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Part Three: The Oil Speculator Witch Hunt »

  • July 1, 2008 01:36 PM EDT by Elizabeth MacDonald

    Part Two: Oil Speculators vs Supply and Demand

    Americans now face sticker shock at the gas pump, as the average cost of gasoline veers towards $5 per gallon.

    And that has oil speculators in the futures market now in the regulators' bulls' eye, as the price of crude has about doubled in a year. The spike has effectively vaporized the $140 bn in fiscal stimulus checks now in the mail.

    Ignored here are some basic supply and demand facts. Nigeria is pumping about a third of the amount it was a few years ago. Russia has major oil infrastructure problems, same with the geriatric refineries in Iran, where the oil mullahs as well as Venezuela are delighted to stick it to the US and Europe.  

    Meanwhile, the Mideast, including Iran, as well as Venezuela, China, India, Malaysia and Indonesia, all shield their citizens from the full rise in oil prices with fuel subsidies. Together the countries that subsidize fuel account for half the world's population and a quarter of the world's fuel use, one report says.

    And countries that subsidize their fuel account for all of the current demand growth, because demand in developed regions such as the US, Europe and Japan is either flat or contracting, as drivers feel the hit of unsubsidized fuel costs, a report says.

    Another factor too: The world's spare capacity, the oil cushion as it were, has dwindled to just over 2 mn barrels per day with global demand at 86 mn barrels a day.

    That's way down, by more than half, from 5 mn nine years ago, says the U.S. Energy Information Administration. And much of today's surplus is sour crude, high in sulphur, which refiners loathe.

    Shoddy and corrupt oil supply data, detrimental weather and ethanol mandates, all cause oil prices to gyrate too.

    And a key driver is the strength of the US dollar. Since oil is traded in dollars, the plunging value of the US dollar likely has traders scrambling, as the amount earned from future oil sales may get slammed as the dollar loses real value.

    However, oil speculators are now held solely to blame for price spikes. But they are not even largely to blame.

    Think about it. As proof that oil price spikes match speculative investments, hedge fund manager Michael Masters told Congress recently that $240 bn sits in commodity index funds, up from $13 bn five years ago. Some have put that figure at $250 bn.

    Paul Horsnell of Barclays Capital, an investment bank, puts the total value of index funds and other similar investments at $225 bn. Horsnell cheekily notes that figure is less than half the market capitalization of Exxon Mobil, but more importantly is a tiny fraction of the $50 trillion-odd of transactions in the oil markets each year.

    The Commodity Futures Trading Commission says that some $5 tn worth of futures and options transaction flow through U.S. exchanges and clearing houses daily. Can that $225 bn to $250 bn in investments, a drop in this $5 tn ocean of money, really move prices?

    But what happens in an oil futures trade?

    No physical barrels of oil are traded. Instead, futures contracts exchange hands, which are essentially bets on the future direction of oil prices, often a year out or as long as eight years out. On the other side of the transaction sits a trader who bets oil is going down.

    These trades are matched. If a big investor is buying oil futures contracts, on the other side is somebody willing to unload a lot of oil futures contracts to them. Airlines, trucking companies, any heavy user of oil use these futures contracts to lock in now their oil costs, in other words, by hedging their future oil costs. No barrels exchange hands.

    But the fact is that if oil was really a speculative bubble, then the future forward contracts should be a lot higher. But they are not, the December 2016 is marked at $136 as well.

    Those who do set the price of physical barrels look to the futures markets for a sense of where prices are headed, but mostly those prices are set by supply and demand.

    Take note of the nearly 90% average price mining giant Rio Tinto disclosed in iron ore for its voracious customers in China to get a sense of what demand can do to commodities prices.

    However, you may have seen the data from the Commodity Futures Trading Commission that showed speculators have increased their share of oil futures contracts in West Texas Intermediate crude on the NYMEX to 71% in April from 37% in 2000.

    But that figure may be inflated due to double counting, as the CFTC says that 70% figure includes both long positions, or bets on a price gain, and short positions, or bets on a fall, held by swap dealers and speculators.

    Moreover, swap dealers, because they tend to hedge their bets, have a virtually neutral position in the crude-oil markets, the CFTC has said, as they are almost equally long and short in the marketplace. Acting CFTC Chairman Walter Lukken said a large portion of those swaps deals would be for commercial businesses looking to hedge fuel costs, such as airlines.

    Instead, the CFTC has said that speculators only make up about 30% of the market.

    Should you blame the shorts and not the speculators? In June 2008, a report from oil analyst Theodore Butler notes that the spike in oil prices began when the credit crunch started in August 2007, primarily due to short sellers buying back futures contracts so as to cut their losses.

