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Gas Prices Could Be Cut In Half In 30 Days If Excessive Oil Speculation Ended

The Senate heard testimony today from hedge funds managers and oil experts who said that prices at the pump could drop by 50% in 30 days if oil speculators could be brought under control. Margins should be raised from 6% to 50% in order to reduce leverage and postion limits would be necessary.

NEW YORK (CNNMoney.com) -- Near-record oil prices could quickly fall by half if Congress were to rein in speculators, according to testimony Monday from a hedge fund manager and oil company adviser on Capitol Hill. Michael Masters, of Masters Capital Management, told a subcommittee of the House Energy and Commerce Committee that - with greater regulation - oil prices could drop to $65 or $70 a barrel within about 30 days. "That's half of where prices are today, and gas prices would reflect that," he said. Roger Diwan, an adviser to oil companies at Washington, D.C.-based PFC Energy, agreed that regulation could lead to a drop in prices. He said it would take no more than 30 days for speculation in the oil market to decrease and gas prices to fall. With more regulation, "prices will reflect closer the marginal cost of producing oil," Diwan said.

The oil experts were in agreement that the ICE exchange which is unregulated by the Commodity Futures Trading Commission should come under its purview even though it's based in London and the CFTC agreed to let it be regulated by the UK. However, this has led to very lax regulation which experts feel has contributed to excessive speculation and the run-up in oil prices. It should be subject to the same regulation that the NYMEX exercises which limits the positions of speculators. Some suggested that those speculating in paper oil should be eliminated altogether and only physical hedgers (those who are actual producers or consumers of oil) should be allowed. Those speculating in paper oil have no intention of ever taking delivery.

A couple of the myths about what's driving up gas prices can be laid to rest. One is that the depreciation of the dollar is causing gas prices to rise. This is, if you think about it, ridiculous. Speculators are driving up the price of oil and they could care less if the value of the dollar is rising or falling. All they care about is making a profit for their hedge fund. If the dollar was rising instead of falling, they could be making an even larger profit by driving up the price of oil through buying and selling future contracts. Does it somehow make it more understandable and acceptable for gas prices to have doubled in the last year because hedge fund and sovereign wealth fund managers have to have a way of making up for the dollar's decline. So they wouldn't be speculating in oil and making a profit if the dollar hadn't declined? I think they'd be in the business of making money regardless of what the dollar was doing. Using the rationale that it's alright to drive the American consumer to the wall because the dollar has declined is patently absurd.

By the same token the rise in demand from China and India has not been 100% in the last year. The increase in demand has been more gradual than that and does not account for the dramatic increase in the price of oil. Then I've heard speculation defended on the grounds that it provides a legitimate function of "price discovery." Price discovery is the price that futures contracts for oil are traded on the last day of trading or, in other words, when the future becomes the present. All the producers of oil say, "Oh, I guess that's what we should sell our oil for," that is the oil not under contract which represents the "spot" market. So the price of oil on the spot market is set by the price of the futures market on the last day of trading. But why is this so? Why shouldn't it instead be set by the supply and demand fundamentals as it is, for example, on the spot market for bushels of wheat and other farm products. And those holding future contracts would then either make or lose money depending on market fundamentals. In the oil market the tail is wagging the dog! The answer is that the price was never set by market fundamentals of supply and demand but by the OPEC cartel, and they found it convenient for their own reasons just to "set" the price of oil on the spot market to the price of the futures contracts on the last trading day. For the market to work in accordance with the laws of supply and demand, 1) futures contracts would have to be a small percentage of the total market and 2) the spot market would have to be set by supply and demand and not the OPEC cartel or the future contracts.

Since futures contracts dominate the oil market, the spot market is set by them and not the reverse as is the case in the commodities market for farm products. This is because speculative money has not invaded the commodities market for pork bellies or bushels of wheat, and there is no cartel in these markets.

