Should Congress investigate why oil is nearing $70 in a recession?
Is it time for the U.S. Congress to systematically investigate the oil futures market? Market absolutists cry no, but an oil price pushing $70 per barrel amid the worst U.S. recession since 1982, the first global recession since World War II, and 10-year-high inventory levels argue otherwise.
After hitting a record high of $147.27 per barrel during the leverage-fed investment and trading frenzy of 2008, the price of oil collapsed with the onset of the U.S. recession and then the implosion of the financial crisis, the latter of which took numerous hedge fund and investment fund oil futures buyers out of the market. Prices plummeted to a low around $35 in December 2008.
Historically, $30 is a high price for oil
Further, it's significant to note that although crude's price collapsed, $35 is still, in historical terms, a strong price for oil, which has averaged $25-30 per barrel, in current dollars, over the past 150 years.
Moreover, many experts expected oil's price to recover only slowly in 2009. U.S. gasoline demand declined for much of the past 12 months, on a weekly basis. Emerging market demand growth -- a major factor in oil's price rise during 2003-2007 -- was low, and the world was set to record its second consecutive decline in global oil demand. But the incremental rise in oil's price did not occur: instead, the price of oil skyrocketed in the past six weeks, essentially doubling in a very short period of time, in macroeconomic terms.
Oil bulls say the oil futures market, like the stock market, is merely pricing in likely oil demand conditions six to nine months out: investors and traders sense a bottoming recession in the U.S. and better economic conditions internationally, and its implied rising global oil demand, and are pushing up oil's price accordingly. Under this thesis, a $70 (or higher) price is justified given likely, future economic conditions.
However, oil industry analysts, among others, are increasingly citing investment funds as the primary reason for the rise.
"It's the funds that are pushing the market higher," Jonathan Kornafel, director for Asia at options trader Hudson Capital Energy in Singapore, told Bloomberg News Friday. "When everyone reads the same report and comes to the same conclusion, then you're going to have the market moving in one direction. The general trend is for the dollar to get weaker and for crude to get stronger."
Or, in other words, some, if not many institutional investors are buying oil futures as an alternative asset – a perfectly normal deployment of capital in free markets, and one that's largely innocuous (except for the speculator or the hedger) if you're investing in oat futures or cotton, so says economist Peter Dawson. However, if the asset is the world's most important commodity - one on which the developed world's, and now much of the developing world's - economy hinges, depending on its price – the deployment of capital could become a concern, particularly if it is concentrated, Dawson told DailyFinance. At least in theory, a sector-wide concentration of institutional investors could 'artificially boost' the price of a commodity well above what supply and demand would typically dictate – in effect grossly distorting its price.
"No conspiracy or collusion need occur. Just concentration," Dawson said. "Concentration is enough to cause a price bubble, and the U.S. housing sector is an example of that. There was no 'conspiracy' to cause U.S. median home prices to rise to dizzying heights, but rise they did, and a bubble formed, due to the concentration of players, in housing's case, a lot of buyers due to the availability of subprime loans."
Tail wagging the dog?
Dawson said he wants price discovery to continue in markets, particularly in oil, "but what could be occurring now is not price discovery, but 'pack mentality.' " The U.S. Congress, Dawson said, should begin a formal, long-term study on the relationship between the rise in futures trading and oil's price, "and systematically research whether the ten of thousands of new oil futures players have led to higher prices than they would have been, under similar supply/demand conditions, with these players absent."
The oil market today - if prices don't moderate in the coming months - also "is capable of exhibiting characteristics that border on 'The Twilight Zone,' " Dawson added.
"The problem with the futures activity is that it's pushed prices up so high that, if a $60-70 price holds, it will further dampen consumer spending and crimp corporate budgets to the point that the economic recovery will be hurt," Dawson said. "And if that's the case, the futures activity will have the affect of eliminating the very economic recovery that prompted the oil futures buying in the first place. And when you think about it, that type of market behavior is just absurd and irrational, from an economic development standpoint."
Economic Analysis: Oil has quickly vaulted to levels few thought possible, given the inventory glut and tepid demand. The weaker dollar has played a role, but the dollar is down roughly 10-15 percent during oil's leap to near $70 – hardly enough to explain the price surge. Like economist Dawson, the view from here argues Congress should research the relationship between the number of oil futures players and oil's price.
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Reader Comments (Page 1 of 1)
6-07-2009 @ 10:58PM
baziz1 said...
