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  • 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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Greedom

from the article: "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." Reading this part gives me an idea to suggest that futures should be mandated to have an actual use for the oil ? That is, you could buy in IF you could vouch that you actually had a real world use for the oil. With Special Drawing Rights moving to paper, just something I started learning about - in Feb. 2008, I wonder if those will get involved in futures ? That is will nation states start gambling on who will be borrowing what in the future. This use of futures sounds like what DARPA had setup only using world political events to place wagers on. This project was shut down as soon as it hit the press some many years ago (6 ? ). People were upset that participants could wager on an assassination. And now ? people are upset that people are wagering on a high utility/high use product, and their wagers are apparently altering the real world pricing of the utility -oil in this case. So, perhaps the solution is to say - if you are to play into oil futures you HAVE to be willing to actually BUY that days order and pick it up, or have it delivered ! heh Just a thought starting my day.

July 2, 2008 at 9:43 am

Mark

This is a good article. You people might as well quit blaming oil speculators. They are NOT the problem. The futures market (for oil and other commodities as well). It helps with price discovery and sends market signals on how to use current supplies and what should be done about future supplies. I see some of you complaining about the intrinsic market element that causes oil to shoot up $3-$5 in a day when some threat is made in the Middle East or some top analyst says oil is likely to go higher. Your argument is that it doesn't change anything about the actual supply of oil. Well, I've got a counter to that argument. What if a leading research company said they had developed a new hybrid vehicle that would help us displace 70-80% of our oil use as a country but it would be at least 5 years before it was commercially available. I can guarantee you that oil prices would retreat significantly. Why? Because the market would be sent a signal that it would be oversupplied in the coming years. Did anything change in the present? No. But it's going to change. This goes the same for the argument in trading for wheat, corn, etc. We need these "bets" to provide market signals and help with price discovery. We could do everything on the spot market, but the swings in prices would be violent and severe. You think things are tough now. Imagine yourself in a situation where one week gas is $2/gallon and then spikes to $6 or $8 the next. Then back down and gyrating wildly.

July 2, 2008 at 9:41 am

MattB is STL

Point 1 Trade is not "fair" with China. Just like in our old SALT treaties. We've failed to change our approach as the economies change. The tax differential ALONE, between imports and exports, makes it nearly impossible for small business to compete. This should have changed a LONG time ago. One reason that it possibly has not, is because many business owners have moved there business off-shore "to compete". They found (essentially) slave labour and they can keep the profits off-shore and skip paying taxes. There have been efforts to remove the tax loop-hole. But until the citizens of the United States educate themselves on what is going on a demand a change....well....the politicians aren't going to change anything. Point 2 This is not supply and demand. This is market manipulation. Pick your conspiracy theory to blame. But someone is manipulating the market for profit, either monetary...or worse. Point 3 Bashing the US will not when you any friends. Once you start done that road, most travelers will not make the journey with you. So you end up talking to yourself.

July 2, 2008 at 9:35 am

mike t

Supply and Demand Theory doesn't work if the producer doesn't lower price when supply goes up. Last week or the week before (can't recall), oil price dropped $5 and the price of gas only dropped $0.002 (not even a penny). At that rate if oil dropped $5 a week from 135 all the way to 50, the price of gas would fall 3 cents. Congrads! Supply and Demand theory is just that a theory...it doesn't apply when there is no competition and the product is so unique that people depend on it to live. You could increase supply 100 times...the oil companies don't have to lower the price...they've identified the point were people are cutting back, so they set the price right at that line. Remember at the rate gas fell last week when crude fell $5, if you increased supply to drop the price of crude all the way back to 50, you have dropped gas price by 3 cents...3 cents.

July 2, 2008 at 9:33 am

rlock

There was a report out about a month ago that said they were producing the same amount of oil worldwide today as they were in 2005. Demand is going to catch up to supply sometime and raise prices dramatically as it did.

