How to Burn the Speculators
NEWS: Why is the price of oil so high? Because the Bush administration did to the commodities market what it did to housing.
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Whenever economies sour, politicians blame speculators. But on occasion, they are right to do so. Speculators did wreak havoc in 1630s Holland, 1720s France, and in the American stock market in 1929. That crash led to the Great Depression and 60 years of tight controls on speculation. Now, thanks to our 30-year infatuation with free markets, the controls are off, and the mad gamblers are at it again. Yesterday's burst bubble was housing; today's expanding ones are energy and food. True, we have major long-term energy problems that cannot be laid at the feet of speculators. To avoid catastrophic global warming, we will be obliged to reengineer the country, from housing to transport to forests, and 
also to develop and export the technologies required for the rest of the world to do likewise. Eight years of George W. Bush's policies have made this much harder, and during that time the world may have passed "peak oil"—that moment when half the recoverable reserves of conventional oil have been drained and burned—so that from now on short supplies will be endemic. Meanwhile, demand grows, notably from China and India, which account for nearly 40 percent of the world's population.
But do supply and demand explain oil prices at $140 per barrel, with voices from Goldman Sachs projecting $200 for next year (a figure that would push gas prices above $5 per gallon) and Russia's Gazprom saying $250, despite a likely US recession? Do they explain the historic price hikes in rice, corn, and wheat, leading to hunger in the developing world? Do they explain the absolutely stratospheric price of copper? No they do not.
Yes, Virginia, speculators can affect the price—if they are large and relentless enough to dominate a market, and especially if they can store the commodity and keep it off the market as the price rises.
Futures markets exist to permit commercial interests to hedge their business risks. For a fee, a farmer (or oil producer) can put a floor under the price at which his product will sell. The forward price is normally a bit lower than the current price, but the contract protects the farmer from a catastrophic price slump—such as may occur in (for instance) bumper years. Speculators buy the futures on the chance that the market price will be substantially higher. They make a respectable profit on what is in effect an insurance function, and a killing in years of drought, flood, and war.
This system works reasonably well so long as speculators do not actually control or manipulate prices. For if they can drive prices way up, they can obviously cash in while the farmer (who has presold his crop) cannot. Strict regulation by the Commodity Futures Trading Commission (cftc) is supposed to prevent that.
But thanks to Phil "nation of whiners" Gramm—the former Texas senator who was until recently John McCain's top economic adviser (see "Foreclosure Phil")—futures market regulation went to hell. Under the "Enron loophole" pushed through by Gramm in 2000, energy futures were allowed to escape all federal and state regulation. Gramm embedded that loophole in a surprise 262-page rider, drafted at the behest of Wall Street and Enron, in an 11,000-page appropriations bill on a Friday evening two days after the Supreme Court handed down its Bush v. Gore ruling and as Congress was rushing home for Christmas. In a separate bit of absurdity, in January 2006, the Intercontinental Exchange (ice) of Atlanta, which trades benchmark US oil futures (West Texas Intermediate or wti), came to be treated by the cftc as a British market (the "London loophole") so that US regulators do not even track what is going on. (Even more surreal, the cftc was going to allow trades of US oil futures on terminals located in America to be "regulated" in Dubai; political pressure put an end to that idea in July.)
Worse still, Gramm's Commodity Futures Modernization Act of 2000 also opened the way for growth in deregulated "credit default swaps"—a way in which financial institutions "insured" that bad loans would not cause them losses. This, combined with other deregulatory moves by the cftc, broadened the "swaps loophole," an enormous backdoor into the commodities markets, basically permitting speculators making bets off the commodities exchanges to be treated as "commercial interests"—like say, farmers—and hence avoid the scrutiny (including limits on the size of their bets) normally applied to financial players. Thus today, when officials like Treasury Secretary Henry Paulson say that speculation is not a factor in the commodity markets, they're not counting hedge funds and investment banks as speculators—even though that's what they really are.
