocketing oil prices and the unregulated trade in ICE oil futures in US markets. Keep in mind that ICE Futures in London is owned and controlled by a USA company based in Atlanta Georgia.
In January 2006 when the CFTC allowed the ICE Futures the gaping exception, oil prices were trading in the range of $59-60 a barrel. Today some two years later we see prices tapping $120 and trend upwards. This is not an OPEC problem, it is a US Government regulatory problem of malign neglect.
By not requiring the ICE to file daily reports of large trades of energy commodities, it is not able to detect and deter price manipulation. As the Senate report noted,
“The CFTC's ability to detect and deter energy price manipulation is suffering from critical information gaps, because traders on OTC electronic exchanges and the London ICE Futures are currently exempt from CFTC reporting requirements. Large trader reporting is also essential to analyzE the effect of speculation on energy prices.”
The report added,
“ICE's filings with the Securities and Exchange Commission and other evidence indicate that its over-the-counter electronic exchange performs a price discovery function -- and thereby affects US energy prices -- in the cash market for the energy commodities traded on that exchange.”
Hedge Funds and Banks driving oil prices
In the most recent sustained run-up in energy prices, large financial institutions, hedge funds, pension funds, and other investors have been pouring billions of dollars into the energy commodities markets to try to take advantage of price changes or hedge against them. Most of this additional investment has not come from producers or consumers of these commodities, but from speculators seeking to take advantage of these price changes. The CFTC defines a speculator as a person who “does not produce or use the commodity, but risks his or her own capital trading futures in that commodity in hopes of making a profit on price changes.”
The large purchases of crude oil futures contracts by speculators have, in effect, created an additional demand for oil, driving up the price of oil for future delivery in the same manner that additional demand for contracts for the delivery of a physical barrel today drives up the price for oil on the spot market. As far as the market is concerned, the demand for a barrel of oil that results from the purchase of a futures contract by a speculator is just as real as the demand for a barrel that results from the purchase of a futures contract by a refiner or other user of petroleum.
Perhaps 60% of oil prices today pure speculation
Goldman Sachs and Morgan Stanley today are the two leading energy trading firms in the United States. Citigroup and JP Morgan Chase are major players and fund numerous hedge funds as well who speculate.
In June 2006, oil traded in futures markets at some $60 a barrel and the Senate investigation estimated that some $25 of that was due to pure financial speculation. One analyst estimated in August 2005 that US oil inventory levels suggested WTI crude prices should be around $25 a barrel, and not $60.
That would mean today that at least $50 to $60 or more of today’s $115 a barrel price is due to pure hedge fund and financial institution speculation. However, given the unchanged equilibrium in global oil supply and demand over recent months amid the explosive rise in oil futures prices traded on Nymex and ICE exchanges in New York and London it is more likely that as much as 60% of the today oil price is pure speculation. No one knows officially except the tiny handful of energy trading banks in New York and London and they certainly aren’t talking.
By purchasing large numbers of futures contracts, and thereby pushing up futures prices to even higher levels than current prices, speculators have provided a financial incentive for oil companies to buy even more oil and place it in storage. A refiner will purchase extra oil today, even if it costs $115 per barrel, if the futures price is even higher.
As a result, over the past two years crude oil inventories have been steadily growing, resulting in US crude oil inventories that are now higher than at any time in the previous eight years. The large influx of speculative investment into oil futures has led to a situation where we have both high supplies of crude oil and high crude oil prices.
Compelling evidence also suggests that the oft-cited geopolitical, economic, and natural factors do not explain the recent rise in energy prices can be seen in the actual data on crude oil supply and demand. Although demand has significantly increased over the past few years, so have supplies.
Over the past couple of years global crude oil production has increased along with the increases in demand; in fact, during this period global supplies have exceeded demand, according to the US Department of Energy. The US Department of Energy’s Energy Information Administration (EIA) recently forecast that in the next few years global surplus production capacity will continue to grow to between 3 and 5 million barrels per day by 2010, thereby “substantially thickening the surplus capacity cushion.”
Dollar and oil link
A common speculation strategy amid a declining USA economy and a falling US dollar is for speculators and ordinary investment funds desperate for more profitable investments amid the US securitization disaster, to take futures positions selling the dollar “short” and oil “long.”