July 2, 2008 at 9:28 am

Johnny35

If you want total and free trade that is great, but then you start by dissolving OPEC. Make the Middle Eastern countries put in bids. I GUARENTEE that if we said that all of our tankers would be sent to Saudi Arabi, there would be a great deal of price reduction then. Because no matter how much Iran and Venezuala say they hate the US, they still want and NEED our money.

July 2, 2008 at 9:27 am

Ted McKeown

Carrie: Here is an article I posted earlier that may enlighten you. Although Oil appears to be a good hedge against inflation, a lower dollar and a low oil supply, in reality nothing could be farther from the truth. The main thing driving inflation is oil prices and as inflation goes higher investors buy more oil driving inflation higher again. Some experts predict this will trigger the worldwide recession. This will result in lower gas consumption and it will free up more gas supplies. Contrary to what US Energy Secretary Samuel Bodman says I don't think supply and demand are really causing the problem. There are to many other factors at play here. Too many middle men skimming profits. The price of oil doubled in price in just one year and gas went up a third and yet figures are coming out that indicate we are using less gas, not more, probably because people are cutting back on gas. That clearly means supply and demand have nothing to do with these prices. Speculation is driving prices!! Lawmakers blame loopholes in commodities trading like the Swaps loophole or Enron Loophole. Whatever you want to call it, It's a get rich quick scheme and not much less obvious than a pyramid scheme. There is no way supply is causing this gas crisis. I put the full blame on speculators and commodities traders. The meeting in Saudi Arabia hasn't achieved any substantial results from what I can see and oil prices continue to rise.

July 2, 2008 at 9:24 am

Bill Rains

Energy futures are also traded in this country otr through ICE an international organization which is NOT regulated by the commondity futures exchange. The ctr only regulates the nymex exchange. You have left this out of your story which leads me me belive you DO NO KNOW WHAT YOU ARE TALKING ABOUT. The price of oil is driven by speculators because of this unregulation by the US govverment in this county. The ctr does nothing because of loop holes in the law and the Bush administration knows this.

July 2, 2008 at 9:21 am

Patty

Will somebody please tell me if ICE, the non-regulated speculators, have anything to do with the high prices. Did Morgan Stanley and Goldman Saks form this company? Aren't the oil companies like Exxon and financials trading and driving the prices up? Isn't this a conflict of interest? Is this correct? Why isn't anyone mentioning ICE. They only mention it briefly on O'Reilly and they don't even mention the two companies that formed it? Aren't they driving their own product up by trading on this site?? Aren't the screwing the American people by doing this?? Why are they allowed to do this?

July 2, 2008 at 9:17 am

Spirit of '76

Rise in oil prices is largely due to government meddling and supposedly "doing good for the people", worldwide. The US has been printing money hand over fist for so many years that it is catching up with inflationary rise of the prices everywhere. The biggest evil that descended upon this nation is the unbridled money explosion by the Feds to "keep the interest rate low" to create economic stimulus. Free market economy will have cycles. Constantly expecting the politicians to protect us from any adverse economic cycle results in inflation. Other nations have been indulging in subsidizing fuel prices by keeping them low. That creates artificial demand. Again, the governments are the culprit. Unfettered markets and free trade are required for basic economic factors to determine pricing. On top of everything else, the US government is prohibiting exploration and production of energy resources based on economic efficiency. Our coal reserves are vast and so are our petroleum and natural gas reserves. But we can't get at it. The governments in the US owns majority of those lands. I thought only the kings used to own vast tracts of lands. We actually fought the English king over that type of behavior. If we want price to go down, increase the interest rates, stop printing money and reduce the size of the US governments of all sizes. Volcker increased interest rates in the 1980's to bring the dollar back. It was painful.

July 2, 2008 at 9:12 am

Pete

If it's primarily the value of the dollar, why is the rest of the world feeling the pinch as well? The fact of the matter is the recent spike is all emotions and if we begin to show the rest of the world that we're willing to become less dependent on foreign oil and increase our own supply, the market will immediately react. Speculators would follow suit. Just let us start drilling here even if we don't believe it will do anything. It can't hurt (the price of oil)!

