Did Speculation Fuel Oil Price Swings?

60 Minutes: Speculation Affected Oil Price Swings More Than Supply And Demand

(CBS)  About the only economic break most Americans have gotten in the last six months has been the drastic drop in the price of oil, which has fallen even more precipitously than it rose. In a year's time, a commodity that was theoretically priced according to supply and demand doubled from $69 a barrel to nearly $150, and then, in a period of just three months, crashed along with the stock market.

So what happened? It's a complicated question, and there are lots of theories. But as correspondent Steve Kroft reports, many people believe it was a speculative bubble, not unlike the one that caused the housing crisis, and that it had more to do with traders and speculators on Wall Street than with oil company executives or sheiks in Saudi Arabia.

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To understand what happened to the price of oil, you first have to understand the way it's traded. For years it has been bought and sold on something called the commodities futures market. At the New York Mercantile Exchange, it's traded alongside cotton and coffee, copper and steel by brokers who buy and sell contracts to deliver those goods at a certain price at some date in the future.

It was created so that farmers could gauge what their unharvested crops would be worth months in advance, so that factories could lock in the best price for raw materials, and airlines could manage their fuel costs. But more than a year ago those markets started to behave erratically. And when oil doubled to more than $147 a barrel, no one was more suspicious than Dan Gilligan.

As the president of the Petroleum Marketers Association, he represents more than 8,000 retail and wholesale suppliers, everyone from home heating oil companies to gas station owners.

When 60 Minutes talked to him last summer, his members were getting blamed for gouging the public, even though their costs had also gone through the roof. He told Kroft the problem was in the commodities markets, which had been invaded by a new breed of investor.

"Approximately 60 to 70 percent of the oil contracts in the futures markets are now held by speculative entities. Not by companies that need oil, not by the airlines, not by the oil companies. But by investors that are looking to make money from their speculative positions," Gilligan explained.

Gilligan said these investors don't actually take delivery of the oil. "All they do is buy the paper, and hope that they can sell it for more than they paid for it. Before they have to take delivery."

"They're trying to make money on the market for oil?" Kroft asked.

"Absolutely," Gilligan replied. "On the volatility that exists in the market. They make it going up and down."

He says his members in the home heating oil business, like Sean Cota of Bellows Falls, Vt., were the first to notice the effects a few years ago when prices seemed to disconnect from the basic fundamentals of supply and demand. Cota says there was plenty of product at the supply terminals, but the prices kept going up and up.

"We've had three price changes during the day where we pick up products, actually don't know what we paid for it and we'll go out and we'll sell that to the retail customer guessing at what the price was," Cota remembered. "The volatility is being driven by the huge amounts of money and the huge amounts of leverage that is going in to these markets."

About the same time, hedge fund manager Michael Masters reached the same conclusion. Masters' expertise is in tracking the flow of investments into and out of financial markets and he noticed huge amounts of money leaving stocks for commodities and oil futures, most of it going into index funds, betting the price of oil was going to go up.

Asked who was buying this "paper oil," Masters told Kroft, "The California pension fund. Harvard Endowment. Lots of large institutional investors. And, by the way, other investors, hedge funds, Wall Street trading desks were following right behind them, putting money - sovereign wealth funds were putting money in the futures markets as well. So you had all these investors putting money in the futures markets. And that was driving the price up."

In a five year period, Masters said the amount of money institutional investors, hedge funds, and the big Wall Street banks had placed in the commodities markets went from $13 billion to $300 billion. Last year, 27 barrels of crude were being traded every day on the New York Mercantile Exchange for every one barrel of oil that was actually being consumed in the United States.

"We talked to the largest physical trader of crude oil. And they told us that compared to the size of the investment inflows - and remember, this is the largest physical crude oil trader in the United States - they said that we are basically a flea on an elephant, that that's how big these flows were," Masters remembered.

Yet when Congress began holding hearings last summer and asked Wall Street banker Lawrence Eagles of J.P. Morgan what role excessive speculation played in rising oil prices, the answer was little to none. "We believe that high energy prices are fundamentally a result of supply and demand," he said in his testimony.