    A run on contracts caused momentum trades in oil to spike the price higher, the thinking goes. Short sellers borrow a stock or in this case an oil  futures contract from a broker and then sells it, in the hope of repurchasing that stock or contract later at a lower price. 

    Butler says that "index funds are holding the same size, or smaller, long positions in crude oil than they held 10 months ago, when crude oil was $70/barrel." Butler adds that "the buying back of previously sold short futures contracts, primarily in the commercial category, account for the bulk of the buying over the past eight months or so." Meaning last fall.

    August 2007. Why should that date stick in your mind? What's the action here? Why did the spike in oil prices begin, as Butler says, in August 2007?

    Because it's when the Federal Reserve opened the monetary taps to save Wall Street. Let's go to the tape.

    The inflation adjusted price of a barrel of crude oil traded on NYMEX generally stayed around under $25 a barrel up until 2003, much as it had the prior 20 years. In 2004 the price spiked above $50, a year later in August 2005 it topped $60, mid 2006 it briefly surpassed $75, dropped back to $60 a barrel in early 2007, then rose inexorably to $99.29 a barrel for December futures in New York on November 21, 2007.

    This year alone has seen record oil prices, with oil now marching toward $150 a barrel. "The number of transactions involving oil futures on the New York Mercantile Exchange (NYMEX), the biggest market for oil, has almost tripled since 2004. That neatly mirrors a tripling of the price of oil over the same period" reports The Economist Magazine in May 2008.

    Not surprisingly, the steady march upward in oil coincides with the steady plunge in the value of the dollar after the Fed opened the money spigots in August 2007 to rescue Wall Street. 

    Does the short action signal a potential strengthening of the dollar, has the jawboning lip service paid by Federal Reserve Chairman Ben Bernanke in a recent speech (not official policy yet, mind you, the strong dollar), worked its magic here to cause the futures markets to think oil prices will go down?

    Still the regulators want to have their say. And indeed they are. Next: The regulators move in on oil speculators.

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Mark W

Inflation, speculation, ignorant monetary policy = the Perfect Storm for oil. I live on the Gulf Coast of Florida...every time someone mentions the words "hurricane" and "Gulf of Mexico" in the same sentence, local gas prices and world oil prices jump...and most of the time the hurricane they were worried about never even gets close to oil interests in the Gulf. Words used to manipulate the market. I could be easily convinced that those invested in oil hire "town criers" to sound the alarm just to drive the price up. Last week it was the Israeli military exercising military scenarios that involve attacking Iranian nuclear (not nucular Mr. President) development. An implied threat only, and yet oil bumps $3 a barrel the day after that tidbit hits the news. They're just words folks. My hope is that in the near future we hear these words: "new technology will make gasoline burning cars obsolete in two years." Then we can give OPEC and Exxon-Mobil et al the middle finger.

July 2, 2008 at 9:52 am

rmulligan

Being the largest consumer of oil on the planet gives us a great deal of control over prices. For all the talk of drilling or not drilling, the largest potential oil reserve lies in harnessing our appetite for oil. Many of the fuel efficient cars being introduced in the United States are larger versions of cars being made for other markets. Auto makers know that Americans will never buy the Nissan Versa or the Honda Fit sold elsewhere with a more efficient 90hp engine, even if it meets the needs of millions of commuters. Why? Because of the American "preference" for horsepower we almost never get the opportunity to use in our suburban commute. If we're so outraged at the oil companies, why not ween ourselves and hit them where it hurts? We could probably cut our oil consumption by 10-15% if we just observed the posted speed limits. Drilling for more oil makes little sense until we change our own habits.

July 2, 2008 at 9:58 am

Mick Edwards

Why are so many unable to grasp speculation as the cause? Hurricane season brings high prices but when no hurricanes happen we still pay the "fear price" of oil and are never refunded that money. This shows that speculation is a real concern and problem. The supply and demand theories no longer apply. If supply and demand were the cause then diesel would be just as expensive in Mexico as it is here in Texas, it's not. Economics 101 taught about "Guns and Butter" but now we have a new category "Fear and Beer".

July 2, 2008 at 10:04 am

jeronne

The oil companies do not buy crude daily on the spot market.. They operate with contracts for delivery at a future date, some of which are 6 years out.. Why then do the oil companies raise prices with the instantaneous increases on the daily spot market when it is not a true reflection of cost?? The oil companies will not drill, develop, and try to bring down prices when they are making record profits under the present structure and pace.. Why would they create competition and trim profit margins unless they were forced ?? -- Congress needs to grow some cojones and not only allow drilling but they should encourage it .. And, they should encourage new oil field developers into the mix.. The same old oil companies have Congress addicted to money and freebies.. Congress is at fault for the log-jam...