Congress should impose a Special Capital Gains Tax on speculators who drive up oil and other vital commodities prices. Preferably a capital gains of 50 to 60% would be essential to send these speculators back to trading equity stocks and stock options contracts. Let them speculatte and drive up stock prices. If they want to trade vital commodities, make them pay steep taxes on their profits.
In the past decade their have been many brokerages pushing commodity and currency trading on to the masses. They have spent millions to train and educate avagerage individuals to trade options, futures, and currencies. Millions have been trained and educated by these companies and they have opened accounts with these brokerage firms that allow small investors to trade options, futures and currencies.
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6-07-2009 @ 11:37PM
Justin White said...
LOL, does anyone really think "Big Oil" cares what Congress does? Big Oil doesnt answer to anyone. Their greed for money is above all and no matter what the price, sheeple will buy it! Wishful thinking, but its a waste of time!
Russel Stover
www.Absolute-Anonymity.com
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6-08-2009 @ 2:34AM
Ali A said...
Crude Oil is a commodity, people use it as an indicator of inflation as they do with copper, gold, silver, coffee, iron ore etc. This article does not take this into account.... The federal reserve is printing money African style so your 5 cent candy at 7/11 is now valued at 10 cents and it is not because the ingredients changed. The enemy isn't traders and investors, the problem with the high price is the governments actions on battling a crisis. The solution to boosting market values and the economy is through artificially creating new money, devaluing our current money.... inflation. Supply and demand for oil do not matter when the value of the dollar is sinking. Look at the chart of the dollar vs Crude oil. They move in opposite direction. So the question is not if Congress should investigate the oil price...the question should be Should Congress stop spending money it doesn't have resulting in money printing which devalues our savings.
Please do more research
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6-09-2009 @ 8:16AM
Sinopec English Class (from Beijing) said...
The Chinese government should cooperate with the United States to investigate this, too! We are the two biggest buyers of crude oil in the world. Call it the G2 Summit on Oil.
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6-08-2009 @ 9:53AM
Master Burns said...
You gotta check this out, it's called an Electronic Cigarette
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6-08-2009 @ 10:00AM
F.P. said...
This is easy. Force speculators to take delivery of whatever they are buying.
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6-08-2009 @ 4:48PM
paxos said...
This is exactly why "outside" speculators can not game the price. On the settlement date of the contract, you must either deliver or accept delivery. Hence, the settled price is the true market price. Speculators are not artificially raising the price.
Supply is fading globally. Read up on "Peak Oil" and "Oil Depletion". Wikipedia.org is good first step.
6-08-2009 @ 12:09PM
Jeremiah said...
This article brings a much-needed sober perspective to the price of oil in the last few months. I liken the oil traders (traitors) to drug addicts: they will do and say absolutely anything to justify and rationalize their addiction, no matter how much their arguments may fly in the face of reality.
I've read that there's almost no supertanker capacity left to transport oil because they're all being used to hold oil off-shore, creating an artificial supply drag. There is a record amount of oil inventory available if you include all these off-shore sources, which simply cannot be sustained. A major oil glut is inevitable when the transportation capacity comes to a halt. This attempt to artificially reduce supply is further exacerbated by commodity traders who want to run the price up as much as possible before finally releasing it to refineries. As the article so correctly states, the price of oil these days has almost nothing to do with supply and demand, and everything to do with traders/investors piling on the oil bandwagon to get a slice of those greasy pie profits.
Yes, there absolutely needs to be some regulation on oil trading so that it can't be artificially inflated by greedy investors. Making the traders actually take delivery of their purchases would help, but unfortunately that's not how the commodity markets operate these days and it would seriously devalue the commodity assets from an investment perspective. It would be a much more accurate supply and demand market, which would ultimately instill more confidence in market prices/investments (thus keep prices much more stable), but would squelch the fast and obsene profits of today's traders. Really, what's wrong with that?
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6-09-2009 @ 8:59AM
alexander said...
as paxos said just before your post, purchasers of oil futures do indeed have to take delivery of the product at the futures expiry, or sell the contract prior to expiry. so the price on the day of expiry really is what is being paid in the underlying market, and you would think that obeys the principles of supply and demand.
that said, the behaviour of the price of crude does seem quite anomalous. some places one might look to shed some light might be the level of crude imports by china. perhaps they really have ramped up very quickly in a few short years, such that even in a (largely western) recession, total demand is still high compared with (the near capacity) opec supply? you might like to look at how oil is priced too. if physical oil contracts use, say, NYMEX futures prices as the price setting mechanism, then futures speculation really could be artificially pushing prices higher.
given the amount of crude consumed in the world, i would be hugely surprised if a significant amount of it is sitting in idle tankers around the world. aside from the quantities involved, it is hard to see how that would work. if producing countries were doing it, their total revenue, which after all is the product of price and volume, would collapse as the tankers filled, and the qty they were shifting collapsed. if middlemen were doing it, i suspect the cost of renting tanker capacity would make that unviable.
i dont know the answers to these issues, but the issue is complex with many nuances, and platitudes about 'greedy' people dont add anything useful. after all, the whole beloved and mostly successful free market, is underpinned by 'greed' ie individuals trying to maximise their return.