July 2, 2008 at 9:06 am

Johnny35

Sometimes there comes a point when some of you people who like to "OVER ANYLIZE" things need to be told to "SHUT UP AND PAY ATTENTION TO WHAT IS REALLY GOING ON!" Greedom - YES, everybody agrees that when the value of the dollar falls, it takes more dollars to buy oil. There is NOBODY disputing that. But you people, including E-MAC need to stop trying to anylize everything to death and pay attention to what is REALLY going on! EXAMPLE - One of the reasons that everybody claims is a leading cause of the price jump in oil is 'Supply and Demand' The fact that the reserves have gone from 5 bn barrels to 2 bn barrels. So the Saudis agree to increase production, this should now help to relieve the 'Supply' side, thus relieving the price. Did it? NO! Instead it went up based on concerns that "If the Saudis increase oil production, they will run out of their oil supply to quickly" BULL! Nobody believes that, do you honestly believe if that were true, the Saudi's themselves would go ahead with the increase? The truth of the matter is, EVERYTIME some little thing happens, the market can find a way to link oil to it, and raise the price. You can tell this just by reading the news. Nearly every artile that addresses the Mideast, has a reference to what it did to the price of oil. The HURICANES, yes did damage several oil platforms and cause SOME oil loss, but theloss was FAR LESS than that of the EXXON Valdez. So why not a bid increase when that happened?

July 2, 2008 at 9:00 am

Steve

What I find most frustrating in the whole oil debate is the fact that EVERYONE wants to blame someone else, when in fact, it is ME and ALL of you who are to blame. Oil companies do what businesses do, they try to earn money. Gas wholesalers do what they do, try to make money. Gas retailers do what they do, they make money. WE all make money. WE all get ourselves into credit debt, make stupid financial decisions (See recent Housing Crunch) and obtain ignorant interest only, and variable rate loans, all the while thinking we got a sweetheart deal on a house we couldn't afford to begin with. THE BEST thing the FED can do is raise interest rates by at least 2 points, to make idiots like us save money, which brings the dollar back, and then we can listen to all the EMOs (Those who run on emotion rather than common sense) whine and cry about the poor oil investor and oil companies who just lost their shirts as the bubble burts and oil is back at 50 bucks a barrel, where it belongs. Stop pointing fingers people, look in the mirror, and then let the idiots in DC (ALL of them) know we aren't gonna sit by anymore, while they sit on their fat assets and the rest of us suffer.

July 2, 2008 at 8:46 am

Roger Myers

As a commodities broker I can tell you this is nothing more than party line rhetoric disseminated by speculators. ICE contracts have no position limits and have no possibility for delivery being cash settled. Trade in this market, which profoundly impacts actual delivery markets, is nothing more than gambling based upon technical signals and has little to do with supply and demand.

July 2, 2008 at 8:45 am

6ftrabbit

A message for environmentalists and politicians concerning oil: "GET THE HELL OUTTA THE WAY!!!

July 2, 2008 at 8:33 am

scott bourne

World Proved Crude Oil Reserves, January 1, 1980 - January 1, 2008 Estimates 1980 - 644+ BILLIONS BARRELS = 644,000,0000,000 AS OF jANUARY 2008 - 1,331+ BILLIONS BARRELS = 1,331,000,0000,000 http://www.eia.doe.gov/pub/international/iealf/crudeoilreserves.xls ?????????????????????????????????????????? Who the heck is getting rich now off of a so called shortage? Guess you won't post this one either.

July 2, 2008 at 8:31 am

Joe

Oil is the lifeblood of the global economy and it should not be used as a gambling tool by speculators and investors to destroy entire economies. It's funny how people who are profiting from rising oil prices seem to always blame supply issues rather than their own self-serving greed. If speculators continue to drive oil prices beyond consumer's affordability, people are simply going to stop buying many products and services which will have a far greater impact on the total global economy. To allow these few "scum bags" to line their pockets at the expense of a total economic collapse is irresponsible. I wish congress and regulators would get off their lazy asses and do something fast to stop the bleeding before it's too late...

