Perhaps 60 percent of today�s oil price is pure speculation
By F. William Engdahl
Online Journal Contributing Writer
May 5, 2008, 00:19
The price of crude
oil today is not made according to any traditional relation of supply to
demand. It�s controlled by an elaborate financial market system as well as by
the four major Anglo-American oil companies. As much as 60 percent of today�s
crude oil price is pure speculation driven by large trader banks and hedge
funds. It has nothing to do with the convenient myths of Peak Oil. It has to do
with control of oil and its price. How?
First, the crucial role of the international oil exchanges
in London and New York is crucial to the game. NYMEX in New York and the ICE
Futures in London today control global benchmark oil prices which, in turn, set
most of the freely traded oil cargo. They do so via oil futures contracts on
two grades of crude oil: West Texas Intermediate and North Sea Brent.
A third rather new oil exchange, the Dubai Mercantile
Exchange (DME), trading Dubai crude, is more or less a daughter of NYMEX, with
NYMEX President James Newsome sitting on the board of DME and most key
personnel British or American citizens.
Brent is used in spot and long-term contracts to value as
much of crude oil produced in global oil markets each day. The Brent price is published by a private oil
industry publication, Platt�s. Major oil producers including Russia and Nigeria
use Brent as a benchmark for pricing the crude they produce. Brent is a
key crude blend for the European market and, to some extent, for Asia.
WTI has historically been more of a US crude oil basket. Not
only is it used as the basis for US-traded oil futures, but it's also a key
benchmark for US production.
�The tail that
wags the dog�
All this is well and official. But how today�s oil prices
are really determined is done by a process so opaque only a handful of major
oil trading banks such as Goldman Sachs or Morgan Stanley have any idea who is
buying and who selling oil futures or derivative contracts that set physical
oil prices in this strange new world of �paper oil.�
With the development of unregulated international
derivatives trading in oil futures over the past decade or more, the way has
opened for the present speculative bubble in oil prices.
Since the advent of oil futures trading and the two major
London and New York oil futures contracts, control of oil prices has left OPEC
and gone to Wall Street. It is a classic case of the �tail that wags the dog.�
A June 2006
US Senate Permanent Subcommittee on Investigations report on �The Role of
Market Speculation in rising oil and gas prices,� noted, � . . . there
is substantial evidence supporting the conclusion that the large amount of
speculation in the current market has significantly increased prices.�
What the Senate committee staff documented in the
report was a gaping loophole in US government regulation of oil derivatives
trading so huge a herd of elephants could walk through it. That seems precisely
what they have been doing in ramping oil prices through the roof in recent
The Senate report was ignored in the media and in the
pointed out that the Commodity Futures Trading Trading Commission, a financial
futures regulator, had been mandated by Congress to ensure that prices on the
futures market reflect the laws of supply and demand rather than manipulative
practices or excessive speculation. The US Commodity Exchange Act (CEA) states,
�Excessive speculation in any commodity under contracts of sale of such
commodity for future delivery . . . causing sudden or unreasonable fluctuations
or unwarranted changes in the price of such commodity, is an undue and
unnecessary burden on interstate commerce in such commodity.�
the CEA directs the CFTC to establish such trading limits �as the Commission
finds are necessary to diminish, eliminate, or prevent such burden.� Where is
the CFTC now that we need such limits?
to have deliberately walked away from their mandated oversight responsibilities
in the world�s most important traded commodity, oil.
Enron has the last laugh . . .
As that US Senate report noted, �Until recently, US energy
futures were traded exclusively on regulated exchanges within the United
States, like the NYMEX, which are subject to extensive oversight by the CFTC,
including ongoing monitoring to detect and prevent price manipulation or fraud.
In recent years, however, there has been a tremendous growth in the trading of
contracts that look and are structured just like futures contracts, but which
are traded on unregulated OTC electronic markets. Because of their similarity
to futures contracts they are often called 'futures look-alikes.'
only practical difference between futures look-alike contracts and futures
contracts is that the look-alikes are traded in unregulated markets whereas
futures are traded on regulated exchanges. The trading of energy commodities by
large firms on OTC electronic exchanges was exempted from CFTC oversight by a
provision inserted at the behest of Enron and other large energy traders into
the Commodity Futures Modernization Act of 2000 in the waning hours of the
<>"The impact on
market oversight has been substantial. NYMEX traders, for example, are required to keep
records of all trades and report large trades to the CFTC. These Large Trader
Reports, together with daily trading data providing price and volume
information, are the CFTC�s primary tools to gauge the extent of speculation in
the markets and to detect, prevent, and prosecute price manipulation. CFTC
Chairman Reuben Jeffrey recently stated: 'The Commission�s Large Trader
information system is one of the cornerstones of our surveillance program and
enables detection of concentrated and coordinated positions that might be used
by one or more traders to attempt manipulation.'
