The following article is an interesting explanation of speculation in the oil markets. It appears that US regulation drove most of these investors off-shore (doing the oil speculation that Americans won't do) to London where we cannot control any of their activities.
Driving the practice offshore was obviously an unintended consequence of regulation. The US government wanted more control over speculation so they regulated it and drove it to the UK where the US government could not control it at all.
With 5% margins a few speculators can have a huge impact on the futures market. A million dollar investment gets you 20 million in oil futures. A million dollars of oil futures is 7500 barrels of oil at $135/barrel. With that in mind, $58,050,000 could buy 10% of all the oil produced in the entire world on a given day. There are a lot of people or entities that can move $60 million on a regular basis.
Low margins mean there is huge potential to manipulate the market by a small number of speculators on a given day. And these low margins increases the probability of another artificial bubble that will eventually burst and cause another financial or investment crisis! The last institutional investors holding oil futures could get crushed when the bubble eventually bursts. This would lead to yet another financial crisis for the economy with demands on the US government for another bailout!
The price of the futures contracts get bid up and up over time and eventually bear no relationship to the actual cost of extracting the actual oil. It becomes a huge ponzi scheme where getting in and out at the right time makes you very wealthy. Messing up costs you a lot of money but it costs the world another financial crisis.
Dick Morris' Political Insider
Oil Prices Looming Over Election
Wednesday, June 18, 2008 8:09 AM
By: Dick Morris & Eileen McGann
Gas prices are the first important issue in the 2008 elections. But both parties have been pathetic in their solutions and, one suspects, in their understanding of what is going on.
Fadel Gheit, managing director of oil and gas research for Oppenheimer and Co. and Jim Norman, author of the book "The Oil Card," coming out next month, say that speculation is responsible for a huge part of the run-up in prices.
The growing demand for oil by India and China and the instability of oil supplies certainly account for much of the increase. But the recent spike, they say, is equally due to the weakness of the dollar and massive speculation.
They argue that oil prices are, indeed, determined by supply and demand — not only the supply and demand for oil, but also the supply and demand for oil futures. (Oil futures are a commitment to buy 1,000 barrels of oil at a certain date at a certain price.)
Formerly, most of the investments in oil futures came from energy companies. The federal Commodities Futures Trading Commission (CFTC) sharply limited investments by those outside the business, to prevent precisely the kind of speculation now gripping the market.
But when the stock market slowed down in 2000–2002, outside investors decided to speculate in oil futures. The new players were institutional investors like corporate and government pension funds, sovereign wealth funds, university endowments and other investors, guided by brokerage firms like Morgan, Stanley, and Goldman, Sachs.
To avoid the CFTC caps, these investors moved their operations to London, setting up the International Commodities Exchange (ICE). Now, they can buy all the oil futures they want.
Michael W. Masters, of Masters Capital Management, told Congress that the volume of investment in commodities futures soared from $13 billion at the end of 2003 to $260 billion in March of 2008.
After a while, the CFTC rescinded its limits on how much speculators could buy as long as they went through special “swap” desks at the major brokerage houses.
You can buy oil futures for only 5 percent down on margin, a bargain considering the 50 percent margin requirement for stock market equity investments. Because the margin requirement on oil futures rises as the due date approaches, few investors actually end up buying the oil, they just roll over their investments.
So the willingness of sellers to unload their oil futures and buyers to acquire them sets up its own market of supply and demand which has more to do with determining the actual price of oil than even the global demand and supply for the product itself.
Masters told Congress, on May 20 of this year: “commodities futures prices are the benchmark for the prices of actual physical commodities, so when index speculators drive futures prices higher, the effects are felt immediately in spot prices and the real economy. So there is a direct link between commodities futures prices and the prices your constituents are paying for essential goods.”
Gheit and Norman suggest that the CFTC regulate the domestic oil futures market (NYMEX) and the participation of U.S. companies in the ICE, restoring the caps on the amount of oil futures speculators can buy. Gheit also urges raising margin requirements for them.
Both worry that the oil futures bubble is going to burst and cost a lot of investors — particularly pension funds who channel their investments through the swap desks of the brokerage houses. We don’t need another subprime or S&L crisis on our hands right now.
The Senate recently tried to force CFTC regulation of all commodities speculators but the bill was loaded down with a windfall profits tax so the Republicans killed it.
McCain needs to get with this program. In his town hall meeting in New York City last Thursday night, he attacked speculators for driving up oil prices but didn’t propose remedies or really explain the problem. Americans will pay close attention if he does. For McCain this is the issue and now is the time to use it.
© 2008 Newsmax. All rights reserved.
Link:
http://www.newsmax.com/morris/oil_price ... 05469.html
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