oil speculation
Source Jim Devine
Date 12/04/12/15:34

The New York Times
The High Cost of Gambling on Oil

BOSTON--The drastic rise in the price of oil and gasoline is in part the
result of forces beyond our control: as high-growth countries like
China and India increase the demand for petroleum, the price will go

But there are factors contributing to the high price of oil that we
can do something about. Chief among them is the effect of “pure”
speculators — investors who buy and sell oil futures but never take
physical possession of actual barrels of oil. These middlemen add
little value and lots of cost as they bid up the price of oil in
pursuit of financial gain. They should be banned from the world’s
commodity exchanges, which could drive down the price of oil by as
much as 40 percent and the price of gasoline by as much as $1 a

Today, speculators dominate the trading of oil futures. According to
Congressional testimony by the commodities specialist Michael W.
Masters in 2009, the oil futures markets routinely trade more than one
billion barrels of oil per day. Given that the entire world produces
only around 85 million actual “wet” barrels a day, this means that
more than 90 percent of trading involves speculators’ exchanging
“paper” barrels with one another.

Because of speculation, today’s oil prices of about $100 a barrel have
become disconnected from the costs of extraction, which average $11 a
barrel worldwide. Pure speculators account for as much as 40 percent
of that high price, according to testimony that Rex Tillerson, the
chief executive of ExxonMobil, gave to Congress last year. That
estimate is bolstered by a recent report from the Federal Reserve Bank
of St. Louis.

Many economists contend that speculation on oil futures is a good
thing, because it increases liquidity and better distributes risk,
allowing refiners, producers, wholesalers and consumers (like
airlines) to “hedge” their positions more efficiently, protecting
themselves against unseen future shifts in the price of oil.

But it’s one thing to have a trading system in which oil industry
players place strategic bets on where prices will be months into the
future; it’s another thing to have a system in which hedge funds and
bankers pump billions of purely speculative dollars into commodity
exchanges, chasing a limited number of barrels and driving up the
price. The same concern explains why the United States government
placed limits on pure speculators in grain exchanges after repeated
manipulations of crop prices during the Great Depression.

The market for oil futures differs from the markets for other
commodities in the sheer size and scope of trading and in the impact
it has on a strategically important resource. There is a fundamental
difference between oil futures and, say, orange juice futures. If
orange juice gets too pricey (perhaps because of a speculative
bubble), we can easily switch to apple juice. The same does not hold
with oil. Higher oil prices act like a choke-chain on the economy,
dragging down profits for ordinary businesses and depressing

When I started buying and selling oil more than 30 years ago for my
nonprofit organization, speculation wasn’t a significant aspect of the
industry. But in 1991, just a few years after oil futures began
trading on the New York Mercantile Exchange, Goldman Sachs made an
argument to the Commodity Futures Trading Commission that Wall Street
dealers who put down big bets on oil should be considered legitimate
hedgers and granted an exemption from regulatory limits on their

The commission granted an exemption that ultimately allowed Goldman
Sachs to process billions of dollars in speculative oil trades. Other
exemptions followed. By 2008, eight investment banks accounted for 32
percent of the total oil futures market. According to a recent
analysis by McClatchy, only about 30 percent of oil futures traders
are actual oil industry participants.

Congress was jolted into action when it learned of the full extent of
Commodity Futures Trading Commission’s lax oversight. In the wake of
the economic crisis, the Dodd-Frank Wall Street reform law required
greater trading transparency and limited speculators who lacked a
legitimate business-hedging purpose to positions of no greater than 25
percent of the futures market.

This is an important step, but limiting speculators in the oil markets
doesn’t go far enough. Even with the restrictions currently in place,
those eight investment banks alone can severely inflate the price of
oil. Federal legislation should bar pure oil speculators entirely from
commodity exchanges in the United States. And the United States should
use its clout to get European and Asian markets to follow its lead,
chasing oil speculators from the world’s commodity markets.

Eliminating pure speculation on oil futures is a question of fairness.
The choice is between a world of hedge-fund traders who make enormous
amounts of money at the expense of people who need to drive their cars
and heat their homes, and a world where the fundamentals of life —
food, housing, health care, education and energy — remain affordable
for all.

Joseph P. Kennedy II, a former United States representative from
Massachusetts, is the founder, chairman and president of Citizens
Energy Corporation.

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