If you think chaos in Libya is the only force driving up gasoline and heating oil prices these days, think again. Over the past few decades, institutional investors like hedge funds and investment banks have flooded oil markets with hundreds of billions of dollars. That massive influx of money has gradually but steadily destabilized markets and inflated prices for petroleum products far beyond their real values (as determined by supply and demand). As the story unfolded, oil trader Dan Dicker had a front row seat: the floor of the New York Mercantile Exchange (NYMEX), where he worked as an oil trader for 25 years. He recently completed his book, Oil's Endless Bid: Taming the Unreliable Price of Oil to Secure Our Economy, the title of which traces back to his financial writings at TheStreet.com.
In an interview with CNBC last week, Dicker expressed his view that large financial interests crowding into oil markets is the main cause of unsteady and inflated oil prices in recent years.
On Wednesday, HeatingOil.com spoke to Dicker by phone and delved more deeply into his beliefs about today's oil market.
HeatingOil.com Managing Editor Josh Garrett: How long did you work as a trader at the NYMEX, and what kind of trading did you do there?
Dan Dicker: I worked on the floor at NYMEX as independent trader (known in the industry as a "local trader") for 25 years, from 1982 to 2006. As a local trader, I traded only on my own behalf, not for outside clients. In terms of products, I jumped around quite a bit, trading mostly gasoline contracts, but also some crude, some natural gas and of course heating oil.
JG: You've linked oil speculation to higher oil prices. How does that connection work?
DD: I don't like to use the term "speculation," as it's taken on a negative connotation that speculators are part of a conspiracy to drive up prices. Really, all speculators are created equal, but I like to call the parties I talk about in my book "financial influences." These financial influences like investment banks, hedge funds, and ETFs [exchange-traded funds] allow what I call "dumb money" to enter the oil markets. By dumb money I mean regular Americans' investments in pension funds or hedge funds that diversify into commodities. Those hedge funds, pension funds, and other financial influences brought an overwhelming flow of money into the market, and swamped out people who had connections to the physical products. Commodities markets need a matching number of buyers and sellers to mitigate risk and discover reasonable prices. The mountain of buyers brought into oil markets by financial influences makes a market and price that's out of control and busted.
JG: Was your observation of those financial influences flooding oil markets the origin of Oil's Endless Bid?
DD: Yes. All the things I knew controlling the oil market stopped controlling the oil market. What I saw changing was who controlled the paper [oil contracts], the growth of over-the-counter oil markets, and so on. You can see the rise of oil commodities as a financial investment in the 800 million ways to trade oil now. In 1983, around when I first stated trading, the NYMEX offered one crude oil contract, WTI [West Texas Intermediate]. Today the NYMEX offers around 75 derivatives of crude oil.
JG: How do you respond to common arguments against new oversight of oil trading--that there is no evidence that speculation by financial institutions drives up oil prices, and that new regulations could drive investors to foreign markets?
DD: I go into tremendous detail in the book (a product of two and a half years of research) and offer some compelling proof of how those investments do in fact drive up prices. But that's too complex to get into here, so I'll just say that it's very difficult to make a case that all this money moving into the market is not affecting prices. In terms of trade exporting overseas, it is a risk, but I think that argument takes a backward view of the situation. After the flood of money and financial industry interest in oil markets, what you come up with is an oil price that's unfair and hits businesses and consumers equally badly. That's a more important problem than losing some commodity investment to foreign markets with bigger loopholes in their trading rules. Also, despite the existence of foreign markets in Britain, in Dubai, the US is still the leader in all things financial.
JG: How do you think your former colleagues, like other traders and exchange employees, will react to the ideas you present in the book?
DD: There's a split. When the big money got into the game, it quickly pushed out independent traders. They're the dinosaurs of the industry--they don't really exist anymore. Those still engaged in oil markets--exchange owners like CME, big oil companies like Exxon, investment banks--they are going to be angry. I'm one of the few guys saying what's going on isn't good. I'm beating up on the market mechanisms that have been allowed to grow, to the benefit of financial interests. But those groups are saying the markets are perfect, because they're making money.
JG: So what made you stand up to those financial interests and express your opinion?
DD: I had a responsibility to tell a story that promotes a stable oil price. Until recently, oil prices discovered by commodities markets were, in quotation marks, "correct." The old way was to lock producers and buyers in a room, and what they arrived at was a reasonable price that reflected a product's value. The financial influences have made that impossible today. If a stock investor loses money, it's their fault. With oil, we don't have a choice--we are all leveraged to the price of crude, and we lose money every time we fill our gas tanks.
JG: Do you think that the proposed position limits under consideration by the Commodity Futures Trading Commission (CFTC) would effectively curb financial interests' influence on oil prices?
DD: No, the tools at the CFTC's disposal are not sufficient to address the problems in the oil market. They were originally required to present new rules at the end of February, and now it's clear that they won't even look at the idea of position limits until the first quarter of next year. I believe that the CFTC commissioners are honest people who know something is wrong, but they are buried by the financial interests trying to prevent new regulations.
JG: It's sort of a David and Goliath situation, where reform proponents and the CFTC are overpowered by the financial interests.
DD: Yes, if there were such thing as a double Goliath, they would be it. The financial arguments come from financial instrument guys who know the rules and know how to argue. Pro-regulation groups like those that represent heating oil dealers are a funny mélange of diverse interests that are hugely out funded by financial interests. I watch what's going on, and I feel bad. Those guys are getting the short end of the stick.
JG: If you were called to testify before the CFTC about oil markets, what would you say?
DD: The last chapters of the book are devoted to solutions that would have a real impact on markets. Position limits are just not there, they are just being considered because they are one of the tools at the disposal of the CFTC. The chances of my suggestions being used are between slim and none, and slim left town. That said, I would suggest returning pricing power to end users and producers. Making commodity-based ETFs and hedge funds illegal would be the first step. Separating physical traders out from financial interests would be difficult. The world's biggest oil trader is Morgan Stanley--they have tons of oil in storage and control oil transport companies, so it would be hard to tell which investors are physically based and which aren't. But taking some of the big money out of the market could help bring the mechanisms that drive the boom and bust cycles in oil markets under control.
JG: Is what's going on now with Middle East unrest driving up oil prices a boom time?
DD: Yes, I knew it was coming, but I didn't know when or how. I also didn't expect it to coincide with the release of the book. In the last three weeks, the long money on oil [bets that the price will rise] has responded to the psychological effects of a tiny supply issue. Next will be the bust, when the price of crude will drop $30 to $40 a barrel in the coming months.
JG: Do you have any advice for heating oil dealers and other businesses with interests in physical oil using the commodities market to hedge their risks?
DD: Unfortunately, they don't have much choice--they are almost forced to be part of this disaster just to support their businesses, and they are at the mercy of markets driven by the financial interests.
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