Oil: Betting on the bubble
Here’s a way to get oil prices down, at least by a little: Take a regulatory whip to the speculators who’ve been bidding prices up.
The Commodity Futures Trading Commission — the somewhat toothless federal watchdog over oil markets — needs to tighten its rules on speculative trading, both in oil and agricultural products. If the CFTC won’t act, Congress should.
Oil prices have risen 39 percent so far this year. Indeed, on Friday alone, the price of a barrel of crude rose $11 to a record $139. Most of that is for a very basic reason: Demand is up around the world, especially in Asia, and supply isn’t keeping pace.
But as prices went up, a new crowd of players jumped into the oil markets. Pension fund managers, hedge fund operators and other big investors shifted money from the stock and bond markets —where they were losing their well-tailored shirts — into commodities.
Investment in commodities index funds grew from $13 billion to $260 billion in five years. Oil futures trading on the Intercontinental Exchange quintupled over two years to a paper value of $8 trillion in 2007, reports the British newsmagazine The Economist.
George Soros is an investor of legendary savvy who last year earned more than $200 million per month. Last Tuesday, he went before the Senate Commerce Committee to warn of a speculative bubble building in oil.
“The bubble is superimposed on an upward trend in oil prices that has a strong foundation in reality,” Mr. Soros said. “The rise in oil prices aggravates the prospects for a recession.”
Players in the commodities markets come in two basic types. Some actually plan to use the commodity. For instance, a refinery might buy a contract for oil to be delivered in the fall. Then there are those who buy futures contracts betting that the price will go up.
The speculators, Mr. Soros said, are misjudging the basic supply-demand equation, and pushing oil prices too high. Bubbles eventually burst, but Mr. Soros sees no sign that this one will burst soon.
How much of the price of a barrel of oil can be attributed to speculation? Mark Cooper, research director at the Consumer Federation of America, says it may be as much as $40 per barrel. Others, including Mr. Soros, think it’s considerably less. Some estimates say speculation adds just a few dollars to the price of each barrel.
Whatever the figure, it should be eliminated. High oil prices slow the economy and cost jobs. Should the bubble grow too large, a sudden pop could weaken workers’ pensions and cause more strain in our weakened credit system. Mr. Soros said the commodities market today reminds him of the stock market before the 1987 crash.
So where’s the CFTC watchdog in all this? It’s chasing the wrong rabbit. The commission recently revealed that for the last six months, it’s been investigating manipulation in the energy markets.
Manipulation is different from speculation. Manipulation means taking action intended to raise prices, rather than simply jumping aboard for the ride. It’s hard to imagine traders manipulating the world price of oil. A conspiracy would require too many conspirators.
The watchdog agency has taken a few steps in the right direction, sharing information with European regulators and requiring more transparency from American market players. But it should go further:
• Raise margin requirements to make it harder to speculate with borrowed money.
• Revise rule changes enacted in 2000 that made the market more speculator-friendly.
• Close loopholes that let speculators skirt trading limits.
• Impose greater limits on the ability of pension fund managers to speculate with money that workers will need when they retire.
Tighter rules in the United States could simply move trading overseas, but the United States is a big and influential player, to say nothing of it being the world’s biggest oil consumer. It should lead by example.
AAHHHAAHAHAHA you guys are crazy if you think the “good old boys” in D.C. are going to do anything to upset that gravy train.
Leave it to the Post Ed Board to come up with a big government ’solution’ to a market problem.
I know! Let’s do… NOTHING! and when the bubble breaks, these guys will go broke.
But then you’ll want to bail them out…
The oil speculators should visit the Hunt family who found out what the free market does to speculators. This is a bubble that will burst if the free market has its way. The problem is the US Government (forced by liberals) is not allowing the free market to work. We refuse to drill our own oil. We refuse to embrace nuclear power. The new, “green” alternatives are embedded with the brothers-in-law of politicians who are otherwise not employable. Turn loose the US oil markets and the price of oil will drop and the speculators will get what they deserve. The problem is, speculating in commodities is now becoming mainstream. The average Joe is seeking to hedge the weak dollar with commodities. Joe is usually the guy who ends up holding the bag and we have to bail out Joe once again. Open drilling on Federal land and use the money for a Manhatten project for a new power source. Start today or tomorrow we will be one more day from a solution.
