Oil speculators dominate trading, driving up gas prices & exploiting gaps in govt oversight

Although this should come as no surprise to readers of a prior Fueling Station blog item, the Commodities Future Trading Commission was shocked -- shocked! -- to learn that a private Swiss energy conglomerate called Vitol was functioning as an oil speculator, the Washington Post reports today.

In fact, last month Vitol had locked up 11 percent of all the oil contracts on the regulated New York Mercantile Exchange, the Post reports. You may recall the name Vitol from last year's headlines, when the company pleaded guilty to paying secret kickbacks to the Iraqi government in exchange for oil under the United Nations' scandal-ridden oil-for-food program.

Previously the CFTC had pooh-poohed complaints that such speculation might be driving up the cost of gas. But now the CFTC figures that speculators like Vitol "account for about 81 percent of the oil contracts on NYMEX, a far bigger share than had previously been stated by the agency," the Post reports.

"The biggest players ... often operate as 'swap dealers' who primarily invest on behalf of hedge funds, wealthy individuals and pension funds, allowing these investors to enjoy returns without having to buy an actual contract for oil or other goods," the Post reports. "To build up the vast holdings ... some swap dealers have maneuvered behind the scenes, exploiting their political influence and gaps in oversight to gain exemptions from regulatory limits and permission to set up new, unregulated markets."

Incidentally, if you're looking for someone to blame here, look no further than Congress and Ken Lay. In 2000 Congress passed a law that "allowed investors to trade energy commodities on private electronic platforms outside the purview of regulators," the Post reports. "Critics have called this piece of legislation the 'Enron loophole,' saying Enron played a role in crafting it." And we all know how well that worked out.

[AP photo of traders at the New York Mercantile Exchange]

--Craig Pittman

Comments

[Kimberly]

You're only a slave to the gas prices if you let yourself be a slave.

Move within 10 miles of your job or get a job within 10 miles of your house. The closer you live to where you work, the more options and less expensive options you'll have for transportation.

Educate yourself on how to bicycle competently and you can leave the car parked, or save even more money by selling the car:

http://www.floridabicycle.org/

http://www.simpleliving.net/main/resource.asp?sku=ehtlcar

[Tino]

The numbers from the Post have been debunked already by the exchange itself.

You should print a correction.

[Craig Pittman]

Tino, I would love to see the source for any sort of debunking of the numbers from the CFTC, but so far there's nothing on the NYMEX website about the Post story. In the meantime, though, I found a story on this same subject from the Wall Street Journal that says pretty much the same thing as the Post. You can see it here: http://online.wsj.com/article/SB121919013508455017.html?mod=googlenews_wsj

[Tino]

Bloomberg distributed this article yesterday afternoon. This is a reprint from the Houston Chronicle:

http://www.chron.com/disp/story.mpl/business/5958979.html

This whole exercise is a moot point, anyway. As a long-time commodities trader, I have yet to figure out why people think that speculators can run up the oil market and keep it there. Unlike speculators in, say, tech stocks, *every* oil futures contract by a speculator must be closed out, creating an opposite trade. Speculators cannot buy oil and hoard it somewhere. Conversely, a buyer of stock can squirrel it away and never be forced to sell it, creating a long-term upward pressure on the stock.

If I buy an October crude oil contract, I am contractually obligated to sell a contract by September 22 to net my position to zero (as much as I would love to see a tanker streaming up Seddon Channel, I am not allowed to take physical delivery of my 1,000 barrels). That means that my net impact on the market over the course of the contract life should be zero.

Sure, speculators can move the market up and down on a daily basis, but in the long run, their impact should be zero, as futures prices will ALWAYS approach the underlying spot prices at which natural buyers and sellers transact. If they do not, there is a juicy arbitrage opportunity (i.e. free money to the natural buyers/sellers), and those do not last very long.

[Craig Pittman]

Tino, thanks for that Bloomberg link -- however...The CFTC is basing its claim that the story is incorrect on the fact that the Post included commercial swap traders in with speculative traders. Include them and the speculators control 81 percent. Exclude them and it's 50 percent (which is still a lot more than the CFTC expected to find). But as the Houston Chronicle noted recently, it's one of those "definition of 'is' is" questions: "At the heart of the issue is the Commitments of Traders report CFTC puts out each week. It's supposed to reflect the positions traders (both commercial and speculative) hold in oil futures, but many say it's a poor indicator, hard to read, easy to manipulate. Case in point: Enron, which has now been shown to be heavy in speculation, was classified as commercial." Here's the Chronicle link: http://blogs.chron.com/newswatchenergy/archives/2008/08/oil_speculators_1.html

[Tino]

I'm still not sure why people have to use the word "Enron" every time there is an issue with regulated commodities markets.

Do you what the "Enron loophole" in Section 2(h)(3) of the Commodity Exchange Act actually means? It dealt with Enron creating their own private exchange to make an over-the-counter market in commodities.

I would love to see the proof defending your statement that oil futures markets are easy to manipulate. It is one of the largest and most liquid markets in the world. So far this morning, from 9 am to 11:48 am, 206 million barrels of crude have traded on the NYMEX. The thought that someone is systematically moving the price around like a marionette's puppet is laughable.

As I've shown above, the speculators may be able to move the market en masse in the near term, but it is the commercial buyers/sellers that set the long term price. If the two groups diverge, the commercial buyers/sellers can arbitrage the difference.

Banning or curbing speculators will have two effects:

1. traders will move offshore and foreign exchanges will pick up the financial windfall.
2. the markets will become more illiquid, more transparent, and yes, easier to manipulate, since the number of players will be severely curbed.