For huge US or EU pension funds or banks desperate to get profits following the collapse in earnings since August 2007 and the US real estate crisis, oil is one of the best ways to get huge speculative gains. The backdrop that supports the current oil price bubble is continued unrest in the Middle East, in Sudan, in Venezuela and Pakistan and firm oil demand in China and most of the world outside the US. Speculators trade on rumor, not fact.
In turn, once major oil companies and refiners in North America and EU countries begin to hoard oil, supplies appear even tighter lending background support to present prices.
Because the over-the-counter (OTC) and London ICE Futures energy markets are unregulated, there are no precise or reliable figures as to the total dollar value of recent spending on investments in energy commodities, but the estimates are consistently in the range of tens of billions of dollars.
The increased speculative interest in commodities is also seen in the increasing popularity of commodity index funds, which are funds whose price is tied to the price of a basket of various commodity futures. Goldman Sachs estimates that pension funds and mutual funds have invested a total of approximately $85 billion in commodity index funds, and that investments in its own index, the Goldman Sachs Commodity Index (GSCI), has tripled over the past few years. Notable is the fact that the US Treasury Secretary, Henry Paulson, is former Chairman of Goldman Sachs.
story end © 2008 F. William Engdahl Editorial Archive
F. William Engdahl is the author of A Century of War: Anglo-American Oil Politics and the New World Order (Pluto Press) and Seeds of Destruction: The Hidden Agenda of Genetic Manipulation, www.globalresearch.ca. The present series is adapted from his new book, now in writing, The Rise and Fall of the American Century: Money and Empire in Our Era. He may be contacted through his website, www.engdahl.oilgeopolitics.net.
As to ''no reputable person who actually has a professional background in these field(sic)...''
No offense, but you're quite wrong in this sentiment. I've 30+ years in crude and energy-related mkmts and businesses, and I say exactly that, exactly what Engdahl says -- the only question is ''how much has the price been driven out of whack by the big specs?''. I'd say, depending upon one's assumptions, anywhere between $40 and $70/bbl.
I suggest you consult with thackney, Eric in the Ozarks, Smokin' Joe, and our other FReeper colleagues who work daily in the ''awl bidness''. I believe you will find that they -- all of them, to a man -- also consider that one heck of a chunk of crude's current price is not due to ordinary physical S/D conditions. (And apologies, gents, if I've misspoken about any of your views!)
FReegards!
OK, 1st off the article states “60% of the price of oil is speculation...”
To which I said was “Notice all his sources are anonymous? That is because no reputable person who actually has a professional background in these field would say such such ignorant crap.
Now to the point. You are going to argue that more then 50% of the price of oil is speculative and does NOT have anything to do with the fact that despite over 15 years of steadily increasing demand around the world which we have to then combined with a 50% decrease in US production since 1986, the issue is NOT supply driven? Where is all the extra supply coming from? OPEC has a production cap in place. We aren't producing it. Where is it coming from that all these nasty speculators are bidding up?
If you'll look at historical crude price charts, you'll see that -- hurricanes Katrina/Rita/Wilma aside, crude prices started exploding right around then, and did for the first half of 2006. Users of crude/products buying in advance of actual need? Not a chance. During that period, not less than half the contracts traded were new long purchases. And that's where the spec bubble began.
Ex-cap has since climbed back to 1.8 MMbbl/day, but this isn't high enough to cool out the mkt. Our colleague thackney is of the view that ex-cap may hit 3 MMbbl/day this autumn, and, if indeed we reach that figure, this will cool out the mkt: about $40.00/bbl worth, unless I miss my guess.
Markets are anticipatory discounting mechanisms for price, ok? Always have been, but this property is much more obvious today because information moves so much faster.
I can't do anything at all about Engdahl's use of anonymous sources, and there's no reason to try. All the sources required to make a successful argument that spec is an enormous chunk of current energy pricing are, effectively, public sources.
Open interest in NYMEX crude, for example, has trebled in 6 years' time, and all -- every damn bit -- of this driving of the OI has been from long-side specs. You can verify this any day you like by going to www.cftc.gov and inspecting the OI histories of energy mkts. Some of the charts are really quite instructive.
However, all this is not by any means the only reason for the spec bubble, not at all. Y'see, some genius created a new locus for market opacity, which is always a huge negative in a mkt.