July 2, 2008 at 10:09 am

RockyB.

I found this article informative and discovered many aspects of commodity trading that I did not know. Could somebody please answer these questions for me? Index funds were mentioned as a way to hedge against price increases. Number 1, My concern is that index funds, such as those funds people are using for retirement, have no reason to be in this volatile of market, unless they understand or want that level of risk. Number 2, Hedging your bet makes sound ecomonic sense, but if factors are in play (look at currency bailouts around the world last 5 years), commodity trading and hedging are being used for malicious gain. Hello, Mr. Soros. Number 3, what happens if the bubble bursts? How many outstanding contracts at this increased price will be held with a commodity that is being sold at a fraction of the price? (see real estate, and hopefully not, corn futures after we fall out of love with corn ethanol) I enjoyed the comments, and would appreciate some experts opinions on my questions. I truly believe that our government should always get the hell out of the way... Rocky

July 2, 2008 at 10:10 am

Geoff

The value of the dollar should be tied to the price of gold.. Wouldn't that eliminate most of the confusing fluctuations and speculations against the dollar??

July 2, 2008 at 10:12 am

Frank

Forget basic economics, they do not apply to oil. If someone (anyone) says that there will be more hurricanes this year, the price for oil goes up. The hurricanes don't show. No commodity brokers/speculators/suppliers/etc. lose any money. The price goes up even more because of the next Chicken Little statement. WE THE PEOPLE are stuck paying for it anyway!! Look at China. One day they say they are going to decrease the amount of their susidies and the price for oil goes down because the Chinese consumer will not be able to afford as much gas anymore. THE NEXT DAY the price goes up because the financial papers say that Chinese (communist) refineries will make more profit selling the same gas to the people who could not afford it just 24 hours before!! STOP THE LIES!! Oils should be taken off of the markets and we should go to a more accurate supply and demand system. The world wants to eat and we want cheap(er) oil. Simple math. When this "bubble" bursts I bet we are going to be expected to bail the oil companies out and give them even more of our money! Meanwhile we are making our enemies even richer.....I wonder who is manipulating the overseas markets???

July 2, 2008 at 10:26 am

Gerald Bartone

Back in the 70's all we talked aboout was developing alternative energy sources like wind and solar power. If we had done any action on that we wouldn't be in the mess we are in. And, we wouldn't be paying billions of dollars to these oil countries and terrorists. I blame the oil companies for dampening all the plans for alternative energy sources and relying on oil for all these years. We should have acted sooner. What ever happened to the cars that went 60+ miles to the Gallon? (in the oil companies file cabinet)

July 2, 2008 at 10:29 am

Not Buyin' It

I dunno, i can not see how you guys KEEP getting it SO WRONG. Where on earth are you getting the data to write such nonsense? Previous comments have suggested that you look into the excellent and long history of reporting on this subject by Ed Wallace, of Inside Automotive. I concur. His last article in Business Week would have been a good place to start for you to gather some facts that can be verified. Letting the facts speak for themselves should be a basic tenet of reporting on such an important issue. Mainstream media must have some type of agenda going on i don't get, because you all keep trying to tell us things that just aren't true. Or you're not doing your own research, i dunno...

July 2, 2008 at 10:32 am

Caveman

Lets talk about what the real issue is, Congress and those that vote them in. Supply v. Demand is a very real issue. The Crude Oil supply isn't the problem and that's easily proven by YOUR OWN PERSONAL research. Do the research and don't read the Blogs, following the rhetoric of others. Who controls formulation and refinement (construction) in the U.S.? That is your area of focus and that would be Congress. We can't refine any more Crude Oil than we already are and we can't make all the formulations, we import some. California doesn't want to build refineries but they want cheaper gasoline? The environmentalists run Congress...a handful of WHACKED OUT NUTS are telling you what gasoline costs. Wait until WINTER folks! You think your wallet hurts now? What do you really know about Crude Oil, Natural Gas and Home Heating Oil? Who did you vote for?

