The Debate over Oil

Last week, the New York Times reported that the ability of oil to hover around the $50/barrel mark for the past several months may have had less to do with the ability of OPEC to put an effective floor on the price of oil (although Roger Diwan of PFC Energy did attribute at least some of the cause of oil's remarkable stickiness to this) and more to do with the return of speculators to the market.

Before I launch all the way into this post, I want to be clear that speculation in commodity markets has been a long standing fact of life. Everyone from oil producers to farmers growing soy beans to airlines to power companies have traded in futures as a way to hedge against price disruptions, whether demand or supply driven. Before 2000, however, commodities were almost always traded by producers and end users through official exchanges, such as NYMEX or the Chicago Mercantile Exchange (now technically defunct.) In 2000, Enron successfully lobbied Congress to remove the Commodities Future Trading Commission's (CFTC from hereon in)ability to regulate over the counter trades. CFTC's ability to regulate the commodities markets was further weakened by its 2006 decision to allow a consortium of oil and financial firms operating in London under the moniker of "Intercontinental Exchange" to open terminals in the US to trade commodity futures. (The CFTC had no regulatory authority over ICE since it was based in London.) Here's a good summary of the regulatory changes that opened the door for wider participation in commodity trading. Remember, all the arguments that apply to oil also apply to most other commodities, such as agriculture in many cases.

Railing against "speculation" (I'll define it hear as commodity trading that is undertaken by non-end users or producers, such as institutional investors and hedge funds to make things a bit easier) became a favorite rant of OPEC last summer even though it was widely dismissed by most analysts and even the IEA at one point. That is, until the CFTC woke up to something fishy going on and formally launched an investigation into market manipulation in commodity markets. That investigation is still pending.

Even if all of the trading was above board, as I blogged at Open Salon last week (here's a link to the full post), there is in my mind something fundamentally wrong about allowing non-end users to make tremendous amounts of money off of commodity markets. At the risk of being unsympathetic to those who took a bath in the market recently, there is a significant difference between the paper losses of equity investors and end consumers of crude oil and agriculture (i.e., all of us who eat and have to rely on transportation everyday.) Speculation in food and fuel drove families of all race, stripe, and economic levels into potentially disastrous economic circumstances.

This fact has not been lost on the powers that be. In Feb, the Senate referred the "Prevention of Excessive Speculation Act" to the Committee on Agriculture, Nutrition, and Forestry. The bill looks to restore some regulatory authority to the CFTC by essentially empowering the group to report on OTC trades. In March, UNCTAD issued a report that called for the end of excessive speculation in commodity markets citing the devastating consequences of the sharp rise in food and fuel prices last year. Finally, OPEC, in a joint statement with consuming countries in Asia, called for greater oversight in commodity markets to prevent the kind of surge in oil prices that the world witnessed last year.

Sounds good if it weren't for the Times article. Sure, oil prices aren't close to $150/barrel like they were last summer, but $50/barrel also doesn't seem to reflect market realities with demand down and inventories growing. What we need now, before we see another run up in prices, is transparency in the market. Who is trading and why. Until then, most of us are left to rely on the B.S. that passes as market analysis these days. Analysts with big banks and private advisory groups will go on about "market fundamentals" until the cows come home but none of it equates with what's really going on in the market these days. Until transparency happens, we can't be sure $50/barrel is anymore "fair" than $150.