Very nice article. What you suggest would work.
However, it does not sit well with me to regulate the commodity market. I am generally a laissez-faire proponent. These bubbles occur constantly. We are currently riding out the ill-effects of the mortgage bubble and have segwayed into a possibly even more potent bubble. I say, leave the traders alone. These fickle investors will eventually transition their money into alternative instruments.
My concern is the large oil companies that are recording record profits on the backs of faltering consumers. They use the rising oil prices as the reason for their increase in $/gallon at the pumps and heating oil. It seems to me they are passing off all, if not more, of the excess cost of oil onto the consumers. I typically have no problem with this, that’s how business works. However, when we are in the arena of a relativley inelastic product, i.e., oil and its derivatives, the consumer is ultimately forced to pay the spot price under duress-like circumstances.
I would like to focus on gasoline at this point. Many consumers do not have the resources to reduce their demand for that product. The reasons for this inability are myriad, ranging from urban sprawl to necessary travel. The result is that prices will continue to increase as demand stays the same while the supply diminishes.
I say ENOUGH. These companies, e.g. Exxon, are the largest companies in the world raking in unfathomable earnings quarter after quarter. I believe these companies should be held accountable for at least a portion of their actions. They freely pollute the environment (believe me, I’m not an eco-nut) while making record profits. They bankrupt poor, graduate students, who are already fully leveraged attempting to better themselves (a little self-pitty), at the pump while making record profits.
There is a reason why non-regulated energy companies in California backfired. When a consumer is held at the whimsy of a large corporation looking to maximize their profits through the marketing of a relatively inelastic product, the consumer will be bitten in the ass.
What is really the only way consumers are able to hedge against the oil comapnies? Buy their stock or oil futures. Ha, it appears they win again…
Why should these companies not face price ceilings when selling their commodity? They are in a better position to hedge their earnings from consumers with the oil market. An important principle in Law is to place the loss upon the party who may best bear that burden. That is an appropriate mindset to take here, in my opinion.
I believe, further, that the next group to be held accountable is our government. The ’70s oil crisis is still burned into the minds of all of those who lived through it. Well, the same situation is occurring not forty years later.
What must happen for our government to protect their populace by expending the necessary monies to initiate a proper program to develop alternative fuel sources? Why doesn’t our government allow the proliferation of nuclear power throughout the country? These are questions which must be answered in the near future… The reluctance to do such things is simply propping up the demand by the US oil consumers. I hate the government, but something this imperative probably necessitates at least minimal governmental action.
Flyover - Nice point. The decline of the U.S. Dollar is also a more-than-marginal cause of the increase in the spot price of oil.
As you say, “Tighter rules in the United States could simply move trading overseas”. Smart American investors already have bigtime money overseas. The liberals in our Congress can complain all they want, and hammer Exxon-Mobil (the world’s biggest corporate market cap), but Petro China is #2 and coming up fast. Russia’s Gazprom is #3, and President Medvedev recently said in an interview with Maria Bartiromo that he expects Gazprom to be #1 shortly.
We have messed in our nest. Better let our oil and gas companies drill the ANWR and the rest of our vast public lands and offshore, and leave them alone taxwise so they can compete with the rest of the world.
Suppy? Demand? Market speculation? And here I thought the BushCheneyHaliburton axis of E-V-I-L was behind all of this…and that Obamessiah was going to fix it. No?
Dear sirs,
Some very interesting comments raised in this article.All of you are right in your own way.
But lets us go back to the Basic Premise behind Speculators/Speculation. What do these guys see in Oil that makes them bid the price higher and higher? One is the perceived or otherwise ,Demand-Supply Mismatch(Peak Oil,Volatility associated with Iran,Iraq,Nigeria and booming demand from Asia coupled with Inelastic consumption in the west-Demand growth might have fallen but Consumption is still high in the western world) and the Second is the fall in the value of the US Dollar and US Equities.
