THE BLOG

Speculators Drive Pain at the Gas Pump

04/15/2011 10:36 am ET | Updated Jun 15, 2011

In February the news headlines blared "Gasoline pump prices hit a 28-month high." The February high has been exceeded in the past two months. Congress and the Obama Administration worry that the surge will drive down consumer spending, dampen business investment and hiring, further weaken housing sales, plunge the dollar, and pummel stocks which have been roaring the past few months.

The standard reasons for the relentless oil price leap is war in Libya, unrest in Bahrain and potentially Saudi Arabia, political instability in Nigeria and Venezuela, and the perennial jitter that global oil supplies are fast running out. They're all wrong. Oil and gas prices jumped during most of the 30 month period when there was no turmoil in Egypt, war in Libya, political instability in other oil producing countries, proven world oil reserves grew, and demand for oil and gas products remained weak.

Speculators drove the prices up, reaped phenomenal profits, gamed the public on the real reason for the price rise, and stymied efforts to toughen regulations to rein in their activities. Speculators buy and sell oil future contracts, better known as derivatives. The value of the oil futures derivative is based on nothing more than the value of the barrel of oil bought. The buyer essentially bets that the oil will hit the purchase price at a future point in time. By pouring billions into such futures, speculators are in a powerful position to manipulate the upward price of the oil.

The bulk of oil futures are bought and sold on the New York Mercantile Exchange in the US and the Intercontinental Exchange in Europe. The Exchange was set up in 2000 by a consortium of oil companies and financial institutions solely to trade European oil futures. The Commodities Futures Trading Corporation which regulates commodities trades gave a major gift to US oil futures traders when it allowed them to buy futures derivatives on the Exchange. The Commission has no regulatory jurisdiction over Exchange oil future trades. NYMEX and the Exchange (ICE) are the virtual unchallenged price-setting mechanisms for oil. OPEC references NYMEX when it sets its price targets.

The impact of oil speculation is hardly a secret in the political and investment world. Goldman Sachs, which has pushed the oil futures envelope the hardest the past decade, issues regular reports that regularly tell how lucrative oil future derivatives have been and continue to be in their estimates and projection of trades. Goldman flatly noted in a research note in March that every million barrels of oil held by speculators contributed an 8 to 10 cent rise in the oil price. As unrest spread in North Africa and the Middle East, Goldman further noted that investors increased their purchases and positions in oil futures to the tune of almost 100 million barrels of oil between mid-February and late March. This is in addition to their already hefty oil futures holdings.

Goldman's estimates and data from the Commodity Futures Trading Commission put the financial bottom line for the total speculative premium in U.S. crude oil at over twenty-five dollars a barrel, or about a fifth of the overall price of oil. But even this estimate may be too low. Global Research, an international energy and environmental organization, puts the cost of oil speculation at nearly 60 percent of the price of oil. In other words, a barrel of oil that sells for $100 should sell for only $40. The difference in the actual production price and sell price is due purely to speculative profit.

In June 2008, then Democratic presidential candidate Barack Obama slammed oil speculation and pledged to close the loophole that allow oil futures to be traded in unregulated markets. About one-third of all U.S. oil futures trading are unregulated. Obama also called for legislation to give CFTC, the Federal Trade Commission and the Department of Justice full power to investigate price manipulation in the oil market, and to boost the regulatory power of the CFTC over oil futures trading. That hasn't happened.

The Dodd-Frank Bill passed last July does give the Securities and Exchange Commission and the CTFC more power to regulate hedge funds, municipal advisers and over-the-counter derivatives trading. But other than propose and debate a handful of proposals on information gathering, and setting a uniform set of rules on energy commodities trading, the Commission has done little to rein in speculation. Commission officials say they're hampered by staff and budget freezes, and outmoded technology.

But even if the CTFC launched a full blown investigation into the futures contract price rigging and had total power to end it, it would not happen. Oil speculators will simply increase trades on the Intercontinental Exchange which the Commission has no authority to regulate. Meanwhile the profits from oil speculation continue to soar and the prospect is that motorists will pay the price for oil speculation riches with more pain at the pump.

Earl Ofari Hutchinson is an author and political analyst. He hosts a national Capitol Hill broadcast radio talk show on KTYM Radio Los Angeles and WFAX Radio Washington D.C. streamed on The Hutchinson Report Newsmaker Hour on blogtalkradio.com and wfax.com and internet TV broadcast on thehutchinsonreportnews.com