Byron Dorgan, oil speculators, and the supply question
Senator Byron Dorgan (D-ND) is pushing for tighter regulation on oil speculators:
Every day, 20 times more oil is traded than delivered. Because of the way energy trades are regulated (or not regulated), speculators control vast amounts of oil by putting down as little as 5% of the purchase cost.
In short, speculators use money they don't have to buy oil they'll never get. The market is treated like a 24-hour casino while the regulators are asleep.
Some say oil speculation isn't a problem, that it doesn't affect gas prices. But plenty of experts disagree. An international investment firm recently said, "We are seeing the classic ingredients of an asset bubble." They called it "oil dot-com." I agree.
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My legislation, called the "End Oil Speculation Act," would shut down casino-like betting. It does not affect legitimate hedging, but it would require energy speculators to put 25% down on their trades, instead of just 5%, and would convene an international group to ensure speculators can't go offshore to hide their trading.
On balance, I think this legislation is commendable; tighter margin requirements and CFTC oversight of free-wheeling offshore commodities exchanges are long overdue. This legislation could bring down oil prices temporarily; however, I'm not sure it will do much good over the long term.
With the US economy spiraling downward, big institutional investors have been putting money into commodities at a record pace; since 2003, institutions like insurance companies and pension funds have increased their investments in commodities from $15 billion to $260 billion. They've been hedging against the declining dollar and the looming prospect of recession by investing in oil, crops, precious metals, and foreign currencies like never before. Obviously, speculation has played some part in the recent escalation of oil prices, but so have the declining dollar (since global oil markets conduct all transactions in dollars, a weaker dollar automatically means higher oil prices), increasing demand in India and China, and the lack of spare production capacity worldwide.
I think raw speculation has contributed at least somewhat to the recent rapid escalation of oil prices, but I believe a more subtle effect may be at play here (although I have no hard data to back this up): I believe market makers in the oil bourses may be seeing the prospect of peak oil looming close at hand and are investing early. I think a lot of them are anticipating a decline in supplies over the next few years, and they've sort of jumped the gun on the supply/demand curve. Right now, supply can more or less meet demand, but after global production has peaked, that will no longer be the case.
The speculators may simply be acting as canaries in the financial coal mine, sending a message that they expect supplies to decline (and prices to skyrocket) in the near future.
Oil futures contracts generally require the purchaser of the contract to agree on a settlement date a certain number of months into the future; whether it's three, or six, or eighteen months, the buyer agrees to take delivery of that commodity at the expiration of the contract. In the current situation, that isn't necessarily the case:
Even analysts who concede the laws of supply and demand are the most significant say that speculation can make price swings more volatile - and that's what's going on now, they say.
"The fundamentals have been fairly firm, but speculation exacerbates the trends," said Tom Kloza, chief oil analyst with the Oil Price Information Service. "More and more money is going into buy-and-hold contracts that simply buy and roll into the next month."
If speculators simply buy and hold oil contracts, then they are not reflecting the current supply and demand.
This means that speculators are buying contracts and rolling them over, in anticipation of oil prices skyrocketing even further in the future.
The market isn't always right; I certainly don't buy into the idea of "perfect information" as a guiding market force. However, I think the big money is anticipating future oil prices that will make $140 a barrel look like a bargain.