According to Senate testimony on June 3 by Michael Greenberger, who used to head the cftc's division of trading and markets, if swaps were properly labeled, about 70 percent of the oil futures now traded on the New York exchanges would be deemed speculative, not commercial, and subjected to a high degree of regulatory scrutiny.
Okay, let's think this through. First, vast sums of money are flowing through regulatory loopholes into the commodities markets, particularly for oil. Second, spot prices (those charged for immediate sale) in all commodity markets have been soaring. In particular, Americans now pay an average of $4 per gallon for gas. Is it possible that these two events are unconnected? Is it possible that Paulson—former ceo of Goldman Sachs—is right when he says that the price of oil is being driven mainly by supply and demand?
No, and Senate testimony in May by Michael W. Masters, a hedge fund manager, illustrates why not. Masters points to the spectacular rise of "index speculation," in which pension funds and other investors invest in the commodities futures markets according to formulas created by, among others, (guess who?) Goldman Sachs. Index speculation investments have risen from $13 billion to more than $250 billion since 2003. Masters calculates that the speculative demand for Texas oil futures from this source is now five times the actual 2003 stockpile (the baseline he used); for corn and aluminum the figure is about nine times; for silver it's a phenomenal fourteen times. There is of course no way that the orders represented by all those futures contracts could be met.
So the futures price goes up. As it does, supplies actually disappear. For instance, copper expert Frank Veneroso believes that 800,000 tons of copper has been hidden away in China, waiting to emerge closer to the market top. For Saudi Arabia and perhaps Russia the matter is simpler: Oil stays in the ground, and the oil not sold boosts the price of the oil that is. As current prices soar, the index speculators obey their computer programs, which tell them to pour still more money into the commodity markets.
There may be a further element at play, according to an April speech by Attorney General Michael Mukasey: "International organized criminals control significant positions in the global energy and strategic-materials markets. They are expanding their holdings in these sectors, which corrupts the normal functioning of these markets and may have a destabilizing effect on US geopolitical interests." To whom exactly Mukasey is referring, he does not say. But that organized criminal interests have the motive, means, and opportunity—handed to them by Phil Gramm—to destabilize the world energy markets seems quite clear.
On these matters, there is a quick fix. Under pressure, the cftc is closing the London loophole. Early in the next administration, Congress must slam shut the Enron and swaps loopholes. Index speculation should be curtailed by making such strategies illegal for regulated pension funds and by imposing limits for all traders on how much they can buy or sell. Investment banks using credit default swaps to enter the commodities markets should be regulated to the standards that apply to speculators, not as if they were heating-oil vendors hedging against a warm winter. Investigations now under way at the Federal Trade Commission, the Federal Energy Regulatory Commission, and the Department of Justice should be intensified, and criminal manipulation of the markets, if detected, should be punished.
Finally, the federal government should burn the oil speculators by selling up to 4 million barrels a day from the Strategic Petroleum Reserve. And as economist Tom Palley has pointed out, consumers can help too. An awful lot of gas is stored in cars. If people stop topping off and make do with half a tank, they'll back up supply and lower demand. It's a brilliant suggestion and definitely worth a try.
And while this is being done, and especially if all this smoke leads to fire, someone should ask, "What did Henry Paulson know, and when did he know it?"
James K. Galbraith is a contributing writer for Mother Jones.
Photo: Phil Schermeister/Corbis | Cartoon by Steve Brodner
More importantly - repeat after me - High Gas Prices are a GOOD thing. I'll say that again: High Gas Prices are a Good Thing (at least at current levels, much higher might cause problems temporarily)
If this audience has any education then I won't have to explain myself further.
People, we are about to be screwed like few living Americans can remember. The 'economically powerful' have become the economically all-powerful. Its no longer about money for them. Its about their thirst and addiction for our life's-blood. The machine has taken over and the guy at the controls is just window-dressing. Like the guy at McDonalds--who pushes the button to lower and raise the fry basket. His job is 100% unnecessary as the same computer that times the fry can just as easily load and empty the French-fries. They keep him around for a cordial atmosphere.
