Did Speculation Fuel Oil Price Swings?

(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.

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[thomasbihn]

This story needs to be revisited with the current spike in oil and gas prices.

[vincel]

OK so what the f*ck can we as citizens and especially Middle Class americans do about this. All we seem to do is wine and complain...Lets have someone step up...I will do it if I have to be I need help and resources...not money...but intellect. I am so tired of hearing the same thing, lets blame this and that...we complain about pro athlete salaries..but people still go..I do not..then they complain about how actors get paid too much..yet people still go to the movies or watch there shows..Here is my solution. Try not going to a Ball Game or go to the movies or go get gas...If we all do this in one day..People would be scrambling..if we do it 2 times a month...Well that will be interesting..Lets stop complaining and taking the bull by the horns and do something....TOGETHER as a Country....We can complain better then anyone. So lets put some People power together....Come on if friggen Egypt can do and Libya the most backward countries in the world do WHY THE F*CK CANT WE!!!!!!! LETS GO SOMEONE START AN OIL UPRISE..I AM SICK OF IT BUT I AM JUST AN AVERAGE GUY...HEY IF I HAD THE RESOURCES AND THE BACKING I would do it......Thats my Rant!!!!!

[MadAmerican]

Fuel prices, Bank Failures, Housing bubble bursts, Bank Bailouts, and then HUGE bonuses paid to executives for doing nothing, Huge numbers of job losses. George W. Bush DID NOT cause these things to happen.

These things happened because of GREED for more money by the ones that were involved and guess what THEY LIED to investigators and we the American People let them by with it!

Since i lost a good paying job due to gas prices, i have had change my way of living and that is what i have learned to attribute my situation to............. PLAIN OLE DOWN RIGHT GREED FOR MONEY by all of those things that i first listed.

YES OIL SPECULATION IN THE FUTURES MARKET DRIVES UP ALL FUEL COST!

[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