[OPE] Perhaps 60% of Today's Oil Price ...

glevy@pratt.edu

via Antonio Pagliarone.

PERHAPS 60% OF TODAY'S OIL

PRICE IS PURE SPECULATION 

By F. William Engdahl, 2
May 2008 

The price of crude oil today is not made
according to any traditional relation of supply to demand. It's controlled
by an elaborate financial market system as well as by the four major
Anglo-American oil companies. As much as 60% of today's crude oil price is
pure speculation driven by large trader banks and hedge funds. It has
nothing to do with the convenient myths of Peak Oil. It has to do with
control of oil and its price. How? 
First, the role of the
international oil exchanges in London and New York is crucial to the game.
Nymex in New York and the ICE Futures in London today control global
benchmark oil prices which in turn set most of the freely traded oil
cargo. They do so via oil futures contracts on two grades of crude
oil?West Texas Intermediate and North Sea Brent. 
A third rather new
oil exchange, the Dubai Mercantile Exchange (DME), trading Dubai crude, is
more or less a daughter of Nymex, with Nymex President, James Newsome,
sitting on the board of DME and most key personnel British or American
citizens. 
Brent is used in spot and long-term contracts to value as
much of crude oil produced in global oil markets each day. The Brent price
is published by a private oil industry publication, Platt's. Major oil
producers including Russia and Nigeria use Brent as a benchmark for
pricing the crude they produce. Brent is a key crude blend for the
European market and, to some extent, for Asia. 
WTI has historically
been more of a US crude oil basket. Not only is it used as the basis for
US-traded oil futures, but it's also a key benchmark for US production.

'The tail that wags the dog' 
All this is well and
official. But how today's oil prices are really determined is done by a
process so opaque only a handful of major oil trading banks such as
Goldman Sachs or Morgan Stanley have any idea who is buying and who
selling oil futures or derivative contracts that set physical oil prices
in this strange new world of "paper oil." 
With the
development of unregulated international derivatives trading in oil
futures over the past decade or more, the way has opened for the present
speculative bubble in oil prices. 
Since the advent of oil futures
trading and the two major London and New York oil futures contracts,
control of oil prices has left OPEC and gone to Wall Street. It is a
classic case of the "tail that wags the dog." 
A June 2006
US Senate Permanent Subcommittee on Investigations report on "The
Role of Market Speculation in rising oil and gas prices," noted,
".there is substantial evidence supporting the conclusion that the
large amount of speculation in the current market has significantly
increased prices." 
What the Senate committee staff documented
in the report was a gaping loophole in US Government regulation of oil
derivatives trading so huge a herd of elephants could walk through it.
That seems precisely what they have been doing in ramping oil prices
through the roof in recent months. 
The Senate report was ignored in
the media and in the Congress. 
The report pointed out that the
Commodity Futures Trading Trading Commission, a financial futures
regulator, had been mandated by Congress to ensure that prices on the
futures market reflect the laws of supply and demand rather than
manipulative practices or excessive speculation. The US Commodity Exchange
Act (CEA) states, "Excessive speculation in any commodity under
contracts of sale of such commodity for future delivery . . . causing
sudden or unreasonable fluctuations or unwarranted changes in the price of
such commodity, is an undue and unnecessary burden on interstate commerce
in such commodity." 
Further, the CEA directs the CFTC to
establish such trading limits "as the Commission finds are necessary
to diminish, eliminate, or prevent such burden." Where is the CFTC
now that we need such limits? 
They seem to have deliberately walked
away from their mandated oversight responsibilities in the world's most
important traded commodity, oil. 