6-08-2009 @ 3:14PM
Iridium said...
Oil reached $65 a barrel in 2008 dollars at the height of the OPEC oil embargo during a massive supply shortage. Global oil demand has not increased above global oil production to a level even close to the supply shortages of the 1970's
If that isn't enough to prove $70 oil has more than doubled the natural supply/demand price then I don't know what else can convince people.
We actually have a situation where we are running out of storage space and refiners are asking for supply. The people who own the oil are refusing to sell it for 2.5 times what they paid because they want a greater return. SO we have a commodity shortage at the same time we have a glut of supply.
I think more than anything else, that needs to be investigated.
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6-08-2009 @ 4:07PM
Paxos said...
This is basic econ-101 -- supply and demand. Supply is fading. Read up on "Peak Oil".
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6-08-2009 @ 7:10PM
George P. Burdell said...
If I hear one more person blame speculators, I am going to commit a crime on someone. If speculators were the problem, then why do the Saudis not just up production and drowned the speculators with supply. The Saudis would only have to do that once, and all the speculators would lose their shirts, never return to the market, and if they did they would be much more cautious and have a lot less money to speculate with. Meanwhile, the Saudis would make a killing selling all that oil at these artificially high prices.
Of course, this does not happen because the price of oil is not high due to speculation, it is high because the dollar is becoming worthless. Last year, the Federal Reserve, at the very least, doubled the amount of money in circulation. 100% inflation (which is Zimbabwe or Wiemar style hyper-inflation by definition) means that prices for everything, all things being equal, are going to double.
Commodities and high demand services, such as health-care, go up in price first and the fastest, while the price of yachts and computers will rise the slowest, or in the example of computers, will never go up because of improvements in productivity (the price of computers should fall by 50%, due to Moore's law, every year).
To all the morons out there that think we need more regulation, taxes, government, and that all these big, bad, evil companies and speculators are at fault, maybe you should look at your beloved myths about governance and how you know how to better engineer the social order of the world..... (This goes for both the Right and the Left)
The laws of nature are clear....
100% Inflation + Increases in Taxes + 2 Wars + Biggest Deficits in the History of the World = (always) Much Much Higher Prices
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6-08-2009 @ 8:27PM
ben2k9 said...
People, if there is such a thing as a global currency now, it is oil. it's the thing that makes the world go around.
The Chinese don't need US dollars as much anymore, with the way our politicians are tanking it.
If you want to keep the price of oil down, the only way to do it is to increase supply. Demand will continue to march higher.
Perhaps you should be buying oil futures yourself to protect yourself from the higher prices you'll be paying as a result of bad fiscal, monetary, and energy policy right here in the US.
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6-12-2009 @ 7:26PM
DON said...
WE SHOULD GET OUR OWN OIL ANYWHERE WE CAN....
WHEN OTHER COUNTRY'S CAN'T SELL AS MUCH OIL AS THEY HAVE BEEN AND FEEL THE CRUNCH,WHAT DO YOU THINK WILL HAPPEN
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6-20-2009 @ 9:21PM
George said...
We may be in a recession, but the ones not affected are driving more. The retired with travel, to slots parlors and eating out and just something to do. There is less car pooling with gas below $4.00 a gallon and more use. Even the police and local governments are driving more as prices dropped. The trucking industry is still delivering food and other staples and using fuel. May be less weight per load but still running.Heating and cooling use has not dropped dramatic so the demand is still high.
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6-22-2009 @ 4:56AM
BRY said...
EITHER MAKE GAS A BUCK OR SEND TROOPS HOME NOW. WERE BEING RIPPED OFF, THERER IS NO SHORATAGE ITS OUR IL CARTEL THAT RUNS OUR GOVERNMENT, AMERICANS SHOULD BE SCREAMING BLOOD-WAR TAXES, AND BEING ROBBED AT THE PUMPS NO WAY THERE SHOULD BE A ULTIMATUM TROOPS OR 1 DOLLAR GAS THATS ALL THERE FOR OVER THERE
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