THE BLOG
11/14/2009 05:12 am ET Updated May 25, 2011

Chairman of Gazprom Predicts $100 Oil Because of Speculation. Speculation, Really?

This weekend, there was Alexei Miller, Chairman of Russia's major energy company, Gazprom, predicting that the price of oil would jump to $100 a barrel because of "speculation." Now there is a man who should know what he is talking about, or certainly what he shouldn't be talking about. And he should know when the fix is in. One little detail however. His language, one could surmise, is willfully misleading. "Speculation" should not be the operative word. Rather, "manipulation" would be more to the point.

"Speculation" is a form of gambling, a wager whereby you may win or lose. "Manipulation" is immeasurably more sinister. It bespeaks of controlling, orchestrating and maneuvering to falsify and rig. In the United States and most everywhere it is illegal to rig markets. When it is attempted either in the commodity or stock exchanges here, we have a plethora of agencies whose task it is to be alert to manipulation, and then to prosecute, imprison and fine. Not always successfully, but to be vigilant nonetheless.

The degree of vigilance varies greatly in international markets, and there is the rub. Oil is traded in markets throughout the world, from London to Singapore, to Dubai to Tokyo among other trading floors. And yet, through arbitrage positioning, they are all closely interrelated. In other words what happens in London and/or Dubai, the trade quoted price of oil is reflected almost simultaneously on prices quoted on the New York Mercantile Exchange with marginal variances according to grade and point of delivery. Thereby "orchestrating" the price of oil in one of the offshore trading exchanges plays back to impact the price of oil on the NY Merc.

With Natural Gas, on the other hand, you have an essentially domestic commodity trading on domestic exchanges. It is a commodity traded under the watchful scrutiny of a newly vigilant CFTC. And why bring up natural gas?

In an enlightening commentary by Donald Marron, a former member of the Council of Economic Advisers pointed out that:

"A barrel of oil has roughly 6 times the energy content of a MMBtu of natural gas. If the fuels were perfect substitutes, oil prices would tend to be about 6 times natural gas prices in practice. In practice the ease of using oil makes oil more valuable. As a result the price of gas is usually traded between 6 and 12 times the price of natural gas."

His commentary also informs us that the ratio of oil prices ($ per barrel) to natural gas prices ($ per million BTU) had hit a record multiplier of 24.5 times as of the date of his writing. Just about where it is today.

With the price of gas at under $3.00 per MMBtu the price of oil should be around $35/bbl with a generous multiplier of 12, and in all likelihood closer to the mid twenties with a historic average multiplier of 9 or less.

On April 27, 2009, in a post "Why Are We Paying $50 a Barrel For $20 Oil," some of these same issues were raised. Since that time the price of oil has increased by some 40%, while talking heads on TV and media analysts have been endlessly repeating the patently erroneous canard that the price of oil is directly tied to the erosion of the value of the dollar. Really? Since earlier this year the price of oil has jumped from $33/bbl to over $72/bbl, a jump of near 110%, while the dollar has eroded some 15%. Correlation? Perhaps, but minimal at best, and far from explaining the dramatic movement in the price of oil.

Then, when comparing the market landscape of oil to natural gas similarities abound. Production exceeds consumption in both commodities placing real physical constraints because storage of excess supply is difficult to find. Land storage terminals for oil is filled to the brim forcing the chartering of oil tankers to hold excess capacity, to the point that the contango play as a speculation (buying and storing oil at current prices, storing it in tankers for future delivery six months or a year down the road -- thereby tying up billions of dollars and taking millions of barrels off the current market adding immediate pressure to ever higher prices -- a favorite ploy of such bank holding companies as Morgan Stanley, JPMorgan Chase, Citigroup) is turning into a pure storage imperative.

But don't take my word for it. In July, Phillip Verleger, a business professor at the University of Calgary (Calgary I'm sure you know is the Houston of the Canadian oil industry), and a fellow at the Peterson Institute for International Economics, predicting $20/bbl oil to come, told CNBC:

"The $20 story is relatively simple... Oil was $31 in December, got up to $70 a few days ago. The price shouldn't have increased. We have a huge surplus on the world market even with the OPEC cuts. It's running a million and a half barrels a day. I've been following this since 1971. We have never had a stretch with such a large surplus."

Over the past years we have been inundated with media and oil industry and sadly, government propaganda under the Bush administration, that the ever-escalating price of oil was a true reflection of market conditions and free market forces. Only recently the CFTC has reversed itself and owned up to the fact that speculation played a key role in market pricing (please see "Wall Street Stampedes To The Aid of the Oil Speculators" 07.12.09). Are we now prepared to go the next step and attribute the otherwise unexplainable pricing of oil to manipulation!?

Certainly the members of the OPEC cartel together with Russia producing nearly 50% of the world's oil, have a keen interest in pushing markets ever higher and given the flood of billions that are being cashed in, have the means to move markets on the commodity exchanges.

Question: Is the CFTC, or for that matter the State Department, the Commerce Department or even the Treasury, doing anything to determine whether the commodity exchanges for oil outside the United States are being manipulated, by whom and/or under whose auspices? The current price for oil is irrational. It is an unauthorized and most likely illegal tax on the daily activities of all consumers, and needs be addressed.

There are those, because of environmental concerns, who cheer high oil prices and for good reason. Yet the way currently construed, those high and feasibly manipulated prices are a tax and transfer of wealth to oil interests and oil producing nations. There are certainly better ways to keep oil consumption down.