July 2, 2008 at 10:42 am

Glen

Supply and demand is causing the price of oil? Yea right!! Why can we price a commodity on something that has not even happened? If it is supply and demand why aren't we running out? The futures say we are? How do they know that there is not a new mother load that might come in tommorrow. I read that there are millionares being made every day in North Dakota with new oil wells. The Traders cause the spike. NO you say? Oh that's right every time one of the major traders like the Sanchas group says it is going up it goes up. (within minutes I might add)The way I see it the speculation needs to be taked out of the market and then supply and demand might work like it is suppose to. Some of you might say that the dollar going down is causing this. Not exactly true. I have been watching the dollar very closely for the last several months. The dollar would gain as much as .02 against the eruo and .01 against the pound and 5.70 against the Yen and the price3 of crude would jump 3-4 dollars a barrel. Why? Not sure. I wish that I had alot of money to invest so I could make a claim that there is going to be s supply shortage because the whales are blocking the ships in the atlantic ocean so my stock would go up. Get Real!!

July 2, 2008 at 10:43 am

Kurt

Interesting, your 3-part hit piece on Michael Masters and commodity speculators only focuses on one commodity - oil. Most of Masters' evidence of the detrimental effects of the growing clout of speculators is in fact in other commodity categories like corn, wheat, and metals. BTW, the same arguments you make today for the lack of power of speculators could also have been made with the Tech and Housing bubbles of the past decade, but we all know now that they were indeed largely fueled by harmful speculation.

July 2, 2008 at 10:52 am

American Man

We have in the Whitehouse the worst enemy the United States has ever had. He is a coward and rarely comes out of hiding. When he does it is only to protect the assets of the International Wealthy. On 9/11 he hid for hours while the mayor of NYC took action. During Katria we watched a city be destroyed while he hid for days in the Whitehouse then responded with a moron like himself to run FEMA. George Bush allowed one thing after another to be visited on the people of the USA in favor of the rich. He favors a sinking dollar not for us but for the Corporations and International Wealthy. He favors illegal labor which undermines American Wages and fills the pockets of the rich. He favors high prices for oil not caring one wit how it affects the people. He proves this by saying and doing absolutely nothing. He is a parrot. "Tax cuts for the rich", "Money in your pocket", "More tax cuts for the rich". In short he is a moron. This is why Obama will be president and those people who have made money beyound their wildest dreams at the expense of America can expect no mercy. Class warfare? You bet cha, Georgie Boy. Millions of us want to get even.

July 2, 2008 at 10:53 am

William

Anyone notice that the "cushion is only 2 rather than 5-7 billion barrells a day? In an era when consumption was 20% less, the cushion of excess was 3 times of what it is today. So we ahave aproximately a 10 percent cushion as compared to more normal price days. A strong signal from our government that a series of new well will be drilled starting now and that new refineries will also go underconstruction can only be seen by the market as a worning sign that the good times may end. If there is any government regulation of any of this, it ought to be that the oil companies be FORCED to spend present profits on new oil finds and construction. That there be almost a requirement that new wells and refinerees go up and that the new found oil may only be used in this country. Not sold on the open market. A strong government intervention in all the funny environmental standards needs to be brought about too. Having one blend of regular unleaded and medium, high octane would be very beneficial. San Francisco and Los Angeles can do without and any city that feels the need for more stringent environmental regulations can do without.

July 2, 2008 at 10:57 am

Dana

This whole argument is based on one statement: can a small ammount of the oil market actually manipulate the price of the whole market? the true answer is YES!!!!!! If the there is a 2% surplus of supply over demand and then someone trys to buy 3% to manipulate prices, the entire lot is now bid to the same price. There is information out there that there is a group of investment bankers with underground oil tanks doing this very thing. And because they know that oil prices are held up, they can play the futures market and make their $$$ on the margins. The second $$$$ generated is they will sell the oil in their tanks a later date when oil prices have been driven up...............

July 2, 2008 at 11:01 am

Jeff Robinson

Sugarcane Ethanol $2.65/gal in Brazil --Sugarcane has higher energy output than corn WHY is Gov Crist shutting down vast tracts of sugarcane in Florida and strapping the taxpayers with $1.7B? Smells like a big oil play under an environmental guise to push for more offshore oil drilling and shut down opportunities for further development of renewable energy. We should be expanding sugarcane production and weaning ourselves off of fossil fuel dependency? Then we would see oil drop like a rock to $50/barrel where it should be. Help stop the madness and push for renewable biofuel development!

July 2, 2008 at 11:12 am

Dana Swan

This is suppliment to my previous comment. For validation on the information about the investment bankers manipulating the oil markets, contact Frank Lohan @ KNX news radio in L.A. Another issue about to effect oil prices is the impending attack on Iran's nuke facilites by Israel. This must occur before the Nov. elections. The result will spike oil well over $200 a barrel for an unknown time. The wild card is if Iran has purchased any black market nukes. If they attempt to use them, Israel will eliminte Iran....