What will increased regulation do to this market?Push more Money into the other Oil Contract traded Globally-Brent crude.Maybe even increase trading in other less well known crude contracts.What will be the end result?
US Exchanges will lose out on all the valuable Trading Margins/Income. Something similar happened after SOX was introduced in the US.
A lot of Foreign companies decided it made no sense to list their Stocks on US exchanges and comply with those onerous regulations and instead chose to list in London/Hong Kong/Shanghai.As more trading happens on these other contracts/exchanges ;Oil Producers will completely start to base their prices on these other contracts thereby ensuring that the WTI contract becomes completely irrelevant.
Is that what the US wants to happen?Lets just wait and watch .
One loophole that definitely needs to be closed is the one which allows hedge funds, pension funds or other major investors simply enter into swap agreements with Wall Street banks to evade CFTC restrictions.It has to be closed as soon as possible.Other than that there is no need to change anything in the Trading of the Crude Markets.
I have a slightly different solution.
Give clear,unambiguous signals to the Speculator community that Oil Consumption will fall and organize a coordinated OECD release of Oil of 10 million barrels from the Strategic Reserves of US,Europe,Japan,China and India. They can even announce a floor price of Oil which they will tolerate (Say $110/Barrel),anything above that will trigger an immediate release of 10 Million Barrels of Oil on the Global market.As for the Signal that Oil Demand will fall,its a little bit tricky and extremely political but I will talk about it anyway.Here’s how:
One)Increase ,yes Increase the federal Sales Tax on Gasoline (currently 18 cents a Gallon),to 50 cents and use the Windfall generated (around $55 Billion Annually- to bridge the Social Security and Medicare Shortfall and the leftover to bridge the Federal Fiscal Deficit).
Two)Increase the Tax on Gas Guzzlers to $10000 per Vehicle and label any Vehicle which has a mileage of less than 25mpg as a “Gas Guzzler”.No Light Truck/Semi loopholes.This Tax would apply to not just new Vehicles but all Vehicles sold in the last Three Years.
Three)Fix The Federal Speed Limit at 55mph.
These moves together would slash American Gasoline Consumption by 30-40% and also bring Crude Oil down to $80-$90 /Barrel levels within a week of them being announced and implemented.
If you want the Price of Oil to fall further than that you have to put pressure on the Chinese to increase the Price of Gasoline($3.20/Gallon) and Diesel($2.90/Gallon) that they charge their Consumers.How do you do this?Use measures similar to what forced the Chinese to let the Yuan Rise against the US Dollar.
I know the measures I have suggested are extremely controversial and unlikely to appeal to a majority of Americans and especially not to the Politicians but its a way which will have an instant (within weeks)impact
on the Oil Market as against Increased Drilling in ANWR/Deep Offshore,OnShore Fields,which will only have an effect on the Price of Oil 5-7 years from now,that is when all the New fields will come Online.
Best Regards
Amazing how people continue to say that drilling the ANWR wouldn’t help because oli wouldn’t be available for 5 to 7 years. An existing pipeline is just 50 miles from the ANWR, at Prudhoe Bay. Drilling could be started quickly and wells could probably be producing within a year.
Liberals in the U.S. Senate and House have repeatedly filibustered for decades to prevent drilling the ANWR and Bill Clinton vetoed it in 1995, otherwise we could have been using this oil years ago. How long do we have to wait?
this is one of the dumber things I’ve read. The CFTC is a government agency, which means that it gets its mandate and rule-making authority from Congress. Any further regulation or oversight requires Congress’ approval, if not affirmative vote. So when you say the “toothless watchdog,” an obvious copy of the congresswoman’s remarks last week, you are really making a statement about Congress, not the CFTC, because any expanded authority is approved by Congress. Its not like the CFTC all of a sudden can say, hey lets regulate the unregulated energy markets. The reason they’re unregulated is because Congress and the Executive say so. All of your suggestions to “go further” are really just changes in legislation and mandate which requires Congress’ teeth.