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.
Follow Raymond J. Learsy on Twitter: www.twitter.com/raymondLearsy
I do concede the price is pushed higher at times due to a new crop of neophyte buyers' desks that are quite vulnerable to current events. The components known as Media noise-du-jour and geopolitical fear premium can add as much as $34/barrel for short durations. But eventually price finds equilibrium.
Barrrel Meter charts: http://trendlines.ca/free/peakoil/BarrelMeter/BarrelMeter.htm
Thought your post was very interesting and informative.
"Imagine that Joe Shmoe and Harriet Who, neither of whom has any direct involvement in the production of oil, make a bet: Joe says oil is going to $150, Harriet says it won’t. What direct effect does this have on the spot price of oil — the actual price people pay to have a barrel of black gunk delivered?
The answer, surely, is none. Who cares what bets people not involved in buying or selling the stuff make? And if there are 10 million Joe Shmoes, it still doesn’t make any difference.
Well, a futures contract is a bet about the future price. It has no, zero, nada direct effect on the spot price. And that’s true no matter how many Joe Shmoes there are, that is, no matter how big the positions are.
Any effect on the spot market has to be indirect: someone who actually has oil to sell decides to sell a futures contract to Joe Shmoe, and holds oil off the market so he can honor that contract when it comes due; this is worth doing if the futures price is sufficiently above the current price to more than make up for the storage and interest costs."
"Volatility is one of those words that has been allowed to become a "trigger term" for "bad". Bad for whom? If prices of a commodity are "volatile", it means that potential for profit is higher risk, and that the price might go down, causing profits to "evaporate" (the original meaning of the word from which financial markets have derived their term).
If prices for oil are at an all time high, wouldn't a little "volatility" actually mean that without the speculation, the prices would drop? In the absence of any real threat to supply, it would seem so.
So, isn't Mr. Levine, the broker quoted in the Reuter's article, actually saying (which would have been a much more honest attribution than to reference it as "CNBC says", as though that was the conclusion of their article) that the way speculation is "stabilizing" the market is to keep prices "consistent" - consistently high, that is?
I'd be OK with a 20% "volatility drop" in the price of oil, whouldn't you?
They need a good long swim out in the ocean for a few months.
I wonder if you have thought of this political implication: Mr. Obama was a senator from Chicago and so necessarily represents the plutocrats that run the Chicago exchanges. For that reason, I don't trust most reforms the current administration proposes. In fact, I'd bet in the long run both the CME and CBOT will be well protected.
Also: the argument about natural gas speculation generalizing to oil speculation is utterly bogus for lots of reasons. The sources and markets as you have noted are different, And I'd add especially so with "fracking" increasing natural gas supply (besides destroying part of the environment). Besides, speculators have controlled natural gas in the past and may well again in the future.
Just by charging speculators $10M fines, won't do enough. Jail is more harsh!!
The GOP blames Obama for high gasoline prices, yet they want to abolish all the agencies that fight speculation. It's no wonder. The Koch Brothers fund both the GOP and the Tea Party. The more you pay for gasoline, the more money the GOP receives. If you are tired of high gas prices, fire the GOP.