Speculators Dominate Oil Futures

The headlines pretty much says it all, and the details are in a Washington Post story. Here are a few points to consider:

• At one time, commodity futures trading was limited to the big companies that used the goods to keep them from becoming another economic tool of wealth collection that would leave the public holding the bag of outrageously high prices.


• At one point in July, one comapny alone, Vitol, held 11 percent of all oil contracts on the New York Mercantile Exchange (NYMEX). All that control could have cost as little as a billion in cash, with the rest borrowed.


• Financial firms speculating for themselves or clients account for 81 percent of all oil contracts on the NYMEX. Their holdings have risen from $13 billion in 2003 to $260 billion this year.


• The drive to end regulation, no matter what the reason for having it, has let companies create unregulated trading exchanges, meaning that no one knows what's going on and, should things fail, it would be like setting off a match in a powder keg. (That's my view, not the Post's.)


• Yet another new exchange is opening up - in Dubai - and US oil contracts will be traded without supervision.

And people wonder why they have to go into hock to fill an auto or heating oil tank.

There's an interesting article in the Washington Post about oil speculation and transparency. The impact of speculation has become enormous:

Big Wall Street firms representing the interests of pension funds, endowments and wealthy individuals around the country have grown in just a few years from minor participants in the oil markets to their most dominant force.

These financial firms -- whose holdings of oil contracts are now larger than the collective demand of airlines, trucking firms and other companies that need oil to run their businesses -- have become the focus of an intense debate in Washington over whether their exponential growth is contributing to the surge in oil prices.

And, apparently, such people as Ben Bernanke are claiming that speculation has no effect on oil prices because about half the people bet that it will rise and half bet that it will fall. That sounds nice, but my bet is that is a "normal" pattern and not what we've been seeing, because then about half the people at any given time would be losing money. When the swings are as big and violent as we've seen, and fueled by margin buying, those losses will be enormous, pushing a lot of people out, which means you now have a mechanism that is leaning one way, not balanced.

Even if the bets were even, it's the mass of investment that causes the problem, because it has no balancing interest, like the organizations that actually want to use oil, and hence are interested in stability and lower prices. According to Bernanke's theory, at least have the people who are taking positions in oil - which means buyers, not sellers - want the price to go higher, a very different mindset than ever before. I'm guessing that's enough to cause the fluctuations and price surges we've seen.

The Commodity Futures Trading Commission has been tracking some of the investment activity, but is keeping the information secret, claiming that it doesn't want to reveal too much proprietary information about the traders, and that the complexity of the information alone, if made public, could have misled the commodities markets. But wouldn't you think that the people who wouldn't be misled would be the people who actually do this for a living - the traders in the commodities markets?

It sounds like the CFTC is dominated, as one might expect, by the biggest trading forces, which means the speculators. The organization does claim that it "always been and continues to be committed to market integrity and to market transparency." It just has an idiosyncratic way of showing it.

Oil Futures Up, Oil Stocks Down

It seems a complete contradiction, but oil companies' stocks aren't keeping pace with rising oil prices. Far from it, according to the Wall Street Journal:

The stock price of major oil companies hasn't kept pace with the price of a barrel of oil, which is now 95% more expensive than 12 months ago. Investors are skeptical that majors such as Exxon Mobil Corp. and Royal Dutch Shell PLC, which do everything from drilling oil to refining it to selling it, are going to have big futures. The stocks are actually down this year.

Apparently analysts are saying that they face problems in oil production in the long term, "making some observers think these companies may not even be around in 10 to 15 years." Jeez, Louise. It makes you wonder why they aren't pumping huge amounts into alternative energy - or even something that seems totally unrelated. When your business depends on goop you pump out of the ground and you know supplies are limited, you might think that finding something with some long-term potential would be, oh, I don't know ... necessary?

ExxonMobile Tries Dodging PR Bullet

It's tough when your own business processes and success come back to bite you. That's exactly the picture that the Financial Times has painted for ExxonMobile selling off its 2,200 company-owned service stations. (Here's the link, but it does require a paid subscription.) The problem is having the company name sitting above those big $4+/gallon price signs. The paper does make one point I've been considering - that oil companies may make a whole lot in gross dollars, but the real price setting comes at the well head, not at the pump.

However, let's take a look at the ExxonMobile financials for a moment. When people have criticized it for windfall profits, it has argued that its prices have gone up as well - which is true, as the company buys gas from nations that own their oil. But look at the income statements from the last three years and you see an interesting pattern. If costs had gone up equivalently with profits, then the operating income should have been roughly the same as a percentage of total revenue.

In 2005, operating income as a percentage of revenue was about 16.4 percent, with net income before taxes being 9.7 percent. In 2006, that jumped to about 18.3 percent and 10.6 percent. And in 2007, the numbers were 17.8 percent and 10.0 percent. In other words, yes, the company has managed to raise its net income slightly. But even if you look at operating income, not net income, the jump is under 2 percent. A low price for regular gas in my neck of the woods is about $4.05 a gallon. Cut 2 percent and you get about $3.97 a gallon - a savings of 8 cents a gallon. Sorry to disappoint everyone who wants to raise taxes on "unjust" profits, but all that will do is transfer some of those profits to the government and not lower prices at the pump.

Do Rising Food Prices Add Up?

The news about rising food prices and the estimations you hear in the news have had me scratching my head. Here's something I wrote about the topic on my food blog. I suspect that the energy and exchange rate excuses, and the estimates at price growth, don't jive with what you see in the grocery stores, and I note how ADM's gross profit growth significantly outstrips its revenue growth.

Fuel Cell Vehicles - and Who Will Sell the Fuel?

I heard a story today concerning GM and a fuel cell vehicle with a supposed 300-mile range on a tank of fuel. That's good to hear, but with all the attention on designing the vehicles, I've seen relatively little about the issue of concept viability: fuel stations. A few years ago I remember sitting over lunch with a PR person from ChevronTexaco as we were killing some time before I was to interview CEO David O'Reilly. We got onto the topic of alternative fuels and how difficult it would be to make that work until some had set up distribution for those fuels.

You can design cars from now to the next decade, and it won't matter if you can't get the substances to run them. That's where the oil companies should be spending some of those large sums of cash that have been coming in - particularly as their capital expenses seem to have been dropping over the years. someone has to build the stations, create the new storage tanks - generate the fuel that will go into those tanks.

It would be a logical step. Oil companies aren't really in the "energy" business so much as they're in the twin industries of chemical refining and transportation of those materials. Moving to a new set of chemicals will require a lot of work and investment, but in the long run, what else are they going to do?