Even the Gas Crisis Needs a Culprit

Michael Masters was quite the star on Capitol Hill yesterday as he testified before the Subcommittee on Oversight and Investigations, a group that is currently tasked with delving into the question of what role "speculation" is playing in soaring energy prices.

With just a little prodding from elected officials, he went so far as to say that, if his recommendations are turned into legislation, the price of gasoline will drop by 50 percent within a month.

Who could have possibly imagined that solving the near-term global energy crisis could be that simple?

He had lots of company on the panel of experts, all of whom were singing pretty much the same tune - just get rid of the speculators and oil will drop to $65 or $70 a barrel and all will be right again in the world.

The most interesting parts of the Masters testimony were the repeated references to "speculators" disrupting the "price discovery process" between producers and consumers, a contention that is being heard quite often in the "hang the speculators" camp.

While there is a case to be made for commodities futures markets not being intended to handle, and perhaps not capable of handling, the amount of money that seems to desperately want to go there these days, the fact that so much money desperately wants to go there these days remains the fundamental problem that no one wants to talk about.

Maybe the right price is being discovered as part of this process.

There are occasional references to the weaker dollar causing higher energy prices, which are then routinely dismissed since a 30 percent decline in the dollar couldn't possibly cause the price of oil to double or triple.

That argument ignores the fact that all paper money is declining in value.

And then of course there's the growing demand from Asia to go along with flat global oil production for the last few years. But these explanations don't seem to satisfy elected officials who view themselves as problem solvers.

Just once it would be nice to hear someone say to Congress, "There's just so damn much paper money in the world today, most of it in the form of U.S. Dollars, that people feel they have to do something to protect themselves from its declining value. If the government would be a little more honest about inflation and if you could get a reasonable rate of return on your money elsewhere, then maybe pension funds wouldn't be so keen on buying oil futures."

Interestingly, the Commodities Futures Trading Commission noted in a fact sheet that "speculative positions have not been increasing during the past year." Some variation of this statement has been heard a number of times in recent weeks, though no one seems to want to listen to it.

The "hang the speculators" angle and the chants of "close the Enron loophole" have drowned out those arguing that the doubling of the oil price over the last nine months can't reasonably be blamed on "index speculators," the name applied by Mr. Masters to pension funds that invest based on well-known commodity indexes.

According to this Bloomberg report, analysts at Sanford C. Bernstein noted in a written report to the committee "Every crisis needs a culprit. Active speculation is a catalyst for market movements, not an underlying cause.''

Wouldn't it be embarrassing for both Congress and Michael Masters if all the speculators were banned from energy markets and the oil price just continued to go higher?

Comments

[pachanguero]

Outstanding! Supply and demand is all it is that is driving this market.

The liberal/greens have destroyed this country with their religion. DRILL NOW!

Obama is a socialist pig who is held captive by the greens and the unions. McCain has finally started to go nuke and offshore drilling.

Finally! If he does take a stand to exploit our own resources then Obama is toast.

[redbaron]

I agree with Tim's thoughts completely, but no where does he mention McCain or Obama.

Kudlow does this all the time, drawing politics into an economic discussion, and when this is done, all logic goes away. Why do we have to distort economic discussion with political arguments? We have a chance to reasonably solve this energy crisis, if we can stick to the facts. But if we continually branch off into a political attack on someone, or some party, when the questions are all economic, we will continue running into a wall, and no progress will be made. Lets keep politics out of this economic discussion, and just stick to the facts in the article. The economic facts are difficult enough to agree on.

[Dr. No]

As opposed to Tim and redbaron, Masters actually delivered numbers ad nauseam. Only numbers are the facts. While Tim reiterated all qualitative arguments which are not facts then, the point Masters and Greenberg make is that if you care to look at the actual proportions and numbers they do not add up to justify the jump in the ENTIRE commodity sector, including oil. Further, even seasoned economists are not anymore defending the effecient market hypothesis. Finally, what we are seeing is a time delay in the system, much like other systems we may need to differentiate between the stochiometrics and the kinetics of the reaction. The kinetics do take time. The CDO and dot.com bust also did not happen over night, it was a six months long implosion.

[Dr. No]

Just to more points:
* Systems can be put into resonance mode which leads to catastrophic failure. So the Sanford Bernstein comment sounds intelligent but actuallty is wrong. You can have catalysts leading to catastrophic failure, think resonane, think nukes.
* The CFTC also admitted that they do neither have enough people nor the data to actually comment on the situation. In fact the very definition of the Enron loophole puts the CFTC out of monitoring ICE and DME, the prior being controlled by GS and MS, talking about fox in the henhouse...