We've a new boy added to the mix since 2002 (actually, since January 2006 regarding WTI crude): ICE, the Intercontinental Exchange, which is an arm of the IPE, International Petroleum Exchange, which is -- ta, daaa -- a UK corporation. Why do I care about ICE? Good question. Here's why. Unlike NYMEX, ICE is not regulated (well, not to speak of) by CFTC. How this little miracle was accomplished, I've no idea. Probably a waiver from State or Commerce, perhaps driven by the White House. In any case, unlike NYMEX, ICE does NOT report volume, open interest, concentration and so forth every Friday.
Net result: some huge number of long specs have gone to ICE **because** they're able to keep their positions unknown to the public (and, perhaps more to the point, unknown to the regulators). No one, bar ICE itself, can tell you how big the spec interest is on ICE...and ICE isn't talking.
It is, however, known from derivative accounting that the open longs are staggeringly huge, and they've been getting way larger in the past 4-5-6 months. Y'see, ICE is completely electronic. All someone needs to trade all the crude/products he wants are: 1) capital, and 2) an office, anywhere in the world.
You can quite clearly see, I'm sure, where this ease of access and thorough mkt opacity leads. Never mind the hundreds of articles in the past 5 years (a couple of which I've written myself) about commodities having become an ''asset class''. This is just business school twaddle writ large -- tell me how much of an ''asset'' physical coffee, or corn, or cocoa, or XYZ will be in, say, 10 years' time, unless VERY carefully (and expensively) stored, eh.
The unfortunate thing is that so many capital pools (read: funds) have bought into this silliness. The result here is that numerous banks have climbed into spec mkts WHILE considering them to be a necessary and desirable part of a ''balanced'' asset portfolio. Well, these chaps will take it in the shorts, all in good time, and it's gonna be damned ugly for them, I'll tell you right now. Expect the investment banks involved to go whining to Washington for some sort of bailout when the balloon pops.
Nonetheless, for right now, spec capital has unquestionably pushed energy prices some sizeable percentage above where supply/demand fundamentals would indicate prices should be.
This is easily fixed, and doesn't require anything draconian, or even legislative at all, from the Regress. However, the Regress have a vested interest in allowing the price of energies to go cuckoo; they derive more power from the public clamour to ''do something''.
The public are idiots. The last thing we require is for the bloody Regress to ''do something'' about energy prices. We've been there, done that. It's called ''The 1970's'', and the intelligence and efficacy of the Regress' actions regarding energy in that decade are zero and -infinity, respectively. Never have so few screwed up a group of mkts so badly for so many for so long...barring of course the Communist interregnum in Russia, 1917-1991.
OK, I am going to have to print your post out and go thru it paragraph by paragraph. Lots and lots of good info that post. If you are willing, I will get back to you with my questions on this.
My 1st question though. IS there a way to undercut the speculators? If I were to make you “King for a day” what would YOU do about the problem of high energy prices?
It a simple issue of supply and demand. When you constrict supply at the same time demand is growing you get a price spike
Except that inventories are up and demand is down.
"In the U.S. alone, stockpiles of oil climbed by 11.9 million barrels in the month preceding the Energy Information Agency's (EIA) May 7 inventory report [an 8-year high]; they were up by nearly 33 million barrels since Jan. 1. At the same time, MasterCard's (MA) May 7 gasoline report showed that gas demand has fallen by 5.8%, while the government suggested that gasoline consumption might have fallen by slightly over 6%."
2) Enforce position limits on ALL players in the energy mkts. Limit violations should be treated as felonies, not just slapped with a piddly fine, but with real live time served at the Greybar Hotel.
3) Change exchange practices on daily trading limits. This has been done before w/o any goobermint input at all, and there is AMPLE precedent for it. The mechanics of this are a bit technical, and I'll spare you the details until/unless you ask for them.
4) Suspend Section 1056 of the IRS code for large specs, banks, and funds regarding any energy market or markets. Again, this is technical; you can have the details if you like.
5) Pick ONE recalcitrant big player (G-S would be my preference), and conduct an unannounced audit raid on their positions, and doings generally, in the energy mkts.
6) Drill. Nukes. Coal.
The first 4 will cool out the mkts, not a doubt in the world of it, and can be accomplished in any 30 given days.
