Oil Prices Double, Futures Contracts Flat & Falling: Where's the Excessive Speculation?

From the Wall Street Journal:

Lawmakers eager to curb speculation in oil markets got support Monday from witnesses who told a House subcommittee that oil prices could fall sharply if Congress put strict limits on trading in energy futures by investment banks, pension funds and other financial investors.

Lawmakers in both the House and Senate are aggressively exploring ways to rein in what they believe is excessive speculation driving skyrocketing oil prices.

"Speculators" in the oil futures market have become a prime target on Capitol Hill, as lawmakers look to respond to voter anxiety about soaring motor fuel prices. A hearing Monday before the House Energy and Commerce subcommittee on Oversight and Investigations highlighted fundamental disputes over the role of financial investors in the recent spike in oil prices.

The chart above provides evidence suggesting that speculators and futures trading may have played almost no role in the recent oil spikes. Since January 2007, oil prices have more than doubled from about $58 to $138 per barrel, a 138% increase. During that same time period, the open interest for futures contracts has remainded relatively stable at an average of about 333,000 contracts (see chart). Further, notice during the recent 55% surge in oil prices since last November ($88.60 to $137), open interest has been falling, not rising!

Where's the "excessive: speculation? The data suggest otherwise.

 

Comments

[Willem D. Okkerse - CEO OK-Rating Inst.]

A dear US friend - Hazel Henderson - President of Ethical Markets explained to me HER solutions in order to solve this oil-crises.
In fact she advocates to increase the margin on oil futures to 50% in order to restrict speculation. This is her story :

I wrote this editorial and sent it to IPS for syndication in early June. The story has broken in mainstream media and in hearings in the US Congress Energy and Commerce Committee and the Joint Economic Committee of the House and Senate. Most expert testimony from independent financial players agrees with my analysis and recommendations.

These witnesses estimate that if the Commodities Future Trading Commission (CFTC) were to implement 50% margin requirements, full disclosure of hedge funds and the volume of "paper barrels" versus real barrels of oil and the huge institutional investor positions in the oil and commodities futures markets and other recommendations, then the price of oil would drop to somewhere between $70-100 per barrel within 30 days. They expect that US gasoline prices would drop in a similar time period by roughly the same percentage. They agree that curbing speculation is urgent, whereas drilling in the US for more supply would produce a small fraction of the reduction that could be achieved by curbing speculation.

I believe that Peak Oil is still looming, as well as that control of 77% of oil reserves is by national governments; but I agree also with the growing expert opinion that the speculative bubble in oil can be addressed and is the best way to reduce oil prices. It is also necessary to keep US gasoline prices at current levels which are more realistic and nearer to global prices of $7-10 a gallon. I have editorialized since the mid-1980s on the need for green tax-shifting (to lower taxes on incomes and payrolls and shift tax to waste, pollution and depletion) which can help the transition to energy-efficiency, solar, wind, ocean and geothermal sources.

This article is also available at ethicalmarkets.com.

[nova]

Nobody wants to face the reality: the cheap energy is over.

As for politicians, they are very good to redistribute the public wealth into their own pockets and continue their demagoguery until things become really bad.

The Fed and US treasury actions to save and protect I-banks through inflation are the real driver for high commodities prices. Thanks to them, US savers are wiped out of their life-long hard work and saving.

Now, polititicians are about to raid private pension funds as they have done it to the Social Security funds.

[Michael Levy]

10 Reasons Why Oil Price Speculation Requires a Change in the Rule of Law by Michael Levy

High oil prices that are governed by the commodity markets are in dire need of common sense law and order. When speculation and detrimental logic and reasoning take central command of human society, the results always turn out to be damaging to the majority, at the abundance of the few. The experts and speculators will argue we need free markets and any interference will take away free trade. Well, in many cases they are correct, however, when it comes to essential commodities of food and energy they are completely out of order. Here are a few reasons why essential commodity markets require new legislation.

1. There has been no shortage of gas at any filling station for the past 10 years yet prices are up 1200% because of futures trading going out more than eight years. Even the Saudi oil minister has recently stated the price of a barrel of oil should be no more than $70.00. Demand from China and India is still far less than that of the USA. The Chinese stock market is down 50% signifying a sharp slow down. This news still is not enough to stop the wild speculators hiking the oil prices.

