Oil Speculators: Manipulative Evil Masterminds or Just Savvy Investors?
May 11th, 11
Here is an interesting take on the influence of "speculators" on the price of crude oil. As with everything involved in the price of crude oil there are no concrete answers. Supply, demand, speculation, politics; they all play a part in our current situation.
Oil Speculators: Manipulative Evil Masterminds or Just Savvy Investors?
By Bruce Watson
As the price of oil climbed over the past few months, a
growing army of commentators and pundits grimly hinted about
"speculators" who were manipulating the oil market and profiting from
the misery of the American people. In the darkest depictions, these speculators
were alleged to be aligned in a vast, global cabal bent on squeezing money out
of the U.S. middle class by driving up the price of crude.
These rumblings about speculators are hardly surprising: They echo the
groundswell that emerged three years ago, the last time that gas prices exploded.
For that matter, there's no doubt that oil speculators exist: Oil futures are
traded on the New York Mercantile Exchange (NYMEX), as well as on London's Intercontinental
Exchange (ICE)
and through direct sales. But do those speculators wield the diabolical, nearly
omnipotent power over the market that some critics claim, or are they -- like
the drivers who are now paying close to $4 a gallon for gasoline -- merely
riding pre-existing trends?
Supply and Demand vs. Speculation
In all likelihood, the answer is a bit of both. The traditional explanation for
gas prices is that they move based on supply and demand: Put simply, there is a
limited supply of petroleum available on world markets at any given time, and
as a rapidly growing number of people in emerging economies like China and
India buy cars and become drivers, Americans must compete for fuel in an
ever-more-crowded marketplace.
With more drivers clamoring for a share of that limited supply of gas, oil
companies, refineries and gas stations can charge more, and the price goes up.
But rising prices may lead drivers to cut back on their gas consumption, which
increases the available supply and pushes the price back down.
According to speculation theorists, this supply-and-demand equation is being
short-circuited by commodities traders, who push the price of gas up in order
to reap a quick profit. These traders buy oil futures at low prices using
mostly borrowed money, encourage the price to rise, then sell the futures at
the new, higher price and collect the difference. Meanwhile, when oil producers
see the market rising, they try to hold on to their crude so that they, too,
can sell it at an inflated price -- which reduces supply further. Between the
traders and the producers, oil prices shoot up, torturing drivers.
The Disappearance of Oversight
Up until a few years ago, oil speculation wasn't really a problem: Crude oil
futures could only be bought and sold on the NYMEX, where they were regulated
by the Commodity Futures and Trading Commission (CFTC), a government
organization that was created in 1974 to -- you guessed it -- protect the
market against speculators. For decades, the CFTC did its job well, watching
over sales of oil futures and ensuring that investors didn't drive up prices to
make a profit at the expense of consumers. But in 2000, everything changed.
While it's difficult to prove whether or not speculators are directly
responsible for high gas prices, most analysts agree that some portion of the
current high cost of gas is attributable to the buying and selling of oil
futures. After the sharp rise and steep fall oil prices took in 2007 and 2008, investigators found that 81% of gas contracts on the NYMEX had been held by
speculators. In fact, 11% were held by a single company, Vitol. With that kind
of pull, anti-speculation analysts argue, there's no question that oil traders
can manipulate oil prices.
We Have Met the Enemy and He Is Us
But are gas speculators really the diabolical masterminds that some analysts
have made them out to be? Fred Rozell, director of retail pricing for the Oil Price Information
Service argues that these investors aren't
malicious.
"Oil is a good bet for investors who are looking to reap a solid return on
investment," he says. "This is especially true in the current
economic climate, as a slowly improving economy points to increased consumption and
tensions in the Middle East are fueling fears of a supply disruption." In
fact, Rozell notes, many of these oil speculators are 401(k) plans that benefit
middle-class consumers.
Beyond that, there's always a seasonal increase in the price of fuel. In the
spring, gas companies switch over from their winter-grade fuel to their
summer-grade. The summer mix contains different additives that, according to
the EPA, cut down on pollution. To make the summer-grade fuel, refineries have
to briefly shut down, a move that causes the price of gasoline to shoot up.
Rozell calls this seasonal increase the "petronoia rally," as the
brief gas shortage fuels paranoia among consumers and investors. He notes that
gas prices usually peak in early May, then slowly decline.
What Can Be Done?
With high gas prices threatening America's fragile economic recovery, many
people are asking what can be done to curb speculation. Last month, the
Department of Justice launched
the Financial Fraud Enforcement Task Force, which is tasked with fighting
illegal oil speculation. While this might help somewhat, the sad fact is that
most oil speculation occurs legally on the NYMEX, the ICE and in OTC trades.
Ultimately, the solution is to increase the power of the CFTC.
Last year's Dodd-Frank Wall Street Reform and Consumer
Protection Act was designed to do just that: Among
other things, it gave the CFTC the power to regulate OTC trades. However,
conservative opponents of the law have fought against its implementation: U.S.
Reps. Darrell Issa (R-Calif.) and Michele Bachman (R-Minn.) introduced legislation to repeal the law, and Rep. Frank Lucas (R-Okla.) recently
proposed H.R. 1573,
which would delay its implementation until 2013.
If the Dodd-Frank Act's provisions go into effect, they could go a long way
toward stabilizing gas prices, which would be a major boon for consumers. If not ...
well, public transportation is looking more and more attractive.