In a scramble to find a fix for energy prices, Congress has tried (and failed) to strip tax breaks from Big Oil, to open protected sites for exploration and drilling, and to jump-start a new era in nuclear power. Now, Capitol Hill is zeroing in on speculators and the legal loopholes that some lawmakers say are adding as much as $70 to the price of a barrel of oil. "Energy speculation has become a fine growth industry and it is time for the government to intervene," said House Energy and Commerce Committee Chairman John Dingell (D) of Michigan, at hearing on Monday. Fixes in the works on Capitol Hill range from new constraints on speculators – including a 50 percent margin requirement on financial speculators, full disclosure of all trading by investment banks in all markets, and prohibiting investment banks from holding energy assets – to more funding and regulatory mandates for the Commodity Futures Trading Commission. Financial speculators – that is, hedge funds, investment banks, and other traders who do not take physical possession of the commodities – are surging into commodities markets. On that point, there is no dispute.

Will any meaningful legislation reigning in speculators ever get through Congress and get signed into law? Don't hold your breath during the Bush administration's remaining days. Meanwhile, the American people will continue to suffer every time they fill up their gas tank. Republicans continue to float straw men as the reasons that oil is so high and blame it on the Democrats. Their contention that drilling in ANWR will bring down gas prices is ridiculous although they continue to sell it to the American people. First the oil companies would only drill in ANWR when it suited them and not tomorrow even if the government gave them the leases today. The oil companies have leases and drilling rites galore in the US and they are not rushing out to increase supply by drilling in them. In addition they even have already drilled and capped wells. All they would have to do is take the caps off and start pumping, but they choose not to do so. Instead they go on a campaign to gain even more leasing rights (in ANWR) so they can exploit them in the future at a time of their own choosing when profits would be higher.

Meaningful legislation to regulate oil speculators could cut prices at the pump in half within 30 days according to the experts, but this was not even considered newsworthy enough to be reported on the evening news on CBS, NBC or PBS. I didn't check NBC. With Republicans filibustering any meaningful legislation and Bush vetoing anything getting through that, nothing will be done to lower gas prices until a Democratic administration takes over and maybe not even then unless the Democrats have a filibuster proof Senate.

Gas Prices: Speculators Have Cornered Market. It's That Simple.

Due to the Enron loophole, which deregulated the commodities exchanges in 2000, first Enron was able to bilk California energy consumers for a couple years and now large commodity speculators are able to bilk the entire world's consumers at the gas pump, and, in addition, at the grocery store. Although much has been said about the need to reregulate the market, (the Farm Bill on Bush's desk contains a provision to eliminate the Enron loophole), it may not be so easy to do so since commodity exchanges are in the process of moving offshore out of the reach of congressional legislators. Therefore, the world's consumers might just suffer the ultimate effect of globalization: paying outrageous prices for basic necessities in order to enrich the very few.

At one time when futures contracts were limited to farming, they served a rational purpose: they guranteed the farmer a certain price for his product regardless of market conditions. It worked like this. Say a farmer was prepared to plant and harvest 10,000 bushels of wheat. He would calculate his costs, figure in a profit and, for example, conclude that he would need to get $3.50 a bushel to make it worth his while to even get out of bed in the morning and plant his crop. So he would sell a future contract to someone to deliver 10,000 bushels of wheat at $3.50 a bushel on a certain date, say three months in the future after his crop was harvested. Now if the market price at that time was $3.00 a bushel, the farmer would still get $3.50, and he would be happy. If the market price was $4.00, the farmer would not be quite as happy, but he still would get his $3.50 making his efforts worthwhile if not quite as profitable as they would have been had he taken his chances in the marketplace.

A further refinement would allow the farmer to get the market price if the market had risen but still get the contract price if the market had fallen. When the farmer sold his contract for 10,000 bushels of wheat at $3.50 a bushel, he would purchase an option contract to buy 10,000 bushels of wheat at $3.50 a bushel. Then if the price in three months had fallen, he would let the option expire and be satisfied with $3.50 a bushel. If, on the other hand, the price had risen to $4.00 a bushel, the farmer would exercise his option to buy 10,000 bushels at $3.50, use those bushels to fulfill his contract to sell 10,000 bushels at $3.50 a bushel and sell the 10,000 bushels he himself had produced on the spot market at $4.00 a bushel thus picking up an additional $.50 a bushel.