to trades conducted on the NYMEX, traders on unregulated OTC electronic
exchanges are not required to keep records or file Large Trader Reports with
the CFTC, and these trades are exempt from routine CFTC oversight. In contrast
to trades conducted on regulated futures exchanges, there is no limit on the
number of contracts a speculator may hold on an unregulated OTC electronic
exchange, no monitoring of trading by the exchange itself, and no reporting of
the amount of outstanding contracts (open interest) at the end of each day.�
Then, apparently to make sure the way was opened really wide
to potential market oil price manipulation, in January 2006, the Bush
administration�s CFTC permitted the Intercontinental Exchange (ICE), the
leading operator of electronic energy exchanges, to use its trading terminals
in the United States for the trading of US crude oil futures on the ICE futures
exchange in London -- called �ICE Futures.�
Previously, the ICE Futures exchange in London had traded
only in European energy commodities -- Brent crude oil and United Kingdom
natural gas. As a United Kingdom futures market, the ICE Futures exchange is
regulated solely by the UK Financial Services Authority. In 1999, the London
exchange obtained the CFTC�s permission to install computer terminals in the
United States to permit traders in New York and other US cities to trade
European energy commodities through the ICE exchange.
The CFTC opens the door
January 2006, ICE Futures in London began trading a futures contract for West
Texas Intermediate (WTI) crude oil, a type of crude oil that is produced and
delivered in the United States. ICE Futures also notified the CFTC that it
would be permitting traders in the United States to use ICE terminals in the
United States to trade its new WTI contract on the ICE Futures London exchange.
ICE Futures, as well, allowed traders in the United States to trade US gasoline
and heating oil futures on the ICE Futures exchange in London.
use by US traders of trading terminals within the United States to trade US
oil, gasoline, and heating oil futures contracts, the CFTC has until today
refused to assert any jurisdiction over the trading of these contracts.
within the United States seeking to trade key US energy commodities -- US crude
oil, gasoline, and heating oil futures -- are able to avoid all US market
oversight or reporting requirements by routing their trades through the ICE
Futures exchange in London instead of the NYMEX in New York.
Is that not elegant? The US government energy futures
regulator, CFTC, opened the way to the present unregulated and highly opaque
oil futures speculation. It may just be coincidence that the present CEO of
NYMEX, James Newsome, who also sits on the Dubai Exchange, is a former chairman
of the US CFTC. In Washington doors revolve quite smoothly between private and
A glance at the price for Brent and WTI futures prices since
January 2006 indicates the remarkable correlation between skyrocketing oil
prices and the unregulated trade in ICE oil futures in US markets. Keep in mind
that ICE Futures in London is owned and controlled by a USA company based in
In January 2006, when the CFTC allowed the ICE Futures the
gaping exception, oil prices were trading in the range of $59-60 a barrel.
Today some two years later we see prices tapping $120 and trending upwards.
This is not an OPEC problem, it is a US government regulatory problem of malign
By not requiring the ICE to file daily reports of large trades of energy
commodities, it is not able to detect and deter price manipulation. As the
Senate report noted, �The CFTC's ability to detect and deter energy price
manipulation is suffering from critical information gaps, because traders on
OTC electronic exchanges and the London ICE Futures are currently exempt from
CFTC reporting requirements. Large trader reporting is also essential to
analyze the effect of speculation on energy prices.�
added, �ICE's filings with the Securities and Exchange Commission and other
evidence indicate that its over-the-counter electronic exchange performs a
price discovery function -- and thereby affects US energy prices -- in the cash
market for the energy commodities traded on that exchange.�
Hedge funds and banks driving oil prices
In the most
recent sustained run-up in energy prices, large financial institutions, hedge
funds, pension funds, and other investors have been pouring billions of dollars
into the energy commodities markets to try to take advantage of price changes
or hedge against them. Most of this additional investment has not come from
producers or consumers of these commodities, but from speculators seeking to
take advantage of these price changes. The CFTC defines a speculator as a
person who �does not produce or use the commodity, but risks his or her own
capital trading futures in that commodity in hopes of making a profit on price
purchases of crude oil futures contracts by speculators have, in effect,
created an additional demand for oil, driving up the price of oil for future
delivery in the same manner that additional demand for contracts for the
delivery of a physical barrel today drives up the price for oil on the spot
market. As far as the market is concerned, the demand for a barrel of oil that
results from the purchase of a futures contract by a speculator is just as real
as the demand for a barrel that results from the purchase of a futures contract
by a refiner or other user of petroleum.