2. When hurricanes hit Florida many gas stations are closed and there is a real shortage of gas for a few days. However, if a gas station increases its prices they will be prosecuted for price gauging. Therefore, if we take the experts argument that there is a shortage of oil then that still does not give anyone the right to profit from the shortage as this is deemed to be prices gauging. How can the USA governments have double standards and prosecute gas station owners who price gauge and not treat commodity markets in the same manner?

3. Oil is an essential commodity for every day living in the same way as water is an essential commodity. It makes no sense to trade water so why leave oil in the hands of anyone who wants to make a quick buck gambling on prices.

4. Pension and hedge fund managers have invested billions of dollars in oil futures. The futures markets are very volatile, thus, no place for pension funds to risk the money for people who trust them to build future wealth. The fiduciary duty of a pension fund manger is to find reasonable returns with low risk and the commodity markets is not that place.

5. If the price of oil was regulated between $40.00 - $80.00 a barrel, the price could go up and down on supply and demand. This would be fair to everyone, for even when supply was plentiful, the price would not drop below $40.00 which will still give a fair profit to most oil related industries. When oil is in short supply the price would be limited to a ceiling of $80.00 which is more acceptable to world economies.

6. There is a moral issue that greed cannot come before peoples basic needs ... No right-minded, ethical, principled government can allow starvation and financial ruin because of a system of trading that is completely out of control.

7. The price of a barrel of oil effects transport, food supply, industrial production and every part of modern day living. If terrorists wanted to devise a plan to destroy the world. economies what better way than finding a method to allow oil to trade at $140.00 a barrel. Why play a game that makes terrorists and anarchists happy.

8. Goodwill to all people is the credo every democratic country is built upon.$140.00 a barrel oil delivers no goodwill. It only brings hardship and political uneasiness.


9. Noble deeds and fair dealing is the hallmark of success for every truly prosperous person. Since the world is made-up from people, where are the noble deeds and fair dealing in the commodity pits.

10. We are all put on earth to help each other succeed in the pursuit of freedom, liberty and happiness. There is no freedom when people are slaves to greed. There are only liberty takers when oil trades over $80.00 a barrel. And finally financial hardship brings misery and discontent.

The time for change in essential commodity trading is now. To quote a few voices from the past...

“Experience demands that man is the only animal which devours his own kind, for I can apply no milder term to the general prey of the rich on the poor”_Thomas Jefferson

“For greed all nature is too little.”_Seneca

“It is greed to do all the talking but not to want to listen at all” _ Democritus

“He who is greedy is always in want.” _Horace

[kharrin49]

Mark true future contracts remain about the same but take a look back to when this whole gas price gouging started and tell your readers how many contracts were being sold.You use 2007 and 333,000 contracts those numbers are more than double what they had been before this crisis started. You are misleading your readers . Why ? The argument for speculators being responsible for these prices are undeniable. Its why people such as your self uses smoke and mirrors to draw attention away. Facts wont work for your position unless they are given out of contex

[LiquidSoapDispenser]

Unlike most people here, I'm no expert on oil or markets. But a couple of common sense reactions to "10 Reasons" come to mind...

1) If Oil were $40-$80, wouldn't consumer keep up excessive demand, thereby bringing the dire effects of peak oil to us even sooner? At least the high prices are pushing people to stop buying vehicles that get poor gas mileage. Hi oil prices also drive more exploration and developmet alternative energy (neither makes financial sense if oil is too low). To me, the high prices make the overall energy market work to our long run benefit -- lower oil prices artificially, and that will cause bigger problems in the future.

2) Sure, maybe there is plenty of gas making it to stations today. But if informed oil buyers (and the US Energy Department) believe there will be a shortage in the coming decade, it seems reasonable for the free market to take that into account when pricing oil today. Clearly the price of oil will be skyrocketing in the coming decade when demand overtakes supply. What is it you want? Are we supposed to keep oil at $40-$70 until suddenly there isn't enough oil, then suddenly it go to $250?

Just my layman's reaction.

[LiquidSoapDispenser]

Damn, I wish I hadn't made so many typos in my rush to make my above point.

I think I'm trying to say that high oil prices might cause some pain now, but by keeping oil prices down by some artificial means (not that it could even be done with a global commodity), the long term effects will be much more painful. We need to try to reduce Western oil consumption for many many important reasons, and the high price of oil helps us move in that direction sooner rather than later. As long as oil is reasonably priced for consumers, there is no action to conserve or move to other energy sources.

[CLH]

Liquid---You may not be an expert on oil but you understand capitalism. The nutcake socialists above have NO understanding of how markets work. If the gov. sets prices, rationing and black markets soon follow.