All this was well and good when it applied to farming, but soon other commodities such as oil and metals started to be traded on the commodities exchanges. Now no one thinks that the oil producers are so economically marginal that they need to lock in a contract in the future to deliver so many barrels of oil. It's just ridiculous, but the futures market for oil works the same way as it does for farm products. A producer will sign a futures contract to sell so many barrels of light sweet crude, for example, at some date in the future. The buyer puts up some money, typically 6% of the contract price, and he owns the oil as of that future date. As that date gets closer, naturally, the price gets bid up since the original buyer of the contract tied up his money for a period of time; think of the interest he might have gotten had he invested otherwise. Since the buyer buys the oil on margin, he can control a lot of barrels of oil by putting up only a relatively small amount of capital or, in other words, he has a lot of leverage. Oil speculators or investors have no intention of taking delivery of the oil they have purchased at some future date. Instead they sell the contract to another investor (making a profit, supposedly), and that investor sells to another etc. until finally someone sells the contract to an actual consumer of oil. That would be the oil company who then refines it and sells it to consumers at the gas station.

WASHINGTON, DC, June 20 -- Citing the harmful impacts record high crude oil prices are having on consumers, US Rep. Bart Stupak (D-Mich.) introduced a bill to close regulatory loopholes that he said have allowed commodity speculators to push oil prices upward and profit from the increase. ... Stupak and Inslee both said that recently soaring crude oil prices reminded them of dramatic increases in Western US wholesale electricity prices in 2001 that were later traced to manipulation by traders at Enron Corp. "I've seen this bad movie before. It's the Enron movie, which hit the West Coast power markets like a bomb because the federal government was asleep at the switch. It has happened again with oil prices," Inslee said. Numbers back this up Stupak said that while Treasury Sec. Henry M. Paulson and the CFTC won't acknowledge that excessive speculation is part of the high oil price problem, others from the International Monetary Fund to Saudi Arabia's oil minister have said that it is. "The numbers back this up: Between Sept. 30, 2003, and May 6, 2008, contracts held by traders jumped from 714,000 to more than 3 million, a 425% increase. Since 2003, commodity index speculation has increased 1,900% from an estimated $13 billion to $260 billion invested," the House member said. He said CFTC data show that in 2000, physical hedges that airlines and other businesses use to ensure a stable price for fuel in coming months and actually imply delivery, accounted for an estimated 63% of the total futures market, while speculators represented about 37%. "By April 2008, physical hedgers only controlled 29% and speculators had taken over a whopping 71% of the oil futures market," Stupak said. He said 85% of the futures purchases tied to commodity index speculation comes through swap dealers—investment banks that serve as intermediaries for their pension fund and sovereign wealth fund customers. One report found that $55 billion of total worldwide commodity trading over 55 days came in as swaps, according to Stupak. "The CFTC has allowed 117 exceptions to swaps. When that many exceptions are allowed, they are not really subject to oversight. We have a CFTC that's supposed to be doing its job. I'm not certain that it is," he said. ... Inslee said many energy commodity trades take place beyond the CFTC's oversight. "If you don't have transparency, you have excessive speculation. We learned from Enron that if you don't have transparency, you have the potential for manipulation," he said. Asked if he still intends to press his legislation if crude oil prices start to drop, Stupak said that he does. "We have not spent 3 years looking at this not to. Rep. Inslee and I were here for the Enron debacle and we're tired of seeing it happen. There's clearly a bubble here that's about to burst. This bill will do more to make it happen than anything the Chinese government could do," he said, referring to China's announcement the previous day that it would raise domestic fuel prices by as much as 18%.

Although much has been written about the need to raise the margins on futures contracts (currently 6% in the commodities market compared with 50% in the stock market) and to limit the amount large scale investors such as hedge funds can invest, no one it seems quite understands how the process that has caused oil to increase by 100% in two years works. No one disputes the fact that, as oil has gone from $60. a barrel to $130. a barrel in two years, gas has gone from roughly $2.00 a gallon to $4.00 a gallon . That's a direct correlation. But what are the mechanisms by which world commodity prices have risen so drastically. The answer is actually very simple: cornering the market. If one entity or several entities working independently but along the same lines own all or a large percentage of a necessary resource, they can set the price at will. In particular if a few very large scale investors such as hedge funds own, say, 90% of the oil futures contracts, they will be able to set the price of oil instead of the price being set by the laws of supply and demand just taking into account producers and consumers. Commodity speculators are middle men who deal in "paper oil." They have no intention of taking delivery of oil. They just buy and sell contracts for oil. Now perhaps I should say quasi-cornering of the market since unlike the Hunt brothers who almost cornered the market for silver in 1979 or the hedge fund Amaranth which attempted to corner the market in natural gas in 2007, the oil market is not being cornered by one individual or entity but by several entites working quasi-independently. There does not necessarily need be any overt collusion among them as they all know what effect they're trying to achieve so they can work in concert without "manipulating" the market, without colluding, but the ultimate effect is the same. Anyway, it's not a question of market manipulation, but what is legal versus illegal manipulation. Whatever is legal that will maximize profits will be done whether someone considers it manipulation or not.