60 percent of oil prices
today pure speculation
Goldman Sachs and Morgan Stanley today are the two
leading energy trading firms in the United States. Citigroup and JP Morgan
Chase are major players and fund numerous hedge funds as well who speculate.
In June 2006, oil traded in futures markets at some
$60 a barrel and the Senate investigation estimated that some $25 of that was
due to pure financial speculation. One analyst estimated in August 2005 that US
oil inventory levels suggested WTI crude prices should be around $25 a barrel,
and not $60.
That would mean today that at least $50 to $60 or more
of today�s $115 a barrel price is due to pure hedge fund and financial
institution speculation. However, given the unchanged equilibrium in global oil
supply and demand over recent months amid the explosive rise in oil futures
prices traded on NYMEX and ICE exchanges in New York and London, it is more
likely that as much as 60 percent of the today oil price is pure speculation.
No one knows officially except the tiny handful of energy trading banks in New
York and London and they certainly aren�t talking.
By purchasing large numbers of futures contracts, and
thereby pushing up futures prices to even higher levels than current prices,
speculators have provided a financial incentive for oil companies to buy even
more oil and place it in storage. A refiner will purchase extra oil today, even
if it costs $115 per barrel, if the futures price is even higher. As a result,
over the past two years crude oil inventories have been steadily growing,
resulting in US crude oil inventories that are now higher than at any time in
the previous eight years. The large influx of speculative investment into oil
futures has led to a situation where we have both high supplies of crude oil
and high crude oil prices.
Compelling evidence also suggests that the oft-cited
geopolitical, economic, and natural factors do not explain the recent rise in
energy prices can be seen in the actual data on crude oil supply and demand.
Although demand has significantly increased over the past few years, so have
Over the past couple of years, global crude oil
production has increased along with the increases in demand; in fact, during
this period global supplies have exceeded demand, according to the US
Department of Energy. The US Department of Energy�s Energy Information
Administration (EIA) recently forecast that in the next few years global
surplus production capacity will continue to grow to between 3 and 5 million
barrels per day by 2010, thereby �substantially thickening the surplus capacity
Dollar and oil link
A common speculation strategy amid a declining USA
economy and a falling US dollar is for speculators and ordinary investment funds
desperate for more profitable investments amid the US securitization disaster
to take futures positions selling the dollar �short� and oil �long.�
For huge US or EU pension funds or banks desperate to
get profits following the collapse in earnings since August 2007 and the US
real estate crisis, oil is one of the best ways to get huge speculative gains.
The backdrop that supports the current oil price bubble is continued unrest in
the Middle East, in Sudan, in Venezuela and Pakistan and firm oil demand in
China and most of the world outside the US. Speculators trade on rumor, not
In turn, once major oil companies and refiners in
North America and EU countries begin to hoard oil, supplies appear even tighter
lending background support to present prices.
Because the over-the-counter (OTC) and London ICE
Futures energy markets are unregulated, there are no precise or reliable
figures as to the total dollar value of recent spending on investments in
energy commodities, but the estimates are consistently in the range of tens of
billions of dollars.
The increased speculative interest in commodities is
also seen in the increasing popularity of commodity index funds, which are
funds whose price is tied to the price of a basket of various commodity futures.
Goldman Sachs estimates that pension funds and mutual funds have invested a
total of approximately $85 billion in commodity index funds, and that
investments in its own index, the Goldman Sachs Commodity Index (GSCI), has
tripled over the past few years. Notable is the fact that US Treasury Secretary
Henry Paulson is a former chairman of Goldman Sachs.
 United States Senate Premanent
Subcommittee on Investigations, 109th Congress 2nd Session, The Role of Market speculation in Rising Oil and Gas Prices: A Need to
Put the Cop Back on the Beat; Staff Report, prepared by the Permanent
Subcommittee on Investigations of the Committee on Homeland Security and
Governmental Affairs, United States Senate, Washington D.C., June 27, 2006. p.
F. William Engdahl is author of "A Century of War: Anglo-American Oil Politics and the New World Order." He
may be contacted at firstname.lastname@example.org.
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