[postoak5]

Consider a jeweler who buys gold for $500/oz, makes a ring, and puts it on display in his store for $200.
Two days later the price of gold goes up 20%. His ring has raw materials worth 20% more. He could melt down the ring and sell it on the open market and make a profit.
Or he can increase the cost of the ring, since the market now reckons it''s worth more.
This is exactly what happens with gasoline retailers, since the raw material they buy (wholesale gasoline) is publicly traded.
When prices drop, jewelers and gas station owners try to cling to their prices, and will only drop them if competitors do also. And this is what happens, as gasoline (excluding tax) now costs about 65% less than it did last July. For price drops this large, you have to believe either that retailers conspired to lower prices, or that they were competing for market share. There is typically a few weeks'' lag between falling oil and gas prices, and although oil is the major price determinant, there are a number of other factors that affect gasoline prices.

[ujeanp]

Every evening the national and local news would talk about the price of gas going up. Just hours later you could drive thru town and see the prices go on on the signs in front of the stations. I often wondered if nothing was said how fast would they have gone up. The prices went up so fast and it makes me wonder why when the price of oil started dropping it took so long to show at the pump. And it didn''t drop near as fast as it went up!

[lilvinnyb]

What a stupid article. Of course speculation has an impact on oil prices. It''s a traded commodity.

no one seems to have a problem when thier 401K returns dividends paid by energy mutual funds.

I bet the same people who did the 60 minutes report has some.

[liberty4you]

The flashpoint of all of this will always be the invasion of the country of Georgia by Russia. Israel and the West never expected this.

Israel was supplying hardware to Georgia to support another political boundary, yet, the Georgian president supported the US heavily...

Freeze Europe, thanks to Israel.

Why don''t they acknowledge their own responsibilities to their own nation-state?

Why? Because they might not last that much longer if they keep fighting like a bunch of soccer hooligans.

[postoak5]

^ the end of the Bush years of "Don''''t worry, steal happy!"
1) Prices didn''t start climbing until the 4th year of the Bush administration.
2) US companies produce around 5% of the world''s oil. OPEC 40%. Russia 12%. The price drop has cost OPEC $3.4 billion/day, Russia $1 billion/day. Why do you think they have allowed this to happen?

^ agricultural commodities shot up because the cost of fertilizers and transportation shot up due to their dependence oil prices...silver and gold shot up because ..
Nice try. Ever look at recent demand growth for some of these materials? This is called, rationalizing your conclusion.

^ like, for instance, how large buys orders in the oil markets create the perception of high demand and drive prices up?

Why did they buy? Speculators can just as easily make money by selling. You dismiss it all as a conspiracy, yet you probably don''t think that the dotcom or housing bubbles were conspiracies. I think the world is a little more complicated than your comic book.

^ That is called being an apologist for the hedge funds
I don''t support speculation if it causes hardships and if abuse can be demonstrated. That needs to be fixed. But the case for speculation is by no means proven, as the article itself says. You are obviously very uninformed about oil price markets, you''re angry about it, and you want a villain. You don''t have the tools to do the analysis so you discard evidence and say: "It''s all Bush''s fault; the speculators did it."

[cvernon5]

Of course it was speculation. There was never a shortage of oil. There were times that the oil supply was close to usage, but, it never crossed that line. Did anyone notice that as soon as the gov''t announced the probe into prices, the prices started to drop? I lost my job because of all of this. Hope the speculators are living happily on MY money.

[missingamerica]

1) If speculators can control prices, how is it that prices have fallen by over 70%. Doesn%u2019t it say that speculators can%u2019t conspire to control markets?

^^^ the end of the Bush years of "Don''t worry, steal happy!" approaches

2) Many commodities, from gold to wheat, behaved similarly to oil over this time frame.

^^^ agricultural commodities shot up because the cost of fertilizers and transportation shot up due to their dependence oil prices

^^^ silver and gold shot up because of mankind''s lingering belief that they represent safety in uncertain times - such as those brought about by increasing global hunger caused by soaring energy prices caused by rampant speculation

The author fails to note that market psychology is at least as important as any supply/demand arithmetic in pricing commodities

^^^ like, for instance, how large buys orders in the oil markets create the perception of high demand and drive prices up?

[...]

The futures traders did not buy as a result of some evil plot; they bought because they perceived ever increasing demand [%u2026]. The traders did not create high prices; the perception of future high prices in effect created the trades. People are confusing cause and effect.