As for speculation: It is always part of the problem. Part of the problem is the very low dollar, which was engineered that way by the Bush administration to favor the large corporations. Since oil is traded in dollars, essentially, the price of gas has NOT gone up in Europe as much as in the USA. The biggest part of the problem is human greed. While the greedy may never get over their abuse problem, we have to get over them. All of us, Ds and Rs and old and young and black and yellow and everyone.
The market for oil, and the oil companies, should be nationalized. Nothing this valuable should be left in the hands of the market...even 'non-speculators.'
Note to Galbraith reptilian brain: you won't lower demand by making do with half a tank if you refill your tank twice as frequently.
Contributors of email voice strong opinions, many have a point to be considered. Some of these contributors should be in politics; however, would they not also join the G and G.
For at least 40 years the GOP has been selling the American voters on the premise that a conservative government is necessary to protect against an overly powerful one that would sap the life from all of us. Well, if wealth is power what the hell do we have now? Federal controls have been lifted in the name of greed alone, and certainly, not for the betterment of society. Wealth and greed is power, and much more detrimental to all of us than a powerful Democratic Congress.
Ask, when these great open markets fail who pays the price? Certainly the wealthy, it is always the taxpayer, sooner or later.
Has anyone been watching the videos on The Bohemian Grove? If not, it shows how all the moguls, political, finance and otherwise all buddy around together and make decisions at a frat boys Druid ritual. Hey you can't make this stuff up!
According to energy investment banker Matthew Simmons and most independent analysts, global oil production is now declining, from 74 million barrels per day to 60 million barrels per day by 2015. During the same time demand will increase 14%.
This is equivalent to a 33% drop in 7 years. No one can reverse this trend, nor can we conserve our way out of this catastrophe. Because the demand for oil is so high, it will always be higher than production; thus the depletion rate will continue until all recoverable oil is extracted.
Alternatives will not even begin to fill the gap. And most alternatives yield electric power, but we need liquid fuels for tractors/combines, 18 wheel trucks, trains, ships, and mining equipment.
We are facing the collapse of the highways that depend on diesel trucks for maintenance of bridges, cleaning culverts to avoid road washouts, snow plowing, roadbed and surface repair. When the highways fail, so will the power grid, as highways carry the parts, transformers, steel for pylons, and high tension cables, all from far away. With the highways out, there will be no food coming in from "outside," and without the power grid virtually nothing works, including home heating, pumping of gasoline and diesel, airports, communications, and automated systems.
This is documented in a free 48 page report that can be downloaded, website posted, distributed, and emailed: http://www.peakoilassociates.com/POAnalysis.html
I used to live in NH-USA, but moved to a sustainable place. Anyone interested in relocating to a nice, pretty, sustainable area with a good climate and good soil? Email: clifford dot wirth at yahoo dot com or give me a phone call which operates here as my old USA-NH number 603-668-4207.
As far as Bush--most problems we are facing have been either caused by his direct action, his neo-con buddies actions, or their lack of taking action to protect anyone but the already filthy rich. It's always "me, me, me." I can't believe they call themselves Christians. If there were a Christian God, he would surely strike them down, for they are the most un-Christian of people--filled with greed, and lust for war. We have a Defense Dept. that is getting ready to throw away billions in parts they haven't yet even received, yet they want to cut money from Social Security. They all deserve a vacation at Guantanamo, with some recreational water-boarding.
Sure they do Mr. Galbraith -- if the real worth of what we get from oil is actually much higher than $150. Until recently spare capacity allowed OPEC to manage prices. Now that supply is very thight we figure out the real worth of this amazing stuff called oil. Think of it -- a few cents and you can transport yourself, your family, all your luggage and your car over a couple of miles. If you had to push all this by yourself i'm quite sure you would be glad to pay dollars not cents to accomplish this task. Let's face it, even at $150 oil is still cheap for what we get from it.
Best hopes, pg
It was largely due to the inefficiency of steam power that Rudolph Diesel invented his heat engine, which after more than a century, remains the most efficient way of converting heat energy into mechanical energy, at 40% to 50% of Carnot efficiency.