Enron has the last
laugh. 
As that US Senate report noted: 
"Until recently,
US energy futures were traded exclusively on regulated exchanges within
the United States, like the NYMEX, which are subject to extensive
oversight by the CFTC, including ongoing monitoring to detect and prevent
price manipulation or fraud. In recent years, however, there has been a
tremendous growth in the trading of contracts that look and are structured
just like futures contracts, but which are traded on unregulated OTC
electronic markets. Because of their similarity to futures contracts they
are often called "futures look-alikes." 
The only practical
difference between futures look-alike contracts and futures contracts is
that the look-alikes are traded in unregulated markets whereas futures are
traded on regulated exchanges. The trading of energy commodities by large
firms on OTC electronic exchanges was exempted from CFTC oversight by a
provision inserted at the behest of Enron and other large energy traders
into the Commodity Futures Modernization Act of 2000 in the waning hours
of the 106th Congress. 
The impact on market oversight has been
substantial. NYMEX traders, for example, are required to keep records of
all trades and report large trades to the CFTC. These Large Trader
Reports, together with daily trading data providing price and volume
information, are the CFTC's primary tools to gauge the extent of
speculation in the markets and to detect, prevent, and prosecute price
manipulation. CFTC Chairman Reuben Jeffrey recently stated: "The
Commission's Large Trader information system is one of the cornerstones of
our surveillance program and enables detection of concentrated and
coordinated positions that might be used by  one or more traders to
attempt manipulation." 
In contrast to trades conducted on the
NYMEX, traders on unregulated OTC electronic exchanges are not required to
keep records or file Large Trader Reports with the CFTC, and these trades
are exempt from routine CFTC oversight. In contrast to trades conducted on
regulated futures exchanges, there is no limit on the number of contracts
a speculator may hold on an unregulated OTC electronic exchange, no
monitoring of trading by the exchange itself, and no reporting of the
amount of outstanding contracts ("open interest") at the end of
each day." 
Then, apparently to make sure the way was opened
really wide to potential market oil price manipulation, in January 2006,
the Bush Administration's CFTC permitted the Intercontinental Exchange
(ICE), the leading operator of electronic energy exchanges, to use its
trading terminals in the United States for the trading of US crude oil
futures on the ICE futures exchange in London - called "ICE
Futures." 
Previously, the ICE Futures exchange in London had
traded only in European energy commodities - Brent crude oil and United
Kingdom natural gas. As a United Kingdom futures market, the ICE Futures
exchange is regulated solely by the UK Financial Services Authority. In
1999, the London exchange obtained the CFTC's permission to install
computer terminals in the United States to permit traders in New York and
other US cities to trade European energy commodities through the ICE
exchange. 

The CFTC opens the door 
Then, in January 2006,
ICE Futures in London began trading a futures contract for West Texas
Intermediate (WTI) crude oil, a type of crude oil that is produced and
delivered in the United States. ICE Futures also notified the CFTC that it
would be permitting traders in the United States to use ICE terminals in
the United States to trade its new WTI contract on the ICE Futures London
exchange. ICE Futures as well allowed traders in the United States to
trade US gasoline and heating oil futures on the ICE Futures exchange in
London. 
Despite the use by US traders of trading terminals within
the United States to trade US oil, gasoline, and heating oil futures
contracts, the CFTC has until today refused to assert any jurisdiction
over the trading of these contracts. 
Persons within the United
States seeking to trade key US energy commodities - US crude oil,
gasoline, and heating oil futures - are able to avoid all US market
oversight or reporting requirements by routing their trades through the
ICE Futures exchange in London instead of the NYMEX in New York. 
Is
that not elegant? The US Government energy futures regulator, CFTC opened
the way to the present unregulated and highly opaque oil futures
speculation. It may just be coincidence that the present CEO of NYMEX,
James Newsome, who also sits on the Dubai Exchange, is a former chairman
of the US CFTC. In Washington doors revolve quite smoothly between private
and public posts.  
A glance at the price for Brent and WTI
futures prices since January 2006 indicates the remarkable correlation
between skyrocketing oil prices and the unregulated trade in ICE oil
futures in US markets. Keep in mind that ICE Futures in London is owned
and controlled by a USA company based in Atlanta Georgia. 
In January
2006 when the CFTC allowed the ICE Futures the gaping exception, oil
prices were trading in the range of $59-60 a barrel. Today some two years
later we see prices tapping $120 and trend upwards. This is not an OPEC
problem, it is a US Government regulatory problem of malign neglect. 
By not requiring the ICE to file daily reports of large trades of energy
commodities, it is not able to detect and deter price manipulation. As the
Senate report noted, "The CFTC's ability to detect and deter energy
price manipulation is suffering from critical information gaps, because
traders on OTC electronic exchanges and the London ICE Futures are
currently exempt from CFTC reporting requirements. Large trader reporting
is also essential to analyze the effect of speculation on energy
prices." 
The report added, "ICE's filings with the
Securities and Exchange Commission and other evidence indicate that its
over-the-counter electronic exchange performs a price discovery function
-- and thereby affects US energy prices -- in the cash market for the
energy commodities traded on that exchange." 