^^^ That is called being an apologist for the hedge funds and others whose speculation put hundreds of thousands of Americans out of their homes because they couldn''t afford their mortgage payments AND the commute to work.

Posted by Postoak5 at 11:22 PM : Jan 14, 2009

[postoak5]

The two crucial and obvious points have been missed.



1) If speculators can control prices, how is it that prices have fallen by over 70%. Doesn%u2019t it say that speculators can%u2019t conspire to control markets?



2) Many commodities, from gold to wheat, behaved similarly to oil over this time frame. Why do you single out oil, whose price behavior was so obviously a subset of the broader global commodity price trends? The inference being made is that the oil industry is somehow guilty of high oil prices, but that the recent high prices of silver, wheat, and many other commodities were the result of normal market forces. I see no evidence at all that oil markets behaved fundamentally differently than most other commodities.



The author fails to note that market psychology is at least as important as any supply/demand arithmetic in pricing commodities, or stock prices for that matter. The wisdom of the day was that commodity price pressure was going to increase for the foreseeable future because of new and (perceived) growing developing world demand. So, just as with homes, or gold prices, or dot.com stocks, a buying fever developed. The futures traders did not buy as a result of some evil plot; they bought because they perceived ever increasing demand and were swayed by the prevailing market psychology. The traders did not create high prices; the perception of future high prices in effect created the trades. People are confusing cause and effect.

[adamcarrenta]

I buy my home heating oil from an oil company that warned, no encouraged me to lobby congress to close the Enron loophole. I just checked their website -news portion- and found 10 articles(days) from Nov 27 2007 to October 29, 2008 where they explained what this article says. But not in as many words or details. They explained that oil delivery companies want the price to be closer to $1 per gallon for home heating oil rather than $4 per gallon because they make cents per gallon, not percent markup.
Check their news paragon oil co - especially the November 27 2007 and link to contact congress.

As this article explains - congess did not pass legislation to stop the manipulation. If they stopped allowing margin on oil speculation oil prices would go down more.

[missingamerica]

What do you call it when the media finally reports something you knew long ago? "Deja News"?

[magistral42]

The article says "investors don''t actually take delivery of the oil. They buy the paper and hope that they can sell it for more than they paid for it. Before they have to take delivery."

What I want to know is what happens if they cannot sell it for more than they paid, like more recently I presume. Do they sell it at a loss? If not, how does a pencil neck capitalist tool wearing a bright white long sleeve shirt (and silk tie with matching cufflinks) take delivery of barrels of oil?

Perhaps he stores them in his Manhattan apartment right next to the cheese and wine and his copy of Madoff''s book, "Getting Rich At Any Cost", and waits for the price to go back up.

[regular87]

I apologize for posting that three times, I thought it didn''t go through

[regular87]

I think it is note worthy that OPEC is pushing for $70-$80 a barrel which would bring retail prices back to the $3+ range. They have announced oil production cuts three times in the last three months totaling 4.2 million barrels per day (a total of 176,400,000 gallons per day) that is nearly 12 percent of their total capacity!
Despite the fact that prices were recently driven by paper buyers rather than users, I think it is almost inevitable that we will see prices spike once again because of supply fears rather than paper demand!
If you are into the macro economics behind the price of oil feel free to visit my blog at http://www.regular87.com

[spwizard]

What shoddy incomplete reporting on the Oil Price Manipulation this week. If 60 Minutes did all its homework they would have known the following:

1) It was Wendy Gramm, as head of the CFTC and wife of TX Senator Phil Gramm, who wrote the Enron Exemption Rules that allowed Enron to manipulate California and other states energy prices.

2) Enron made over $40 billion the first year Gramm''''s "Exemption Rules" were in effect mainly in California. Major news networks played Enron broker audiotapes discussing this theft.

3) Ms. Gramm quit as CFTC Head, 3 months after she had her Enron Exemption Rules legally approved, and went to work for Enron as a Board Director and was paid $1.4 to $1.8 million by Enron.

4) Ms. Gramm pulled the same conflict of interest scam with Iowa Beef, and other commodity companies who also paid her off as a Board Director.

5) In 1996, Enron''''s CEO Ken Lay became her husband''''s Phil Gramm''''s Presidental Committee Director and he contributed $1 million to the Gramm''''''''s Mason University think tank. Plus other cash disbursements via campaign contributions.