Like Clifford Wirth, we are working on solutions. We currently produce about 2/3rds of our own energy. We're looking for skilled people to help us become debt-free. http://www.EcoReality.org
If gas prices jump to $15 per gallon, is that "too high" so that people will stop purchasing gas? Or maybe they'll just fill their tank halfway? Or maybe they are forced to continue to sacrifice other elements of their life in order to pay that amount.
Maybe if somebody who "owns" water ... a very similar commodity ... started charging more and more money for its use, then people wouldn't use so much of it? Or maybe just use half?
Arguments like that are specious, as they ignore the truism that people do what they must to survive. People will continue to pay ever-increasing prices for gas not because they feel it is "worth it", but because they MUST use it, in the absence of a viable alternative. This is not to be confused with someone who pays $250,000 for a Mustang GT because they think the car is "worth it", which IS a value proposition.
High gas prices are an abomination, just like high water prices or high air prices would be. I wish that it were otherwise, but the world has been reorganized around petroleum, and it has come to the point where gas is a necessity, like it or not.
Let's work harder to develop alternatives. You won't find any help from BushCo or its ilk, so it will be expensive and it will take longer than it should to get around the roadblocks that the vested interests have put in place (EVO, anyone?), but it is required if the world is ever to get out from under the heavy hand of the profiteers.
Thank you.
Anyway, peak oil is not "that moment when half the recoverable reserves of conventional oil have been drained and burned". It is the point in time when the maximum rate of extraction is reached, either locally or globally. If it is true that we have reached peak oil it means that it is not possible to further raise supply.
I guess he was researching the market.
Burn, speculators, burn!
For those that really want to know more:
http://energycommerce.house.gov/cmt e_mtgs/110-oi-hrg.062308.EnergySpec.shtml
I liked Michael Master's work too.
BTW: President Clinton signed Gramm's bill, not President Bush.
If you dont think this loophole was created for large profits please explain the purpose of the Gramm legilation and why it was snuck in.
The top reasons for high gas prices:
1. Lack of competition translates into paying more at the pump.(Exxon merges with Mobil, ChevronTexaco, BPArco, etc )
2. Were the diplomatic skills of this administration up to par, oil prices would be far more stable. Invading Iraq has only brought instability. Angering Russia by placing our military and our missiles at their doorstep only brings more instability.
3. If the dollar was as strong today as it was when Bush took office, $140 would fetch closer to 2 barrels of oil.
4. Weak CAFE standards. Stop wainting for future technology. Just by making cars lighter and more aero-dynamic, efficiency could double.
It seems like our President wants high oil prices. But that would make him an oil man...inconceivable!
WE NEED ATTACK DOGS BRAVE ENOUGH TO STAND UP TO BIG OIL! Instead we get politicians too eager to roll over.
And Galbraith's point would be what: That the holiness that lingered over the time at which the move (not even a new one) was made demands that Congressional Dems be seen as victims?
I'm a Dem who's tired of journalists expecting me to carry on my back a bunch of mulitmillionaires known as Congressional Dems.
One of the first things Bush did was to rip up mandatory higher mileage stndards for US cars and trucks when he took office. Oil men don't want cars with great gas mileage but, Bush has effectively put the big three out of business, and all you Jap and Korean car drivers will be paying tripple for the price of the high mileage car they have flooded the American market with. Why is it all the countries we were at war with seem to be hell bent in destroying the American car market, although driving a big Escalade in Hong Gong is considered the ultimate status symbol, go figure.
Oil is half what it should be. A carbon tax satisfies the parameters life set up.
Posted by:Benny MullerAugust 22, 2008
Actually, in theory both statements are true. The peak oilers state that oil production follows a standard normal curve at any scale, so the point at which there is no further increase in extraction is also the point at which extraction rates will fall symmetrically to production. By this logic, the area under the curve is the same on both sides of the "peak" and as such, half of the total global capacity will have been extracted (assuming that extraction will continue until the last well goes dry)
Big Oil=Big greed.