Hedge
Funds and Banks driving oil prices 
In the most recent sustained
run-up in energy prices, large financial institutions, hedge funds,
pension funds, and other investors have been pouring billions of dollars
into the energy commodities markets to try to take advantage of price
changes or hedge against them. Most of this additional investment has not
come from producers or consumers of these commodities, but from
speculators seeking to take advantage of these price changes. The CFTC
defines a speculator as a person who "does not produce or use the
commodity, but risks his or her own capital trading futures in that
commodity in hopes of making a profit on price changes." 
The
large purchases of crude oil futures contracts by speculators have, in
effect, created an additional demand for oil, driving up the price of oil
for future delivery in the same manner that additional demand for
contracts for the delivery of a physical barrel today drives up the price
for oil on the spot market. As far as the market is concerned, the demand
for a barrel of oil that results from the purchase of a futures contract
by a speculator is just as real as the demand for a barrel that results
from the purchase of a futures contract by a refiner or other user of
petroleum. 

Perhaps 60% of oil prices today pure speculation

Goldman Sachs and Morgan Stanley today are the two leading energy
trading firms in the United States. Citigroup and JP Morgan Chase are
major players and fund numerous hedge funds as well who speculate. 
In June 2006, oil traded in futures markets at some $60 a barrel and the
Senate investigation estimated that some $25 of that was due to pure
financial speculation. One analyst estimated in August 2005 that US oil
inventory levels suggested WTI crude prices should be around $25 a barrel,
and not $60. 
That would mean today that at least $50 to $60 or more
of today's $115 a barrel price is due to pure hedge fund and financial
institution speculation. However, given the unchanged equilibrium in
global oil supply and demand over recent months amid the explosive rise in
oil futures prices traded on Nymex and ICE exchanges in New York and
London it is more likely that as much as 60% of the today oil price is
pure speculation. No one knows officially except the tiny handful of
energy trading banks in New York and London and they certainly aren't
talking. 
By purchasing large numbers of futures contracts, and
thereby pushing up futures prices to even higher levels than current
prices, speculators have provided a financial incentive for oil companies
to buy even more oil and place it in storage. A refiner will purchase
extra oil today, even if it costs $115 per barrel, if the futures price is
even higher. 
As a result, over the past two years crude oil
inventories have been steadily growing, 
resulting in US crude oil
inventories that are now higher than at any time in the previous eight
years. The large influx of speculative investment into oil futures has led
to a situation where we have both high supplies of crude oil and high
crude oil prices. 
Compelling evidence also suggests that the
oft-cited geopolitical, economic, and natural factors do not explain the
recent rise in energy prices can be seen in the actual data on crude oil
supply and demand. Although demand has significantly increased over the
past few years, so have supplies. 
Over the past couple of years
global crude oil production has increased along with the increases in
demand; in fact, during this period global supplies have exceeded demand,
according to the US Department of Energy. The US Department of Energy's
Energy Information Administration (EIA) recently forecast that in the next
few years global surplus production capacity will continue to grow to
between 3 and 5 million barrels per day by 2010, thereby
"substantially thickening the surplus capacity cushion." 

Dollar and oil link 
A common speculation strategy amid a
declining USA economy and a falling US dollar is for speculators and
ordinary investment funds desperate for more profitable investments amid
the US securitization disaster, to take futures positions selling the
dollar "short" and oil "long." 
For huge US or EU
pension funds or banks desperate to get profits following the collapse in
earnings since August 2007 and the US real estate crisis, oil is one of
the best ways to get huge speculative gains. The backdrop that supports
the current oil price bubble is continued unrest in the Middle East, in
Sudan, in Venezuela and Pakistan and firm oil demand in China and most of
the world outside the US. Speculators trade on rumor, not fact. 
In
turn, once major oil companies and refiners in North America and EU
countries begin to hoard oil, supplies appear even tighter lending
background support to present prices. 
Because the over-the-counter
(OTC) and London ICE Futures energy markets are unregulated, there are no
precise or reliable figures as to the total dollar value of recent
spending on investments in energy commodities, but the estimates are
consistently in the range of tens of billions of dollars. 
The
increased speculative interest in commodities is also seen in the
increasing popularity of commodity index funds, which are funds whose
price is tied to the price of a basket of various commodity futures.
Goldman Sachs estimates that pension funds and mutual funds have invested
a total of approximately $85 billion in commodity index funds, and that
investments in its own index, the Goldman Sachs Commodity Index (GSCI),
has tripled over the past few years. Notable is the fact that the US
Treasury Secretary, Henry Paulson, is former Chairman of Goldman Sachs.

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