Oil Prices

The Federal Reserve has pumped trillions into the financial system at the taxpayer's potential expense and all the taxpayer has received in return, so far are, higher oil prices. The increase in oil prices over the last few months has been almost entirely due to speculation. You hear the argument that oil prices have been increasing because it appears that the recession is ending and increased business activity will require more energy. However, oil prices for light sweet crude for July 09 delivery are currently over $70 per barrel. There is no one who believes that the economy will turn around and be in high gear within a month. Buyers of oil are currently renting unused oil tankers to store oil. Given that there is currently about 4.5 million bbls per day of capacity that is not being used, oil prices should be going down rather than up. The current situation with oil reminds me of the silver market in 1979 when the Hunt brothers bid up the price of futures contracts for silver expecting to create a shortage and then cashing in when they sold the silver at the higher prices. Now that liquidity is available, hedge funds and pension funds are again speculating on the price of oil.

When Congress enacted the Commodity Exchange Act of 1936, they did so with the understanding that speculators should not be allowed to dominate the commodities futures markets. Unfortunately, the US Commodity Futures Trading Commission (CFTC) has taken deliberate steps to allow certain speculators virtually unlimited access to the commodities futures markets through the use of swaps contracts. In 2007, hedge funds and other speculative investors were responsible for one-third of all trades on the Intercontinental Exchange, a key market for setting oil prices, up from 0.2 per cent of trades in 2002. Currently, the margin requirements are less than 5% on the purchase of an oil futures contract. Commodity futures were originally intended to be used by users of the commodity such as air lines who would lock in future fuel prices to enable planning by buying an oil futures contract.

Another argument for the increase in the price of oil is the weakening dollar since international oil prices are expressed in US dollars (USD). Over the last 6 months, the USD has slid against the Euro by about 10% while short term oil prices have increased by about 100%. Based on these facts, I'd estimate that about $31 per bbl of the current oil price is due to speculation.

Some market analysts have argued against enforcing the anti-speculative requirements of the Commodity Exchange Act stating that the speculative investors are absorbing risk from the system in that if the price of oil goes down that the speculators will take the loss. Let's see, the US government lends money to the investment banks and the investment banks lend that money to commodity speculators who bid up the price of futures contracts with a leverage ratio of over 20 to 1 at a 5% margin requirement (they buy $20 of oil futures for each $1 they borrow from the investment bank). As far as the argument that the speculators will absorb all of the losses if the energy price collapses, the reality is that if the energy prices collapse that the speculators will not be able to repay the loans from the investment banks who may then return to the US government for additional capital. The taxpayer ultimately will pay for any losses on commodities while the speculators will pocket the gains. The taxpayer actually loses twice in that we are paying higher prices now for energy.

The swaps loop hole must be closed at the CFTC.