The fifth is to set an example for the next group of would-be runaway specs: this will happen to you, next time.
The sixth is to prevent this sort of nonsense from occurring again for the foreseeable future.
I haven’t seen any filling stations hurting for customers at $3.75. I haven’t seen them closing down because nobody will pay them.
It appears that for a lot of years, the oil companies were vastly under-pricing the value of what consumers were willing to pay.
And if people are willing to pay $3.75 a barrel for gas, and companies are willing to pay 126 a barrel for the raw oil, that must be what the price should be.
I think if the oil market were closed to speculators tomorrow, there would only be a $10-20 drop in the price, initially, no way it would drop 60%. Wishful thinking on someone's part, anticapitalist nonsense at worst.
Others here could give a better idea what the results of closing the futures market would ultimately be, however, as spot price scrambles for refinery feedstocks would cause wild fluctuations in the price of crude and refined products, especially in a high-demand market.
Ultimately, the consumer would likely suffer far more.
If someone thinks specualtors are making that much, they are free to invest in such a way that they can take advantage of those profits, too.
bookmark
Thank you SAJ for the rational and succinct explanation of this current oil “crisis”. One thing that I have learned in my middle-aged life is this: If you do not understand what is happening in our economy and our government - then try to follow the money. This will usually explain many things.
There is no doubt that as soon as these speculators like GS have extracted their pound of flesh, they will turn around and short oil and the price will drop as if by magic. They will push the price right up to the amount of extreme pain on the public. It’s pathetic that GS continues to publish their $200/barrel estimate all in order to keep the price going up.
I wonder if you have heard that the Saudi’s are sending quite a few billions of oil to us in June? Somewhere I saw a reference to that. Also that Iran is sitting on billions of barrels that they can’t sell due to lack of heavy sour crude refining capacity?
Thanks.
The notion, however, that anyone with a pile of capital can jump in and distort a mkt, or several mkts, for months and/or years simply because they have more capital than is usual for said mkts (and physical mkts are ALWAYS of a finite size, of course), with no fear of immediate retribution, is simply abhorrent to me.
Oh, many of them will indeed pay the piper, in future. Always happens; mkts simply do not rise this quickly and STAY at these levels. In the meantime, though, these 'traders' -- and what they really are is manipulators -- will wreak considerable pain on the citizenry and the economy.
The fact that goobermint hasn't reined them in already, by which means I outlined in the post to which you replied, is -- unfortunately -- very telling.
Call me an idealist, but, in the meantime, FReegards to you!
The reason is simple: it was his malevolent trading of currencies that destroyed the British pound in 1994 and triggered off the Asian financial crisis of the late 1990's. Because Soros is heavily into hedge-fund trading, it would not take much to figure out that a way to ensure a Democrat becomes President is to malevolently bump up the price of oil through hedge-fund trading, closely supported by other billionaires with Leftist tendencies like Warren Buffett and by quietly providing financial incentives for certain governments in the Middle East and Venezuela.
What are your thoughts on the algae and turkey offal?
It seems that advancements in tapping energy resources are being made everywhere.
Widescale Biodiesel Production from Algae
Oil from Turkey Offal
Yes, but what is the hold up? Everything says that at a price of oil at $60/barrel, these other methods are profitable so what is the holdup, waiting for the bubble to bust?
This guy is not blaming the Bush administration or the oil companies, but speculators that are taking advantage of loop holes in the regulation of derivatives.
If you are a free market supporter then you should support the concept of a free flow of information. The author's contention is that information is not being allowed to flow freely and this is allowing speculators in-the-know to profit at the expense of those in-the-dark. And not because the speculators build a better mousetrap or because they provide better service, but merely because they are the ones running the Ponzi scheme.
When you constrict supply a bit and increase demand a bit then you git a bit of a price spike. If you get a large price spike then someone is taking advantage of the "free market" system.
I suppose you still think that 25-50% yearly increases in home prices from 2000 - 2005 was justified because population was increasing slightly and houses were a bit more difficult to build with slightly more regulations.
Personally, if this was the first time that we’ve been burned as a consequence of our dependence on foreign oil then I’d trust Congress to do something about it. But Congress has essentially proved itself useless in resolving the situation since the 1973 oil embargo. So I’m planning to use my wallet to “vote” on energy options.
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