The man from ethical markets should go to church. Religion will not solve our problems. Socialism has been tried and it failed.

[Irony]

Today volumes are more than 208 000 contracts. This is 208 million barels in front-month contract. Oil trading is 86 million barels. So, this is not a speculation, right? This is just a GAME?

[Jacktrader]

In order to get a complete and accurate assessment of crude oil open interest it would be necessary to include the data from the ICE that is not now being reported to the CFTC. This is referred to as the “London Loophole” because the ICE data market data including the classification of the trades as commercial or speculative is not included in the CFTC reports. Futures market professionals pay attention to the “commercial net shorts” for clues as to the actions of producers and refiners of crude oil. If speculators are misclassified as being commercials then the commercial net short numbers are distorted and have less analytical value. We understand the CFTC is now attempting to obtain this data and to incorporate it into their reporting. Correcting the data is the first step to insure the market sends the proper information. Currently it seems that market participants that are natural sellers do not have enough confidence in the data and are unwilling to short this market.

[ohsobeau]

SO it is evident that greed has taken over one of the fundamental necessities of our daily lives. The middle class is suffering and hoarding their money. Thus the effect is felt across the spectrum of societies economy. Service industries and "luxury" industries have taken giant hits and many independent companies have had to close their doors. Leaving even more people out of work and in need of government assistance, which results in higher taxes. This has snowballed out of control and it seems as though the people who have invested in energy futures (and I am one of them) may be blind to those facts. It's hard to see the poor people from my beach houses in my gated community. I did retain my lawn service, my trainer and my weekly massages. These folks need to make money also and if I have enough to go around then I would be negligent by not continuing my lifestyle. Some may think that it is extravigant. I think that it is needed to keep the econonmy going. Oil is the most recent bubble. People are going to get hurt when it breaks. I think legislation that requires an investor or fund to actually "HOLD" in their posession the oil which they "OWN" is desperately needed. I assure you that a law like that would truly drive oil prices down to a realistic level. As far as being on par with the rest of the planet and their oil prices. If you think that you should pay that much. Move there. For the rest of us, smart legislation and regulation of the energies markets is a must.

[icandoitdon]

another lame analysis by the professor.

as pointed out by kharrin49, the volume of futures trading has exploded since the beginning of oil's price surge, a period not captured by the professor's "analysis.".... use the term loosely. the tremendous surge in trading by pension funds, hedge funds, commodity funds, stock funds, armchair speculators and my grandma speaks for itself...none of these people are users of the end product. their interest is purely financial and that makes them speculators by definition.

the professor's main point...that the influence of speculators on price must be accompanied by higher trading volumes...is simply absurd. you don't need higher volume to influence prices...all it takes is a predominance of buyers or sellers to push the market one way or another to estabish a new equilibrium price. more buyers push the price higher, which attracts more sellers, and vice versa.

IT IS ACTIVITY AT THE MARGIN THAT SETS THE EQUILIBRIUM PRICE. to the extent that the source of marginal activity comes from speculation, the price is effectively controlled by speculators.

irony makes the further point that the number of barrels of oil represented by open interest in the futures markets is about 2 1/2 times annual consumption. it is this enormous leverage...roughly 14:1 as i recall... that permits the distortive effect of speculation on prices. to put this in layman's terms, for around $9,000 margin you can control 1000 bbl of oil worth $140,000.

the bottom line: increased margin requirements would kill speculative demand. the price of oil would fall to a new equilibrium prices based on actual production and consumption.

those who deny the effects of speculation are often sef-serving. hank paulson comes to mind. he wouldn't want those voters to think that the high price of oil is related to an incompetent treasury department that has lost control of the currency and the budget; and the futures exchanges certainly wouldn't want speculative volume to dry up, on which their profitability depends; and traders certainly don't want to be forced to put up $70,000 per contract instead of $9,000 per contract.

as far as those who don't have an obvious ax to grind, i'd label as ignorant their argument that speculation plays no role in setting the price of oil.

[jjason]

Mark Perry is wrong.

There is speculation. Why Perry keeps writing B/S is incomprehensible to me. I would expect better research from someone who puts Ph.D. behind his name.

[LiquidSoapDispenser]

I certainly am ignorant in my knowledge compared to most of you. But what I don't understand about the "bubble" is:

1) If so many of you experts are sure it is a giant bubble, aren't you all going to make a killing by (speculatively) shorting oil and waiting for the bubble to burst? And doesn't shorting put downward pressure on the price? I don't understand why speculation only goes one way, and I can't understand where all the upward speculative pressure is coming from as oil gets higher than just about everyone thought it would this year... Are that many people getting on this elevator just because they see it going up, rather than seeing fundamental reasons that oil should be going up?

