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President Obama Speaks and the Oil Speculators React

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Last week President Obama gave the nation a briefing from the White House on the perils of speculation and the potential for abuse in oil futures trading contributing to the distortion of oil prices and in turn the high price for gasoline we are paying at the pump. Though short on specifics the president did call for increasing penalties, both civil and criminal, for market manipulation and significantly increasing the budget of the oversight agencies such as the Commodity Futures Trading Commission (CFTC) so as to "crack down on illegal activity and hold accountable those who manipulate the market for private gain at the expense of millions of working families."

Promptly of course, as if on cue, from their headquarters in Chicago's Loop, the prodigious exchange operator, the CME Group, the largest in the country comprising the Chicago Mercantile Exchange (CME), the Chicago Board of Trade (CBOT) the New York Mercantile Exchange (NYMerc-where oil futures contracts are traded), and the Commodity Exchange, Inc. (Comex), called the president's plan "misplaced."

Wall Street, in the mantle of a Citigroup head of commodities research, would immediately opine, according to CNBC's dutifully entitled "Obama's Plan Could Increase Price Swings" (4.20.12), quotes, "The attack on speculation is an attack on better functioning markets. If there were not liquidity in the futures market ... the chances are overwhelming that price volatility would be greater."

Clearly there's no knowledge nor appreciation here of the sage words uttered before the Senate Committee on Government Affairs as long ago as November 1st 1990 by Leon Hess, the founder and Chairman of Hess Oil: "I'm an old man but I'd bet my life if the Merc (New York Mercantile Exchange) was not in operation there would be ample oil at reasonable prices all over the world without this volatility." Clearly some words of wisdom only become wiser with time.

Consider the distortion the futures markets brings to oil trading. In 2011 the average daily volume on the NYMerc was just under 190,000 contracts per day, shooting up to an all-time high of 311,000 during the Libyan cutoff in February/March 2011, when prices rose to a yearly peak of $110.55/bbl for West Texas Intermediate (WTI).

Each futures contract is for 1,000 barrels of oil. At 190,000 contracts/day that represents 190,000,000 barrels of oil traded daily on the New York Merc alone, not to speak of the exchanges in London, Singapore, Dubai, Hong Kong and on who cumulatively far exceed trading on the NYMerc. Now the daily consumption worldwide of actual 'wet barrels' of crude oil is some 85 million barrels/day. One would be hard pressed to present a coherent economic justification for the enormous difference between the vast number of derivative, or 'paper barrels,' traded on the exchanges vs. the number of 'wet' barrels actually shipped and consumed.

Then, as if preprogrammed, in the very same week the CFTC announced a "milestone victory" in its first major case against algorithmic oil trading and the biggest financial penalty involving manipulation in the oil futures markets. The CFTC alleged that the Dutch firm Optivers's Chicago office attempted to move U.S. crude, gasoline, and heating oil prices by executing large volume trades during the final moments of trading as the exchanges settled their end of trading day prices. The court decreed that Optiver was to pay $14 million, $1 million in disgorged profits and $13 million in fines.

"Those who seek to manipulate oil or other commodity markets should know we aren't messing around," Bart Chilton, certainly the most attuned CFTC Commissioner, was quoted as saying. Yes, but this case dates back to 2007, and in its being shows how sclerotic the process is and how ineffectual oversight has become in the tsunami of commodity trading of oil and oil products worldwide. Where there is no cop on the beat, anything goes, and with an ineffectual cop, most anything. As if to assuage the trading community in the face of this "milestone" victory, and seemingly forever responsive to the relentless lobbying by such as the commodity exchanges, the bank holding companies, the CFTC in their inimical fashion of their oversight mandate monitoring derivatives trading last week significantly narrowed the range of companies that were to be subject to strict requirements and heightened supervision.

Frequently the current price of natural gas at under $2.00 mmbtu, trading at 10-year lows, is given as proof positive of the effectiveness of the commodity markets.

Or, as CNBC quoted, "that while politicians had been quick to criticize speculators in oil, they've been quiet about speculators in the natural gas market, who have been betting on lower gas prices since at least June 2009, according data from the CFTC."

Perhaps, but as currently traded on the U.S. exchanges, natural gas is exclusively sourced in the United States without the interface of such collusionary price distortions as those orchestrated by OPEC, nor the opaque trading over commodity exchanges worldwide, open to all manner of influences. Natural gas, as traded today on U.S. exchanges, is a uniquely isolated American commodity and any attempt at influencing its price, overt or otherwise, would fall under the purview of the nation's anti-trust laws and its stated prohibitions to all manner of collusion. Ergo the cop on the beat goes well beyond the lame CFTC, but in this instance also includes the Justice Department and the Federal Trade Commission. In other words, enough firepower to make sure the playing field remains an honest playing field and a true reflection of supply and demand. In effect the price of natural gas as traded here serves as a beacon to the enormous distortion in the traded price of crude oil.