http://www.globalresearch.ca/index.php?context=va&aid=8878
May 14, 2008
‘Perhaps 60% of today’s oil price is pure speculation’
by F. William Engdahl
Global Research, May 2, 2008
The price of crude oil today is not made according to any traditional
relation of supply to demand. It’s controlled by an elaborate
financial market system as well as by the four major Anglo-American
oil companies. As much as 60% of today’s crude oil price is pure
speculation driven by large trader banks and hedge funds. It has
nothing to do with the convenient myths of Peak Oil. It has to do with
control of oil and its price. How?
First, the crucial role of the international oil exchanges in London
and New York is crucial to the game. Nymex in New York and the ICE
Futures in London today control global benchmark oil prices which in
turn set most of the freely traded oil cargo. They do so via oil
futures contracts on two grades of crude oil—West Texas Intermediate
and North Sea Brent.
A third rather new oil exchange, the Dubai Mercantile Exchange (DME),
trading Dubai crude, is more or less a daughter of Nymex, with Nymex
President, James Newsome, sitting on the board of DME and most key
personnel British or American citizens.
Brent is used in spot and long-term contracts to value as much of
crude oil produced in global oil markets each day. The Brent price is
published by a private oil industry publication, Platt’s. Major oil
producers including Russia and Nigeria use Brent as a benchmark for
pricing the crude they produce. Brent is a key crude blend for the
European market and, to some extent, for Asia.
WTI has historically been more of a US crude oil basket. Not only is
it used as the basis for US-traded oil futures, but it's also a key
benchmark for US production.
‘The tail that wags the dog’
All this is well and official. But how today’s oil prices are really
determined is done by a process so opaque only a handful of major oil
trading banks such as Goldman Sachs or Morgan Stanley have any idea
who is buying and who selling oil futures or derivative contracts that
set physical oil prices in this strange new world of “paper oil.”
With the development of unregulated international derivatives trading
in oil futures over the past decade or more, the way has opened for
the present speculative bubble in oil prices.
Since the advent of oil futures trading and the two major London and
New York oil futures contracts, control of oil prices has left OPEC
and gone to Wall Street. It is a classic case of the “tail that wags
the dog.”
A June 2006 US Senate Permanent Subcommittee on Investigations re****t
on “The Role of Market Speculation in rising oil and gas prices,”
noted, “…there is substantial evidence sup****ting the conclusion that
the large amount of speculation in the current market has
significantly increased prices.”
What the Senate committee staff documented in the re****t was a gaping
loophole in US Government regulation of oil derivatives trading so
huge a herd of elephants could walk through it. That seems precisely
what they have been doing in ramping oil prices through the roof in
recent months.
The Senate re****t was ignored in the media and in the Congress.
The re****t pointed out that the Commodity Futures Trading Trading
Commission, a financial futures regulator, had been mandated by
Congress to ensure that prices on the futures market reflect the laws
of supply and demand rather than manipulative practices or excessive
speculation. The US Commodity Exchange Act (CEA) states, “Excessive
speculation in any commodity under contracts of sale of such commodity
for future delivery . . . causing sudden or unreasonable fluctuations
or unwarranted changes in the price of such commodity, is an undue and
unnecessary burden on interstate commerce in such commodity.”
Further, the CEA directs the CFTC to establish such trading limits “as
the Commission finds are necessary to diminish, eliminate, or prevent
such burden.” Where is the CFTC now that we need such limits?
They seem to have deliberately walked away from their mandated
oversight responsibilities in the world’s most im****tant traded
commodity, oil.
Enron has the last laugh…
As that US Senate re****t noted:
“Until recently, US energy futures were traded exclusively on
regulated exchanges within the United States, like the NYMEX, which
are subject to extensive oversight by the CFTC, including ongoing
monitoring to detect and prevent price manipulation or fraud. In
recent years, however, there has been a tremendous growth in the
trading of contracts that look and are structured just like futures
contracts, but which are traded on unregulated OTC electronic markets.
Because of their similarity to futures contracts they are often called
“futures look-alikes.”
The only practical difference between futures look-alike contracts
and futures contracts is that the look-alikes are traded in
unregulated markets whereas futures are traded on regulated exchanges.