July 2, 2008 at 8:22 am

R. Hancox San Antonio, TX

There is some merit to economics fundamentals being PART of the problem. But the real problem is people moving their money out of other investments and into the oil market. As the fed continued to lower interest rates (as though blind to the rest of the world) oil became more and more attractive. The most incredulous reason for the spike in prices is the whimsical reaction to simple quotes from "important" people. Some oil minister says the price will reach $170 soon and the price goes up $5 in a day. What was really different that day? Did a bunch of oil just go off the market? Did an oil field somewhere just get bombed? No, someone with a stake in the game made a comment. It is absolutely irresponsible of all those involved to allow a commodity, that is basically at the root of today's economic system, to rise so rapidly. The mear fact that such a commodity is allowed to be traded the way it is, is irresponsible. To be treated, as someone put it, like poker chips is beyond me. And we're the uneducated ones.

July 2, 2008 at 8:06 am

bubba j

the dollar is weak because of the bush economic policies, start a war, give big business huge tax breaks and fund the war by letting foreign countries by commodities in the u.s., i work in europe and it is truly sad to see the u.s. dollar so week, but then again, the bush economic policies let the dollar get weak so that big business would be competitive against european products, sad thing is, the europeans have such hatred for bush, they dont buy american, at the same time, the german economy is so bad that the people can barely afford anything with the euro

July 2, 2008 at 7:57 am

Joe Solters

So far no comments focus a major problem with crude world prices. Arguments directed to inflation and the dollar's value are trivialized nonsence, and always invoke basic supply-demand, free market dogma. As long a OPEC exists, crude oil pricing is NOT a free market commodity. The usual "free marget" dogmas simply don't apply. So all these "let the market work" speeches are worthless noise, and will never solve the current price issue, and it's attendant misery. The debate needs to focus other solutions. Let's start with US domestic crude production, which is about 60% of US consumption. US crude sales contracts contain short term escalators which track world crude price indices. That's why gasoline pump prices jump so quickly. US oil producers are simply reflecting prices controlled, in large part, by OPEC's effort to curtail swing production volumes; ie, Saudi Ababia swing production. The real political and economic question is: Are US domestic supplies entitled to charge world prices, when the price doubled in 6 months and goes up daily, and is ruining the lives of most Americans? The answer is NO! Price controls?Probably the only short term emergency solution. Free market speeches notwithstanding.

July 2, 2008 at 7:40 am

Steven Harrell

All I can say is NObama!

July 2, 2008 at 7:03 am

Roy

Seems like price fixing to me. In other industries when you discuss what price you will charge you go to jail.

July 2, 2008 at 6:34 am

rdw

drill here, drill now!!! create good paying jobs in this country now!! elininate the speculation if it is the speculators, because if you drill here, and drill now.... the speculation turns against middle east oil and towards home grown oil production. I could care less about what a frigging environmentalist or georgie think. you can not run this country without oil. friggin democrats are such idiots!!!!!!!~!

July 2, 2008 at 5:58 am

david wilkerson

Well it's 08. I'm been telling everybody i know since 05, that if yall think gas is high then, then JUST wait till 08. Last year the two foxes are in the chicken coop so its pig out time. Duh, people there two in the white house that tied up with oil so Duh it don't take a guiness about what is going on DUH!!!!!!!!!!!!!!!!!!

July 2, 2008 at 12:18 am

Dan

Some experts believe that as much as 60 percent of the cost of a gallon of gasoline or heating oil can be attributed to pure speculation and abusive –even manipulative – trading practices, yet most trading is “dark” and federal authorities can neither fully police or see the data in the majority of the trading markets. The energy trading markets were originally set up to provide energy producers and distributors with an environment to manage risk and produce the best possible price for their customers. But they are clearly no longer the driving force in the market. Profiteering speculators and investment banks care little about establishing a price for energy based on supply and demand Go to csapn.org and put in Energy Market Manipulation, June 8 and get the truth.

July 2, 2008 at 12:17 am

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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