The "spot" market for oil is the market for physical oil as it exists today; that is, if you were going to go out and buy some today. The futures market for oil is the market for contracts for oil to be delivered sometime in the future. Since demand for oil is only going to rise, speculators can take long positions knowing they can't lose. The demand for oil is not going to go down what with the growing demands of the Indian and Chinese markets. After several rounds of buying and selling oil contracts, the price of oil gets bid up, and, because of the large number of contracts involved representing a huge volume of oil, the spot market price, instead of being set by the law of physical supply and demand, actually gets set by the price of future contracts on the last day of trading. The experts will tell you that the futures price and the spot market price will converge and this is how the price of physical oil is determined. However, whether the convergence is upward to the futures price or downward to the spot price never gets mentioned. I contend that the spot market price is being set by the futures price and, therefore, speculators are determining that price and not the law of supply and demand for physical oil. Rather price is being determined by the law of supply and demand for future contracts. If oil were sold directly by the producers to the consumers, then the OPEC cartel would be setting the price, but, since it's being sold by the holders of futures contracts, then they determine the price especially if they've quasi-cornered the market, that is, if most of the oil has been bought up by speculators. If, on the other hand, the amount of oil held in future contracts is relatively small compared to the total amount available for sale, then the price of oil would be determined by the OPEC cartel who would set the price for oil on the spot market. So OPEC has lost control of the price setting mechanism, and prices are being set by the value of a futures contract on the last day of trading. And for this scenario to be valid, demand need only be increasing slowly and gradually not rapidly.

Now consider what would happen if demand were  to decrease. Then all available oil on any given day would not be sold. The price of oil on the spot market would come down, and those holding oil purchased on futures contracts at a higher price would be left holding the barrel, so to speak. If oil is bid up by multiple rounds of trading on the futures market and then demand slackens, the speculators would lose money. They'd be holding contracts they couldn't sell at the price they paid for them. But this will never happen as long as demand is increasing even slightly so they can effectively set the price wherever they want and, because of inelastic and increasing demand, get it. The combination of huge amounts of money invading the commodities market and rising demand for physical oil, food and other commodities is what's causing the price of these necessities to skyrocket. It's not rocket science to figure out why demand is rising. The world's population will have gone from 6 billion to 7 billion in just a few short years. As world population rises, globalization has led to the fact that nation states no longer have regulatory control over markets so that from a world perspective markets are effectively deregulated leading to large investor ability to set prices at exhorbitant levels in order to extract as much as possible financially from the world's population who need to eat and drive to work. The antidote to this malady, of course, is decentralized solar energy production, the last thing that large energy corporations want to happen. They want whatever form of energy production that is encouraged or subsidized to be one that is centralized so that they can meter, price and control it as well as trading it on the commodities markets which would lead to the same situation we're in today even if the entire world's energy needs were obtained through solar and not non-renewable resources such as oil, coal and natural gas.

Decentralized solar energy production by installing and subsidizing solar panels on each citizen's house rooftop and car rooftop will take energy production out of the hands of large corporations and commodities speculators. The same can be said for localized food production. Not only is it ecologically more copacetic to buy at farmer's markets because food need not be transported over huge distances, but is sold directly from producer to consumer, and, therefore, cannot be commodified and traded on the commodities market. It just makes sense that prices will be lower. In the meantime far wiser people than I have suggested that the commodities markets need to be reregulated so that large futures contracts can be limited so they can't dominate the market, and margin requirements need to be increased in order to decrease the leverage speculators now enjoy. The Commodity Futures Trading Commission is attempting to crack down on speculators but it just might be a case of too little too late. Like most government agencies under the Bush administration, the CFTC has been underfunded and staffed with personnel whose mission is to represent the interests of those they are supposed to regulate.