The trading of energy commodities by large firms on OTC electronic
exchanges was exempted from CFTC oversight by a provision inserted at
the behest of Enron and other large energy traders into the Commodity
Futures Modernization Act of 2000 in the waning hours of the 106th
Congress.
The impact on market oversight has been substantial. NYMEX
traders, for example, are required to keep records of all trades and
re****t large trades to the CFTC. These Large Trader Re****ts, together
with daily trading data providing price and volume information, are
the CFTC’s primary tools to gauge the extent of speculation in the
markets and to detect, prevent, and prosecute price manipulation. CFTC
Chairman Reuben Jeffrey recently stated: “The Commission’s Large
Trader information system is one of the cornerstones of our
surveillance program and enables detection of concentrated and
coordinated positions that might be used by one or more traders to
attempt manipulation.”
In contrast to trades conducted on the NYMEX, traders on
unregulated OTC electronic exchanges are not required to keep records
or file Large Trader Re****ts with the CFTC, and these trades are
exempt from routine CFTC oversight. In contrast to trades conducted on
regulated futures exchanges, there is no limit on the number of
contracts a speculator may hold on an unregulated OTC electronic
exchange, no monitoring of trading by the exchange itself, and no
re****ting of the amount of outstanding contracts (“open interest”) at
the end of each day.” 1
Then, apparently to make sure the way was opened really wide to
potential market oil price manipulation, in January 2006, the Bush
Administration’s CFTC permitted the Intercontinental Exchange (ICE),
the leading operator of electronic energy exchanges, to use its
trading terminals in the United States for the trading of US crude oil
futures on the ICE futures exchange in London – called “ICE Futures.”
Previously, the ICE Futures exchange in London had traded only in
European energy commodities – Brent crude oil and United Kingdom
natural gas. As a United Kingdom futures market, the ICE Futures
exchange is regulated solely by the UK Financial Services Authority.
In 1999, the London exchange obtained the CFTC’s permission to install
computer terminals in the United States to permit traders in New York
and other US cities to trade European energy commodities through the
ICE exchange.
The CFTC opens the door
Then, in January 2006, ICE Futures in London began trading a futures
contract for West Texas Intermediate (WTI) crude oil, a type of crude
oil that is produced and delivered in the United States. ICE Futures
also notified the CFTC that it would be permitting traders in the
United States to use ICE terminals in the United States to trade its
new WTI contract on the ICE Futures London exchange. ICE Futures as
well allowed traders in the United States to trade US gasoline and
heating oil futures on the ICE Futures exchange in London.
Despite the use by US traders of trading terminals within the United
States to trade US oil, gasoline, and heating oil futures contracts,
the CFTC has until today refused to assert any jurisdiction over the
trading of these contracts.
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 re****ting 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 Wa****ngton 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.
By not requiring the ICE to file daily re****ts of large trades of
energy commodities, it is not able to detect and deter price
manipulation. As the Senate re****t noted, “The CFTC's ability to
detect and deter energy price manipulation is suffering from critical
information gaps, because traders on OTC electronic exchanges and the
London ICE Futures are currently exempt from CFTC re****ting
requirements. Large trader re****ting is also essential to analyze the
effect of speculation on energy prices.”
The re****t added, “ICE's filings with the Securities and Exchange
Commission and other evidence indicate that its over-the-counter
electronic exchange performs a price discovery function -- and thereby
affects US energy prices -- in the cash market for the energy
commodities traded on that exchange.”
Hedge Funds and Banks driving oil prices
In the most recent sustained run-up in energy prices, large financial
institutions, hedge funds, pension funds, and other investors have
been pouring billions of dollars into the energy commodities markets
to try to take advantage of price changes or hedge against them. Most
of this additional investment has not come from producers or consumers
of these commodities, but from speculators seeking to take advantage
of these price changes. The CFTC defines a speculator as a person who
“does not produce or use the commodity, but risks his or her own
capital trading futures in that commodity in hopes of making a profit
on price changes.”
The large purchases of crude oil futures contracts by speculators
have, in effect, created an additional demand for oil, driving up the
price of oil for future delivery in the same manner that additional
demand for contracts for the delivery of a physical barrel today
drives up the price for oil on the spot market. As far as the market
is concerned, the demand for a barrel of oil that results from the
purchase of a futures contract by a speculator is just as real as the
demand for a barrel that results from the purchase of a futures
contract by a refiner or other user of petroleum.