6) Gramms bought a 1000 acres Texas ranch paid for by Enron and Iowa Beef.

Now for the investment bank payoffs her husband Senator Phil Gramm received for voiding the Glass-Steagle Act? I have only scratched the surface here about the avaricious Gramms.

60 Minutes dropped the ball not reporting the whole truth on oil speculation which they should have known!

[spwizard]

What shoddy incomplete reporting on the Oil Price Manipulation this week. If 60 Minutes did all its homework they would have known the following:

1) It was Wendy Graham, as head of the CFTC and wife of TX Senator Phil Graham, who wrote the Enron Exemption Rules that allowed Enron to manipulate California and other states energy prices.

2) Enron made over $40 billion the first year Graham''s "Exemption Rules" were in effect mainly in California. Major news networks played Enron broker audiotapes discussing this theft.

3) Ms. Graham quit as CFTC Head, 3 months after she had her Enron Exemption Rules legally approved, and went to work for Enron as a Board Director and was paid $1.4 to $1.8 million by Enron.

4) Ms. Graham pulled the same conflict of interest scam with Iowa Beef, and other commodity companies who also paid her off as a Board Director.

5) In 1996, Enron''s CEO Ken Lay became her husband''s Phil Graham''s Presidental Committee Director and he contributed $1 million to the Graham''''s Mason University think tank. Plus other cash disbursements via campaign contributions.

6) Grahams bought a 1000 acres Texas ranch paid for by Enron and Iowa Beef.

Now for the investment bank payoffs her husband Senator Phil Graham received for voiding the Glass-Steagle Act? I have only scratched the surface here about the treasonous Grahams.

60 Minutes dropped the ball not reporting the whole truth on oil specualtion which they should have known!

[regular87]

I think it is note worthy that OPEC is pushing for $70-$80 a barrel which would bring retail prices back to the $3+ range. They have announced oil production cuts three times in the last three months totaling 4.2 million barrels per day (a total of 176,400,000 gallons per day) that is nearly 12 percent of their total capacity!
Despite the fact that prices were recently driven by paper buyers rather than users, I think it is almost inevitable that we will see prices spike once again because of supply fears rather than paper demand!
If you are into the macro economics behind the price of oil feel free to visit my blog at http://www.regular87.com

[regular87]

I think it is note worthy that OPEC is pushing for $70-$80 a barrel which would bring retail prices back to the $3+ range. They have announced oil production cuts three times in the last three months totaling 4.2 million barrels per day (a total of 176,400,000 gallons per day) that is nearly 12 percent of their total capacity!
Despite the fact that prices were recently driven by paper buyers rather than users, I think it is almost inevitable that we will see prices spike once again because of supply fears rather than paper demand!
If you are into the macro economics behind the price of oil feel free to visit my blog at http://www.regular87.com

[larryburns94]

whatithink,

come one, this is supposed to be balanced journalism. you know as well as I do, that if Bush would have signed the de-regulation bill, the crux of the this story would have been oil-man bush lets speculators run wild. instead, nary a mention of clinton''s name.

[aceditor]

I have just read the "recent report out of MIT, analyzing world oil production and consumption, also concluded that the basic fundamentals of supply and demand could not have been responsible for last year''s run-up in oil prices." What aload of rubbish. It is just an opinion piece. If the author of that report or you journalist knew anything they would undertand that the supply of refinable crude was less than demand for the first 6 months of 08 (any supply increases were in heavy crude that cannot be refined) and that inventories were decreasing. If it was speculation then inventories should increase...

[pavoldi]

My question after reading the quote below is this - What exactly is the difference between "the farmers" or "the airlines" and "me and my family"?

How is it that when I hedge my future fuel costs in the exact same way big industry players do, that I become an evil ''speculator'' or ''part of the problem'' that needs to be regulated, maybe even taken out of the game completely as if the banks I depend on to make this possible are somehow treasonous in their efforts?

Granted I don''t take delivery, but I am using meager gains now to offset the higher priced gas i will assuredly be buying next year.

"It was created so that farmers could gauge what their unharvested crops would be worth months in advance, so that factories could lock in the best price for raw materials, and airlines could manage their fuel costs..."

pavoldi(dot)com