2) Capping leverage makes sense to me in every market. Again, I am no expert, but I really don't understand how leverage helps any market function better, it seems more like a financial tool that ends up causing market problems (such as bubbles).

3) Speculation seems necessary in all free markets. Sure, you don't want the uninformed masses piling into a market wreaking havoc, and I guess that's what many of you say has happened with oil (I have no clue if that is accurate or not). With speculation, futures contracts, etc., events that have yet to actually affect the supply chain can be taken into account. That seems like an important process keeping markets fluid, helping companies control future costs, and allow those with enough insight to plan ahead. Can speculation be limited to keep other traders out of the oil market? I don't know...

I still believe that high oil, while causing a lot of pain today, may be for the longterm good, as it drives exploration, conservation, and alternative energy development -- all necessary with the growth of energy consuming people in the world. High oil also brings to the forefront that the US needs a meaningful energy policy, something that has been lacking for 30+ years. I think we need these types of serious problems to wake everyone up and understand that something needs to be done to address the world's projected energy needs.

Even if $140 oil is a bubble today, I believe it won't be tomorrow. The US Energy Department sees oil going much higher in coming years, and doesn't seem to think $140 is that much higher than would be expected. With a world population of oil consumers that grows faster than the oil supply, it will take many years before alternative energy and conservation can make much of a dent on demand. At least that's the opinion of this ignoramus.

[icandoitdon]

hello liquid soap, a.k.a. ignoramus (just kidding)

here are my thoughts on each of your points:

1. speculation can have an enormous effect on prices...both ways. look at the tech bubble at the turn of the century for the most recent example. in precious metals, silver reached $50/oz in the eary 70s on the back of a singe man's attempt to corner the silver market...even in today's bull market in precious metals it trades at $17 today.

speculative markets take time to build and the characteristic is they go parabolic toward the end...and they often die hard as upward momentum takes time to subside. when they crash they tend to crash hard. i don't know when oil stops climbing because it is unpredictable. but neither do i expect a crash, as fundamentals have cearly accounted for some of the rise in price. i do expect a significant drop as soon as fear subsides, which it eventually will...fear of war; fear that the dollar keeps weakening...fear of the stability of the financial system, etc. my point is that speculation clearly accounts for a fairy significant piece of the price. if the fed were to raise rates to strengthen the dollar and if margin requirements were increased on futures trading in oil...on any exchange anywhere...oil would be well below $100 a barrel in my view. it is only my view.

as to why those with my view don't join the ranks of speculators and make a fortune shorting oil? because it is a dangerous game. if israel attacks iran tomorrow..not an outlier event by any means...oil probaby goes to $200 and shorts would get killed. that's why. predicting the crash isn't difficult...but predicting the timing is a fool's game.

2. your views on leverage are consistent with mine...it can cause enormous problems, as it has in the financial system. banks, brokerage firms are on their backs and there could very well be another failure or two because of it, a.k.a. bear stearns. BUT....leverage does provide liquidity to financial markets. i don't give a damn if someone goes broke because they made bad bets....but i do mind that the fed uses taxpayer money to bail out the morons who have compromised not only their own well being but that of the financial system because of their excess use of leverage on a thin capital base. they deserve to fail and i don't give a damn about the consequences to the economy. pain is a good teacher. excess leverage is a scourge on the financial system.

3. specuation provides liquidity in markets and it is not inherently bad. excess speculation...driven by manias...can be damaging with a key commodity that everyone depends on. i don't believe speculation should be eliminated....far from it. i believe that speculators should not be given 14:1 leverage. let them put up 50%....that is no different than margin requirement on stocks. that would eliminate 90% of the speculation that exists in oil markets. apply the same to agricultural commodities.

futures markets were originally designed for hedging by producers and consumers of the product. it is appropriate for federal express to hedge jet fuel, for example. grant them an exemption from the margin rquirements.

as for high oil prices forcing conservation, i suppose so. by that logic, however, if we coudn't afford food we'd all lose weight too...is that good? oil is a commodity that greases the world economy. prices should be based on fundamentals to the extent possible. we don't need speculators to force us to change our bad habits. they aren't our saviors and they don't give a damn about the public good.

take care!