Perhaps 60% of oil prices today pure speculation
Goldman Sachs and Morgan Stanley today are the two leading energy
trading firms in the United States. Citigroup and JP Morgan Chase are
major players and fund numerous hedge funds as well who speculate.
In June 2006, oil traded in futures markets at some $60 a barrel and
the Senate investigation estimated that some $25 of that was due to
pure financial speculation. One analyst estimated in August 2005 that
US oil inventory levels suggested WTI crude prices should be around
$25 a barrel, and not $60.
That would mean today that at least $50 to $60 or more of today’s $115
a barrel price is due to pure hedge fund and financial institution
speculation. However, given the unchanged equilibrium in global oil
supply and demand over recent months amid the explosive rise in oil
futures prices traded on Nymex and ICE exchanges in New York and
London it is more likely that as much as 60% of the today oil price is
pure speculation. No one knows officially except the tiny handful of
energy trading banks in New York and London and they certainly aren’t
talking.
By purchasing large numbers of futures contracts, and thereby pu****ng
up futures prices to even higher levels than current prices,
speculators have provided a financial incentive for oil companies to
buy even more oil and place it in storage. A refiner will purchase
extra oil today, even if it costs $115 per barrel, if the futures
price is even higher.
As a result, over the past two years crude oil inventories have been
steadily growing, resulting in US crude oil inventories that are now
higher than at any time in the previous eight years. The large influx
of speculative investment into oil futures has led to a situation
where we have both high supplies of crude oil and high crude oil
prices.
Compelling evidence also suggests that the oft-cited geopolitical,
economic, and natural factors do not explain the recent rise in energy
prices can be seen in the actual data on crude oil supply and demand.
Although demand has significantly increased over the past few years,
so have supplies.
Over the past couple of years global crude oil production has
increased along with the increases in demand; in fact, during this
period global supplies have exceeded demand, according to the US
Department of Energy. The US Department of Energy’s Energy Information
Administration (EIA) recently forecast that in the next few years
global surplus production capacity will continue to grow to between 3
and 5 million barrels per day by 2010, thereby “substantially
thickening the surplus capacity cu****on.”
Dollar and oil link
A common speculation strategy amid a declining USA economy and a
falling US dollar is for speculators and ordinary investment funds
desperate for more profitable investments amid the US securitization
disaster, to take futures positions selling the dollar “short” and oil
“long.”
For huge US or EU pension funds or banks desperate to get profits
following the collapse in earnings since August 2007 and the US real
estate crisis, oil is one of the best ways to get huge speculative
gains. The backdrop that sup****ts the current oil price bubble is
continued unrest in the Middle East, in Sudan, in Venezuela and
Pakistan and firm oil demand in China and most of the world outside
the US. Speculators trade on rumor, not fact.
In turn, once major oil companies and refiners in North America and EU
countries begin to hoard oil, supplies appear even tighter lending
background sup****t to present prices.
Because the over-the-counter (OTC) and London ICE Futures energy
markets are unregulated, there are no precise or reliable figures as
to the total dollar value of recent spending on investments in energy
commodities, but the estimates are consistently in the range of tens
of billions of dollars.
The increased speculative interest in commodities is also seen in the
increasing popularity of commodity index funds, which are funds whose
price is tied to the price of a basket of various commodity futures.
Goldman Sachs estimates that pension funds and mutual funds have
invested a total of approximately $85 billion in commodity index
funds, and that investments in its own index, the Goldman Sachs
Commodity Index (GSCI), has tripled over the past few years. Notable
is the fact that the US Treasury Secretary, Henry Paulson, is former
Chairman of Goldman Sachs.
F. William Engdahl is an Associate of the Centre for Research on
Globalization (CRG) and author of A Century of War: Anglo-American Oil
Politics and the New World Order. He may be contacted at
info@[EMAIL PROTECTED]
United States Senate Premanent Subcommittee on Investigations, 109th
Congress 2nd Session, The Role of Market speculation in Rising Oil and
Gas Prices: A Need to Put the Cop Back on the Beat; Staff Re****t,
prepared by the Permanent Subcommittee on Investigations of the
Committee on Homeland Security and Governmental Affairs, United States
Senate, Wa****ngton D.C., June 27, 2006. p. 3.
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