Persons within the United States seeking to trade key US energy commodities – US crude oil, gasoline, and heating oil futures – are able to avoid all US market oversight or reporting requirements by routing their trades through the ICE Futures exchange in London instead of the NYMEX in New York. Is that not elegant? The US Government energy futures regulator, CFTC opened the way to the present unregulated and highly opaque oil futures speculation. It may just be coincidence that the present CEO of NYMEX, James Newsome, who also sits on the Dubai Exchange, is a former chairman of the US CFTC. In Washington doors revolve quite smoothly between private and public posts.  A glance at the price for Brent and WTI futures prices since January 2006 indicates the remarkable correlation between skyrocketing oil prices and the unregulated trade in ICE oil futures in US markets. Keep in mind that ICE Futures in London is owned and controlled by a USA company based in Atlanta Georgia.  In January 2006 when the CFTC allowed the ICE Futures the gaping exception, oil prices were trading in the range of $59-60 a barrel. Today some two years later we see prices tapping $120 and trend upwards. This is not an OPEC problem, it is a US Government regulatory problem of malign neglect.

So the doubling of price of gas at the pump in the last two years is directly correlated with the inflow of money into oil futures by hedge funds. Hmmm. It doesn't take a rocket scientist ...

The Coming Depression: Capitalism Devours Itself

Compared to the Great Depression of the 1930s, the next one will be a Mega Depression brought on by escalating oil prices, resource shortages including water in California, the decreasing value of the dollar, lowered property values and increasing foreclosures and national US deficits and debts as far as the eye can see. Instead of investing in its people and infrastructure, the US has chosen the course of policing the world and spending its money on the largest miltary industrial complex the world has ever seen. At the same time, it's borrowing by the billions every day in order to keep taxes low (fiscal responsibility has been totally disconnected from reality and thrown to the wind). The debate should be about how to be fiscally responsible, not about raising or lowering taxes. Instead massive debt keeps lowering the value of the dollar and hedge funds have arbitraged the price of oil against the dollar. As the dollar goes lower, the price of oil gets bid up. Commodification of resources drives prices higher so that (as always) the poor of the world are affected first. Just as in a sinking ship, steerage (where the poorest people are) fills first, then the next level affected is the lower middle class, then the middle middle class and so on with the very rich usually being able to bail out in lifeboats as they did during the "Great" Depression. The rich never missed a meal. Only the lower classes were affected. If you're worth a billion dollars and you lose 90% of your money you still have 100 million. You can live on that very nicely.

Actually the Great Depression was sort of a joke compared to the reality facing us today. The only thing that really happened was that the stock market went kerfluie. So what!  All that means is that the investor class has lost some of its money. What does that have to do with the real economy? Of course, I'll grant you there was also high unemployment. That really hurt poor people, but not the middle class so much. Farmers weren't hurt, and there were a lot of small independent farmers in those days. There was a yeomanry unlike today where practically everyone is dependent on the system to a large extent. Small farmers during the Great Depression (as well as before and after) could feed themselves since on a typical dairy farm they also had chickens and hogs as well as extensive vegetable gardens. Vegetables were canned for the winter months. Hogs, cows and chickens were butchered for meat and dairy farms had milk and cheese in abundance.  The people that were hurting were basically unlanded surplus labor, factory workers whose factories were shut down. The yeomanry did just fine. Today there is no longer a yeomanry except for small businessmen and tradesmen like electricians and plumbers. The professional class - teachers, doctors and lawyers - again had no problems during the Great Depression. They still worked. Schools were not shut down. Local and state governments (unlike today) were not in financial trouble. They continued to function.