July 2, 2008 at 11:15 am

Karnak ..

Gov. Crist is shutting down US Sugar because of the incredible pollution over the decades that has impacted the Everglades.. Sugar cane can be grown practically anywhere, though.. In north Fla and all through the South there are a lot of farms that have suffered with the loss of tobacco sales.. They could be easily converted.. And, the cotton overplanting could be converted..

July 2, 2008 at 11:37 am

Brad (Houston, TX)

If there is still a worldwide surplus of crude as noted in the article, then the basic laws of supply and demand don't support a rise in prices yet. The Saudi's have said that they are meeting demand. I would love to see someone tell us exactly who sets the price of crude. It is not supply and demand if there is a surplus and true competition. Since neither of those factors are present here, stop calling this a supply and demand issue. Another point that is basic ecomonics is that there are limited number of suppliers, major barriers to entry and inelastic demand. When those items are present, basic supply and demand rules don't apply. That is why we have price fixing laws in our country. Stop the game. Big oil can't set the price of crude. It is obvious that our speculators use things like "tension in the middle east" to quote why they think the price of oil will go up. Last I checked, tension in the middle east has been there my whole life and I was born in the early 1960's. Anytime someone can make money by driving fear they will do it. The speculators will quote anything they can to raise their futures price. They are all make huge money and the oil producers are just going along with it. The oil producing nations have to be laughing until they are sick at how we are self destructing. Wake up everone.

July 2, 2008 at 11:42 am

MattB in STL

60 MPG cars! Ha. They'll just charge twice as much as with the 30 MPG cars. Like it has been said here, this is NOT Econ 101 supply and demand. Pure capitalist will tell you to not get involved, let the market right itself. But it is obvious that there are not proper corrective mechanisms in place. The system IS broken and someone is capitalizing on it. Just like the mortgage markets of recent, the internet dot-bombs of the 2000's and the strip malls of the 80's and countless other times when a handful of harmful people, who obviously don't believe in honesty, see an opportunity to stick it to someone and get rich quick. They drag us all down. And then, to top it off, we have to bail the (name your industry here) out. I know this is really hard for some of you to believe but... We are the most empowered people that the planet has ever seen. As citizens of the United States have unbelievable rights guaranteed (at least at this point) by our Constitution. We also have the ability to vote with our pocketbooks. Somebody, somewhere, knows who these speculators are. I urge them to step up for their country and release the information. We can then decide how we want to react to their greed. Just like with the possible hostile take over of Busch beer. If the board had decided to sell. I was going to do everything in my legal power to find out what the other interests of the board members are and go after them fiscally. Is it right. Maybe. Is it MY right. YES!

July 2, 2008 at 1:57 pm

R Mason

Congress and the general public they play to always wants simple answers to complex questions. First it was "big oil" excess profits, now it is "speculators" and soon it will be another. The true "fix" is to get off oil and go to a hyrogen based system. All we need in the infrastructure as most car companies today can produce these cars and they do not use a single barrel of oil. Google hydrogen cars and read the articles!

July 2, 2008 at 3:02 pm

Scott Bourne

O'Malley, I wonder how far the advance of electricity will go with out wire which is coated with an oil by product, I wonder how far solar power can go when the collection plates are made from an oil by product. People scream for all this great change but fail to realize with out oil products their great green change is nothing. People need to educate them selves about the myths of the so called "Tech advancement" most of which would never have been possible with out oil.

July 2, 2008 at 4:00 pm

Bruce

I'm not a economics expert or an direct investor. But I have watched bloomberg everyday this year and although I agree there are some supply and demand issues and dollar issues. The one thing I see every day is a story of gloom and doom happening somewhere and the price of oil rising. Now that is the true measure of speculation and is driving oil prices. either Nigeria rebels are attacking or something is going to happen in Iran or some other problem and price goes up. Its the chicken little syndrome and every day the sky is going to fall. This is the facts though, there is no shortage of oil, there is no shortage of gasoline, there is no shortage of diesel. Now, until that changes we will have 200 dollar a barrel oil soon, for no other reason but that something MAY happen which hasn't and nobody is going to change it because too many people are making ungodly amounts of money because of it.

July 2, 2008 at 4:33 pm

about this blog

  • Elizabeth MacDonald is the stocks editor for Fox Business Network. She is recognized as one of the top prize-winning business journalists in the country, and has received 14 awards, including the top prize in business journalism, the Gerald Loeb Award for Distinguished Business Journalism, and the Newswomen's Club of New York Front Page Award for Excellence in Investigative Journalism.

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