[CaptBob]

To assume that "Speculators"... can levy whatever premium they wish on a gallon of gas, just because they bought a futures contract and the consumer will pay&pump just as he did last year, no matter the new price tag on the pump is sheer folly.

Of course a Govt. that was happy to get $.18 on a gallon of gas a few years ago, has an absolute need and right to collect $.72 today.
This should go a long way to fund --MORE HEARINGS!!

[Marcus Aurelius]

redbaron, Nice sentiment but it runs smack into its own wall of the real world. Two people can look at the same facts and figures and come up with different actions to solve the problem, then we have to decide which course to take, how do we do that through politics.

High energy prices are a problem and we have differing views on how to deal with them. The Democrats I think want to say "leave 'em high in order to spur conservation & innovation in alternative energy" but they know that will not sit very well with the public, so they find a convenient scapegoat, as we see that is strong medicine that is going to rough up the patient before the patient gets well. The Republicans (disclosure this is my side) want to ease the immediate pain of high energy this will lead to ease short term pain, but seem to have an overconfidence in our ability to quickly solve the problem which the Democrats seem to have as well.

[badbernanke]

Funny how basic economic theory kicks in when prices are high. All of a sudden alternative energy has the prospect of being cost-effective, possibly without giving away the farm on tax breaks like ethanol production.

And alternative energy has the prospect of converting demand for fossil fuels into demand for solar, wind and perhaps ocean tidal power. How is that a bad thing?

If I had to choose between paying the world's oil unfriendly robber barons (which are nations, not oil companies by the way) or paying domestic producers for energy, I'd take the domestic producer. That would arguably help US employment, cut trade deficits caused by oil prices and perhaps increase tax revenue from the profits which would inhere in the US -- right now, the profits are frequently either non-taxed foreign income or simply a transfer from US citizens to oil tyrannies.

[Dean Plassaras]

The reason for high oil prices is that big oil discoveries are all behind us and that present and future demand (China and India are the largest components) outstrip supply. All politicians had been warned of such for years; they all foolishly thought that it will happen on somebody else's watch. Think again.

[nakedjaybird]

Keeping politics out of economic discussions is like keeping politics out of morality or visa-versa morality out of politics (which should be fine - morality in economics would even be good, huh???).

When politicians encroach into economics or morality, which they do, eg., laws,..... duh....
then one cannot any longer neatly separate them.

[lefty]

ALL commodities should have only this route. From producer to only one wholesaler, to retailer, and then to consumer.

[scfranklin94]

Dennis Gartman pointed out Michael Masters' largest holdings in his hedge fund are American Airlines, United Airlines, and Delta Airlines - shares and call options .... gee, do you think he should disclose to the Congressional commitee that he would make out like a bandit if crude oil prices plummetted?

[Commodity bubble proponent]

Nice written piece...although I do disagree with you on a couple of points.

1. CFTC data is incomplete and does not include the people that have actually left the NYMEX to go trade on the ICE.
2. Speculation is a problem because there is no incentive for people to actually purchase the oil.

What needs to happen (in order to get rid of this) is 4 things:

1. Have recourse for cancelling or rolling forward all oil contracts. So if you decide to cancel your August contract and move it to september, you lose your margin. Similar rules should be put in on the short side too (I'm not one sided about this).

If this was employed, it would really change the risk/reward ratio of oil investing without taking delivery. So if you're on the long side and your contract comes due and you decide to roll it forward, you just lost your initial investment. If you decide to take delivery, more power to you.

2. Any publicly traded company or pension fund that clears OTC swaps in the US that gets caught on an unregulated exchange faces fines of millions of dollars/day/violation. If the ICE was regulated, its still ok to trade on the ICE.

3. Separate the functions of clearing a transaction from loaning money to an investor to go bet on oil futures. What Goldman and Co. do is lend money to the investor to take the long side, clear the OTC derivative trade, and then take the short side themselves. This enables the i-bank to win b/c they know that these guys can't actually take delivery of the oil.

This can be stopped by requiring that the guys who clear the contract can't loan the investor money. So, I don't have a problem with the above transaction taking place if Goldman was clearing the swap, JP Morgan was lending the investor the money to invest, and Morgan Stanley took the short side of the deal.
But to have the same investment bank do all three things is a tradgedy.