[LiquidSoapDispenser]

@ ICANDOITDON

Thanks for your response. Most of what you say makes sense to me, though I do have a couple of questions/issues:




"as to why those with my view don't join the ranks of speculators and make a fortune shorting oil? because it is a dangerous game. if israel attacks iran tomorrow..not an outlier event by any means...oil probaby goes to $200 and shorts would get killed. that's why. predicting the crash isn't difficult...but predicting the timing is a fool's game."

But aren't the specific risks of shorting oil that you list the very same (and real) issues that push oil up beyond what you feel is the "proper" price for oil? As long as these risks exist, isn't it a normal market function to push oil up above what you call the "fundamental"... price?

It seems you want oil to be at a "non-speculative&... price that reflects current supply and demand, but completely ignores what people perceive as future supply and demand as well as potential risks to the oil market.





"as for high oil prices forcing conservation, i suppose so. by that logic, however, if we coudn't afford food we'd all lose weight too...is that good?

The difference is that oil is a limited commodity (at least, that is what most of the geological community seems to believe), whereas food can be grown, it spoils, etc. If there was a finite amount of food and there didn't seem to be enough to go around, I think it would make sense for people not to eat beyond the point of satiation.

[LiquidSoapDispenser]

Damn quote marks really get messed up by this site. Upon rereading my response, I realize my food comment doesn't really address your question. Obviously, poor people not getting what they need (food, oil, water) because they can't afford it is not good. But if the supply/demand situation is going to make that happen in the future (perhaps without much warning, and perhaps in a much more dramatic way than the high prices we are experiencing), I can't help but think that high oil prices are a wake-up call for all of the world to REALLY work on a solution, so it's better prepared for the time when there absolutely is not enough oil to go around. The US has done nothing for decades to address energy in a meaningful way, and so perhaps crazy oil prices will finally get people to do something. And just look at the effect high oil is having on consumers -- people aren't buying gas hogs like they were 5 years ago.

So back to your example -- if everyone loses weight because there isn't much food around, that may seem bad. However, if that gets people up off their asses to figure out ways to provide for more food, than maybe it's a good think in the long run for society.

[icandoitdon]

liquid soap....

your thoughtful comments point out the two sided coin. yes, the negative effect of high oil prices can bring about some positive developments, including conservation, more exploration, alternative technologies, etc. future generations might see the dramatic increase in energy costs as a blessing in disguise. but the "blessing" could also be mixed. there is no certainty of a pleasant outcome. nuclear energy, for example, has significant risks as well as benefits. coal is filthy as hell. people could use wood burning stoves and spend their spare time chopping wood and breathing filthy air because they're forced to live in cities for lack of gasoline, too. you can't ignore the downside and just focus on the upside of high oil prices.

today, oil is a necessary fuel that the world economy depends on and my conern is the current effect of financial speculation on the price of this critical resource. if such specualation did not exist the price of oil and gasoline would be significantly lower than they are today based solely on production and consumption fundamentals.

let me make an analogy....

the destructive collapse of home prices has raised havoc throughout the investment world...here in abroad. broadly speaking it happened because of bad lending. does this believe i don't believe in lending money? of course not. money lending is not the problem.

speculation has its place. it provides liquidity. a speculator is usually on the other side of the contract for the farmer who wants to hedge his corn production or an airline that wants to hedge their cost of jet fuel. it provides liquidity and is its rightful place is good for the markets.

BUT

what is going on in oil is unusual. it has nothing to do with hedging. it has to do with confidence in the financial system. this type of speculation used to be the sole domain of precious metals but it now includes oil, which has far more utility than gold. and that's what makes it dangerous...oil is a critical resource that must not only have a stable source of supply but a stable price. the world economy depends on it.

this problem can be solved and it is not necessary to ban speculation to solve it. raise margin requirements for futures trading in oil to 50%...the same as for stocks. grant exemptions for identified, licensed hedgers of the product..producers or users. the speculators who take the other side of contracts designated as hedges need not meet the higher margin requirement. but those financial speculators for their own accounts can pay the higher margin. i challenge anyone to make a case that this is unfair.

but what about those who believe the country is going to hell, you say? let em buy gold....nobody needs it.

[Pauly B]

As painful as energy prices are, I am glad the futures pits are there. The futures are telling us that we need more product or we need to change our habits, in essence they act as a safety valve.

With the futures system at least I can get gas and as much as I want. President Nixon put price controls in and I was in a long line getting gas if my license plate matched an odd or even day.

We need to lock our politicians in the capital until they come up with a major energy policy for this country. They should be in session now working on this, and not on vacation.