In truth, President Obama's recent move -- discussing proposals to limit speculation in the oil markets -- does hint at political rhetoric. There is an instant suspicion, and rightly so, when the president unveils measures to attack "high gas prices" in an election year and asks for congressional help he knows he's not going to get.
But, political posturing aside, Obama is not wrong: Oil speculation, in its many forms, has driven prices upward and away from the true supply-and-demand fundamentals that exist.
What's maddening to me, even discounting the political calculus of an electioneering president, is how fast the "defenses" of speculation reemerge whenever any help of new regulations are proposed. I had never thought my book on the topic, Oil's Endless Bid, would be the last word on the subject -- rather, I had assumed the conversation on the financial influences on oil would have progressed. It doesn't have seemed to have done so.
Indeed, from editorials on Bloomberg extolling the "positives" of rampant speculative activity, to the very tired memes proffered by the home of oil-futures trading, the Chicago Mercantile Exchange -- the idea that real risk is being reflected in prices -- we continue to argue the same stuff over and over. From my perspective, it is a continual effort to rage against the machine. No matter how hard or often I tell the real truth of how we arrive at oil prices, there appears an army of protectors of Wall Street profit machines ready to fight. So, again, I will quickly explain why the common arguments against speculative influences in oil, and those most often made, are inherently wrong.
First, remember: What drives speculation frenzy in any market is a story -- one that may even contain some kernels of fact, but can be hyped exponentially. In oil, there are many of these, but none really hold water.
1. High oil prices are reflecting real future supply risks.
For the moment, forget that the market is more than adequately supplied presently, that we are in fact swimming in oil, as borne out by recent statements by the Saudi oil minister Al-Naimi and by our own domestic export of finished products. But if in fact there are very real supply risks in the future, shouldn't the prices in the future be higher than what they are today? In a futures market, we can actually see what prices are expected to do in the future, unlike most other asset markets -- and, in oil, we are in backwardation. This means that, as time goes on, prices go down, and by a lot.
2. Speculation isn't to blame. It's the easy-money Fed, devaluing dollars in which oil is priced.
This one has some truth to it, but it is greatly overrated. We saw a $147-per-gallon peak oil price, for example, in 2008. That was before the world ever heard of quantitative easing, let alone Operation Twist and long-term refinancing operations and a dollar environment that's not particularly weak. Historically, some of the strongest years in oil inflation were in years of a rising dollar, and that was particularly so for 2005. In short, the dollar matters, but not nearly as much as does the money chasing the oil trade.
3. Speculators help smooth out volatility, and crushing them would make oil prices less reliable.
This one's too silly to even challenge. Before the explosion of "liquidity" from high-frequency algorithms, hedge fund programs, investment bank trade and institutional and retail investment, volatility was a fraction of what it is today. Believe me, I've been trading oil for 25 years. No one ever complained of a lack of liquidity before 2005, and everyone with a legitimate interest in real oil-hedging managed to get done whatever they needed to do. Oil also never moved $2 a day, which it does regularly now.
4. Attacking speculators is an attack of floor traders, just regular Joes trying to make a living.
Please, the game has moved so far past us by now. We've got nothing to do with what oil trade is about anymore, and we haven't had any influence (if we ever did) since about 2003. The oil game is overrun with investment-banking desks, hedge funders, long/short punters, algorithms, HFTs and private trade houses such as Vitol, Trafigura and Glencore. Also, yes, Virginia - fraud can happen. We've forgotten too quickly about such stellar examples as Enron and Amaranth.
These are not the guys that anyone should look to protect. They absolutely jack up the prices of oil that you and I are forced to pay at the pumps. But they are the beneficiaries of the continued defense of the oil market as it is today.
We haven't made much progress.
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