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.