Today its a different story. There are no small farmers. Global warming has made the US one big disaster city. Every day we hear of a new disaster, Katrina only being the largest example. The Federal government, according to its philosophy of not doing anything to help the average person, deliberately let the Katrina victims suffer. They deliberately let the environment suffer, and they deliberately have gutted the Pure Food and Drug Administration letting poisonous foods and drugs, both domestic and imported, proliferate. The Federal government under the Republicans has opened the doors for corporations to prey on the middle class while undermining every Federal agency that's supposed to protect them. Politicians suck up to lobbyists and then go through the revolving door to become lobbyists themselves and make millions. Lobbyists write the legislation. Senators and Congresspersons don't even have time to read it before it's voted upon, and the political thieves insert earmarks at the last minute. A  drug benefit for seniors turns into a giveaway to the pharmaceutical industry and a further bankrupting force to the Federal government. Remember that during the Great Depression the Federal government was not bankrupt. Today it is owing some $10 trillion in national debt which again is driving down the value of the dollar. Capitalism is sinking without a shot being fired except against some other poor people who are no major threat to us. All the while we're throwing away $12 billion a month in Iraq while being told we're winning. If we're winning, why is the monthly outlay not diminishing? I'll believe we're winning when we're only spending $6 billion a month in Iraq, then $3 billion the next month, then nothing. But they want to occupy Iraq permanently, and now they're trying to get the Iraqi government to agree to let the US build some 50 military bases there without any accountability for American contractors and military personnel.

The Great Depression was largely due to the financialization of the economy at that time which allowed banks to operate in an unregulated manner. The Glass-Steagall Act of 1932 put a firewall between commercial and investment  banking which was eliminated by the Gramm-Leach-Bliley Act of 1999 thus allowing the financial sector to again run amok. The result was the sub-prime mortgage crisis which continues rolling along unlike the stock market internet bubble of 2000. Stock market bubbles usually burst at some point but the commodity market speculation bubble may continue to expand indefinitely due to rising demand and diminishing supply of oil. The mortgage, gas and food crises, unlike what happens in the stock market, affect real people in real ways. Commodities speculators can be sure that demands in these sectors will continue to grow so how can they go wrong in bidding up commodity prices. Unlike losses in the stock market which affect the rich investor class and increasingly average people who have traded defined benefit pensions for 401k's, losses in housing values, run-ups in adjustable rate mortgages and rising food prices affect the poor and middle class. Rising unemployment and Republican unwillingness to extend unemployment benefits increase the desperation and pain felt by those losing their homes, cars and boats. Even the rich are realizing that living the rich lifestyle and not putting anything away for a rainy day was not such a good idea especially when they can no longer afford to keep it up like Ed McMahon who has become the Gary Coleman of the 21st century.

Hopefully, Barack Obama will be able to create jobs by subsidizing the solar industry and incentivizing homeowners to put solar panels on their roofs as they've done in Germany thus decentralizing ownership of energy producing assets. To pay for these subsidies and incentives though, he'll have to take money away from the $500 billion spent annually on the American war machine. Of course, no politician will talk of the trade-off between new social programs and funding the war machine. They want to talk in terms of reducing benefits for social security or some other social program, but the real trade-off has to be solar instead of the war machine in order to maintain fiscal responsibility. Boo hoo, Republicans who love their war machine and have made a killing off it (no pun intended).

This would be the sensible course, but will anything get through the Filibusters-R-Us Senate. I don't think so. Rude awakening, America! The Republicans will still hold the cards and call the shots via the filibuster mechanism, and no one thinks there will be a filibuster proof Senate. That would require 60 Democrats and not all of them are reliable since they're in the pockets of the same lobbyists and large corporations as the Republicans. So massive frustration as Obama squirms and the US continues on the same insane path of massive deficits (both budget and trade), massive spending on the military-industrial complex while stingily spending next to nothing on the welfare of its people and the devaluation of the dollar leading to increased costs of imports from China and the Middle East who increasingly have the  upper and controlling hand. As Europe raises interest rates, the US will be forced to too in order to defend the dollar which is like trying to defend the Maginot line after the Germans invaded France. Too little, too late. And Bush talks of a "slowdown." Yeah, like the Great Depression was a slowdown. Only this is 10 times worse just as the folly of the Iraq War was 10 times worse than the folly of Vietnam. The only bigger folly was World War I. World War II, at least, had a legitimate purpose - to stop a madman - but it was brought on by - some think it was a continuation of - WW I.

So did I leave anything out?

US inflation soars on rise in energy costs By James Politi and Chris Bryant in Washington, Joe Leahy in Mumbai and Chris Flood in London Published: June 13 2008 14:15 | Last updated: June 13 2008 18:53